What is Risk Capital?

Sometimes referred to as speculative capital, risk capital is the money that is set aside for investing in financial opportunities that carry a higher degree of risk. Funds of this type may be used to invest in futures that have the potential to earn a high return over time. Risk capital may also be used to invest in new businesses that are about to launch, or existing businesses that are preparing to expand. The capital may also be used to invest in any type of real estate deal where there is some speculation that the property will rapidly increase in value within a short period of time.

One of the characteristics of risk capital is that the money can be lost without creating a great deal of financial hardship for the investor. For example, if an investor purchases a piece of property because there is speculation that developers will soon want the land for a new shopping mall, and this anticipated deal never materializes, the investor may not be able to sell the land and recover his or her original cost. If the investor was not counting on the resale of the land to provide capital for other obligations, then he or she can stand to incur the loss and still enjoy the same standard of living.

The same general concept applies when considering the possibility of becoming an angel investor with a new startup company. Essentially, angel investors contribute a certain amount of risk capital to help the business launch and sustain the operation until it can begin to turn a profit. If the business does reach that point, then the investor begins to realize a return on the investment. Should the business fail to build a viable customer base and ultimately folds, the investor may receive only a portion of that original investment, or possibly nothing at all. Since the funds invested were not needed for other obligations, the impact on the overall financial stability of the investor is minimal at best.

While an investor may be able to afford the loss of risk capital when a deal fails to turn a profit, the goal is always to earn some sort of return on the investment. For this reason, investors will look closely at the potential return associated with the investment opportunity. That potential return will be compared to the degree of risk that is associated with the investment. If the investor believes that the projected return is worth the degree of risk, and it is possible to manage all other obligations even after making the investment, there is a good chance that he or she will make the purchase. If the projected rate of return is not sufficient to justify the degree of risk, the investor is more likely to decline the deal and seek opportunities elsewhere.