Venture Capital

Venture capital, or VC means a sort of private sector equity and a form of funding that is extended to the startup enterprises, as well as small entities, which have a long-run growth capacity. Venture capital, as a rule, is forthcoming from high-income investors, issuing houses, and other financial organizations. But the monetary means aren’t the only form of financing: technical and administrative experience is also provided. 

In fact, small firms with extraordinary upside potential, along with enterprises that are ready to broaden their market share, have the opportunity to source venture capital. Despite being risky, a prospective return for investments generally exceeds all expectations. As for recently established firms or enterprises with limited background (less than 2 years), venture capital mobilization seems to be attractive, particularly in case of not having access to capital markets, bank accommodation, or other debt facilities. 

Essence of Venture Capital

In the course of a venture capital settlement, there exists a formation of certain ownership interests that are further sold to several investors via limited partnerships. In some cases, they include a number of similar organizations. 

But there is one significant difference between venture capital and other private funds settlements. The first centers on startups looking for considerable monetary means for the first time, while the latter provides financing for larger enterprises that are willing to make an equity infusion, or a transfer of the ownership stakes by a firm's founders. 

Historical perspective of Venture Capital

Some believe that the first stage of venture business development was whaling in the 19th century. Mariners could be considered the first entrepreneurs, while the shipowners were the first venture capitalists.

Nevertheless, it is generally accepted that the first prototype of a venture fund was the American Research and Development Corporation (ARD), founded in 1946 in the United States. More than fifty years later, venture capital has become a well-established funding mechanism in a majority of developed countries. Despite this fact, the U.S. still accounts for almost half of all venture capital activity in the world.

The ARD was led by professor Georges Doriot, known as the "father of venture capital". The firm invested $70,000 in the life cycle of Digital Equipment Corporation (DEC). Within a decade, the DEC became one of the most successful companies in the minicomputer industry, and later was valued at $35.5 million, which was 507 times higher than the original investment. In this way, ARD has proven to the entire industry that venture capital funding can generate excessive returns for the investor.

Financial meltdown in 2008. The financial crisis manifested itself in the form of a strong drop in key economic indicators, even in most advanced economies, which subsequently escalated into a global recession. Notably, the decline in the venture capital market was accompanied by a significant reduction of venture capital funds and deals.

Enlargement to the west. Since the 2008 financial crisis, over 365 technology companies with a valuation of more than $1 billion have formed on the market and remained private. Despite providing finance from eastern and northern banks, venture capital, as a rule, has been accumulated in western direction. At the end of 2021, a record amount of monetary means was invested in the U.S. startups. The greatest demand among venture capitalists was for budding companies in the digital solutions. This is due to high market uptake for business software, e-commerce decision-making products and other enterprises.

Assistance from regulatory institutions. Several statutory regulations act as an impetus to the development of venture capital in the capacity of funding source. For instance, the SBIC guaranteed tax privileges for venture capitalists, while the ERISA presupposed investing the assets of pension funds to small and medium business. As a result, there was an outbreak of venture funding. 

Business angels

Business angels are private investors, i.e. wealthy individuals with high net worth, who, for various reasons, invest their spare cash and experience in startup ideas. Usually, they are also referred to as angel investors, extending venture capital to small and promising firms. 

As a rule, these individuals provide funding to a scope of enterprises, since most of them could fail, while only one may bring enough profit to cover all losses. Business angels invest part of their own wealth in innovative companies that are startups, supporting their further technical and commercial development. Instead of lending money like a bank (debt financing), they accommodate financial facilities, business connections, and expertise in exchange for an equity stake in a new enterprise. 

The contrast between angel investors and venture capitalists lies in fact that the latter present a group of professional funds providers. Alternatively, business angels are the well-offs who prefer investing as a pastime or an indirect result of their activities. 

Operating principle of the term

First, any enterprise seeking for venture capital is obliged to draft a business plan, which is further provided to the investor. In case of approval, market participants should carry out a due diligence that contemplates a full investigation of the firm and its activities. 

As long as venture investing presupposes more funding to the fewer spectrum of organizations, the aforesaid historical analysis is really significant. In fact, venture capitalists have experience in certain domains. So that they are more focused on a particular one rather than divert attention to several. 

After the investigation is completed, an enterprise or funds provider agrees to put up the money in return for a stake. These financial facilities can be allocated immediately or step by step. Therefore, the investor is at the forefront of all managerial processes. 

The average term of venture investment is 7-10 years. And there are few ways to exit a venture deal: 

1. Expect the enterprise to go public and sell shares on the stock exchange.
2. Wait for the company to be acquired by a strategic buyer.
3. Sell shares in a private over-the-counter transaction.

The latter option is difficult to implement, so venture investors usually play in the long run.

Real life examples

Venture capital is considered highly profitable and the most risky in the world. However, lots of companies attract monetary means through using it. 

There are a few recent high-profile stories that have generated billions of dollars for venture capitalists. For instance, Zoom video conferencing service. Zoom was founded in 2009 and today has 750,000 users. Its shares are publicly traded and have a capitalization of $24 billion.

Or let’s consider Airbnb private rental service. In fact, the same Uber, only for renting an apartment, and not for ordering a taxi. Airbnb was launched in 2008, and is now valued at $35 billion. This is one of the few venture projects that has a positive operating income. The enterprise's angel round valuation was $2.5 million back in the day. Currently, it has grown 14,000 times.

Venture Capital today

In 2021, venture capital investments worldwide hit a record $621 billion, doubling the last year figure. Silicon Valley ($105 billion) and New York ($55 billion) have retained their lead in terms of the number of investment rounds in the United States.

In addition, the top three American regions with the largest startup investments consist of Boston, which is largely facilitated by biotech projects, while New York should be primarily marked for fintech budding companies. 

Life aspects of Silicon Valley are not easy to replicate. It is still a center of gravity due to the large number of IT professionals, world-class research labs at top universities, and the physical location of some of the world's largest venture capitalists. 

If the US is still leading in terms of startup investments, then Asia ranks first in funding rounds with 12,485 deals registered in 2021. This figure corresponds to 36% of the total world number. More than half of transactions are conducted in China.