2.1 Definition and history of venture capital
4 min read•august 9, 2024
revolutionized startup funding in the mid-20th century. Pioneered by , it evolved from government initiatives to independent firms, focusing on high-risk, high-return investments in tech and healthcare sectors.
The industry's structure involves limited partners providing capital and general partners managing funds. Key periods include Silicon Valley's rise as a VC hub and the , shaping modern investment strategies and practices.
Origins and Early History
Emergence of Modern Venture Capital
Top images from around the web for Emergence of Modern Venture Capital
File:Venture Capital Fund Diagram.png - Wikipedia View original
Is this image relevant?
Georges Doriot - Wikipedia View original
Is this image relevant?
Digital Equipment Corporation PDP 11-34, National Museum o… | Flickr View original
Is this image relevant?
File:Venture Capital Fund Diagram.png - Wikipedia View original
Is this image relevant?
Georges Doriot - Wikipedia View original
Is this image relevant?
1 of 3
Top images from around the web for Emergence of Modern Venture Capital
File:Venture Capital Fund Diagram.png - Wikipedia View original
Is this image relevant?
Georges Doriot - Wikipedia View original
Is this image relevant?
Digital Equipment Corporation PDP 11-34, National Museum o… | Flickr View original
Is this image relevant?
File:Venture Capital Fund Diagram.png - Wikipedia View original
Is this image relevant?
Georges Doriot - Wikipedia View original
Is this image relevant?
1 of 3
- Venture capital emerged as a formalized investment practice in the mid-20th century
- Georges Doriot pioneered the concept of venture capital in the 1940s
- Known as the "Father of Venture Capital"
- French-born American entrepreneur and Harvard Business School professor
- Recognized the need for long-term capital investment in emerging companies
- (ARDC) founded in 1946
- First publicly owned venture capital firm
- Established by Doriot along with Ralph Flanders and Karl Compton
- Aimed to commercialize technologies developed during World War II
- ARDC's most successful investment included (DEC)
- 355 million by 1968
- Demonstrated the potential for high returns in venture capital investments
Evolution of Early Venture Capital Practices
- Post-ARDC, venture capital firms began to adopt structures
- of 1958 encouraged private investment in small businesses
- Allowed the formation of (SBICs)
- SBICs received government funding to invest in small enterprises
- 1960s and 1970s saw the rise of independent venture capital firms
- Focused on technology and healthcare sectors
- Began to develop more sophisticated investment strategies and practices
Investment Characteristics
High-Risk, High-Return Nature
- Venture capital investments target startups and early-stage companies
- Companies often have limited operating history
- Unproven business models or technologies
- High failure rate among venture-backed companies
- Typically, only 1 in 10 investments generates significant returns
- Potential for exponential returns on successful investments
- Known as "home runs" or "unicorns" in the industry
- Venture capitalists aim for a portfolio approach to manage risk
- Invest in multiple companies to spread risk
- Expect a few highly successful investments to offset losses from failures
Startup Funding Stages and Processes
- provides initial capital for product development and market research
- Often ranges from 2 million
- Series A funding supports early growth and product-market fit
- Typically ranges from 15 million
- Series B and beyond focus on scaling operations and market expansion
- Can range from 100+ million
- Venture capitalists often provide non-financial support
- Strategic guidance and mentorship
- Access to networks and industry connections
- Assistance with recruitment and operational challenges
Key Players
Limited Partners: The Capital Providers
- Institutional investors form the majority of limited partners
- Pension funds, endowments, and foundations
- High-net-worth individuals and family offices
- Commit capital to venture capital funds
- Typically invest for 7-10 year fund lifecycles
- Do not participate in day-to-day operations or investment decisions
- Receive returns through and
- Carried interest: Share of profits (typically 20%) after return of capital
- Management fees: Annual fee (usually 2%) on committed capital
General Partners: The Fund Managers
- Experienced professionals who manage venture capital firms
- Often have backgrounds in entrepreneurship, finance, or technology
- Responsible for fundraising, deal sourcing, and investment decisions
- Conduct due diligence on potential investments
- Negotiate deal terms and valuations
- Provide ongoing support and guidance to portfolio companies
- Often take board seats in invested companies
- Assist with strategic planning and subsequent funding rounds
- Compensated through management fees and carried interest
- Align interests with limited partners through personal investment in the fund
Notable Periods
Rise of Silicon Valley as a Venture Capital Hub
- Silicon Valley emerged as the epicenter of venture capital in the 1970s and 1980s
- Concentration of technology companies and research institutions
- Stanford University played a crucial role in fostering innovation
- Pioneering venture capital firms established in the region
- founded in 1972
- founded in 1972
- Success stories fueled the growth of the venture capital ecosystem
- Apple Computer (1976)
- Genentech (1976)
- Cisco Systems (1984)
Dot-com Boom and Its Impact on Venture Capital
- Period of excessive speculation and investment in internet-based companies (1995-2000)
- Rapid growth in venture capital funding and valuations
- Emergence of numerous startups with unproven business models
- Notable investments during this period
- Amazon (1994)
- Google (1998)
- PayPal (1998)
- Dot-com bubble burst in 2000-2001
- Significant losses for many venture capital firms
- Led to more cautious investment approaches and stricter due diligence
- Long-term impact on the venture capital industry
- Increased focus on sustainable business models and profitability
- Shift towards mobile and cloud technologies in the following decade
Key Terms to Review (25)
American Research and Development Corporation: The American Research and Development Corporation (ARDC) is one of the earliest venture capital firms in the United States, established in 1946. It played a pivotal role in shaping the venture capital industry by investing in and nurturing innovative companies, most notably in the technology sector, which helped to lay the groundwork for modern venture financing.
