editione1.0.2
Updated February 11, 2023While venture capital enables company expansion that is far less possible with other methods, there are many vehicles and strategies for funding an early-stage company, not least boot-strapping, which is the art of rapidly creating customer revenues that fuel the growth of the company. As we examine who can access venture capital in the modern era and look at those who are invariably excluded from the wealth that venture-backed businesses can create for entrepreneurs, their families, investors, and the communities these players belong to, we acknowledge just how skewed the industry is towards nurturing and perpetuating its existing flywheels. The consequences of these flywheels are explored in this book, along with the substantial returns available from historically overlooked market segments. Investors are missing opportunities for higher financial returns by undervaluing high-performing companies led by diverse groups or by overvaluing white-male-led firms. Moreover, capital allocators may well be infringing their fiduciary duty to generate the most significant possible returns for their investors by not investing in diverse companies that could produce returns as high or even higher than white-male-led companies they are most familiar with backing.
Venture capital (VC) is invested by general partners in venture capital firms, who use their domain expertise to allocate high-risk capital into entrepreneurial ventures to generate significant returns on behalf of limited partners, who are most commonly pension funds, university endowments, state funds, foundations, and insurance companies, who do not usually act as direct investors in startup companies. Venture capital firms are compensated in two ways: annual management fees (usually 2% of the capital pledged by limited partners) and “carried interest,” which is a percentage of the profits created by an investment fund (typically 20%). VC funds usually have a lifespan of seven to ten years, and the corporations that fund them frequently manage many funds simultaneously. In terms of payoffs, the venture capital model differs from other types of financing. Returns for venture capital investments do not often follow standard distribution curves but are skewed. The majority of the aggregate return is generated by a few exceptional investments, such as Tesla, Microsoft, Meta, Google, or Oracle.
Funding of this nature has proven pivotal for disrupting the way we work, produce, and live, as technology evolves and advances by investing in high-tech companies that promote the development of industries, support innovation, and drive economic growth. The benefits to society over the years have been described as immeasurable, while the casualties created by technological changes that disrupt labor markets and increase inequity are cited as necessary evils that are far outweighed by the essential innovation that leads to competitive advantage, productivity gains, and increased economic growth over the longer term. Yet, what are the long-term effects of capitalism at all costs? The cataclysmic impact on the environment, society, and governance structures over time are leading all too often towards climates in which wages are depressed as businesses compete on the price, over the quality, of goods; where unskilled workers are incentivized with punishments, over promotions; and where bubbles expand and eventually burst, usually to the detriment of those who are already the most vulnerable in society. Time and time again, these results demonstrate that existing models are not fit for purpose as inequality preponderates and poverty expands. Thus, were these premeditated, globalized, and impeccably organized models ever fit for purpose, or is a shift to a more sustainable modus operandi long overdue? Answering such a question effectively relies on accurate knowledge and examining the foundations upon which venture capital was built.
Contrary to popular belief, the earliest forms of venture capital can be found long before the whaling industry took off. Other popular maritime money spinners, more commonly known as the transoceanic spice, tea, and slave trades, were instrumental in the creation of several innovations that shaped both modern venture capital and the systems it is inherently reliant upon, such as insurance, productization, leveraging equity and debt, economies of scale, high-risk, high-reward financing, and many more.
Venture capital has been widely accepted as existing in one form or another since the earliest forms of commercialization. Scholars, such as Harvard historian Tom Nicholas in his VC: An American History, have accredited the first venture capital style investments to whaling, the transatlantic voyage of Christopher Columbus, and Georges Frédéric Doriot, who is seen as being the first venture capitalist to raise money from non-family sources—believing there was a strong business case for investing in entrepreneurs with the vision and acumen to create a future not yet imagined. Among each slightly varying narrative about how venture capital has evolved through the ages, from the financing of whaling ships that were to set sail on perilous waters, carrying precious cargo from one port to another and emblematic of Moby Dick; to the underwriting of risky expeditions leading to the discovery of new territories; and the founding of Doriot’s American Research and Development Corporation (ARD) in 1946, the belief in an entrepreneur to execute the completion of tasks in which there is a high probability of failure and the promise of outsized returns if successful is the golden thread running through a complex and intricate tapestry of events.
Most fascinating is that the invention of venture capital is often ascribed to Americans—despite Doriot being French—with much of the activity being focused on post-World War II exploits. The “VC is an all-American invention” narrative essentially negates the part that the Europeans, mainly the British, played in the formation of venture capital and sweepingly omits the transatlantic slave trade, which was the predecessor of the whaling industry and the foundation for the insurance and banking industries to which venture capital has been intrinsically linked and remains heavily reliant upon today.