Venture Capital. What was once the exclusive sport of kings, is going mainstream. Even though venture-backed technology IPOs are taking a break and mutual funds are fiddling with the value of their stakes in private companies, the world of private investing remains on center stage as the opportunities for market value creation by private companies continue to dwarf value creation opportunities in the public markets. But to many, the private markets are increasingly confusing and dramatic (as in the life and death of unicorns), and are crying out for order.
There are a few forces at play: Angel investors became angel syndicates and gave rise to seed funds. The JOBS Act is giving rise to crowdfunding, bringing the ability to invest directly in private companies to households across America. Incubators and accelerators are increasingly dotting the startup landscape. Corporations, seeking access to promising technologies, are again investing in private companies in record numbers. Banks and non-bank lenders are mixing debt with stock warrants. Traditional Limited Partners (LPs), which once invested only in venture capital funds, are now joining family offices and trying to invest directly in private, venture-backed growth companies. And while interest rates were tweaked in December for the first time in years, public stock mutual funds continue to reach for return in a low interest rate environment by investing directly in private companies and holding their positions.
Amidst this backdrop, venture capital is still seen as a secretive art practiced only by venture capital funds and their fund managers. The time has come to recognize that the entrepreneurial ecosystem has matured and to expand the definition of venture capital to include all forms of investing directly in private companies.
For me, “Venture Capital” is any money that is injected directly in to a private company. Not to buy the company outright (this would be the realm of the buyout shops), but instead to help the company grow.
A “venture” is something new. This could be a new product, service or market. It is perhaps unproven, still private, likely small but with the aspirations and the potential to be big.
“Capital” is money. Money is like Baskin Robbins and it comes in more than 31 flavors. A “simple agreement for future equity” (SAFE) instrument is capital. Debt is capital. A pre-paid order for a new product is capital. Warrants and options and pro rata rights are potential capital. Convertible debt is capital. A bridge round is capital. Of course equity, whether in the form of common stock or preferred stock, whether early in the life of a company or just prior to an IPO, is capital.
Bobby Franklin, President of the National Venture Capital Association (NVCA), proposes we convene the entrepreneurial ecosystem. It is a message that is orders of magnitude broader and more important I suggest, than just the traditional venture capital “fund” industry. He includes entrepreneurs, angels, incubators, accelerators, seed funds, MicroVCs, traditional venture funds, corporations, lenders, traditional LPs (including family offices, endowments, foundations, and pensions) wishing to invest directly in companies, growth equity funds, and public mutual funds, all as integral parts of the venture capital ecosystem. He is on to something.
Why bother, you might ask? Well, names matter.
The first names for new products or industries are often limiting once those products and industries mature. Which explains why personal digital assistants became smartphones, why shopping for books online became ecommerce, and why the Blockchain is much more interesting than Bitcoin. The right name can be inviting, reflect the current nature of what you’re describing and usher in possibility for the future.
The financial services industry has been brilliant at expanding the definition of products and services as each crossed the chasm from niche player to the mass market. Junk Bonds became High Yield Debt. Leveraged Buyouts became Private Equity. Second mortgages became home equity lines available in an assortment of flavors.
Similarly, crowdfunding, angel, seed, early stage, expansion, mezzanine, late stage and growth equity are all just different flavors of venture capital.
I think venture capital is a great name. Though it is time to expand its definition to recognize that all private capital investors backing entrepreneurs who are running growing companies, are, in fact venture capitalists.
A quick history lesson.
Venture capital can trace its roots back hundreds of years when essentially, the very wealthy in society, funded entrepreneurs. These were artists, musicians and explorers, much like Spain’s Queen Isabella funded Christopher Columbus’ quest to find a new sea route to Asia. Venture capital’s modern day interpretation came into its own 500 years later, with the help of people like Arthur Rock and Laurance Rockefeller, introducing the modern institutional venture capital fund.
Traditional institutional venture capital funds are built around three prongs:
- Institutional Investors (Limited Partners)
- Venture Capital Fund Managers (General Partners)
- Modern portfolio theory around diversification
This three-prong model has served us well for a half a century, creating trillions of dollars of market value and tens of millions of high paying jobs. The NVCA was formed in 1973 to support the venture capital fund industry from a policy perspective trumpeting the sector as a major player the global economy. But the venture capital industry began to change 16 years ago when the tech bubble burst. 2000 was a year unlike no other. We saw $100 billion raised by venture capital funds, versus $20 billion in a normal year. We saw 6,500 new startup companies funded by 1300 groups calling themselves venture capital firms. Today, roughly 550 traditional venture capital firms exist, and fund around 1400 new companies annually. This excess from the 2000 venture capital market gave rise to poor returns to investors which gave rise to the Shumpterian creative destruction of the venture capital industry that we are seeing play out right before our eyes.
To many, it is confusing, especially as new entrants make their moves. I hear entrepreneurs echo that. Allow me to take a page from my Stanford Business School classmate, Benchmark co-founder Andy Rachleff, who teaches there now and is gifted at shedding light on venture capital economics.
Why do we refer to our investments and group ourselves, often by the legal names of the investments – Series A, Series B, Series C and so on? It is as technical and dull as the thankfully defunct name, “Personal Digital Assistant.” There is a better and simpler way to think about the venture capital industry. I see four main “products” within venture capital:
- Seed: This is generally to turn an idea into a product, to see if there is indeed product-market fit.
- Venture: This turns a product or a service that has product-market fit into a business.
- Venture Debt: This is generally offered to companies that have hit some measure of market traction, and generally have real and growing revenue, even though the company is still likely cash flow negative.
- Growth: This is money to pour gasoline on to the fire. It helps a market leading company grow bigger, faster and globally. It prepares the best companies to become public companies.
But we need a “tool” to translate all of the jargon that is widely used in the venture capital industry into something that is actionable for entrepreneurs. This is why I created the “Venture Capital Rosetta Stone.” If you are an entrepreneur, use this to figure out what type of money you are looking for. Identify where you are on the continuum. And where you should look for that money. And how much money each of these players “might” provide if they like you and your idea. And what control you might give up. And what “security” you may end up selling. And what percentage of the company you might sell.
And how they might value your business.
Photo illustration of translation in 3D courtesy of Shutterstock
Venture Capital Rosetta Stone was originally posted on The PE Hub Network.