Andreessen Horowitz: Andreessen Horowitz is a prominent venture capital firm founded in 2009 by Marc Andreessen and Ben Horowitz. It has become known for its unique approach to investing in technology startups, providing not just capital but also extensive support through a large network of resources and expertise, which has significantly influenced the landscape of venture capital and startup culture.
Carried Interest: Carried interest refers to the share of profits that general partners (GPs) of private equity and venture capital funds receive as compensation, which is typically a percentage of the fund's profits after returning capital to limited partners (LPs). This mechanism aligns the interests of GPs and LPs by incentivizing GPs to maximize the fund's performance, creating a potential for substantial earnings that reflect their success in managing the investments.
Digital Equipment Corporation: Digital Equipment Corporation (DEC) was a pioneering American company in the computer industry, founded in 1957, that specialized in manufacturing computers, particularly in the realm of minicomputers. DEC played a significant role in the development and commercialization of computer technology, contributing to the rise of the computer age and the venture capital ecosystem by attracting investment for innovation in computing.
Dot-com boom: The dot-com boom refers to a period in the late 1990s and early 2000s characterized by a rapid rise in the stock prices of internet-based companies. This surge was fueled by widespread internet adoption and significant venture capital investments, leading to an unprecedented number of startups and initial public offerings (IPOs). The boom culminated in a market bubble that ultimately burst in 2000, resulting in significant financial losses and the collapse of many tech companies.
Exit Strategy: An exit strategy is a planned approach that investors and business owners use to divest from their investment in a company, typically to maximize returns and minimize risks. This strategy is crucial for venture capitalists and private equity firms, as it outlines how they intend to realize the value of their investments, often through methods such as selling the business, merging with another company, or taking it public.
General Partner: A general partner is an individual or entity in a partnership who has unlimited liability and is responsible for the management of the partnership's operations and decisions. This role is crucial in venture capital and private equity as they lead fund management, make investment decisions, and engage with limited partners to secure funding and provide updates on fund performance.
Georges Doriot: Georges Doriot was a pioneering figure in the field of venture capital, often referred to as the 'father of venture capital.' He was instrumental in shaping the industry by establishing the first formal venture capital firm, American Research and Development Corporation (ARDC), in 1946. His vision helped to transform entrepreneurial financing, bridging the gap between innovative ideas and the necessary funding for startup companies, which ultimately laid the groundwork for the modern venture capital landscape.
Internal Rate of Return: The Internal Rate of Return (IRR) is a financial metric used to evaluate the profitability of an investment, representing the discount rate at which the net present value (NPV) of cash flows from the investment equals zero. It serves as a crucial indicator in assessing potential investments in venture capital and private equity, guiding decision-makers on the expected returns relative to risks and costs.
Kleiner Perkins: Kleiner Perkins is a prominent venture capital firm based in Silicon Valley that specializes in investing in early-stage and growth-stage technology companies. Established in 1972 by Eugene Kleiner and Tom Perkins, the firm has played a pivotal role in the development of the venture capital landscape, particularly in technology sectors such as software, biotechnology, and clean energy. Its long history and notable investments have made it one of the leading players in the venture capital industry.
Limited Partnership: A limited partnership is a business structure consisting of at least one general partner, who manages the business and has unlimited liability, and one or more limited partners, who contribute capital and have limited liability based on their investment. This structure is crucial in venture capital and private equity as it enables the pooling of funds while protecting limited partners from personal liability beyond their initial investment.
Management Fees: Management fees are the charges that venture capital and private equity funds impose on their investors to cover operational expenses and compensate the fund managers for their services. These fees are typically calculated as a percentage of the committed capital and are a critical aspect of fund economics, influencing both fund performance and investor returns.
