When investing in venture capital, always keep one thing in perspective. All investments have equal risk, and the average cost of capital for the firm can be used for evaluating investment proposals. Investment proposals differ in risk. An investment proposal to manufacture a new product, for example, is likely to be more risky than one involving replacement of an existing plant. In view of such differences, variations in risk need to be considered in venture capital investment appraisal.

In many cases, the revenues expected from a project are conservatively estimated to ensure that the viability of the proposed project is not easily threatened by unfavorable circumstances. The capital budgeting systems often have built-in devices for conservative estimation.

A margin of safety in venture capital investing is generally included in estimating cost figures. This varies between 10 and 30 per cent of what is deemed as normal cost. The size of the margin depends on how management feels about the likely variation in cost. The cut- off point on an investment varies according to the judgment of management on how risky the project might be. In one company, replacement investments are okayed if the expected post-tax return exceeds 15 per cent but new investments are undertaken only if the expected post-tax return is greater than 20 per cent. Another company employs a short payback period of three years for new investments. Its finance controller stated this rule as follows:

Our policy is to accept a new project only if it has a payback period of three years. We have never, as far as I know, deviated from this. The use of a short payback period automatically weeds out risky projects. Some companies calculate what may be called the overall certainty index, based on a few crucial factors affecting the success of the project.