Venture capital is a term that was invented to describe a particular type of financial transaction that banks chose not to pursue because of the perceived and actual very high risk: giving funds to a team to build a product or service, when there was no existing business to validate that this investment would be recouped.
In the United States after World War II a small set of investors began to create what is called the venture capital business. Notably Jock Whitney created J.H.Whitney & Company in New York City, while General Georges Doriot created American Research and Development Corporation in Boston.
In the United States in the Boston area a number of venture capital firms started up to fund and grow local businesses: Greylock, Matrix, Battery, Polaris, Accel, Advanced Technology Ventures, Charles River Ventures are all examples.
In the New York City area was Venrock, Rothschild, Union Square, Bessemer as examples.
In the San Franciso Bay area was Kleiner Perkins Caufeld Byers, Sequoia, Andreesen Horwitz, Menlo Ventures, Canaan, et al.
As an asset class, venture capital was able to return 60% Internal Rate of Return from 1980-200, far above the 15%-20% of the S&P 500 Index, and this led to venture capital funds attracting larger and larger sums of money. In 1980 a typical top tier venture capital fund would have $50M assets under management in a given fund; in 2000 a typical top tier venture capital fund would have $500M assets under management in a given fund.
This led to a sea change in motivations: if the fund was $50M a 2% annual management fee was $1M, and if the fund returned $250M then the fund managers received 20% of that or $50M, so the bulk of the compensation was tied to the success of the fund in finding profitable investments. If the fund was $500M, 2% annual management fee was $10M, and if the fund lost $50M in a particular investment it was a small fraction of the fund assets, leading to very different behavior by the fund managers than before.
From the 1980s to 2005 significant venture capital funding went into hardware and hard science ventures. The end result was the buildout of megabit and gigabit per second networks around the world, and this plumbing permitted the proliferation of software businesses (more on this in a moment). MoneyTree, a volunteer survey of venture capital funding has been in existence for decades; every quarter venture capital funds are asked to disclose what investments were made that quarter in what companies at what valuation. From 1980 to 2007 over 24,000 companies received venture capital funding, and yet 13,000 returned ZERO, while 3,500 did a stock floatation or Initial Public Offering and that paid for all the remaining companies and then some. This is NOT for the faint of heart.
Software as a business involves far less technical risk than hardware: given enough time and money, a software package can be turned into a viable product, and the manufacturing of additional copies is straightforward and relatively risk free, unlike hardware. The main issue in software is finding a solution to a compelling need, and creating a viable business model to monetize this concept, and so from 2005 onward the bulk of venture capital funding went into software and away from hardware.
The innovation of software as a service had a major impact on venture capital funding. Prior to this, software was sold as a license: a customer would purchase a license typically for five years, and would pay an annual service fee for updates and support equal to 20% of the purchase price. This led to significant money being received by the software supplier as each license was sold, and led to software firms typically being funded to reach positive cash flow for $20M-$30M over a period of three to five years. With software as a service, initially the customer pays a monthly fee, perhaps $100 or less, and this includes service and support; the end result is that far less money is received until the number of customers reaches ten times or more that of the license model, and in order to reach positive cash flow $100M-$150M has to be spent over five to seven years.
Currently there are estimated to be several thousand venture capital funds, excluding crowd sourcing activities, in the United States, with the top fifty venture capital funds enjoyed returns of 60% per year, year in and year out.
Venture capital has always tried to invest capital while minimizing risks: this has led to funding moving to software and away from software because the technical risk of software was far less than that for hardware (both in product development but also in scaling up manufacturing, as shown by the trials and tribulations of electric vehicle startups). The current hype in artificial intelligence software can be used in a variety of ways, for example in medical devices. Here are some examples of the synergies between hardware and software: 1)chronic pain can be treated electrically by attaching electrodes on either side of the pain center and generating waveforms with different levels of currents and voltages that shock the brain into ignoring this area for months on end, in contract to conventional treatments involving opiates, 2)microcapillary blood flood and muscle stimulation can be triggered by pulsed magnetic fields, 3)magnetocardiograms can be generated by an array of magnetic sensors that detect the magnetic fields of the electric currents in the heart muscles. All these examples can be coupled to artificial intelligence/neural networks that adapt to individual to provide custom treatment.
