The venture capital industry drives U.S. job creation and economic growth by helping entrepreneurs turn innovative ideas and scientific advances into products and services that change the way we live and work.
Venture capitalists do this by providing the funding and guidance — and by assuming the risks — necessary for building high-growth companies capable of bringing these innovations to the marketplace.
Many venture capitalists come to the industry after successful careers as scientists, engineers, doctors or entrepreneurs. Working through tight-knit firms, they raise money from pension funds, endowments, foundations and high-net-worth individuals to form a venture fund. This fund is then invested in the most promising start-up companies (which become part of the VC’s “portfolio”), typically over the course of 10 years.
VCs focus exclusively on companies developing significant innovations — be it a new piece of software, a life-saving cancer drug, or a new model for consumer sales. Unless the company is poised for significant growth, a VC won’t invest. Making investments at the earliest stages of a company’s development — often before a product or service is more than just an idea — involves significant entrepreneurial risk, which severely limits capital sources for such companies. Yet, venture capitalists assume this risk alongside the company founders by providing capital in exchange for an equity stake in the company.
During this investment stage, venture capitalists provide more than just money to the company. Typically, VCs take seats on the boards of directors and participate actively in company operations and management personnel. This commitment often includes providing strategic counsel regarding development and production, making connections to aid sales and marketing efforts, and assisting in hiring key management.
As part of this process, the venture capitalist also guides the company through multiple rounds of financing. At each point, the company must meet certain milestones to receive fresh funds for continued growth. If the company fails to meet these goals, the VCs’ responsibility to their investors may require them to walk away.
The VC’s goal is to grow the company to a point where it can go public or be acquired by a larger corporation (called an “exit”) at a price that far exceeds the amount of capital invested. Approximately one-third of portfolio companies fail, so those that do succeed must do so in a big way. Typically, when a venture-backed company exits the portfolio, the VC distributes the profits to the fund’s investors and eventually leaves the portfolio company’s board of directors. Once all the investments of a particular fund have been exited and the proceeds have been distributed, the fund ends. In many cases, however, the institutional investors reinvest these earnings in a new crop of funds and the process begins anew.
These elements — the patience, the hands-on guidance, the willingness to take on risk and fail — make venture capital unique as an asset class and enable it to drive U.S. economic growth faster and generate more jobs than other asset classes. Historically it has helped set the US economy apart from our international competitors.