One of the most serious challenges to new entrepreneurs in the innovation process is capitalor the lack thereof. Venture capitalists typically make investments in small, young companies that may not have access to public or credit-oriented institutional funding. Venture capital investments can be long term and high risk, and may include hands-on involvement by the venture capitalist in the firm. Venture capital thus can aid the growth of promising small companies and facilitate the introduction of new products and technologies, and is an important source of funds used in the formation and expansion of small high-technology companies. This section examines investments made by U.S. venture capital firms, by stage of financing and by technology area.
The pool of capital managed by venture capital firms grew dramatically during the 1980s as venture capital emerged as a truly important source of financing for small innovative firms. (See text table 7-7.) By 1989, the capital managed by venture capital firms totaled $33.5 billion, up from an estimated $4.1 billion in 1980. The number of venture capital firms also grew during the 1980sfrom around 448 in 1983 to 670 in 1989.
In the early 1990s, the venture capital industry experienced a recession of sorts, as investor interest waned and the amount of venture capital disbursed to companies declinedespecially compared to the extensive venture capital activity of the late 1980s. The number of firms managing venture capital also declined during the early 1990s, but the slowdown was short-lived. Investor interest picked up during 1992, and disbursements began to rise. Both investor interest and venture capital disbursements have continued to grow through 1998. The latest data show that total venture capital under management rose to $84.2 billion in 1998, more than double the amount managed just three years earlier.
California, New York, and Massachusetts together account for about 65 percent of venture capital resources. It appears that venture capital firms tend to cluster around locales considered to be "hotbeds" of technological activity, as well as in states where large amounts of R&D are performed.
Several years of very high returns on venture capital investments have stimulated increased investor interest. This interest soared from 1995 to 1998, with new commitments reaching $25.3 billion in 1998, up from $15.2 billion in 1997, and $10.5 billion in 1996. Pension funds remain the single largest supplier of new funds, supplying nearly 60 percent of committed capital in 1998. Corporations are the next largest source, supplying 12 percent of committed capital, followed closely by individuals at 11 percent.
Starting in 1994, new capital raised exceeded capital disbursed by the venture capital industry. In each of the following years, that gap has grown larger and larger, creating surplus funds available for investments in new or expanding innovative firms. Since 1990, firms producing computer software or providing computer-related services generally received the largest share of new disbursements. (See figure 7-25 and appendix table 7-14.) In 1990, software companies received 17 percent of all new venture capital disbursements, twice the share going to computer hardware companies and biotechnology companies. That share rose to 27 percent in 1993, and again in 1997. The latest data show software companies receiving more than one-third of all venture capital disbursements in 1998. Telecommunications companies also attracted large amounts of venture capital during the 1990s, and edged out software companies for the lead in 1992 and 1994. Medical and health-care related companies received a large share of venture capital throughout the 1990s, reaching a high of 18 percent in 1994 before dropping to 14 percent in 1998. Computer hardware companies, an industry highly favored by the venture capitalists during the 1980s, received just 3 percent of total venture capital disbursements in the most recent period.
The investments made by venture capital firms may be categorized by the stage at which the financing is provided:
For this report, the first three are referred to as early-stage financing and the remaining three as later-stage financing.
An examination of venture capital disbursements by financing stage clearly shows that most of the funds are directed to later-stage investments. Since 1982, later-stage investments captured between 59 and 75 percent of venture capital disbursements, with the high and low points both reached in the 1990s. In 1998, later-stage investments represented 72 percent of total disbursements. (See figure 7-26 and appendix table 7-15.) Capital for company expansions attracted by far the most investor interest with this financing stage alone attracting more than half of all venture capital disbursed since 1995.
Contrary to how venture capital is often viewed, only a relatively small amount of venture capital goes to the struggling inventor or entrepreneur trying to prove a concept or to help with product development. Over the 19-year period examined, such seed money never accounted for more than 6 percent of all venture capital disbursements, and most often represented between 2 and 4 percent of the annual totals. Seed financing represented about 5 percent of all venture capital in four of the last five years. Consistent with observations made when all venture capital investments are examined, firms developing computer software, telecommunications technologies, and those classified as medical and health-related are the largest recipients of venture capital seed-type financing in the late 1990s. (See appendix table 7-16.) Computer software is the leading technology area receiving seed-type financing, although its share is slightly lower than that seen in the examination of total venture capital investments (34 percent overall versus 32 percent as seed money). Recently, telecommunications firms gained favor with forward-looking venture capitalists and attracted 21 percent of venture capital seed-stage investments in 1998, up from 15 percent in 1997, and 7 percent in 1996. Medical and health-related firms received about 20 percent in each of the last two years examined.