What is Venture Capital?
Venture capital (VC), a form private equity, is financing that investors provide to startups businesses and small businesses with long-term potential. Venture capital is generally provided by well-off investors, banks and other financial institutions. Venture capital does not have to be in the form of monetary investment. It can also come in the form technical or managerial knowledge. Venture capital is usually allocated to small businesses with extraordinary growth potential or companies that have grown rapidly and seem poised for continued expansion.
Although it is risky for investors who invest in venture capital, there are attractive returns and a chance to make more than average. Venture capital is becoming increasingly popular for ventures with a short operating history (less than two years), especially if they don’t have access to capital market, bank loans or any other debt instruments. The downside is that investors often get equity and a voice in company decisions.
- Venture capital financing refers to funding that is provided to entrepreneurs and companies. Venture capital financing can be offered at any stage of a company’s development, but it is often early or seed round funding.
- Venture capital funds are open to accredited investors only and make pooled investments in high growth opportunities in startups and early-stage companies.
- Venture capital is no longer a niche activity that existed at the end the Second World War. It has become a highly developed industry with many players who play an important role in fostering innovation.
Histories of Venture Capital
Venture capital is a subset private equity. Venture capital was only established after the Second World War. However, the origins of PE can be traced back as far back as the 19th century.
Georges Doriot, a Harvard Business School professor, is widely considered to be the “Father” of Venture Capital. In 1946, he founded the American Research and Development Corporation (ARD), which raised $3.5 million to invest in companies that had commercialized technology developed during WWII. The first investment of ARDC was made in a company with ambitions to use xray technology in cancer treatment. Doriot’s initial investment of $200,000 turned into $1.8million when the company went public.
The 2008 Financial Crisis: What Happened?
The 2008 financial crisis was a blow to venture capital because institutional investors who had been a major source of funding, tightened their belts. A diverse group of players have been attracted to the industry by the emergence of unicorns (or startups valued at over a billion dollars). Notable private equity firms and sovereign funds have joined the ranks of investors looking for multiple returns in low-interest rates and participated in large-ticket deals. Their participation has led to changes in the venture capital ecosystem.
It was initially funded mainly by Northeast banks, but venture capital shifted to the West Coast as a result of the rise in the tech industry. Fairchild Semiconductor was founded by eight engineers (“the “traitorous 8”) from William Shockley’s Semiconductor Laboratory. It is widely considered to be the first company to receive VC funding. Sherman Fairchild, an east coast industrialist from Fairchild Camera & Instrument Corp, funded it.
Arthur Rock, an investment banker from Hayden, Stone & Co., New York City, was instrumental in facilitating the deal. He also founded one of Silicon Valley’s first VC firms. Arthur Rock, an investment banker at Hayden, Stone & Co. in New York City, helped facilitate the deal and later founded one of the first VC firms in Silicon Valley. 3
The situation is not changing much according to Pitchbook (NVCA) and National Venture Capital Association. According to Pitchbook and National Venture Capital Association (NVCA), the situation has not changed much.
However, the Midwest saw a lot of action in the first quarter 2021. The value of deals increased 265% in Denver, and 3311% in Chicago. While West Coast deals are decreasing, the San Francisco Bay Area is still the most important VC market with 630 deals valued at $25 billion
The 405 deals in venture capital in New York City during Q1 2021 accounted for 143% of total value. 5
Regulations for your assistance
Venture capital was further popularized by a series of regulatory innovations.
- First, a modification to the Small Business Investment Act (SBIC), in 1958. The Revenue Act provided tax breaks for investors, which helped to boost the venture capital sector. The Revenue Act was amended in 1978 to lower the capital gains tax from 49% down to 28%. 6
- 9 The capital gains tax was further reduced by 20% in 1981.
These three developments accelerated growth in venture capital. 10 Venture capitalists sought quick returns from high-value Internet companies. Some estimates suggest that funding levels reached $30 billion during this period. However, many publicly-listed Internet companies of high valuations went bust.
