A financing diagram illustrating how start-up companies are typically financed. First, the new firm seeks out "seed capital" and funding from "angel investors" and accelerators. Then, if the firm can survive through the "valley of death"–the period where the firm is trying to develop on a "shoestring" budget–the firm can seek venture capital financing.
Venture capital (VC) is a type of private equity, a form of financing that is provided by firms or funds to small, early-stage, emerging firms
that are deemed to have high growth potential, or which have
demonstrated high growth (in terms of number of employees, annual
revenue, or both). Venture capital firms or funds invest in these
early-stage companies in exchange for equity, or an ownership stake, in the companies they invest in. Venture capitalists take on the risk of financing risky start-ups in the hopes that some of the firms they support will become successful. Because startups face high uncertainty, VC investments do have high rates of failure. The start-ups are usually based on an innovative technology or business model and they are usually from the high technology industries, such as information technology (IT), clean technology or biotechnology.
The typical venture capital investment occurs after an initial "seed funding" round. The first round of institutional venture capital to fund growth is called the Series A round. Venture capitalists provide this financing in the interest of generating a return through an eventual "exit" event, such as the company selling shares to the public for the first time in an initial public offering (IPO) or doing a merger and acquisition (also known as a "trade sale") of the company. Alternatively, an exit may come about via the private equity secondary market.
In addition to angel investing, equity crowdfunding and other seed funding options, venture capital is attractive for new companies with limited operating history that are too small to raise capital in the public markets and have not reached the point where they are able to secure a bank loan or complete a debt offering. In exchange for the high risk
that venture capitalists assume by investing in smaller and early-stage
companies, venture capitalists usually get significant control over
company decisions, in addition to a significant portion of the
companies' ownership (and consequently value). Start-ups like Uber, Airbnb, Flipkart, Xiaomi & Didi Chuxing
are highly valued startups, commonly known as unicorns, where venture
capitalists contribute more than financing to these early-stage firms;
they also often provide strategic advice to the firm's executives on its
business model and marketing strategies.
Venture capital is also a way in which the private and public sectors can construct an institution that systematically creates business networks
for the new firms and industries, so that they can progress and
develop. This institution helps identify promising new firms and provide
them with finance, technical expertise, mentoring, marketing "know-how", and business models.
Once integrated into the business network, these firms are more likely
to succeed, as they become "nodes" in the search networks for designing
and building products in their domain.
However, venture capitalists' decisions are often biased, exhibiting
for instance overconfidence and illusion of control, much like
entrepreneurial decisions in general.
History
A
startup may be defined as a project prospective converted into a process
with an adequate assumed risk and investment. With few exceptions,
private equity in the first half of the 20th century was the domain of
wealthy individuals and families. The Wallenbergs, Vanderbilts,
Whitneys, Rockefellers, and Warburgs were notable investors in private
companies in the first half of the century. In 1938, Laurance S. Rockefeller helped finance the creation of both Eastern Air Lines and Douglas Aircraft, and the Rockefeller family had vast holdings in a variety of companies. Eric M. Warburg founded E.M. Warburg & Co. in 1938, which would ultimately become Warburg Pincus, with investments in both leveraged buyouts and venture capital. The Wallenberg family started Investor AB in 1916 in Sweden and were early investors in several Swedish companies such as ABB, Atlas Copco, Ericsson, etc. in the first half of the 20th century.
Origins of modern private equity
Before World War II
(1939–1945), money orders (originally known as "development capital")
remained primarily the domain of wealthy individuals and families. Only
after 1945 did "true" private equity investments begin to emerge,
notably with the founding of the first two venture capital firms in
1946: American Research and Development Corporation (ARDC) and J.H. Whitney & Company.
Georges Doriot, the "father of venture capitalism" (and former assistant dean of Harvard Business School), founded the graduate business school INSEAD in 1957. Along with Ralph Flanders and Karl Compton (former president of MIT), Doriot founded ARDC in 1946 to encourage private-sector investment in businesses
run by soldiers returning from World War II. ARDC became the first
institutional private-equity investment firm to raise capital from
sources other than wealthy families, although it had several notable
investment successes as well. ARDC is credited with the first trick when its 1957 investment of $70,000 in Digital Equipment Corporation
(DEC) would be valued at over $355 million after the company's initial
public offering in 1968 (representing a return of over 1200 times on its
investment and an annualized rate of return of 101%).
Former employees of ARDC went on to establish several prominent venture-capital firms including Greylock Partners
(founded in 1965 by Charlie Waite and Bill Elfers) and Morgan, Holland
Ventures, the predecessor of Flagship Ventures (founded in 1982 by James
Morgan). ARDC continued investing until 1971, when Doriot retired. In 1972 Doriot merged ARDC with Textron after having invested in over 150 companies.
