Venture Capital: Investment Strategies, Structu...
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This reliable resource provides a comprehensive view of venture capital by describing the current state of research and best practices in this arena. Issues addressed include sources of capital-such as angel investment, corporate funds, and government funds-financial contracts and monitoring, and the efficiency implications of VC investment, to name a few.
Friends and family, angel investors, and venture capital funds are common types of investors in early-stage companies. However, each differ in their investor profile, the stage or funding round(s) in which they generally invest in companies, the structure of their investment, their level of involvement with the company, and the size or scale of their investments. More details on each of these differences are outlined below.
VC funds may syndicate together with other funds during a funding round. Because of regulatory requirements, most venture capital investments are structured as equity, such as preferred stock. VC investments have a long time horizon and are generally locked in until a liquidity event (such as an acquisition or initial public offering), when the VC fund and its investors hope to realize profits from their investment.
As long as venture capitalists are able to exit the company and industry before it tops out, they can reap extraordinary returns at relatively low risk. Astute venture capitalists operate in a secure niche where traditional, low-cost financing is unavailable. High rewards can be paid to successful management teams, and institutional investment will be available to provide liquidity in a relatively short period of time.
There are many variants of the basic deal structure, but whatever the specifics, the logic of the deal is always the same: to give investors in the venture capital fund both ample downside protection and a favorable position for additional investment if the company proves to be a winner.
These odds play out in venture capital portfolios: more than half the companies will at best return only the original investment and at worst be total losses. Given the portfolio approach and the deal structure VCs use, however, only 10% to 20% of the companies funded need to be real winners to achieve the targeted return rate of 25% to 30%. In fact, VC reputations are often built on one or two good investments.
The newest funding source for entrepreneurs are so-called angels, wealthy individuals who typically contribute seed capital, advice, and support for businesses in which they themselves are experienced. We estimate that they provide $20 billion to start-ups, a far greater amount than venture capitalists do. Turning to angels may be an excellent strategy, particularly for businesses in industries that are not currently in favor among the venture community. But for angels, these investments are a sideline, not a primary business.
The system described here works well for the players it serves: entrepreneurs, institutional investors, investment bankers, and the venture capitalists themselves. It also serves the supporting cast of lawyers, advisers, and accountants. Whether it meets the needs of the investing public is still an open question.
CVC, a subset of and different from traditional venture capital, is the investment of corporate funds directly into emerging companies. CVC programs allow companies to gain insight and access to new markets, trends, and technologies.
Entities engaging in capital raising activities need to understand the implications of the domicile of their investors. As part of their capital formation strategies, private equity and venture capital funds routinely raise significant capital from tax-exempt organizations and non-U.S. investors. Those funds must take special care to shield their tax-exempt and foreign investors from a large bill from the IRS when investing in companies subject to certain domestic tax structures.
Unlike evergreen private equity or real estate funds, there are rarely interim cash flows in venture capital between investment and exit. This can present distribution scenarios where there is nothing for a long period, followed by a huge exit that can instantly wash a waterfall down to its final step.
Venture capital (commonly abbreviated as VC) is a form of private equity financing that is provided by venture capital firms or funds to startups, early-stage, and emerging companies that have been deemed to have high growth potential or which have demonstrated high growth (in terms of number of employees, annual revenue, scale of operations, etc). Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an ownership stake. Venture capitalists take on the risk of financing risky start-ups in the hopes that some of the companies they support will become successful. Because startups face high uncertainty,[1] VC investments have high rates of failure. The start-ups are usually based on an innovative technology or business model and they are usually from high technology industries, such as information technology (IT), clean technology or biotechnology.
Typical venture capital investments occur 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 disposal of shares happening via a merger, via a sale to another entity such as a financial buyer in the private equity secondary market or via a sale to a trading company such as a competitor.
Only after 1945 did \"true\" venture capital investment firms begin to emerge, notably with the founding of American Research and Development Corporation (ARDC) and J.H. Whitney & Company in 1946.[4][5]
Georges Doriot, the \"father of venture capitalism\",[6] along with Ralph Flanders and Karl Compton (former president of MIT) 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. Unlike most present-day venture capital firms, ARDC was a publicly-traded company. ARDC's most successful investment was its 1957 funding of Digital Equipment Corporation (DEC), which would later be valued at more than $355 million after its initial public offering in 1968. This represented a return of over 1200 times its investment and an annualized rate of return of 101% to ARDC.[7]
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 financing of technology ventures. An early West Coast venture capital company was Draper and Johnson Investment Company, formed in 1962[14] 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.[15] Bill Draper and Paul Wythes were the founders, and Pitch Johnson formed Asset Management Company at that time.
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.[note 1]
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.[16] 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\"[note 2], thus allowing corporate pension funds to invest in the asset class and providing a major source of capital available to venture capitalists.
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.[17]
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.[17][18][19] 59ce067264
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