History and functioning of Venture Capital
Venture Capital (VC): institutional investment activity in risk capital directed at unlisted companies, typically in the start-up or scale-up phase, which are distinguished by a high potential for development and growth. Historically, the origins of VC can be traced back to investments in emerging companies provided by wealthy families, or high-net-worth individuals, existing for some time.
It is not a simple loan, but a medium-to-long-term investment with the goal of obtaining a substantial capital gain at the time of the exit from the investment, which can occur through the sale of the stake or the listing on the stock exchange.
HISTORY
The roots of Venture Capital as a formalized and institutional activity are in the 20th century, although the practices of investment in emerging companies by wealthy families have existed for some time.
As early as 1938, Laurance S. Rockefeller helped finance the creation of Eastern Air Lines and Douglas Aircraft. In the same year, Eric M. Warburg founded EM Warburg & Co. (later Warburg Pincus), which invested in both leveraged buyouts and venture capital.
The Wallenberg family in Sweden had founded Investor AB as far back as 1916, investing in companies such as ABB, Ericsson, and Atlas Copco.
The institutional turning point is often attributed to Georges Doriot, a Frenchman who emigrated to the United States, who founded the American Research and Development Corporation (ARDC), considered the first venture capital company in the modern sense. ARDC was innovative because it raised money not only from the wealthy but also from ordinary people.
A crucial act for the development of Venture Capital in the United States was the approval of the Investment Act of 1958, five years after the establishment of the US Small Business Association. This led to an increase in the number of Venture Capital funds and the birth of the National Venture Capital Association.
In the 1980s, US Venture Capital firms suffered losses due to the emergence of competing funds outside the United States. In the early 2000s, Venture Capital suffered a severe blow due to the bursting of the dot-com bubble, aggravated by financial scandals involving large corporations.
Despite the crises, the venture capital financing activity has returned to full operation and has demonstrated resilience, even overcoming the 2008 global financial crisis.
FUNCTIONALITY
Venture Capital is an essential form of financing for emerging companies that, due to the high risk inherent in their business model or their initial stage of development, can hardly access traditional bank credit.
Venture Capital activity is not limited to just the contribution of risk capital, in fact, the VC investor assumes the role of a strategic and active partner in the company.
The investor contributes their knowledge, professional experience, and know-how, participating in the strategic decisions of the company.
The institutional investor, often a prestigious figure in the financial landscape, confers notoriety and credibility on the company. This facilitates the company’s acceptance in the market, activating new business opportunities and facilitating commercial agreements.
VC investments generally concern Start-ups or Scale-ups and More Structured Companies. In fact, companies that have already started the production of goods or services and need capital to expand and grow in the market. On the other hand, companies that intend to launch a new brand and plan the creation of spin-offs or newcos to market the new product or service.
VENTURE BACKED
The term Venture Backed, literally “supported by venture,” defines a start-up or an emerging company that has received funding from Venture Capital (VC) investors. A “venture backed” company is distinguished by the following aspects:
- Equity Financing: VCs provide capital in exchange for an equity stake in the company, and this makes them partners, not simple creditors.
- High Risk and High Potential: The capital is invested in companies with high growth potential but, by their nature, also with a high risk of failure.
- Expansion Goal: The capital provided is specifically used to support the company’s expansion and development, allowing it to grow rapidly.
- Risk Sharing: By becoming equity partners, VCs share the business risk and, consequently, the company’s potential future success.
Being a Venture Backed company implies having access to vital financial resources and a network of contacts made up of the VC investors themselves. The latter are the foundational elements.