John Hay Whitney (1904–1982) and his partner Benno Schmidt (1913–1999) founded J.H. Whitney & Company in 1946. Whitney had been investing since the 1930s, founding Pioneer Pictures in 1933 and acquiring a 15% interest in Technicolor Corporation with his cousin Cornelius Vanderbilt Whitney.
Florida Foods Corporation proved Whitney's most famous investment. The
company developed an innovative method for delivering nutrition to
American soldiers, later known as Minute Maid orange juice and was sold to The Coca-Cola Company in 1960. J.H. Whitney & Company continued to make investments in leveraged buyout transactions and raised $750 million for its sixth institutional private equity fund in 2005.
Early venture capital and the growth of Silicon Valley
A highway exit for Sand Hill Road in Menlo Park, California, where many Bay Area venture capital firms are based
One of the first steps toward a professionally managed venture capital industry was the passage of the Small Business Investment Act of 1958. The 1958 Act officially allowed the U.S. Small Business Administration
(SBA) to license private "Small Business Investment Companies" (SBICs)
to help the financing and management of the small entrepreneurial
businesses in the United States. The Small Business Investment Act of 1958 provided tax breaks that helped contribute to the rise of private equity firms.
During the 1950s, putting a venture capital deal together may
have required the help of two or three other organizations to complete
the transaction. It was a business that was growing very rapidly, and as
the business grew, the transactions grew exponentially.
During the 1960s and 1970s, venture capital firms focused their
investment activity primarily on starting and expanding companies. More
often than not, these companies were exploiting breakthroughs in
electronic, medical, or data-processing technology. As a result, venture
capital came to be almost synonymous with technology finance. An early
West Coast venture capital company was Draper and Johnson Investment
Company, formed in 1962 by William Henry Draper III and Franklin P. Johnson, Jr. In 1965, Sutter Hill Ventures
acquired the portfolio of Draper and Johnson as a founding action. Bill
Draper and Paul Wythes were the founders, and Pitch Johnson formed
Asset Management Company at that time.
It is commonly noted that the first venture-backed startup is Fairchild Semiconductor (which produced the first commercially practical integrated circuit), funded in 1959 by what would later become Venrock Associates. Venrock was founded in 1969 by Laurance S. Rockefeller, the fourth of John D. Rockefeller's six children, as a way to allow other Rockefeller children to develop exposure to venture capital investments.
It was also in the 1960s that the common form of private equity fund, still in use today, emerged. Private equity firms organized limited partnerships to hold investments in which the investment professionals served as general partner and the investors, who were passive limited partners,
put up the capital. The compensation structure, still in use today,
also emerged with limited partners paying an annual management fee of
1.0–2.5% and a carried interest typically representing up to 20% of the profits of the partnership.
The growth of the venture capital industry was fueled by the emergence of the independent investment firms on Sand Hill Road, beginning with Kleiner Perkins and Sequoia Capital in 1972. Located in Menlo Park, CA, Kleiner Perkins, Sequoia and later venture capital firms would have access to the many semiconductor companies based in the Santa Clara Valley as well as early computer firms using their devices and programming and service companies.
Throughout the 1970s, a group of private equity firms, focused
primarily on venture capital investments, would be founded that would
become the model for later leveraged buyout and venture capital
investment firms. In 1973, with the number of new venture capital firms
increasing, leading venture capitalists formed the National Venture
Capital Association (NVCA). The NVCA was to serve as the industry trade group for the venture capital industry.
Venture capital firms suffered a temporary downturn in 1974, when the
stock market crashed and investors were naturally wary of this new kind
of investment fund.
It was not until 1978 that venture capital experienced its first
major fundraising year, as the industry raised approximately $750
million. With the passage of the Employee Retirement Income Security Act (ERISA) in 1974, corporate pension funds were prohibited from holding certain risky investments including many investments in privately held companies. In 1978, the US Labor Department relaxed certain restrictions of the ERISA, under the "prudent man rule",
thus allowing corporate pension funds to invest in the asset class and
providing a major source of capital available to venture capitalists.
1980s
The public successes of the venture capital industry in the 1970s and early 1980s (e.g., Digital Equipment Corporation, Apple Inc., Genentech)
gave rise to a major proliferation of venture capital investment firms.
From just a few dozen firms at the start of the decade, there were over
650 firms by the end of the 1980s, each searching for the next major
"home run." The number of firms multiplied, and the capital managed by
these firms increased from $3 billion to $31 billion over the course of
the decade.
The growth of the industry was hampered by sharply declining
returns, and certain venture firms began posting losses for the first
time. In addition to the increased competition among firms, several
other factors affected returns. The market for initial public offerings
cooled in the mid-1980s before collapsing after the stock market crash
in 1987, and foreign corporations, particularly from Japan and Korea, flooded early-stage companies with capital.
