What are venture capitalists?
Discussions About Venture Capitalists
In the course of one decade, the venture capital segment of risk capital went from a $3 billion industry to a $100 billion industry. We describe venture capital as a unique alignment of interests between entrepreneurs, venture capitalists (VCs), and the VCs’ investors.
Depending on where you stand, venture capital can be cash investment, capital resources, leadership and contacts, economic development, commercializer of innovations, job creator, or research magnet. The NVCA defines venture capital as money provided by professionals who invest alongside management in young, rapidly growing companies that have the potential to develop into significant economic contributors.
According to Steve Jurvetson, partner at Draper Fisher Jurvetson, “The venture capitalist works closely with portfolio companies to build the team, form partnerships, sign on key customers, gain awareness in the press, and secure follow-on rounds of financing.” Thomas Hellman at Stanford University’s Graduate School of Business uses a sports analogy when looking at the entrepreneur/venture capitalist relationship. The entrepreneurs are the athletes and the venture capitalists are the coaches. The coaches choose which athletes get to play and the coaches train and motivate them and help create the plays and plans so that they all win.
Jim Clark, co-founder of Netscape, says the best VCs are like chess masters, always six moves ahead of the game. They finance new and rapidly growing ventures through the purchasing of equity securities. They add value to the venture through active participation, generally as a director, and assist in the development of new products or services. They have a long-term orientation and take higher risks with the expectations of higher rewards.
Such risk is inherent with the venture capital industry. In Confessions of a Venture Capitalist, Ruthann Quindlen writes, “Venture Capital is hard. It’s stressful. It’s lonely.” It is a tough business because, like the saying goes, “You can count how many seeds are in the apple, but not how many apples are in the seed.” Venture capitalists, as they count the dollars going out, assume that some deals will not work out. Vinod Khosla, a partner at Kleiner, Perkins who spotted winners like Juniper Networks (which returned some 5,000 times their capital invested), says this, “If things don’t fail, it means we are not taking enough risk.”
As we first discussed, the venture capital industry has grown to a size that could only be imagined in the recent past. Capital under management by venture capitalists increased from $226 billion in 2000 to $250 billion in 2001. Capital under management is defined as the cumulative total of committed funds less liquidated funds or those funds that have completed their life cycle. This $24 billion difference in capital under management, which represented an 11 percent increase, was due primarily because of the existing capital commitments from 1998 to 2001. This increase, however, was the lowest annual percentage increase since 1993 and the lowest dollar increase since 1997.
There are several types of venture capital firms. Most mainstream firms invest their capital through funds organized as limited partnerships in which the venture capital firm functions as the general partner. Thompson Financial Venture Economics and the NVCA classify venture capital firms into four main categories. The most common type is an independent firm. This category refers to independent private and public firms including institutionally and noninstitutionally funded firms and private family groups. This category manages about $204 billion, or 82 percent of the total capital under management in the United States.
The second category is financial institutions. This category refers to firms that are affiliates and/or subsidiaries of investment banks and non-investment banks financial entities. This includes commercial banks and insurance companies. This category manages about $31 billion, or 13 percent of the total.
The third is corporations. This category includes venture capital subsidiaries and affiliates of industrial corporations. This category manages about $13 billion, or 5 percent of the total. The fourth category is all other firms, which may include government-affiliated investment programs that help start up venture either through state, local, or federal programs. This category manages about $2 billion, or less than 1 percent of the total.
At the end of 2001, there were 8,891 venture capitalists working at 761 firms, managing 1,627 funds. On the average, each firm had about 11 principals, who collectively managed two funds each worth $156 million, or a total of $333 million per firm, meaning each principal managed $28 million. Comparatively speaking, the number of firms managing large amounts of capital has increased over the last couple of years. In 2000, 106 venture capital firms managed over $500 million, with 56 of them managing over $1 billion. In 2001, 132 firms managed over $500 million, and 72 managed over $1 billion.
Finally, it is important to point out the difference between venture capitalists and angel investors. Venture capital firms are professional investors who dedicate 100 percent of their time to investing and building emerging growth companies. Most venture capitalists have a fiduciary responsibility to their investors. Most of the angel investment community in the United States is an informal network of investors who invest in companies for their own interests. And typically, angel investors invest less than $1 million in any particular company, whereas venture capitalists will usually invest more than $1 million per company.