(Pretty) Concise History of Venture Capital
Entrepreneurialism is deeply rooted in the history of the United States. The United States, as we know it, was explored and settled by adventurers and risk-takers. However, while entrepreneurship has been evident in America for hundreds of years, venture capital and angel investing in the U.S. market is still a relatively recent concept.
Briefly, venture capitalists (VCs) invest in high-risk, high-growth start-ups which traditional financial institutions can’t.[1] VCs traditionally do not lend money but rather exchange capital for an ownership or equity stake in the companies they finance.
The first modern venture capital firms were developed following WWII to commercially capitalize on war technologies. American Research and Development (ARD) was established on the East Coast in 1946 by acclaimed Harvard professor General Georges F. Doriot. ARD was the first, and one of the only publicly traded venture capital companies. In that same year John H. Whitney also started a venture capital company, but organized the company as a venture partnership, which has served as the model for venture capital organizational structure since.
One of the first steps towards the dynamic venture capital industry the U.S. enjoys today was the passage of the Small Business Investment Act of 1958[2] which officially allowed the U.S. Small Business Administration (SBA) to license private "Small Business Investment Companies" (SBICs) to help finance and manage start-ups all over the country.
In the 1960s private equity funds began to emerge. Private equity funds are limited partnerships that hold investments where investment professionals serve as general partner and the investors finance the operation.
Venture capital investing was still a cottage industry in the late 1970’s and early 1980’s consisting largely of pooled funds of wealthy East Coast individuals and a growing number West Coast partnerships and investments.
Venture capital partnerships, specifically in Silicon Valley, came into its own in the 1990’s incited by an abundance of developing technologies, in the computer and Internet sectors. The ‘dot com’ era was a boon to venture capitalism, providing numerous opportunities for new firms to emerge and go public, as well as for existing firms to put financing into the seemingly endless array of internet startups. Demand for stock in technology and other growth companies, many of which were venture backed, was up and venture firms were reaping large windfalls.
The number of venture capital firms increased drastically from 1980 to 1999.[3] However in 2001, because of the burst tech bubble the venture capital market fell apart. For the year ending September 30, 2001, the annual rate of return on venture capital investments fell to 47.17% from over 200% in the prior year.
When the market recalibrated, venture capital quickly rebounded and in 2004, investments totaled $20.9 billion. Today, roughly 11% of private sector jobs in the year 2011 came from venture-backed companies and venture-backed revenue accounted for a whopping 21% of US GDP.[4]
This article was written by Curtis Roberts, the founder of The Founder's Attorney.
If you have any questions or suggestions he can be reached at curtis@foundersattorner.com. You can check out his LinkedIn page here.
[1] Richard L. Florida & Martin Kenney, Venture capital-financed innovation and technological change in the USA, Technology, Innovation and Social Change Project Research Policy 17, 120–21 (1988). "The rule of thumb among venture capitalists is that some 20 percent to 30 percent of their companies fail, returning nothing to any investor, including the venture capitalists.”
[2] “[T]he Small Business Investment Act of 1958, which provides generally for the licensing and regulation by the Small Business Administration of small business investment companies authorized to provide financing, and consulting and advisory services, to small business concerns.” 7 A.L.R. Fed. 224 (Originally published in 1971).
[3] The History Of Private Equity & Venture Capital.
[4] IHS Global Insight 5 Ed., Venture Impact 2. (2011)
This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.