Venture capital

Venture capital is capital provided by outside sources for financing of new, growing or struggling businesses. A venture capitalist (VC) is a person who makes such investments. A venture capital fund is a pooled investment vehicle (often a partnership) that primarily invests the financial capital of third-party investors in enterprises that are too risky for the standard capital markets or bank loans. A limited partner is a person or organization who invests capital in a venture capital fund for financial gain. A general partner is a venture capitalist who manages the fund and makes investments. Venture capital investments generally are high risk investments but offer the potential for above average returns. Investments by a venture capital fund can take the form of either equity participation or a combination of equity participation (typically with preferred stock) and debt obligation—often with convertible debt instruments that become equity if a certain level of risk is exceeded. In most cases, the venture capitalist becomes part owner or a member of the Board of Directors of the new venture. Most investments are structured as preferred shares—the common stock often reserved by covenant for a future buyout, as VC investment criteria usually include a planned exit event (an IPO or acquisition), normally within three to seven years. In case a venture fails, then the entire funding by the venture capitalist has to be written off.

History

The first venture-backed startup is generally considered to be Fairchild Semiconductor, funded in 1959 by Venrock Associates. Before World War II, venture capital investments were primarily the domain of wealthy individuals and families. 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 authorized the U.S. Small Business Administration (SBA) to license private "Small Business Investment Companies" (SBICs) to provide financing and management assistance to small entrepreneurial businesses in the United States. Passage of the Act addressed concerns raised in a Federal Reserve Board report to Congress that concluded that a major gap existed in the capital markets for long-term funding for growth-oriented small businesses. The goal of the SBIC program was, and still is, to stimulate the U.S. economy in general, and small businesses in particular, by facilitating the flow of capital to "pioneering" small concerns.

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Venture capital is a phenomenon most closely associated with the United States and technologically innovative ventures. Due to structural restrictions imposed on American banks in the 1930s there was no private investment banking industry in the United States, a situation that was quite unique in developed nations. As late as the 1980s Lester Thurow, a noted economist, decried the inability of the USA's financial regulation framework to support any investment bank other than one that is run by the United States Congress in the form of federally-funded projects. These, he argued, were massive in scale, but also politically motivated—too focused on defense, housing and such specialized technologies as space exploration, agriculture, aerospace.

Related Topics:
United States - 1930s - Investment bank - Developed nation - 1980s - Lester Thurow - Economist - United States Congress - Defense - Housing - Space exploration - Agriculture - Aerospace

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Investment banks were confined in general to large merger and acquisition activity, the issue of so-called "junk bonds", and, often, the breakup of industrial concerns to access their pension fund surplus or sell off infrastructural capital for big gains.

Related Topics:
Junk bond - Pension fund - Infrastructural capital

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Not only was the lax regulation of this situation very heavily criticized at the time, this industrial policy was not in line with that of other industrialized rivals—notably Germany and Japan which at that time were gaining world markets in automotive and consumer electronics. There was a general feeling that the United States was in an economic decline.

Related Topics:
Industrial policy - Germany - Japan - Automotive - Consumer electronic

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However, those nations were also becoming somewhat more dependent on central bank and elite academic judgement, rather than the more populist and consumerist way that priorities were set by government and private investors in the United States—a model that proved to have some advantages when the public's greed was strongly activated by the IPO of Netscape and other Internet-related firms. This highlighted the nearly invisible role that Silicon Valley had played in the sustaining of American economic innovation.

Related Topics:
Central bank - Greed - Netscape - Silicon Valley

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Due almost entirely to this dotcom boom, the late 1990s were a boom time for the globally-renowned VC firms on Sand Hill Road in the San Francisco, California area. IPOs were taking truly irrational leaps, and access to "friends and family" shares was becoming a major determiner of who would benefit from any such IPO—the ordinary investor rarely got a chance to invest at the strike price in this period.

Related Topics:
Dotcom boom - 1990s - Sand Hill Road - San Francisco, California - IPO - Strike price

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The NASDAQ crash and technology slump that started in March 2000, and the resulting catastrophic losses on overvalued, non-performing startups, has shaken VC funds deeply. In 2003, many VCs were focused on writing off companies they funded just a few years ago. At the same time, venture capital investors are seeking to reduce the large commitments they have made to venture capital funds. As of mid-2003, the conventional wisdom is that the venture capital industry will shrink to about half its present capacity in the next few years.

Related Topics:
NASDAQ - 2000 - Startup - 2003

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Meanwhile, investment banks of the more conventional sort have emerged due to some loosening of US financial regulations and the establishment of US bases for the largest global investment banks. It seems that the US model and the prevailing big investment bank model from the rest of the developed world have more or less merged. Given that almost all ventures ultimately merge, a more appropriate ending is hard to imagine.

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US firms have traditionally been the biggest participants in venture deals, but non-US venture investment is growing. The Indian Venture Capital Association estimates funding of Indian companies will reach $1 billion in 2004.http://in.news.yahoo.com/040224/137/2bn25.html In China, venture funding more than doubled from $420 million in 2002 to almost $1 billion in 2003. For the first half of 2004, venture capital investment rose 32% from 2003.

Related Topics:
Indian Venture Capital Association - India

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