Venture Capital

Chris Jackson, MGT 386, December 5, 2008

Venture Financing basics provide that venture capital financing is done to provide capital to companies that have started to do business. This type of financing is done primarily by rich investors as well as financial organizations such as investment banks (Basics of Venture Capital Financing, http://finance.mapsofworld.com/equity/basics-of-venture-capital.html). During this process the investor’s only concern is to see some type of return on their investment. As discussed in class, a well developed business plan or a convincing elevator pitch can give these potential investors the ability to interpret what type of business you may be pursuing and how you plan to make it work. Most of all they want to know how you can give them a substantial return on their investment. They will do so by receiving dividends and some ownership in hopes that the company will one day have an Initial Public Offering (IPO), which will benefit everyone that either put time or money into that developing company.
As for the size and scope of the venture capital industry in the United States, “it is enormous,” (The Practical Lawyer, http://files.ali-aba.org/thumbs/datastorage/lacidoirep/articles/PL_TPL0702-Tannenbaum_thumb.pdf). In 2005, there were 2,200 reported venture capital transactions at an estimate of close to $20 billion in volume. That number grew in 2006, increasing to an annualized rate of $22 billion of total venture capital transactions. This may only be miniscule when compared to the entire economy in the United States at that time, but has been a booming industry that has continued to increase in volume until recently when our economy went under somewhat of a mini-recession. The Practical Lawyer also states that, “Venture Capital in the United States, however, is more than just another source of capital. It constitutes and industry, a culture, and a mystique that is uniquely American.” As of 2006, there were approximately 798 venture capital firms in the United States, and these firms managed about $236 billion (National Venture Capital Association, http://www.nvca.org/faqs.html).
According to recent studies, “the failure rate can be quite high, and in fact, anywhere from 20 to 90 percent of portfolio companies may fail to return on the VC’s investment,” (My Capital, http://www.mycapital.com/Veneture%20Capital%20101_MyCapital.pdf). Though most of these investments fail, the ones that succeed usually earn a return on investment anywhere from 300 to 2,000 percent. This is an astronomical amount of money, and is one of the reasons that venture capitalists are known as moderate risk-takers. Most venture capitalists provide their investments for the long-term and not so much for the short-term, which provides that they will more than likely back the company even in the roughest of times for the fact that it is their money at stake. Venture Capitalists usually invest in young, private companies that have great potential for innovations and growth.
If you are wondering where these venture capitalists obtain this vast amount of wealth to make such a risky investment, “they raise their funds from institutional investors, such as pension funds, insurance companies, endowments, foundations and high net worth individuals” (My Capital, http://www.mycapital.com/Veneture%20Capital%20101_MyCapital.pdf). There are obviously inherent risks, but if the ideas are good and there is a valid business plan that has the potential for growth and innovation, then companies will find viable opportunities to help them through the seed, start-up, second, third, and bridge/pre-public stages with lucrative success in the balances. For those who do make it, they are considered great success stories and should be validated as such.