In response to the changing conditions, corporations that had sponsored in-house venture investment arms, including General Electric and Paine Webber either sold off or closed these venture capital units. Additionally, venture capital units within Chemical Bank and Continental Illinois National Bank,
among others, began shifting their focus from funding early stage
companies toward investments in more mature companies. Even industry
founders J.H. Whitney & Company and Warburg Pincus began to transition toward leveraged buyouts and growth capital investments.
Venture capital boom and the Internet Bubble
By the end of the 1980s, venture capital returns were relatively low, particularly in comparison with their emerging leveraged buyout
cousins, due in part to the competition for hot startups, excess supply
of IPOs and the inexperience of many venture capital fund managers.
Growth in the venture capital industry remained limited throughout the
1980s and the first half of the 1990s, increasing from $3 billion in
1983 to just over $4 billion more than a decade later in 1994.
After a shakeout of venture capital managers, the more successful
firms retrenched, focusing increasingly on improving operations at
their portfolio companies rather than continuously making new
investments. Results would begin to turn very attractive, successful
and would ultimately generate the venture capital boom of the 1990s. Yale School of Management Professor Andrew Metrick
refers to these first 15 years of the modern venture capital industry
beginning in 1980 as the "pre-boom period" in anticipation of the boom
that would begin in 1995 and last through the bursting of the Internet bubble in 2000.
The late 1990s were a boom time for venture capital, as firms on Sand Hill Road in Menlo Park and Silicon Valley
benefited from a huge surge of interest in the nascent Internet and
other computer technologies. Initial public offerings of stock for
technology and other growth companies were in abundance, and venture
firms were reaping large returns.
Private equity crash
The technology-heavy NASDAQ Composite index peaked at 5,048 in March 2000 reflecting the high point of the dot-com bubble.
The Nasdaq
crash and technology slump that started in March 2000 shook virtually
the entire venture capital industry as valuations for startup technology
companies collapsed. Over the next two years, many venture firms had
been forced to write-off large proportions of their investments, and
many funds were significantly "under water"
(the values of the fund's investments were below the amount of capital
invested). Venture capital investors sought to reduce the size of
commitments they had made to venture capital funds, and, in numerous
instances, investors sought to unload existing commitments for cents on
the dollar in the secondary market. By mid-2003, the venture capital industry had shriveled to about half its 2001 capacity. Nevertheless, PricewaterhouseCoopers' MoneyTree Survey shows that total venture capital investments held steady at 2003 levels through the second quarter of 2005.
Although the post-boom years represent just a small fraction of
the peak levels of venture investment reached in 2000, they still
represent an increase over the levels of investment from 1980 through
1995. As a percentage of GDP, venture investment was 0.058% in 1994,
peaked at 1.087% (nearly 19 times the 1994 level) in 2000 and ranged
from 0.164% to 0.182% in 2003 and 2004. The revival of an Internet-driven
environment in 2004 through 2007 helped to revive the venture capital
environment. However, as a percentage of the overall private equity
market, venture capital has still not reached its mid-1990s level, let
alone its peak in 2000.
Venture capital funds, which were responsible for much of the fundraising volume in 2000 (the height of the dot-com bubble), raised only $25.1 billion in 2006, a 2% decline from 2005 and a significant decline from its peak.
Funding
Obtaining
venture capital is substantially different from raising debt or a loan.
Lenders have a legal right to interest on a loan and repayment of the
capital irrespective of the success or failure of a business. Venture
capital is invested in exchange for an equity stake in the business. The
return of the venture capitalist as a shareholder depends on the growth
and profitability of the business. This return is generally earned when
the venture capitalist "exits" by selling its shareholdings when the
business is sold to another owner.
Venture capitalists are typically very selective in deciding what
to invest in, with a Stanford survey of venture capitalists revealing
that 100 companies were considered for every company receiving
financing. Ventures receiving financing must demonstrate an excellent management
team, a large potential market, and most importantly high growth
potential, as only such opportunities are likely capable of providing
financial returns and a successful exit within the required time frame
(typically 3–7 years) that venture capitalists expect.
Because investments are illiquid and require the extended time frame to harvest, venture capitalists are expected to carry out detailed due diligence
prior to investment. Venture capitalists also are expected to nurture
the companies in which they invest, in order to increase the likelihood
of reaching an IPO stage when valuations are favourable. Venture capitalists typically assist at four stages in the company's development:
- Idea generation;
- Start-up;
- Ramp up; and
- Exit
Because there are no public exchanges listing their securities,
private companies meet venture capital firms and other private equity
investors in several ways, including warm referrals from the investors'
trusted sources and other business contacts; investor conferences and
symposia; and summits where companies pitch directly to investor groups
in face-to-face meetings, including a variant known as "Speed
Venturing", which is akin to speed-dating for capital, where the
investor decides within 10 minutes whether he wants a follow-up meeting.
