A Historical Overview of Venture Capital in U.S.

and
its Past Performance

Nousha Tajer Moshaei

Azadeh Daniali
Behrooz Ataee
 What is Venture Capital ?

 Venture capital is defined as “money made available for investment

in innovative enterprises or research, especially in high technology,
in which both the risk of loss and the potential for profit may be
considerable. Also known as risk capital.”

 Venture money is used to build a business in the expectation that

value of the resulting business will be much grater than the initial
investment.

 An important source of equity capital for start-up companies.

 Why use venture capital

 Provides a solid, flexible, capital base to meet future growth and

development of the start-up company.

 Returns to the venture capitalist depend on the success and growth

of the business, hence the entrepreneurs can relay on the vast
business network of the VCs.

 If the business runs into difficulty the VCs will work hard to ensure
that the company is turned around.

 VC funding is committed until exit (M&A, IPO, LBO, MBO –

usually 3-5 years).
 7 levels of research and planning for every startup

• Feasibility studies to determine whether a given venture should

be started.
• The preparation of the business plan for the seed round, and
subsequent rounds of investment and operation.
• Determining optimum debt and equity ratios, and developing a
financial plan.
• The development of an operational plan to get the project up and
running.
• Development of prospective funding sources for both debt and
equity.
• Preparation of project evaluation for both pre- and post-
investment analysis.
• Planning investor and owner exit strategies through M&A, IPO’s,
LBO, MBO, etc.
 History of Venture Capital

 In the fifteenth century, Christopher Columbus sought to travel westwards

instead of eastwards from Europe and so planned to reach India. His far-
fetched idea did not find favor with the king of Portugal, who refused to
finance him. Finally, Queen Isabella of Spain, decided to fund him and the
voyages of Christopher Columbus are now empanelled in history.

 In the 1920’s and 30’s, the wealthy families and individuals investors
provided the start up money for companies that would later become
famous. Eastern Airlines and Xerox are the most famous ventures they
financed. Among the early VC funds set up was the one by the Rockfeller
family which started a special fund called VENROCK in 1950, to finance
new technology companies.

 American Research and Development Corporation, formed in 1946. the

founder of ARD was General Georges Doroit, a French-born military man
who is considered “the father of venture capital”. In the 1950s, he taught at
the Harvard Business School. ARD was the first firm, as opposed the
private individuals, at MIT to finance the commercial promotion of
advanced technology developed in the US Universities. ARD’s biggest
success was investment in digital equipment corporation (DEC) in 1957.
 History of Venture Capital in US

Creation of American Research and Development (ARD) just after the

1946 second world war.

A law was passed by congress which allowed small businesses to

1958 borrow from the federal government at below-market interest rates.

A few wealthy individuals in California called “Angles” invested

1960’s money in private companies.
VC activity was depressed by a weak stock market, high taxation of
1970’s capital gains and a global economic recession.
Capital gains taxes were reduced from 49 percent to 28 percent, hence
1979 it encouraged investors making profits from investing in Venture
Capital firms.
The capital gains tax was further reduced from 28 percent to 20
1981 percent.
There were over 100 initial public offerings for the first time in U.S.
1983 some of 1983’s funding went to newly funded companies that are
today’s largest and most prominent firms*.
 Venture capital stages

 Early Stage:

 Seed Capital: primary for product development and market research. (seed
investing)

 Start-up capital: company has complete business plan, initial marketing begins.

 Expansion Stage:
Company is ready for business, but no commercial sales yet.

