Venture Capital Resources
Boom and Bust in New Venture Capital Commitments
Venture Capital Investments by Stage of Financing
Venture capitalists typically make investments in small, young
companies that may not have access to public or credit-oriented
institutional funding. Such investments can be long term and high
risk and, in the United States, almost always include hands-on involvement
in the firm by the venture capitalist. This money can aid the growth
and development of small companies and new products and technologies,
and it is often an important source of funds used in the formation
and expansion of small high-technology companies. This is of special
interest to the S&E field, as small businesses play a vital
role in the U.S. economy and have become important employers of
recent S&E graduates (National Venture
Capital Association 2002).
For most of the 1990s, computer technology businesses engaged in
hardware or software production and related services and medical
and health care companies were the leading recipients of venture
capital in the United States. This pattern changed significantly
in 1999, when Internet-specific businesses emerged in the marketplace.
This section examines venture capital investment patterns in the
United States since 1980, with special emphasis given to a comparison
of trends in 1999 and 2000 (hereafter called the bubble years)
with trends in 2001 and 2002 (hereafter called the postbubble
period). It discusses changes in the overall level of investment,
the technology areas U.S. venture capitalists find attractive, and
the types of investments made.
U.S. Venture Capital Resources
Several years of high returns on venture capital investments during
the early 1990s led to a sharp increase in investor interest. The
latest data show that new commitments rose vigorously each year
from 1996 through 2000, with the largest 1-year increase in 1999
(table 6-6 ).
Investor commitments to venture capital funds jumped to $62.8 billion
that year, a 111 percent gain from 1998. By 2000, new commitments
reached $105.8 billion, more than 10 times that recorded in 1995.
Quickly, venture capital emerged as a key source of financing for
small innovative firms. Evidence of a slowdown emerged in 2001 when
new commitments declined for the first time in 10 years.
Commitments fell by more than 64 percent that year, to $37.9 billion.
Still, this sharply reduced total was quite large when compared
with capital investments during the prebubble years. Another sharp
drop in 2002 reduced the amount of new money coming into venture
capital funds to only $7.7 billion, a level not seen since 1994.
The pool of money managed by venture capital firms grew dramatically
over the past 20 years as pension funds became active investors
following the U.S. Department of Labor's clarification of the "prudent
man" rule in 1979.
In fact, pension funds became the single largest supplier of new
funds. During the entire 19902002 period, pension funds supplied
about 44 percent of all new capital. Endowments and foundations
were the second-largest source, supplying 17 percent of committed
capital, followed closely by financial and insurance companies at
16 percent (table 6-7
California, New York, and Massachusetts together account for about
65 percent of venture capital resources, as 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 (Thomson Financial Venture
Boom and Bust in New Venture Capital Commitments
High returns on venture capital investments during the 1990s made
the funds attractive for risk-tolerant investors. Starting in 1994,
the amount of new capital raised exceeded that disbursed by the
industry, leading to a large pool of money available for investments
in new or expanding firms. As early as 1990, firms producing computer
software or providing computer-related services began receiving
large amounts of venture capital (appendix
table 6-15 ).
Software companies received 17 percent of all new venture capital
disbursements in 1990, more than any other technology area. This
figure fluctuated between 12 and 21 percent thereafter. Communication
companies also attracted large amounts of venture capital during
the 1990s, receiving from 12 to 21 percent of total disbursements.
Medical and health care-related companies received a high of almost
21 percent of venture capital in 1992 before dropping to just 5
percent in 1999.
In the late 1990s, the Internet emerged as a business tool, 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,
whereas before 1999, some of these funds were classified as going
to companies involved in computer hardware, computer software, or
communication technologies. Internet-specific businesses involved
primarily in online commerce were the leading recipients of venture
capital in the United States during the bubble years. They collected
more than 40 percent of all venture capital funds invested in each
of those years. Software and software services companies received
1517 percent of disbursed venture capital funds. Communication
companies (including telephone, data, and wireless communication)
were a close third with 1415 percent.
The U.S. stock market suffered a dramatic downturn after its peak
in early 2000, with the sharpest drops in the technology sector.
Led by a dot.com meltdown, technology stock valuations generally
plummeted and many Internet stocks were sold at just a fraction
of their initial price. Venture capital investments, however, continued
to favor Internet-specific companies over other industries in the
postbubble period. In 2001 and 2002, Internet companies received
far less venture capital, 28 and 21 percent, respectively, of the
total dollars disbursed. This was a sharp drop from the previous
2 years but still more than the amount received by any other industry
area. Companies involved primarily in computer software, communication,
and medical and health care also continued to attract venture capital-backed
investments during this period (figure
The decline in enthusiasm for Internet companies seems to have
benefited other technology areas, because their shares of total
venture capital disbursements increased during a time when venture
capitalists were sharply curbing their activity. A comparison of
venture capital disbursements in 1999 and 2000 with those in the
2001 and 2002 shows that medical and health care-related and biotechnology
companies attracted much higher percentages in the latter period.