In addition, some new private online networks are emerging to provide
additional opportunities for meeting investors.
This need for high returns makes venture funding an expensive
capital source for companies, and most suitable for businesses having
large up-front capital requirements,
which cannot be financed by cheaper alternatives such as debt. That is
most commonly the case for intangible assets such as software, and other
intellectual property, whose value is unproven. In turn, this explains
why venture capital is most prevalent in the fast-growing technology and life sciences or biotechnology fields.
If a company does have the qualities venture capitalists seek
including a solid business plan, a good management team, investment and
passion from the founders, a good potential to exit the investment
before the end of their funding cycle, and target minimum returns in
excess of 40% per year, it will find it easier to raise venture capital.
Financing stages
There are typically six stages of venture round financing offered in Venture Capital, that roughly correspond to these stages of a company's development.
- Seed funding: The earliest round of financing needed to prove a new idea, often provided by angel investors. Equity crowdfunding is also emerging as an option for seed funding.
- Start-up: Early stage firms that need funding for expenses associated with marketing and product development
- Growth (Series A round): Early sales and manufacturing funds. This is typically where VCs come in. Series A can be thought of as the first institutional round. Subsequent investment rounds are called Series B, Series C and so on. This is where most companies will have the most growth.
- Second-Round: Working capital for early stage companies that are selling product, but not yet turning a profit. This can also be called Series B round and so on.
- Expansion: Also called Mezzanine financing, this is expansion money for a newly profitable company
- Exit of venture capitalist: VCs can exit through secondary sale or an IPO or an acquisition. Early stage VCs may exit in later rounds when new investors (VCs or Private Equity investors) buy the shares of existing investors. Sometimes a company very close to an IPO may allow some VCs to exit and instead new investors may come in hoping to profit from the IPO.
- Bridge Financing is when a startup seeks funding in between full VC rounds. The objective is to raise smaller amount of money instead of a full round and usually the existing investors participate.
Between the first round and the fourth round, venture-backed companies may also seek to take venture debt.
Firms and funds
Venture capitalists
A
venture capitalist is a person who makes venture investments, and these
venture capitalists are expected to bring managerial and technical
expertise as well as capital to their investments. A venture capital
fund refers to a pooled investment vehicle (in the United States, often an LP or LLC) that primarily invests the financial capital of third-party investors in enterprises that are too risky for the standard capital markets or bank loans.
These funds are typically managed by a venture capital firm, which
often employs individuals with technology backgrounds (scientists,
researchers), business training and/or deep industry experience.
A core skill within VC is the ability to identify novel or
disruptive technologies that have the potential to generate high
commercial returns at an early stage. By definition, VCs also take a
role in managing entrepreneurial companies at an early stage, thus
adding skills as well as capital, thereby differentiating VC from
buy-out private equity, which typically invest in companies with proven
revenue, and thereby potentially realizing much higher rates of returns.
Inherent in realizing abnormally high rates of returns is the risk of
losing all of one's investment in a given startup company. As a
consequence, most venture capital investments are done in a pool format,
where several investors combine their investments into one large fund
that invests in many different startup companies. By investing in the
pool format, the investors are spreading out their risk to many
different investments instead of taking the chance of putting all of
their money in one start up firm.
Diagram of the structure of a generic venture capital fund
Structure
Venture capital firms are typically structured as partnerships, the general partners
of which serve as the managers of the firm and will serve as investment
advisors to the venture capital funds raised. Venture capital firms in
the United States may also be structured as limited liability companies, in which case the firm's managers are known as managing members. Investors in venture capital funds are known as limited partners.
This constituency comprises both high-net-worth individuals and
institutions with large amounts of available capital, such as state and
private pension funds, university financial endowments, foundations, insurance companies, and pooled investment vehicles, called funds of funds.
Types
Venture capitalist firms differ in their motivations and approaches. There are multiple factors, and each firm is different.
Venture capital funds are generally three in types:
1. Angel investors
2. Financial VCs
3. Strategic VCs.
Some of the factors that influence VC decisions include:
- Business situation: Some VCs tend to invest in new, disruptive ideas, or fledgling companies. Others prefer investing in established companies that need support to go public or grow.
- Some invest solely in certain industries.
- Some prefer operating locally while others will operate nationwide or even globally.
- VC expectations can often vary. Some may want a quicker public sale of the company or expect fast growth. The amount of help a VC provides can vary from one firm to the next.