Venture capital is usually provided by high-net worth individuals (HNWIs), also known as ” Angel Investors” and venture capital firms. The National Venture Capital Association (NVCA), a group of hundreds of venture capital companies that provide funding for innovative businesses, is an organization.
Angel investors typically consist of a wide range of people who have amassed wealth from a variety sources. They are often entrepreneurs or have recently retired from their business empires.
Many key characteristics are shared by self-made investors who provide venture capital. Most investors are looking to invest in well-managed companies with a fully-developed plan and potential for significant growth. They may also offer funding for ventures in similar or related industries and business sectors. They might have received academic training in the field if they haven’t worked in it. A common practice among angel investors is Co-Investing. This involves one angel investor funding a venture with a trusted friend, associate, or other angel investor.
Venture Capital Process
Any business seeking venture capital should first submit a business plan to either a venture capital company or an angel investor. The investor or the firm must conduct due diligence to determine if the proposal is acceptable. This includes an in-depth investigation of the company’s product, management, and operational history.
Venture capital is known for investing in smaller companies and tends to be more expensive. This background research is crucial. Venture capital professionals often have prior investment experience as equity research analysts. Others have a Master in Business Administration degree. Venture capitalists tend to focus on one industry. For example, a venture capitalist who specializes in healthcare may have previously worked as an analyst in the healthcare industry.
After due diligence is completed, the investor or firm will make a pledge to invest capital in return for equity in the company. The funds can be given in one lump sum, or more often in smaller amounts. The investor or firm then becomes active in the company and advises and monitors its progress, before releasing additional funds.
After a certain period, usually four to six years, the investor leaves the company by initiating a acquisition or initial public offer (IPO).
Day in the VC Life
As with most professionals in finance, venture capitalists start their day with a copy of the Wall Street Journal and the Financial Times. This information is often consumed daily along with breakfast.
The majority of the day for venture capital professionals is spent in meetings. The meetings include a variety of participants including partners and/or members from his or her venture capital company, executives from an existing portfolio firm, contacts in the field of specialty and budding entrepreneurs looking for venture capital.
An example of this is a discussion at an early morning meeting where potential portfolio investment options are discussed. The company’s due diligence team will discuss the pros and cons of investing. A vote on whether to add the company or not may be held the next day.
A portfolio company may arrange for a meeting with the current client. These meetings are held on a regular basis to assess the company’s performance and determine if the venture capital firm has been wise in its investment. The venture capitalist will take evaluative notes and circulate the results amongst the other members of the company.
After spending the afternoon reviewing market news and writing that report, it may be time for a dinner meeting with budding entrepreneurs looking to raise capital. Venture capital professionals get a feel for the potential of the emerging company and decide if further meetings are necessary.
When the venture capitalist leaves the dinner meeting, they might take with them the due diligence reports on the company. This will allow them to have a final look at all the important facts and figures before heading home.
Trends in Venture Capital
Venture capital funding was originally intended to help start an industry. Georges Doriot was committed to actively contributing to the success of the startup. He offered advice, funding, and connections for entrepreneurs.
In 1958, the SBIC Act was amended to allow novice investors to invest in startups and small businesses. An amendment to the SBIC Act in 1958 led to more novice investors in small businesses and startups.
Silicon Valley’s growth
Because the industry is close to Silicon Valley, most deals funded by venture capitalists are in technology industries, such as healthcare, internet and mobile telecommunications. Venture capital funding has also been beneficial to other industries. Staples, Starbucks and others are two notable examples of venture capital.
Venture capital is no longer reserved for elite companies. Venture capital is not only for elite companies. Established businesses and institutional investors have also joined the fray. Institutional investors and established companies have also joined the fray.
Venture capital has grown over the years due to an increase in deal sizes and the inclusion of more institutional investors. Venture capital now has a variety of investors and players who invest at different stages of a startup’s development, depending on their risk appetite.
Venture Capital: Why is it Important?
Entrepreneurship and innovation are key ingredients of a capitalist economy. However, new businesses are often risky and costly ventures. External capital is often needed to spread the risk of failure. Investors in new companies can get voting rights and equity for cents per dollar for taking on this risk by investing. Venture capital allows founders and startups to succeed.