Venture Capital History From Venice and Maritime to the Us and the 2008 Crisis
The Advantage of Loan Over the Shares in Financing
For a long time in the history of capitalism, entrepreneurial activities were financed through loans or credits. The following are some of the reasons why loans were preferable over buying stocks:
- Lack of transparency in executive and financial operations (revenue, profits generated, etc.) and inefficient informational systems to track company operations. In other words, there was no way for investors to ensure the proper and efficient use of capital.
- Corporate structure with unlimited liability. In this structure, in the event of bankruptcy, investors were responsible for refunding all obligations. It’s like the guarantor partners in a company with a partnership structure)
Therefore, the investor used to prefered to provide the loan in exchange for the borrower’s obligation to repay on a specific date rather than buy the company’s shares. Regardless of the company’s status, the founders had to reimburse the amount received on the specified date.
The Limited Liability Companies Approval
In 1811, for the first time, the government approved the limited liability structure in New York City. Consequently, the capital was transferred to manufacturing companies in exchange for shares. Hence, some believe that New York City has been the heart of financial capital ever since.
Prior to this event, financing was primarily through loans. The first type of venture capital investment was about long sea voyages. In this investment ship captains were the first entrepreneurs. Shipowners, on the other hand, were the first venture capitalists.
Shipowners, trusting the captain and accepting risks such as piracy and hurricanes, put their capital at the disposal of the ship’s captains. The captain was, in fact, the founder who need capital (ship) to set up the business.
The First Contracts Between Venture Capitalists and Entrepreneurs
However, it is not surprising that the first contracts between venture capitalists and entrepreneurs were in Venice:
“The most famous of these contracts was Commanda, a start-up corporation credited solely for a business mission. The command consisted of two sides: The resident side who stays in Venice, and the passenger side who travels. The resident party was responsible for financing, while the passenger side accompanied the cargo. If the capital were joint, the resident party would provide most of it. In this way, young entrepreneurs who did not have wealth could enter the business. They could travel with merchandise, which was pivotal to moving to higher social ranks.
Each loss was divided according to the amount of capital provided by the partners. If the trip was profitable, the distribution of benefits was different depending on the type of command. If the command was unilateral, the capital’s principal, together with 75% of the profits, belonged to the resident party. However, if the financing were reciprocal, the resident would provide 65% of it and receive half of the profit.” Daron Acemoglu said in his book “Why Nations Fail.”
Entrepreneurship Renaissance and the First Venture Capital Fund
If we go back decades, we find that innovative technologies belonged to two categories: large monopoly companies and wealthy families. On the other hand, events such as the global economic downturn in the late 1920s and World War II led to an atmosphere that had little to do with entrepreneurship.
Shortly after World War II, an educated generation of ex-US soldiers entitled to benefits such as tuition under the Servicemen’s Readjustment Act of 1944 were the founders of the entrepreneurial renaissance.
The history of the venture capital industry goes back to the American Research and Development Company in 1946. A renowned professor of Harvard School of Business, Georges Doriot owned the company. Professor Doriot had $ 3.5 million in funding, $ 1.8 million of which came from nine institutional investors, including Umayyad University, the University of Pennsylvania, and Rice Corporation.
George Dorothy is the father of venture capitalism, to the extent that the school of Doriotism can be recognized as the first school of its kind.
Tax Breaks for Private Equity Firms
Another event that helped the industry grow and expand was the passage of the Small Business Investment Act in 1958. The bill led to tax breaks for private equity firms, and with its passage, venture capital firms were created with expert management to sponsor entrepreneurs.
The passage of the bill, as well as the establishment of NASA and DARPA, were solid response to the US launch of the Sputnik satellite by the United States. Although the program failed, it enabled young management teams in the United States to build their own businesses. It helped them to make significant advances in technology risk assessment.
Following the bill’s passage, 585 Small Business Investment Act licenses were approved between 1960 and 1962, representing $ 205 million in committed capital.
Among the companies that managed to raise capital from the first venture capital firms are Intel, Xerox and American Microsystems. In fact, in the 1960s and 1970s, computers, electronics, and data processing flourished, and venture capital firms played a very important role in financing these risky activities.
As this trend continued, it became more and more aware of financing for start-up businesses in the field of technology. That continued to the point that this type of financing became the primary way of funding for these companies.
The Result of a Study by Paul A. Gompers in 1995
Before 1979, the US Department of Labor severely restricted pension funds in allocating funds to high-risk investments, such as venture capital funds. In 1979, the government allowed fund managers to invest more than 10% of their capital in venture capital funds.
In the following years, the liabilities of pension funds to finance venture capital funds increased significantly. “From $ 100 million to $ 200 million in the 1970s to more than $ 4 billion in the late 1980s.”
The start-ups that managed to raise capital at that time were Compaq, Intel, McAfee, Hotmail, Skype and American Online, which emerged at the height of the growth of the Internet age.
In the ’90s and the era of .coms, venture capitalization experienced a unique and pleasing period. At first, there were many opportunities to invest in start-up companies with the exit strategy through the initial public offering in the stock market. However, soon the bubble exploded and caused irreparable damage.
The Role of the.Com Bubble and the Global Financial Crisis in the Venture Capital Industry
The amount of committed capital and the size of venture capital funds (the “size” means the amount of money available for investment) between 1978 and 1994 had almost a logical and increasing trend. However, between 1998 and 2000, with the rise of Internet-based companies such as eBay and Amazon, there was a sudden and rapid growth. Then in 2001 and 2002, it fell sharply due to the bursting of the .com bubble. This sudden decrease also happened in the number of investment cycles.
The rate of decline decreased in the following years. However, with the onset of the global financial crisis, it experienced a sharp decline again in 2008 and 2009. Studies in 2007 show that the number of venture capital funds has increased eightfold since the 1980s. The industry also has 8,900 people who manage more than $ 255 billion in various stages of venture capital. Studies also show that the number of venture capital funds this year is 200 less than in 2001. This means that these numbers had been dissolved after the .com bubble burst.