Roles
Within the
venture capital industry, the general partners and other investment
professionals of the venture capital firm are often referred to as
"venture capitalists" or "VCs". Typical career backgrounds vary, but,
broadly speaking, venture capitalists come from either an operational or
a finance background. Venture capitalists with an operational
background (operating partner)
tend to be former founders or executives of companies similar to those
which the partnership finances or will have served as management
consultants. Venture capitalists with finance backgrounds tend to have investment banking or other corporate finance experience.
Although the titles are not entirely uniform from firm to firm, other positions at venture capital firms include:
| Position | Role |
|---|---|
| General Partners or GPs | They run the Venture Capital firm and make the investment decisions on behalf of the fund. GPs typically put in personal capital up to 1-2% of the VC Fund size to show their commitment to the LPs. |
| Venture partners | Venture partners are expected to source potential investment opportunities ("bring in deals") and typically are compensated only for those deals with which they are involved. |
| Principal | This is a mid-level investment professional position, and often considered a "partner-track" position. Principals will have been promoted from a senior associate position or who have commensurate experience in another field, such as investment banking, management consulting, or a market of particular interest to the strategy of the venture capital firm. |
| Associate | This is typically the most junior apprentice position within a venture capital firm. After a few successful years, an associate may move up to the "senior associate" position and potentially principal and beyond. Associates will often have worked for 1–2 years in another field, such as investment banking or management consulting. |
| Entrepreneur-in-residence | Entrepreneurs-in-residence (EIRs) are experts in a particular industry sector (e.g., biotechnology or social media) and perform due diligence on potential deals. EIRs are hired by venture capital firms temporarily (six to 18 months) and are expected to develop and pitch startup ideas to their host firm, although neither party is bound to work with each other. Some EIRs move on to executive positions within a portfolio company. |
Structure of the funds
Most venture capital funds
have a fixed life of 10 years, with the possibility of a few years of
extensions to allow for private companies still seeking liquidity. The
investing cycle for most funds is generally three to five years, after
which the focus is managing and making follow-on investments in an
existing portfolio. This model was pioneered by successful funds in Silicon Valley
through the 1980s to invest in technological trends broadly but only
during their period of ascendance, and to cut exposure to management and
marketing risks of any individual firm or its product.
In such a fund, the investors have a fixed commitment to the fund
that is initially unfunded and subsequently "called down" by the
venture capital fund over time as the fund makes its investments. There
are substantial penalties for a limited partner (or investor) that fails
to participate in a capital call.
It can take anywhere from a month or so to several years for
venture capitalists to raise money from limited partners for their fund.
At the time when all of the money has been raised, the fund is said to
be closed, and the 10-year lifetime begins. Some funds have partial
closes when one half (or some other amount) of the fund has been raised.
The vintage year generally refers to the year in which the fund was closed and may serve as a means to stratify VC funds for comparison.
From investors' point of view, funds can be: (1) traditional—where all the investors invest with equal terms; or (2) asymmetric—where
different investors have different terms. Typically the asymmetry is
seen in cases where there's an investor that has other interests such as
tax income in case of public investors.
Compensation
Venture capitalists are compensated through a combination of management fees and carried interest (often referred to as a "two and 20" arrangement):
| Payment | Implementation |
|---|---|
| Management fees | an annual payment made by the investors in the fund to the fund's manager to pay for the private equity firm's investment operations. In a typical venture capital fund, the general partners receive an annual management fee equal to up to 2% of the committed capital. |
| Carried interest | a share of the profits of the fund (typically 20%), paid to the private equity fund's management company as a performance incentive. The remaining 80% of the profits are paid to the fund's investors Strong limited partner interest in top-tier venture firms has led to a general trend toward terms more favorable to the venture partnership, and certain groups are able to command carried interest of 25–30% on their funds. |
Because a fund may run out of capital prior to the end of its life,
larger venture capital firms usually have several overlapping funds at
the same time; doing so lets the larger firm keep specialists in all
stages of the development of firms almost constantly engaged. Smaller
firms tend to thrive or fail with their initial industry contacts; by
the time the fund cashes out, an entirely new generation of technologies
and people is ascending, whom the general partners may not know well,
and so it is prudent to reassess and shift industries or personnel
rather than attempt to simply invest more in the industry or people the
partners already know.
Alternatives
Because of the strict requirements venture capitalists have for potential investments, many entrepreneurs seek seed funding from angel investors,
who may be more willing to invest in highly speculative opportunities,
or may have a prior relationship with the entrepreneur. Additionally,
entrepreneurs may seek alternative financing, such as revenue-based financing, to avoid giving up equity ownership in the business.
Furthermore, many venture capital firms will only seriously evaluate an investment in a start-up company
otherwise unknown to them if the company can prove at least some of its
claims about the technology and/or market potential for its product or
services. To achieve this, or even just to avoid the dilutive effects of
receiving funding before such claims are proven, many start-ups seek to
self-finance sweat equity until they reach a point where they can credibly approach outside capital providers such as venture capitalists or angel investors. This practice is called "bootstrapping".
