Venture capital
Venture capital (VC) is a form of private equity financing provided by firms or funds to startup, early-stage, and emerging companies, that have been deemed to have high growth potential or that 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 start-ups in the hopes that some of the companies they support will become successful.[1] Because startups face high uncertainty,[2] VC investments have high rates of failure. Start-ups are usually based on an innovative technology or business model and they are often from high technology industries, such as information technology (IT), clean technology or biotechnology.
Pre-seed and seed rounds are the initial stages of funding for a startup company,[3] typically occurring early in its development. During a seed round, entrepreneurs seek investment from angel investors, venture capital firms, or other sources to finance the initial operations and development of their business idea. Seed funding is often used to validate the concept, build a prototype, or conduct market research. This initial capital injection is crucial for startups to kickstart their journey and attract further investment in subsequent funding rounds.
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.
In addition to angel investing, equity crowdfunding and other seed funding options, venture capital is attractive for new companies with limited operating history that are too small to raise capital in the public markets and have not reached the point where they are able to secure a bank loan or complete a debt offering. In exchange for the high risk that venture capitalists assume by investing in smaller and early-stage companies, venture capitalists usually get significant control over company decisions, in addition to a significant portion of the companies' ownership (and consequently value). Companies such as Stripe, Airtable, and Brex are highly valued startups, commonly known as Unicorns (when a company has reached a market valuation of over $1 billion). Venture capitalists also often provide strategic advice to the company's executives on its business model and marketing strategies.
Venture capital is also a way in which the private and public sectors can construct an institution that systematically creates business networks for the new firms and industries so that they can progress and develop. This institution helps identify promising new firms and provide them with finance, technical expertise, mentoring, talent acquisition, strategic partnership, marketing "know-how", and business models. Once integrated into the business network, these firms are more likely to succeed, as they become "nodes" in the search networks for designing and building products in their domain.[4] However, venture capitalists' decisions are often biased, exhibiting for instance overconfidence and illusion of control, much like entrepreneurial decisions in general.[5]
Role in employment[edit]
Every year, there are nearly 2 million businesses created in the US, but only 600–800 get venture capital funding.[63] According to the National Venture Capital Association, 11% of private sector jobs come from venture-backed companies and venture-backed revenue accounts for 21% of US GDP.[64]
Gender disparities[edit]
In 2020, female-founded companies raised 2.8% of capital investment from venture capital, the highest amount recorded.[65][66] Babson College's Diana Report found that the number of women partners in VC firms decreased from 10% in 1999 to 6% in 2014. The report also found that 97% of VC-funded businesses had male chief executives, and that businesses with all-male teams were more than four times as likely to receive VC funding compared to teams with at least one woman.[67]
Currently, about 3% of all venture capital is going to woman-led companies. More than 75% of VC firms in the US did not have any female venture capitalists at the time they were surveyed.[68] It was found that a greater fraction of VC firms had never had a woman represent them on the board of one of their portfolio companies. For comparison, a UC Davis study focusing on large public companies in California found 49.5% with at least one female board seat.[69]
Confidential information[edit]
Unlike public companies, information regarding an entrepreneur's business is typically confidential and proprietary. As part of the due diligence process, most venture capitalists will require significant detail with respect to a company's business plan. Entrepreneurs must remain vigilant about sharing information with venture capitalists that are investors in their competitors. Most venture capitalists treat information confidentially, but as a matter of business practice, they do not typically enter into Non Disclosure Agreements because of the potential liability issues those agreements entail. Entrepreneurs are typically well advised to protect truly proprietary intellectual property. Startups commonly use a data room to securely share this information with potential investors during the due diligence process.
Limited partners of venture capital firms typically have access only to limited amounts of information with respect to the individual portfolio companies in which they are invested and are typically bound by confidentiality provisions in the fund's limited partnership agreement.
Governmental regulations[edit]
There are several strict guidelines regulating those that deal in venture capital. Namely, they are not allowed to advertise or solicit business in any form as per the U.S. Securities and Exchange Commission guidelines.[121]