ACCA Financial Management (F9) Certification Practice Exam

What risk does a venture capitalist take when investing in a startup?

1. The guarantee of a fixed return.

2. The potential for total loss of the investment.

3. The inability to convert shares into cash.

4. The restriction on future investments.

The correct answer is: The potential for total loss of the investment.

A venture capitalist faces a significant risk of total loss when investing in a startup due to the inherent uncertainties associated with early-stage companies. Startups often operate in competitive markets with unproven business models, which can result in failure to gain market traction or achieve profitability. As a result, the capital invested may not be recovered if the business collapses or underperforms. This risk is critical to understand in the context of venture capital, where investments are typically made in exchange for equity stakes. The expectation is that a few successful investments will yield substantial returns, but many may fail, leading to the total loss of that investment. This potential for loss underscores the importance of thorough due diligence and risk assessment by venture capitalists when selecting startups for investment. In contrast, the notion of a fixed return is not applicable since venture capital investments do not guarantee any returns, and the ability to convert shares into cash can often be problematic depending on the company's future performance and market conditions. While restrictions on future investments could be a concern, they are not as fundamentally defining of the risk associated with the initial venture capital investment as the potential for total loss.