Equity crowdfunding is emerging as an alternative to traditional venture capital. Traditional crowdfunding
is an approach to raising the capital required for a new project or
enterprise by appealing to large numbers of ordinary people for small
donations. While such an approach has long precedents in the sphere of
charity, it is receiving renewed attention from entrepreneurs, now that
social media and online communities make it possible to reach out to a
group of potentially interested supporters at very low cost. Some equity crowdfunding models are also being applied specifically for startup funding, such as those listed at Comparison of crowd funding services.
One of the reasons to look for alternatives to venture capital is the
problem of the traditional VC model. The traditional VCs are shifting
their focus to later-stage investments, and return on investment of many VC funds have been low or negative.
In Europe and India, Media for equity
is a partial alternative to venture capital funding. Media for equity
investors are able to supply start-ups with often significant
advertising campaigns in return for equity. In Europe, an investment
advisory firm offers young ventures the option to exchange equity for
services investment; their aim is to guide ventures through the
development stage to arrive at a significant funding, mergers and
acquisition, or other exit strategy.
In industries where assets can be securitized effectively because they reliably generate future revenue streams or have a good potential for resale in case of foreclosure,
businesses may more cheaply be able to raise debt to finance their
growth. Good examples would include asset-intensive extractive
industries such as mining, or manufacturing industries. Offshore funding
is provided via specialist venture capital trusts, which seek to use
securitization in structuring hybrid multi-market transactions via an
SPV (special purpose vehicle): a corporate entity that is designed solely for the purpose of the financing.
In addition to traditional venture capital and angel networks,
groups have emerged, which allow groups of small investors or
entrepreneurs themselves to compete in a privatized business plan
competition where the group itself serves as the investor through a
democratic process.
Law firms are also increasingly acting as an intermediary between clients seeking venture capital and the firms providing it.
Other forms include venture resources that seek to provide non-monetary support to launch a new venture.
Societal impact
Venture capital is also associated with job creation (accounting for 2% of US GDP), the knowledge economy, and used as a proxy measure of innovation
within an economic sector or geography. Every year, there are nearly 2
million businesses created in the US, and 600–800 get venture capital
funding. According to the National Venture Capital Association, 11% of
private sector jobs come from venture-backed companies and
venture-backed revenue accounts for 21% of US GDP.
Babson College's Diana Report found that the number of women partners in VC firms decreased from 10% in 1999 to 6% in 2014. The report also found that 97% of VC-funded businesses had male chief executives,
and that businesses with all-male teams were more than four times as
likely to receive VC funding compared to teams with at least one woman.
Currently, about 3 percent of all venture capital is going to woman-led
companies. More than 75% of VC firms in the US did not have any female
venture capitalists at the time they were surveyed. It was found that a greater fraction of VC firms had never had a woman represent them on the board of one of their portfolio companies. In 2017 only 2.2% of all VC funding went to female founders.
For comparison, a UC Davis study focusing on large public companies in California found 49.5% with at least one female board seat. When the latter results were published, some San Jose Mercury News readers dismissed the possibility that sexism was a cause. In a follow-up Newsweek article, Nina Burleigh asked "Where were all these offended people when women like Heidi Roizen published accounts of having a venture capitalist stick her hand in his pants under a table while a deal was being discussed?"
Geographical differences
Venture
capital, as an industry, originated in the United States, and American
firms have traditionally been the largest participants in venture deals
with the bulk of venture capital being deployed in American companies.
However, increasingly, non-US venture investment is growing, and the
number and size of non-US venture capitalists have been expanding.
Venture capital has been used as a tool for economic development
in a variety of developing regions. In many of these regions, with less
developed financial sectors, venture capital plays a role in
facilitating access to finance for small and medium enterprises (SMEs), which in most cases would not qualify for receiving bank loans.
In the year of 2008, while VC funding were still majorly
dominated by U.S. money ($28.8 billion invested in over 2550 deals in
2008), compared to international fund investments ($13.4 billion
invested elsewhere), there has been an average 5% growth in the venture
capital deals outside the US, mainly in China and Europe.
Geographical differences can be significant. For instance, in the UK,
4% of British investment goes to venture capital, compared to about 33%
in the U.S.
VC funding has been shown to be positively related to a country's individualistic culture.
United States
Quarterly U.S. Venture Capital Investments 1995-2017
Venture capital investment by area
Venture capital by state (2016)
Venture capitalists invested some $29.1 billion in 3,752 deals in the U.S. through the fourth quarter of 2011, according to a report by the National Venture Capital Association. The same numbers for all of 2010 were $23.4 billion in 3,496 deals.