Market Trends: Market trends refer to the general direction in which a market is moving over time, encompassing the changes in consumer preferences, technological advancements, and economic conditions. Understanding these trends helps investors identify potential opportunities and risks, shaping their decisions in venture capital and private equity. By analyzing market trends, investors can evaluate the potential for growth and profitability in various sectors, making it a crucial aspect of both historical context and due diligence processes.
Portfolio Diversification: Portfolio diversification is the investment strategy of spreading assets across various financial instruments, industries, and other categories to minimize risk. By diversifying a portfolio, investors aim to reduce the impact of poor performance in any single investment or sector on the overall portfolio's performance. This strategy is particularly important in alternative investments and venture capital, where individual asset classes can be highly volatile and risky.
Post-wwii funding: Post-WWII funding refers to the financial support mechanisms established after World War II aimed at rebuilding economies and fostering innovation, particularly in the United States. This period saw significant growth in venture capital as private investors began to finance startups and emerging technologies that could drive economic recovery and growth. It was during this time that the foundations for modern venture capital were laid, with government initiatives and private investments aligning to stimulate entrepreneurial activity.
Return on Investment: Return on Investment (ROI) is a financial metric used to evaluate the profitability of an investment, calculated by dividing the net profit of the investment by its initial cost. This measurement helps investors assess the efficiency of their investments and compare different ventures, particularly in the context of venture capital, where determining the potential returns on startup investments is crucial for decision-making. In the history of venture capital, ROI has been a fundamental concept as it drives funding strategies and influences the overall success of venture-backed companies.
SEC Regulations: SEC regulations refer to the rules and laws established by the U.S. Securities and Exchange Commission (SEC) to govern the securities industry and protect investors. These regulations ensure transparency, fairness, and efficiency in the financial markets, impacting everything from venture capital funding to mergers and acquisitions. They play a crucial role in setting the standards for disclosures, reporting, and compliance that companies must follow during various financial transactions, which is vital for maintaining investor confidence and market integrity.
Seed funding: Seed funding is the initial capital used to start a business, typically provided by angel investors, venture capitalists, or crowdfunding sources. This early investment is crucial for startups as it helps them develop their product or service, conduct market research, and establish their business infrastructure before seeking larger rounds of financing.
Sequoia Capital: Sequoia Capital is a prominent venture capital firm that specializes in investing in early-stage and growth-stage technology companies. Founded in 1972, it has played a critical role in shaping the venture capital landscape and is known for backing some of the most successful startups in history. The firm's strategic focus and strong network have made it a key player in identifying and nurturing innovative businesses, particularly in Silicon Valley.
Series A Financing: Series A financing is a critical stage of investment in a startup's growth, where early-stage investors provide funding to help the company scale its operations after initial seed funding. This type of financing typically involves venture capital firms and serves as the foundation for subsequent rounds of funding. It often focuses on building a strong business model and user base, allowing startups to gain traction in their market.
Series B Financing: Series B financing is a stage of funding that occurs after a startup has successfully completed its initial round of financing (Series A) and seeks additional capital to scale operations, develop products further, and expand market reach. This phase typically involves larger investments from venture capital firms or institutional investors, reflecting the company's growth potential and market traction. Series B funding often supports significant scaling efforts, such as hiring new talent, increasing production capacity, or entering new markets.
Silicon Valley Emergence: Silicon Valley Emergence refers to the development of Silicon Valley as a global center for technology and innovation, primarily from the mid-20th century onwards. It highlights the convergence of academia, entrepreneurship, and venture capital that created a fertile environment for startups and tech companies to flourish. This unique ecosystem has significantly influenced the growth of venture capital, shaping investment strategies and the overall landscape of technology-driven businesses.
Small Business Investment Act: The Small Business Investment Act is a federal law enacted in 1958 that was designed to encourage the growth of small businesses by facilitating access to capital through private investment. This act established the Small Business Investment Company (SBIC) program, which allows private investors to invest in small businesses while providing them with financial leverage through government-backed loans. This framework not only supports entrepreneurs but also helps foster innovation and job creation across the economy.
Small Business Investment Companies: Small Business Investment Companies (SBICs) are private investment firms that are licensed and regulated by the Small Business Administration (SBA) to provide financing to small businesses in the form of equity, debt, or a combination of both. They were established to stimulate the growth of small businesses by providing them with access to capital that may not be available through traditional funding sources.
Venture Capital: Venture capital refers to a form of private equity financing that provides funding to startups and small businesses with long-term growth potential. This investment often comes from venture capital firms that manage pooled funds from various investors, focusing on high-risk, high-reward opportunities in emerging industries. Through this capital, startups can innovate and expand, while investors aim for substantial returns as these companies grow and potentially go public or get acquired.