What is Venture Capital?
3 Things to Know about "VC" = Venture Capital
#1 Venture Capital Definition
Venture Capital is a fund, group, or firm targeting high-growth startups and early-stage companies. Venture Capital (VC) is an alternative source of capital, typically allocated on the private markets. Venture Capital has been around for hundreds of years in the form of "angel investing," but has become more mainstream with the advent of the stock market, and recent legislation in America such as the JOBS Act of 2012.
#2 Venture Capital brings a higher risk, but often a higher return on investment (ROI)
Here are some examples of some of the biggest Internal Rate of Return (IRR) and ROI for venture capital funds:
Among the most notable are Peter Thiel's investment in Facebook and Marc Andreessen's 312x return on Instagram, but there are others. Each year, angel investors and venture capitalists invest $25 billion in the U.S. and $3 billion in Canada. Though plenty of reliable information exists on how much of a return venture capitalists get, there's almost nothing to be found on angel investors. Fortunately, a recent study has been done on angel investors that can shed some light on the subject. The study was relatively comprehensive, analyzing 86 groups of angel investors throughout the U.S. encompassing 539 actual investors. Results of the study showed that the average angel investor received a return of 2.6 times the capital that was invested over a 3.5–year period. The internal rate of return on an angel investor's investments averaged a comfortable 25%.
Examples of Successful Venture Capital Investments
Peter Thiel' Investment in Facebook (ROI)
Peter Thiel's return on his Facebook investment is around 6,000 times what he put into the company. That's far more than what the typical angel investor can expect, but it's certainly not out of the realm of possibility. It's been done, and it's provable – it's just not common. Thiel got involved with Facebook in 2005, paying $500,000 and receiving a 10% stake in the company. Facebook was worth over $33 billion in 2010, so his stake would have been in the area of $2 billion to $3 billion at that time. In just a few years, he made a return on his capital that is unparalleled.
While that's one the best investment deals in history, it isn't the only major return that has been seen when an angel investor got involved in a startup that took off.
Marc Andreessen's Investment in Instagram (ROI)
With numerous filters and editing options that make photos more fun, Instagram changed the picture-taking experience by allowing every cellphone owner to become a professional photographer with a quick tap of a button. With its instant sharing across social media, Instagram created a platform for people to share their pictures across the globe. But the company, like so many others, was once a startup, struggling along and looking for investment money. In swooped angel investor Marc Andreessen, who ended up with an astronomical return on his original $250,000 investment. His return was worth $100 million. He made well above the 2.6x return common to many angel investors.
Kleiner Perkins and Google (ROI)
Another significant angel investing win was Google. Kleiner Perkins and Sequoia acquired a 20% stake in the search engine conglomerate for $25 million. Google's IPO was worth $27 billion, so the 20% stake became worth $5.4 billion. That's a return of 216x the investment. While it can't quite touch Peter Thiel's Facebook deal, it's a return any angel investor would be more than happy to make. These kinds of returns are becoming more common with tech startups, as it can be hard to tell what the next big thing is going to be. It might be something that starts out small, but suddenly snowballs into one of the biggest technological advances in history. Any investor would want to be a part of that.
Investing early, and making non–monetary contributions as well, can make angel investing an excellent choice for many venture capitalists. Still, having an idea of how well angel investors have performed in the past and anticipating how well any single angel investor will do in the future are two different things. There have certainly been angel investors who have lost money, just as there have been angel investors who have made their money back more than 100 times from a particular startup. It's about the company itself, and how well it will actually perform. Sometimes even the best, most educated assessments fail to be accurate.
#3 Venture Capital continues to grow rapidly.
We estimate that there are more than 10,000 new self-designated "venture capitalist" from the year 2000 until present.
There was an estimated $100 billion in venture capital allocations/investments in the year 2015. The amount of Venture Capital investments continue to grow about 5.7% each year. The amount of VC investments is growing faster than the rate of the GDP; the venture capital IRR is estimated between 15 to 25% - which outperforms the S&P's 5% average over 20 years.
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