Venture Capital Commitments and Disbursements
Venture Capital Investments by Stage of Financing
One of the most serious challenges to new entrepreneurs is capital, or 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 they may include hands-on involvement in the firm by the venture capitalist. Venture capital can aid the growth of promising small companies and facilitate the introduction of new products and technologies, and it is an important source of funds for 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 latest data show total venture capital under management rising vigorously each year from 1996 through 2000. The largest one-year increase occurred in 1999, when the pool of venture capital jumped to nearly $145.2 billion, a 72.5 percent gain from the previous year. In 2000, once again, the pool of venture capital grew sharply, rising 60.9 percent to $233.7 billion, more than six times the amount managed only five years earlier.
The amount of capital managed by venture capital firms grew dramatically during the 1980s as venture capital emerged as an important source of financing for small, innovative firms. (See text table 6-11 .) By 1989, the capital managed by venture capital firms totaled nearly $33.5 billion, up from almost $4.1 billion in 1980. The number of venture capital firms also grew during the 1980s from around 448 in 1983 to 670 in 1989.
In the early 1990s, the venture capital industry slowed as investor interest waned and the amount of venture capital disbursed to companies declined. The number of firms managing venture capital also declined during the early 1990s. The slowdown was short lived, however; investor interest picked up in 1992 and the pool of venture capital has grown steadily since then.
California, New York, and Massachusetts together account for about 65 percent of venture capital resources. 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 (Venture Economics Information Services (VEIS) 1999). See sidebar, "Business Incubators Nurture Future Entrepreneurs on U.S. Campuses."
Venture Capital Commitments and Disbursements
Several years of high returns on venture capital investments have stimulated increased investor interest. This interest soared after 1995, with new commitments rising 24.2 percent in 1996 to nearly $10.5 billion and then rising 45.0 percent the following year. By 2000, new commitments reached $93.4 billion, more than 10 times the amount available in 1995. Pension funds remain the single largest supplier of committed capital, supplying 41 percent in 2000. (See text table 6-12 .) Banks and insurance companies are the next largest source, supplying 23 percent of committed capital, followed closely by endowments and foundations at 21 percent (VEIS 1999).
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, creating surplus funds available for investments in new or expanding innovative firms. As early as 1990, firms producing computer software or providing computer-related services received large amounts of new venture capital, but they became the clear favorite beginning in 1996. (See figure 6-32 and appendix table 6-19.) In 1990, software companies received 17.4 percent of all new venture capital disbursements, nearly twice the share going to computer hardware companies and biotechnology companies. That share rose to about 27.1 percent in 1993 and then fluctuated between 16.4 and 27.1 percent until 1998, when software companies received more than one-third of all venture capital disbursements. Telecommunications companies also attracted large amounts of venture capital during the 1990s, edging out software companies for the lead in 1992 and 1994. Medical and health care companies received a large share of venture capital throughout the 1990s, reaching a high of 17.8 percent in 1994 before dropping to 13.6 percent in 1998. Computer hardware companies, an industry highly favored by the venture capitalists during the 1980s, received only 2.4 percent of total venture capital disbursements in 2000.
The latest data include a new category that makes comparisons with previous years more difficult. In the late 1990s, the Internet emerged as a key new tool for business, and companies developing Internet-related technologies drew venture capital investments in record amounts. Beginning in 1999, investment dollars disbursed to Internet companies were classified separately in the statistics that track venture capital investment trends. Before 1999, some of these investments would have been classified as going to companies involved in computer hardware, computer software, or communications technologies.
In 1999, Internet companies became the leading recipients of venture capital funds, collecting 41.7 percent of all venture capital disbursed. The latest data show their share increasing to 45.2 percent in 2000. Computer software companies, the leader through much of the 1990s, drew 12.9 percent of all venture capital disbursed in 1999 and 14.3 percent in 2000. The share of investments going to communications companies averaged 16.5 percent in 1999 and 2000.
Venture Capital Investments by Stage of Financing
The investments made by venture capital firms may be categorized by the stage at which the financing is provided (VEIS 1999). Early-stage financing involves the following:
Seed financingusually involves a small amount of capital provided to an inventor or entrepreneur to prove a concept. Seed financing may support product development but rarely is used for marketing.
Startup financingprovides funds to companies for use in product development and initial marketing. This type of financing usually is provided to companies that are newly organized or have been in business for a short time and have not yet sold their product in the marketplace. Generally, such firms have already assembled key management, prepared a business plan, and conducted market studies.
First-stage financingprovides funds to companies that have exhausted their initial capital and need funds to initiate commercial manufacturing and sales.
Later stage financing includes the following:
- Expansion financingincludes working capital for the initial expansion of a company; funds for major growth expansion (involving plant expansion, marketing, or development of an improved product); and financing for a company expecting to go public within six months to a year.
- Acquisition financingprovides funds to finance the purchase of another company.
- Management/leveraged buyoutincludes funds to enable operating management to acquire a product line or business from either a public or private company. These companies often are closely held or family owned.
Most venture capital disbursements are directed to later stage investments. Since 1982, later stage investments captured between 59 and 79 percent of venture capital disbursements, with the high and low points both reached in the 1990s. In 2000, later stage investments represented 78 percent of total disbursements. (See figure 6-33 and appendix table 6-20.) Capital for company expansions attracted the most investor interest by far; this financing stage alone attracted more than half of all venture capital disbursed since 1995. In 2000, venture capital funds to finance company expansions accounted for 61 percent of total disbursements. Nearly half (48.1 percent) of the $55.2 billion disbursed by venture capital funds to finance expansions of existing businesses in 2000 went to Internet companies.
Contrary to expectations, only a relatively small amount of venture capital helps struggling inventors or entrepreneurs prove a concept or develop their products. During the 21-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. The latest data show the share of all venture capital disbursements classified as seed financing falling to its lowest level ever, representing just 1.4 percent of all venture capital in both 1999 and 2000. Nevertheless, nearly $1.3 billion in seed money was disbursed by venture capital funds in 2000, up from $710.7 million in 1999 and $312.5 million in 1995.
Computer software, telecommunications technologies, and medical and health-related firms were the largest recipients of venture capital seed-type financing during the late 1990s. (See appendix table 6-21.) Computer software firms received the most seed money from 1996 to 1998 before relinquishing the top position to Internet companies in 1999 and 2000. Investments in Internet companies represented 60.8 percent of all seed money from venture capital funds in 1999 and 43.7 percent in 2000.
Communications firms gained favor with forward-looking venture capitalists in 2000, attracting 26.2 percent of all seed-stage investments disbursed by venture capital funds that year, up from just 5.0 percent in 1999. The shares of venture capital seed money going to computer software companies fell to 11.3 percent in 1999 and to 10.5 percent in 2000.
With more than 80 percent of seed money going to either Internet, communications, or computer software companies, seed money for companies involved in other technologies declined. Biotechnology, which in 1998 received 11.9 percent of the venture capital disbursed as seed money, saw its share drop to 6.3 percent in 1999 and 0.9 percent in 2000. Medical and health-related firms fared better than biotechnology firms, yet they saw their share drop from 20 percent in both 1997 and 1998 to 6.9 percent in 1999 and 2.9 percent in 2000.