Venture Capital Redefined

The first chapter focuses on the definition of venture capital and its characteristics. It provides a brief overview of venture capital and its underlying concepts that serve as a reference point throughout the entire book. Specifically, the chapter focuses on a number of specific discussion segments, the first of which includes the discussion about where venture capital financing fits into the entrepreneurial finance ecosystem. Secondly, the first chapter provides an overview of the historical trends in the global venture capital industry over the last 20 years. Thirdly, the chapter provides background discussion of venture capital returns in the context of the “promise” made to capital providers (i.e., LPs) by venture capitalists. This section also discusses the maturation of the venture capital industry. Lastly, the chapter ends with a summary of venture capital in the pre-COVID era and the significant, fundamental challenges that the venture capital industry has faced prior to the post COVID era.

The second chapter provides background information on the political reactions and socioeconomic consequences of COVID, as well as a general discussion regarding the implications of these restrictions on venture capital. When the novel coronavirus initially appeared, the vast majority of political leaders and public officials around the globe moved to implement a range of restrictive public measures, mandates, and orders. Although public officials aimed to introduce some measures to counteract the effect of these restrictions, the social, economic, and human consequences of these restrictions are massive. The small and medium-sized enterprise (SME) sector was one of the hardest-hit segments of the economy. In terms of human cost, however, these restrictions have also negatively impacted mental health. Drawing on this important background analysis, the second chapter begins a discussion of the direct and indirect impact of political, social, and economic changes on the venture capital industry, which will be continued in more detail in subsequent chapters.

The third chapter describes the fundamental building blocks of the venture capital ecosystem, which is inherently complex. In spite of its complexity, the existence of the venture capital ecosystem relies on a delicate balance between different stakeholders in the system. If this delicate balance is upset, longer term and more profound changes in the industry are likely to emerge, which have also been visible prior to COVID-response and have beset the industry for some time. The chapter also outlines how COVID-response has redefined personal relations. Since venture capital is a people-centric business, restrictions have affected virtually every aspect of fund managers’ interaction with entrepreneurs and limited partners. The chapter also extrapolates what venture capital may look like in the future and describes that the venture capital industry would evolve through a number of stages, which include global consolidation of GPs partners (i.e., growing emergence of mega-funds), global pooling of LPs (i.e., emergence of global LPs), and the development of more futuristic structures based on the complete digitization of the investment process and the wide-ranging disintermediation of GPs.

This chapter broadly focuses on the major external undercurrents, which have emerged post COVID-response. These trends are likely to impact venture capital in terms of existing portfolio firms and new investment opportunities. The six major trends detailed include changes to industrial structures, alterations to consumer behavior, mass digitization, the increased role of home as a center of human gravity, public health apprehensions, and the abolition of the middle class in developed countries. This chapter also illustrates investment opportunities in specific segments of the economy related to these major trends. Lastly, the chapter discusses the likely sources of venture capital transactions in the COVID era, which may consist of the privatization of state firms, disposals from major multinationals, and founders.

This chapter explores the changes to the venture capital investment process post COVID-response. Normal patterns of venture capital daily operations, deal processing routines, regular habits of communication, and other tacit behaviors that were previously established in the pre-COVID era have been disrupted. COVID restrictions have affected the venture capital community differently from country-to-country, although during March and April of 2020, the venture capital industry as a whole went into a retreat-and-hide mode. In most countries, the situation improved in June, but by the fall the venture capital community understood that it would not be able to engage in its normal processes in the foreseeable future because of the strict COVID-response measures that emerged. This chapter discusses many dislocations to normal patterns of processing venture capital deals, as well as the challenges experienced within each stage of the investment process (i.e., deal generation, evaluation and screening, financial contracting, monitoring, and exiting).

The this chapter suggests what venture capital performance could look like in the future. The chapter begins with a discussion of fund formation and the provision of capital by limited partners (LPs) to the venture capital ecosystem. This section stresses that LPs can contribute to the deterioration of financial performance by providing capital to suboptimal general partners (GPs), performing poor due diligence on funds, tolerating limited access to information, and so on. The chapter subsequently discusses the cost of “carried interest” and the provision of venture capital services to LPs, which are two of the most expensive components within the LP-GP arrangement. Moreover, the chapter examines the value chain-analysis, provides another historical look at venture capital performance, assesses the industry’s performance prospects in the context of a longitudinal analysis, and outlines the profiles of superior and inferior GPs.

One of the most important components of the venture capital ecosystem is the small and medium-sized (SME) sector, which was one of the hardest hit segments of the economy. Many entrepreneurial firms were left financially devastated. The seventh chapter concentrates on the entrepreneurial crisis; evidence suggests that up to 80 percent of firms were affected, with about 40 to 50 percent of firms impacted so severely that they were unsure of business survival. Furthermore, the harm to the SME sector was indirectly related to the firm size (i.e., larger firms were less impacted by COVID-response). While firms from the SME sector are typically flexible and agile in their ability to pivot and generate revenue through different streams, their capacity to respond was thwarted by the speed and strictness of public restrictions. The negative impact of public restrictions has also affected different market segments to varying degrees.

Entrepreneurial firms have been critically impacted post COVID-response in key areas of financial management, including liquidity, capital budgeting, financial forecasting, capital structure, and valuation. One of the most severe impacts came from a severe decline, or a complete loss, of revenue. The combination of revenue decline or loss with high fixed costs of business operations has directly impacted the profitability, cash flow, and liquidity of firms. Moreover, these challenges to the businesses’ financial parameters have negatively influenced the value of entrepreneurial firms. The chapter also focuses on another critical finance-oriented area, namely access to finance.

The closing chapter of the book focuses on the most fundamental question of whether the venture capital industry’s current situation would lead to its revival or ultimate decline. The case for the descent of the venture capital industry is strong as there are many destructive undercurrents for the industry now and in the future. These negative trends represent a cascading effect through the entire venture capital ecosystem. But, of course, there are conditions, the fulfillment of which would lead to industry revival and revitalization. The chapter also discusses the industry in terms of its key statistics in the context of three stages in the anticipated evolution of the industry.