The issue of how to make money, how to monetize a set of ideas, and the ability to execute on that concept, is the crux of business. Business exists to meet the needs of customers that need products and services. Intellectual property provides an edge for a business over its competitors, and can be embodied in patents or in trade secrets or both; many feel the greatest value is in trade secrets, how to scale up and manufacture products and services, but patents are the core seeds of intellectual property. Patents can be licensed to others for a fee, or be the basis for a product or service that is offered by the business. This is the single most critical decision any business makes.
MIT graduates have started up numerous venture capital funded businesses. The graduates created the MIT Enterprise Forum, bringing together science and engineering along with business skills, as a forum for networking and for education. Bart Stuck served on the Global Board of the MIT Enterprise Forum from 2004-2006; the global board has oversight over tens of chapters in the United States and elsewhere. Bart Stuck suggested that the MIT Enterprise Forum focus on early stage startups, getting panels of experts and investors to evaluate business presentations by startup teams. The Global Board turned this idea down; in 2008 CNBC launched Shark Tank following this format with a panel of knowledgeable investors bidding on investing (or not) in startups after hearing a presentation, and this has been a great commercial success.
The global telecom networks underwent massive innovation from 1990-2005, creating a broadband infrastructure or plumbing that could support myriad new software based applications. This in turn led to a revolution in venture capital, as the bulk of the money began to invest in lower risk software based businesses rather than higher risk hardware based businesses, and increasingly invested in software based service businesses.
Steve Blank developed three critical questions that any startup must answer: 1)what is the problem you are solving? if it is a real problem, and you explain to a potential customer that you have a solution to this problem, the test is WILL THE POTENTIAL CUSTOMER WRITE A CHECK ON THE SPOT TO PAY OR NOT, if NOT it is NOT a real problem, 2)how are you different from solving this from other ways that it might be solved, and do you have a sustainable differentiable advantage in this regard, others might copy you quickly to get 80% of what you can do and that is enough to wipe you out, and 3)how do you price your product or service? is there sufficient gross profit margin to generate profits that will sustain an ongoing operating business?
Some of the new technologies for the next wave of venture capital investment lie in materials (graphene, carbon nanotubes, carbon composite fibers, et al), in biomedical (using electricity and magnetism to stimulate the self healing properties of the body without drugs), in energy (photovoltaics, zero point energy, wind, superconductivity).
Here are some examples to back up those claims: 1)graphene when added to concrete in small amounts results in far stronger concrete with far less greenhouse gas contribution, 2)carbon nanotubes are moving to replace glass screens for phones and computers, 3)barocaloric materials (those that convert heat to pressure and vice versa) and magnetocaloric materials (those that convert magnetism into heat and vice versa) can result in cost effective air chillers and refrigerator/freezers, 4)nanofiber materials can result in bandages that stop bleeding immediately and then dissolve into the body over months, 5)gallium arsenide photovoltaics are 50% efficient vs silicon photovoltaics that are 20% efficient, and this can be coupled with heat pipes to provide a small footprint electric power generator that also provides hot water as a byproduct.
Venture capital funding in the US followed product development waves:
1a) electronic semiconductors in the 1960-1990s,
1b)photonic semiconductors in the 1990s-
2a) IBM compatible computer systems hardware and software 1960-2000,
2b)Minicomputer systems hardware and software 1970-2000,
2c)Personal computers hardware and software 1975-2000,
2d)Workstations hardware and software 1980-2000,
2e)Servers hardware and software, 1990-,
3a)electrical communications equipment 1970-2000,
3b)photonic communications equipment, 1990-
4)biogenetics, 1960-,
5)biomechanical devices, 1960-,
6)Internet software: 1995-,
7)Energy, 1980-
8)carbon materials (graphene, carbon nanotubes), 2000-
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