What is venture capital? If you’re asking this question, you’ve already come farther than you think. Venture capital, often just referred to as “VC” for short, is an essential term to know for any conversation about startups or startup investing. In short: it’s how the majority of startups today get funded and it’s a big part of how entrepreneurship works. But, let’s dig in a bit deeper to understand where it came from, why it’s important and how it became what it is today. What most don’t know is that there’s a secret just waiting to be discovered that’ll forever change who can play the venture capital game.
What is venture capital?
Venture capital applies to small businesses and startups. Startups have stepped into the spotlight in the last few years and are widely recognized as drivers of innovation – and, sometimes a bit of drama. We see investors pummeling entrepreneurs with questions on Shark Tank, the fast rise of tech giants from startup to ‘unicorn’ (meaning: a $1B company) in a matter of years, and how the sharing economy (think: Uber, Airbnb, TaskRabbit, Kickstarter) has changed the way we live forever. New technology that disrupts the status quo is a ‘not if, but when’ scenario. Yet, who understands how these startups get their start in the first place? How do they get funded? Better yet, who funds them? If we think about the impact startups have on our world, it’s pretty clear to imagine the influence startup investors have on the future.
Investopedia defines venture capital as:
“… a form of private equity and a type of financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential. Venture capital generally comes from well-off investors, investment banks and any other financial institutions.”
This definition brings another term into the mix that’s intrinsically linked to venture capital: private equity.
What is private equity?
To understand venture capital, it’s important to know what private equity is. Because, even for those familiar with the terms, they can be easily confused.
Again, Investopedia helps us out with a breakdown of the differences between private equity and venture capital. But, to put it simply: private equity is one step broader in definition than venture capital. Another way to put it is that venture capital is a subcategory of private equity. While venture capital refers to money given to startups, private equity refers to money invested in a private company. Meaning, a company that has not yet gone public – aka, had an IPO (Initial Public Offering) – is funded with private equity.
private company = private equity
Terms defined, check. Now, for some more context to understand not only what venture capital is, but how venture capital works.
And, in case you need a little nudge as to why all this matters, think about this: the idea that big corporations drive the economy is a myth. And, Pitchbook has the data to prove it:
“Because the private markets control over a quarter of the US economy by amount of capital and 98% by number of companies, it’s important that anyone in any business capacity—from sales to operations—understands what they are and how they work.”
A brief history of venture capital
The concepts of venture capital and private equity are not novel or unique to our times. They date back hundreds of years. Columbus even employed these tactics when trying to get his famous voyage funded.
But, it wasn’t until 1946 that venture capital as we know it took shape when Georges Doriot (oh hey, that’s where Doriot comes from!), or the ‘Father of Venture Capital’, founded the American Research and Development Corporation (ARDC). With soldiers returning from the war, Doriot saw a need to help fund companies founded by war veterans. In part, the ARDC was his innovative solution to make that happen, but was also a means to a greater end: funding any private business via private investment. This set the tone for an entirely new way to invest with more of a grassroots feel. Before then, investing in companies was only done by the ultra rich (which is, unfortunately, still mostly how it is today).
The ARDC’s investing strategy drew national attention with it’s highly successful investment in Digital Equipment Corporation (DEC) in 1957. A year later, the US Small Business Administration enacted the Small Business Investment Act of 1958 to give better access to financing for small businesses and drive US innovation and technology in the midst of the Cold War. (There was a very real concern about Russia dangerously out-innovating the US.)
California stole the show in the 1960s & ‘70s, with the emergence of Silicon Valley and venture capital funds. This fund structure – a firm managing investments on behalf of investors – still exists today. Venture capital played a major role in the dot-com boom and most modern big tech company successes. It’s now common practice for young companies to ‘sell’ part of their company by giving equity to venture capitalist investors in exchange for the necessary capital to launch their business.
The evolution of venture capital
Today, venture capital is going through the next phase of its evolution. And, while the game has been dominated by the wealthy and connected, there’s an opportunity to bring it back to its roots and make startup investing accessible to all.
The SEC – the governing body for venture capital investments – has changed the rules. Prior to 2016, only ‘accredited’ investors who met certain criteria could be startup investors. But today, a new class of investor exists: a ‘sophisticated’ investor. This effectively opens up venture capital to the majority of Americans, officially, for the first time in history. Talk about game changing! There’s a catch: you have to prove that you have the knowledge and/or experience to be a startup investor. Learn more about this in our post about learning how to become a venture capitalist.
Startup investing: a risky, but lucrative game
Startup investing has a reputation for being highly risky. This is rooted in truth. It is the definition of ‘high risk, high reward’ because there’s also the chance for impressive returns. If you’re lucky enough to win big, it blows even the highest potential stock market returns to the moon and back.
But, what if we told you it’s not about luck? And, that there’s a proven strategy to mitigate risk when investing in vetted, high potential startups?
It’s called diversification and it’s real. So, why aren’t more people doing it?
Even though the SEC opened up the playing field, the players haven’t been prepared or recruited. Even though the financial barriers to startup investing have been shattered, – with crowdfunding equity platforms allowing people to invest with as little as $10 – there’s hardly any educational resources to qualify ‘sophisticated’ investors.
This is where Doriot steps in. We believe in a future in which everyone has equal access to opportunity in the entrepreneurial economy, and this starts by educating and empowering the next wave of entrepreneurs and investors. We’re on a mission to make startup investing simple and accessible to all. Join the movement and change your future. Invest in disruption and create the new economy. Play the game the elite have been playing for decades.