According to a report by Dow Jones VentureSource, venture capital
funding fell to $6.4 billion in the US in the first quarter of 2013,
an 11.8% drop from the first quarter of 2012, and a 20.8% decline from
2011. Venture firms have added $4.2 billion into their funds this year,
down from $6.3 billion in the first quarter of 2013, but up from $2.6
billion in the fourth quarter of 2012.
Mexico
The
Venture Capital industry in Mexico is a fast-growing sector in the
country that, with the support of institutions and private funds, is
estimated to reach US$100 billion invested by 2018.
Israel
In Israel, high-tech entrepreneurship and venture capital have
flourished well beyond the country's relative size. As it has very
little natural resources and, historically has been forced to build its
economy on knowledge-based industries, its VC industry has rapidly
developed, and nowadays has about 70 active venture capital funds, of
which 14 international VCs with Israeli offices, and additional 220
international funds which actively invest in Israel. In addition, as of
2010, Israel led the world in venture capital invested per capita.
Israel attracted $170 per person compared to $75 in the USA. About two thirds of the funds invested were from foreign sources, and the rest domestic. In 2013, Wix.com joined 62 other Israeli firms on the Nasdaq.
Canada
Canadian
technology companies have attracted interest from the global venture
capital community partially as a result of generous tax incentive
through the Scientific Research and Experimental Development (SR&ED) investment tax credit program.
The basic incentive available to any Canadian corporation performing
R&D is a refundable tax credit that is equal to 20% of "qualifying"
R&D expenditures (labour, material, R&D contracts, and R&D
equipment). An enhanced 35% refundable tax credit of available to
certain (i.e. small) Canadian-controlled private corporations (CCPCs).
Because the CCPC rules require a minimum of 50% Canadian ownership in
the company performing R&D, foreign investors who would like to
benefit from the larger 35% tax credit must accept minority position in
the company, which might not be desirable. The SR&ED program does
not restrict the export of any technology or intellectual property that
may have been developed with the benefit of SR&ED tax incentives.
Canada also has a fairly unusual form of venture capital generation in its Labour Sponsored Venture Capital Corporations (LSVCC).
These funds, also known as Retail Venture Capital or Labour Sponsored
Investment Funds (LSIF), are generally sponsored by labor unions and
offer tax breaks
from government to encourage retail investors to purchase the funds.
Generally, these Retail Venture Capital funds only invest in companies
where the majority of employees are in Canada. However, innovative
structures have been developed to permit LSVCCs to direct in Canadian
subsidiaries of corporations incorporated in jurisdictions outside of
Canada.
Switzerland
Many Swiss start-ups are university spin-offs, in particular from its federal institutes of technology in Lausanne and Zurich.
According to a study by the London School of Economics analysing 130 ETH Zurich spin-offs over 10 years, about 90% of these start-ups survived the first five critical years, resulting in an average annual IRR of more than 43%.
Switzerland's most active early-stage investors are The Zurich Cantonal Bank, investiere.ch, Swiss Founders Fund, as well as a number of angel investor clubs.
Europe
Europe has a large and growing number of active venture firms. Capital raised in the region in 2005, including buy-out funds, exceeded €60 billion, of which €12.6 billion was specifically allocated to venture investment. Trade association Invest Europe has a list of active member firms and industry statistics.
European venture capital investments in 2015 increased by 5%
year-on-year to €3.8 billion, with 2,836 companies backed. The amount
invested increased across all stages led by seed investments with an
increase of 18%. Most capital was concentrated in life sciences (34%),
computer & consumer electronics (20%) and communications (19%)
sectors, according to Invest Europe's annual data.
In 2012, in France, according to a study by AFIC (the French Association of VC firms), €6.1B have been invested
through 1,548 deals (39% in new companies, 61% in new rounds) by firms
such as Partech Ventures or Innovacom.
A study published in early 2013 showed that contrary to popular
belief, European startups backed by venture capital do not perform worse
than US counterparts.
European venture-backed firms have an equal chance of listing on the
stock exchange, and a slightly lower chance of a "trade sale"
(acquisition by other company).
Leading early-stage venture capital investors in Europe include Mark Tluszcz of Mangrove Capital Partners and Danny Rimer of Index Ventures, both of whom were named on Forbes Magazine's Midas List of the world's top dealmakers in technology venture capital in 2007.
Poland
As of March 2019, there are 130 active VC firms in Poland
which have invested locally in over 750 companies, an average of 9
companies per portfolio. Since 2016, new legal institutions have been
established for entities implementing investments in enterprises in the
seed or startup phase. In 2018, venture capital funds invested €178M in
Polish startups (0.033% of GDP). As of March 2019, total assets managed
by VC companies operating in Poland are estimated at €2.6B. The total
value of investments of the Polish VC market is worth €209.2M.