 Later Stage:
Invest in a company throughout the company’s life cycle: providing financing to help
the company grow to a critical mass to attract public financing through stock offering.
%Distribution of Investment
 U.S. Venture Capital Investment by Stage of Company Development

70%

60%

50%

40%

30%

20%

10%

0%
1997 1999 2002 2004

Early Stage Expansion Later Stage

 The Economic Impact of Three Decades of
U.S. Venture Capital Funding

Cumulative VC Sales of VC- Employment by 5-Yr Compound

Invested, Backed Firms, VC-Backed Firms, Annual VC
State 2000
1970-2000 2000 Growth Rate,
($ billions) ($ billions) (# of workers) 1996-2001
California 108.8 207.6 1,415,748 24.3%
Massachusetts 26 48.9 381,433 35.7%
Texas 17.2 158.2 676,158 29.8%
New York 16.1 65.9 369,314 33.1%
Colorado 9.9 14.6 62,971 32.1%
New Jersey 9.1 38.2 260,114 23.3%
Washington 7.4 75.4 263,585 20.9%
Virginia 7.2 35.7 207,777 14.5%
Pennsylvania 7.2 58 424,652 na
Georgia 6.4 62.8 338,188 34.5%
U.S. Total $ 273.3 $ 1,300 7,600,000 -
 Year 2000 Venture Capital and Stock
Market Capitalization, R&D, GDP

R&D
VC Stock Market R&D VC as Market
GDP Spending
Investment Capitalization Spending % of Capitalization as
($ Billions) ($ Billions) GDP % of GDP as % of
($ Billions) ($ Billions)
Country GDP
United States $9,152 $122.1 $16,635 $243.5 1.33% 181.8% 2.66%
United Kingdom 1,442 12.2 2,933 25.8 0.85 203.5 1.79
Germany 2,112 4.4 1,432 50.3 0.21 67.8 2.38
Canada 635 4.3 801 10.0 0.68 126.2 1.58
Israel 101 3.2 64 2.8 3.17 63.6 2.78
Italy 1,171 2.8 728 12.2 0.24 62.2 1.04
Hong Kong 159 2.2 609 0.35 1.38 383.3 0.22
Sweden 239 2.1 373 8.8 0.88 156.4 3.69
Japan 4,347 2.0 4,547 141.7 0.05 104.6 3.26
Singapore 85 1.2 198 1.6 1.41 233.7 1.85
India 447 0.5 148 2.3 0.11 33.1 0.51
 Venture Capital fund-raising worldwide

250

200

150

100

50

0
1989 1995 2000 2002

$billion
 Venture Capital Fund-raising

$ Billions

250
200

150
100
50

0
1996 1998 2000 2002

Asia Pacific North America World

World Investment and Fund raising
North America Investment and fund raising
Cumulative Investment
 Annual Venture Capital Investment in the U.S.

120

100

80

60

40

20

0
1990 1995 1998 2000 2002 2003

in billion $
 Average Investment Per Company

12

10

0
1995 2000 2002 2004

in million $
 Historical Trend Data-By Quarter

2004
2003
2002
2001
2000
1999
1998
1997
1996
1995

0 5 10 15 20 25 30 Billions $
Qtr 1 Qtr 2 Qtr 3 Qtr 4
 U.S. Venture Capital Investment by Industry:
1998 - 2003

Industry 1998 2000 2002 2003

Computer Software & Services 21.6% 14.0% 17% 19.4%

Networking & Equipment 13.4% 46.4% 14.4% 7.9%

Biotechnology 5.2% 2.7% 12.1% 20.7%

Telecommunications 17.6% 17.1% 11.6% 11.7%

Consumer related 6.9% 1.6% 7.2% 3.3%

Semiconductor 4.2% 5.9% 6.9% 4.1%

Medical Devices & Equipment 12.8% 3.5% 6.6% 8.9%

Media & Entertainment - - 5.6% 5.0%

Computer Hardware 3.1% 2.2% 3.8% 4.0%

Industrial / Energy 2.4% 1.4% 4.5% 3.8%

Other products 12.7% 5.1% 0.7% 11.2%

Total ( $ Million) $18,705 $102,976 $21,400 $18,200

 Venture Capital Funding in Information Technology

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%
1998 2000 2002

% of total
High-technology investment trends
Top 20 countries based on high-tech investment
 Venture Capital Fund-raising sources 1979-2000