Medical and health care-related companies received 11 percent of
total investments in 2001 and 2002, nearly triple their share of
4 percent received in 1999 and 2000. Biotechnology companies doubled
their share, from 3 to about 6 percent. Other industries attracting
larger shares of the smaller pool of investment funds in 2001 and
2002 were software companies, semiconductor and other electronics
companies, and industrial and energy companies.
Venture Capital Investments by Stage of Financing
The investments made by venture capital firms can be categorized
by the stage at which the financing is provided (Venture
Economics Information Services 1999):
- Seed financing usually involves a small amount of capital
provided to an inventor or entrepreneur to prove a concept. It
may support product development but is rarely used for marketing.
- Startup financing provides funds to companies for product
development and initial marketing. This type of financing usually
is provided to companies just organized or to those that have
been in business just a short time but have not yet sold their
product in the marketplace. Generally, such firms have already
assembled key management, prepared a business plan, and made market
- First-stage financing provides funds to companies that
exhausted their initial capital and need funds to initiate commercial
manufacturing and sales.
- Expansion financing includes 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
6 months to 1 year.
- Acquisition financing provides funds to finance the
purchase of another company.
- Management and leveraged buyout includes funds to enable
operating management to acquire a product line or business from
either a public or private company. Often these companies are
closely held or family owned.
For this report, the first three types of funds are referred to
as early-stage financing and the remaining three as later-stage
Two patterns stand out in an examination of venture capital disbursements
by financing stage: (1) most of the funds' investment dollars are
directed to later-stage investments, and (2) during the postbubble
period, venture capital funds directed more money to later-stage
investments than ever before. (See appendix
and sidebar, "U.S. Government Support for Small Technology
Later-stage investments ranged from 60 to 79 percent of total venture
capital disbursements, with both the highest and lowest points reached
in the 1990s. In 1999 and 2000, later-stage investments made up
72 percent of total disbursements, rising to 77 percent in the postbubble
period. Although early-stage, venture-backed investments as a share
of total disbursements have gradually declined over time, during
the 200102 period they fell to their lowest level ever (figure
The postbubble trend toward later-stage investing is also evident
when analyzing the three early-stage categories. Most of the postbubble
venture capital that previously went to early-stage investments
shifted to the most mature of the early-stage companies-those companies
that had exhausted their initial capital and were in need of funds
to initiate commercial manufacturing and sales. During a period
when venture capital became increasingly scarce, the more high-risk
early-stage projects suffered.
Expansion financing has typically been favored by venture capital
funds, with this stage alone accounting for more than half of all
venture capital disbursements since 1997. In 2000, the amount of
venture capital invested to finance company expansions reached 57
percent of total disbursements. This upward trend continued into
the postbubble period, with the share rising to 62 percent in 2002.
About one-quarter of the $36.3 billion disbursed to finance expansions
of existing businesses during 2001 and 2002 went to Internet companies.
Venture Capital as Seed Money
Contrary to popular perception, only a relatively small amount
of dollars invested by venture capital funds ends up as seed money
to support research or early product development. Seed-stage financing
never accounted for more than 8 percent of all disbursements over
the past 23 years and most often represented between 2 and 5 percent
of the annual totals. The latest data show that seed financing represented
just 1 percent of all venture capital in 2001 and 2002, falling
from just 2 percent in 1999 and 2000. Over the past 23 years, the
amount invested in a seed-stage financing has averaged about $1.8
million per disbursement. The average peaked at $4.3 million per
disbursement in 2000 before falling in 2001 and 2002 (figure
In 2002, the average seed-stage investment was about $1.9 million.
The same three technologies, Internet, communication, and computer
software, attracted the bulk of seed financing during the past 4
years. They were the largest recipients of venture capital seed
financing during the 1999 and 2000 bubble years, with Internet companies
the preferred investment destination. Internet companies received
58 percent of all disbursements in 1999 and 43 percent in 2000 (appendix
table 6-17 ).
In 2001 and 2002, seed investments going to Internet companies fell
off considerably but still represented 21 percent of all such investments
in 2001 and 7 percent in 2002.
As dot.com panic replaced dot.com mania, other technology areas
attracted more attention. Medical and health care-related companies
received 10 percent of seed money in 2001 and 20 percent in 2002,
up from 4 and 5 percent during the bubble years. The share going
to biotechnology companies rose to 5 percent in 2001 and to 15 percent
in 2002. Semiconductor companies received 8 percent in 2001 and
15 percent in 2002, up from 4 percent in 1999.
Over the past 23 years, venture capital investment showed consistent
support for technology-oriented businesses, particularly companies
and industries that develop and rely on information technologies.
And, despite the recent reduction in new money invested in venture
capital funds, information technologies continue to attract the
largest shares of total U.S. venture capital.
During the late 1990s, venture capitalists increasingly favored
later-stage investments over early-stage investments that are more
likely to support exploratory R&D and product development. That
trend continued in the postbubble years of 2001 and 2002. If this
trend continues, U.S. Government programs like the Small Business
Innovation Research program and Advanced Technology Program may
become more important sources of early-stage funds for new technology-oriented