When it comes to innovation, funding is often the key factor that makes or breaks a fledgling idea. And in a troubled sea of startups, the backbone of that funding over the past 75 years has been venture capital. It has been behind the most important technological advances of our time, from personal computers to artificial neural networks.
So let's refresh your memory and take a 5-step tour through the history of venture investing, including the heyday of Silicon Valley, the dot-com bubble, and the unicorn boom.
Although private equity (PE) can be dated to the 19th century, venture capital emerged only after WWII.
High-risk investing started in the 1940s-1950s with the founding of the American Research and Development Corporation (ARDC) by Georges Doriot. Doriot, now known as "the father of venture capital," saw the potential of investing in startups that were too audacious for conservatively-oriented banks or investors.
ARDC’s team took a leap of faith by allocating funds to aerospace, semiconductor, and alternative energy industries and X-ray technology for cancer treatment. The latter was in the hands of High Voltage Engineering, founded by MIT professors. The company received $200,000 from Doriot, which then turned into $1,800,000 after it went public in 1955.
Another of the many success stories was ARDC's investment in Digital Equipment Corporation (DEC) in the late 1950s, which became the legendary one. DEC grew into a significant player in the computer industry, and ARDC's funding returned more than 5,000 times its original value in just 14 years.
Another major development was America’s adoption of the Small Business Investment Act of 1958 and the inception of the Small Business Investment Companies (SBIC). The act's passage was partly motivated by the launch of the Soviet satellite, which alarmed the US Congress and advanced investment in America’s small businesses.
Many market participants believed that the SBIC program was overly bureaucratic and failed to incentivize innovation requiring risk-taking. However, prominent pioneers later acknowledged that this legislative framework paved the way for subsequent efforts to create a more professional and organized VC industry.
Back in 1969, if the entire San Francisco venture capital community got together for lunch, the group would be no larger than 20 people. So how did Silicon Valley become the center of gravity for the global venture business?
A combination of factors played a role. Before WWII, the northern part of the East Coast was the dominant region in terms of investment because of New York’s and Boston’s technical expertise and capital.
But California's sunny climate and increased federal funding to its universities' engineering departments helped the region to gain competitiveness. In addition, the West Coast had a culture that valued young engineers and bankers who could run and finance companies. So astute venture capitalists began to migrate westward.
What came next? Remember these names: Davis and Rock, Draper and Johnson Investment Company, Mayfield Fund, and Sutter Hill Ventures. All of these pioneering VC firms believed in innovation and people, and all of them laid the groundwork for the Valley — and the world.
Thanks to pathfinders, Silicon Valley evolved into the hub of innovation and venture capital in the 1970s and 1980s. Firms like Kleiner Perkins and Sequoia Capital emerged, backing companies like Cisco, Apple, and Intel. During this period, venture capitalists became more than just investors: they also became advisors, providing guidance and expertise to help portfolio companies grow.
Fast forward to 1992, and we have 48% of all investment dollars on the West Coast of the United States, with the Northeast enjoying only 20%.
The laws have continued to evolve. In addition to the US Small Business Investment Act mentioned above, in 1978, the federal government amended the Revenue Act to reduce the capital gains tax from 49.5% to 28%. Then, in 1979, the Employee Retirement Income Security Act (ERISA) was revised — allowing US pension funds to invest up to 10% of their total funds in the industry. A few years later, in 1981, the capital gains tax shrunk to 20%.
These legislative improvements catalyzed venture capital growth, and the 1980s was the peak. In 1987, for example, venture funding reached $4,9 billion.
In the mid-1990s, the Internet and personal computers made things even more encouraging for the venture industry. Ground-breaking projects like Amazon, Yahoo, and PayPal hinged on venture money, and everyone believed in "new millennium companies." By the beginning of the 21st century, the VC sector boasted over 230 operating firms running about $70 billion.
Then the dot-com crisis occurred. It went down in history as one of the greatest economic upheavals due to an exuberant revaluation of the assets and prospects of Internet companies.
The 2008 financial crisis also reduced risk appetite, but the emergence of unicorn startups has brought investors back to life.
In 2013, for example, venture capitalist and Cowboy Ventures founder Aileen Lee analyzed over 60,000 promising companies and found only 39 startups worth at least $1 billion. By mid-2022, there were 1,312 unicorns, according to Hurun Research Institute. Their combined value is $4,2 trillion — a staggering amount comparable to Germany's GDP.
Now unicorns are born every day, and many are used almost daily, be it Twitter or Airbnb. Decacorns also appeared — projects valued at $10 billion or more. These are the high-profile, fast-growing giants like Dropbox, SpaceX, WeWork, and Uber. And don't forget the hectocorns such as ByteDance (owner of TikTok), whose capitalization has already surpassed the $100 billion mark.
These superstars will only keep multiplying: each mega-success spawns new promising ones. Data analytics firm Dealroom and VC fund Accel report that former employees of Europe's 61 fintech unicorns have collectively launched 310 new startups.
As scale grew, so did the complexity of the industry — and eventually, venture capital in its modern guise was molded. The field was divided between angel, seed, and growth investors. Among angel investors, angel operators stood out. Unconventional forms of venture capital emerged, including hedge and mutual funds, and crossover and corporate investors. Lastly, accelerators and incubators were bred.
Based on the National Venture Capital Association’s estimates, it can be assumed that the VC market exceeds one trillion dollars and comprises ten thousand funds and firms. Even so, the venture industry needs to be revitalized to continue expanding and reveal its potential.
One of the biggest challenges facing VC today is the need for more diversity. Just one example: only 7% of partners of the top 100 venture firms are women, and investments in female-founded startups are seven times less likely to occur, TechCrunch claims. And we're not even talking about discrimination based on nationality, religion, and health. Perception bias influences people who make investment decisions and, therefore, the types of companies that will receive funding.
Another critical area of focus should be impact investing, which focuses on social and environmental issues. One more challenge to the VC market is the surging competition for deals. As more and more individuals and firms enter this realm, the demand for deals grows, leading to higher valuations and ferocious competition for the best startups.
These are just a few of the bottlenecks. In other words, the industry must evolve to remain successful. At the end of the day, the best venture capitalists are those who have the humility to acknowledge that things will change and that they need to change along with them.
Cover image: Unsplash
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