Asia
India
is fast catching up with the West in the field of venture capital and a
number of venture capital funds have a presence in the country (IVCA). In 2006, the total amount of private equity and venture capital in India reached $7.5 billion across 299 deals.
In the Indian context, venture capital consists of investing in equity,
quasi-equity, or conditional loans in order to promote unlisted,
high-risk, or high-tech firms driven by technically or professionally
qualified entrepreneurs. It is also used to refer to investors
"providing seed", "start-up and first-stage financing",
or financing companies that have demonstrated extraordinary business
potential. Venture capital refers to capital investment; equity and debt
;both of which carry indubitable risk. The risk anticipated is very
high. The venture capital industry follows the concept of "high risk,
high return", innovative entrepreneurship, knowledge-based ideas and
human capital intensive enterprises have taken the front seat as venture
capitalists invest in risky finance to encourage innovation.
Vietnam
is experiencing its first foreign venture capitals, including IDG
Venture Vietnam ($100 million) and DFJ Vinacapital ($35 million).
Singapore
is widely recognized and featured as one of the hottest places to both
start up and invest, mainly due to its healthy ecosystem, its strategic
location and connectedness to foreign markets.
With 100 deals valued at US$3.5 billion, Singapore saw a record value
of PE and VC investments in 2016. The number of PE and VC investments
increased substantially over the last 5 years: In 2015, Singapore
recorded 81 investments with an aggregate value of US$2.2 billion while
in 2014 and 2013, PE and VC deal values came to US$2.4 billion and
US$0.9 billion respectively. With 53 percent, tech investments account
for the majority of deal volume. Moreover, Singapore is home to two of
South-East Asia's largest unicorns. Garena is reportedly the highest-valued unicorn in the region with a US$3.5 billion price tag, while Grab is the highest-funded, having raised a total of US$1.43 billion since its incorporation in 2012.
Start-ups and small businesses in Singapore receive support from policy
makers and the local government fosters the role VCs play to support
entrepreneurship in Singapore and the region. For instance, in 2016,
Singapore's National Research Foundation (NRF)
has given out grants up to around $30 million to four large local
enterprises for investments in startups in the city-state. This first
of its kind partnership NRF has entered into is designed to encourage
these enterprises to source for new technologies and innovative business
models.
Currently, the rules governing VC firms are being reviewed by the Monetary Authority of Singapore (MAS)
to make it easier to set up funds and increase funding opportunities
for start-ups. This mainly includes simplifying and shortening the
authorization process for new venture capital managers and to study
whether existing incentives that have attracted traditional asset
managers here will be suitable for the VC sector. A public consultation
on the proposals was held in January 2017 with changes expected to be
introduced by July.
Middle East and North Africa
The Middle East and North Africa (MENA) venture capital industry is an early stage of development but growing. The MENA Private Equity Association.
Guide to Venture Capital for entrepreneurs lists VC firms in the
region, and other resources available in the MENA VC ecosystem.
Diaspora organization TechWadi aims to give MENA companies access to VC investors based in the US.
Sub-Saharan Africa
The Southern African venture capital industry is developing. The
South African Government and Revenue Service is following the
international trend of using tax efficient vehicles to propel economic
growth and job creation through venture capital. Section 12 J of the Income Tax Act
was updated to include venture capital. Companies are allowed to use a
tax efficient structure similar to VCTs in the UK. Despite the above
structure, the government needs to adjust its regulation around intellectual property, exchange control and other legislation to ensure that Venture capital succeeds.
Currently, there are not many venture capital funds in operation
and it is a small community; however the number of venture funds are
steadily increasing with new incentives slowly coming in from
government. Funds are difficult to come by and due to the limited
funding, companies are more likely to receive funding if they can
demonstrate initial sales or traction and the potential for significant
growth. The majority of the venture capital in Sub-Saharan Africa is
centered on South Africa and Kenya.
Confidential information
Unlike public companies, information regarding an entrepreneur's business is typically confidential and proprietary. As part of the due diligence
process, most venture capitalists will require significant detail with
respect to a company's business plan. Entrepreneurs must remain
vigilant about sharing information with venture capitalists that are
investors in their competitors. Most venture capitalists treat
information confidentially, but as a matter of business practice, they
do not typically enter into Non Disclosure Agreements
because of the potential liability issues those agreements entail.
Entrepreneurs are typically well advised to protect truly proprietary
intellectual property.
Limited partners
of venture capital firms typically have access only to limited amounts
of information with respect to the individual portfolio companies in
which they are invested and are typically bound by confidentiality
provisions in the fund's limited partnership agreement.
Governmental regulations
There
are several strict guidelines regulating those that deal in venture
capital. Namely, they are not allowed to advertise or solicit business
in any form as per the U.S. Securities and Exchange Commission guidelines.