Sources of Funds 1979 1983 1987 1991 1995 1999 2001

Private Pension Funds 31% 26% 27% 25% 38% 9% 42%

Public Pension Funds a 5% 12% 17% a 9% a

Corporations 17% 12% 10% 4% 2% 16% 4%

Individuals 23% 21% 12% 12% 17% 19% 8%

Endowments 10% 8% 10% 24% 22% 15% 23%

Insurance Companies & Banks 4% 12% 15% 6% 18% 11% 23%

Foreign Investors & others 15% 16% 14% 12% 3% 22% na

Independent Venture Partnerships as

na 68% 78% 80% na na na
a share of total Venture Capital pool
 Law Origin vs. VC Performance

Venture Capital Stock Market

R&D Spending
Legal Origin Investment Capitalization
Country
Nation’s Commercial Code As % of As % of As % of
Ranking Ranking Ranking
GDP GDP GDP

Israel English common law 3.17% 1 63.6% 16 2.78% 4

Singapore English common law 1.41 2 233.7 3 1.85 11

Hong Kong English common law 1.38 3 383.3 1 0.22 20

United States English common law 1.33 4 181.8 5 2.66 5

Sweden Scandinavian law / Civil 0.88 5 156.4 7 3.69 1

France French civil law 0.34 10 103.0 11 2.21 8

Switzerland German law / Civil 0.23 14 268.0 2 3.12 3

Japan German law / Civil 0.05 20 104.6 10 3.26 2

Average, English common law countries 1.14% - 166.4% - 1.60% -

Average, all civil law countries 0.31% - 105.0% - 2.10% -

Top 20 countries – based on investment
Top 20 countries – based on growth
1998-2002
Top 20 VC countries (Total VC Investment)
 Annual Rate of Return to Investors in U.S VC Funds, (1974-1999)

160
140
120
100
80
60
40
20
0
1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 1999
-20

% Return
 The pricing of Venture Capital Investment

FV=A(1+r)n % Equity = FV/ Exp MV

%Equity= % of equity that Venture

FV= Future Value Capitalist will receive
A= Initial Investment Amount FV= Future Value
r= required return Exp MV=Expected Market Valuation
n= investment horizon, (years)
 Asia Pacific Region Venture Capital Investment

12

10

0
1995 2000 2002

$billion
Asia Pacific Investment and Fund raising trends
Asia Pacific
 Reasons for low VC investment in Asia

 Lack of the basic legal and accounting infrastructure

 Lack of an efficient IPO market

 Characteristics of a successful VC industry

 A tradition of entrepreneurship & risk-taking.

 A well- established legal system, with good investor protection.
 A supportive, but non-interventionist, government.
 A stable regulatory system, that doesn’t penalize start-ups.
 A free (and mobile) labor market, rich in engineering talent.
 A non-punitive taxation regime that allows use of stock options.
 A strong R&D culture especially in Universities or national labs.
 A vibrant IPO market, though this could be a result, rather than a
precursor of a strong VC industry.
 A risk-tolerant pension system.
 Why Use Venture Capital in Iran

 Iranians contribute more than $6 billion per year to high technology

industries in United States ~ 25% of Iran’s Oil Revenue
 In 2003, all 15 Sharif University PhD students who participated in
Engineering School Doctoral Exam at Stanford University passed the exam.
No other university in the world could claim such achievement.
 No.1 student in the exam was from Sharif University, Abtin Keshavarzian.
 75% of population below 30 years of age (~ 55,000,000 people)
 15.7% official unemployment rate (~25% if taxi agency drivers are included)
 1.6 million official number of collage students.

This mental power of expatriates should be absorbed back into Iran’s

industry and academia.
 What we can do for developing a VC industry
in Iran?

1. IP protection strategy

2. Transfer of investment practices know how

3. Establishment of an investment bank support unit

4. Creation of financially streamlined corporate structure

5. Creation of synergic new business models

6. Creation of win-win business development practices

 Data Sources

• “Synergetic Combination of Idea, Capital, and

Management”, by Behrooz Ataee, in the First IDRO
Conference of Human Resources Development, October 25-
26, 2003

• The Pricewaterhouse Coopers/Venture Economics / National

Venture Capital Association MoneyTree Survey
www.pwcmoneytree.com

• “Toward A Global Model of Venture Capital” by William

L.Megginson, University of Oklahoma