Academic types, and I’m talking about the purists among my colleagues, have long been enamored with high growth companies (they call them gazelles, always with a whimsical tone in their voices) rather than small businesses (which they call life-style businesses, always with bit of a condescending tone). And if you read their text books and research articles on entrepreneurial finance, you would think that all entrepreneurs are funded through venture capital. The facts are that VCs have always played a very small part in entrepreneurial financing.
In a report in Inc.com on Kauffman’s GEM (Global Entrepreneurship Monitor) study, this bias comes through loud and clear. The article sounds alarm bells even in its headline “VC Money for Start-ups Continues to Dry Up: Report shows amount of investments in early-stage companies hit lowest level since 1980.” Is this evidence that our entrepreneurial economy is collapsing? The shrill tone of Inc.com’s report leads one to conclude that it may be true (I won’t go so far as to claim this is politically motivated by journalists or academics — I’ll leave that to the reader to decide).
“Small business owners looking for investors would do better with their time than to seek venture capital. According to a study by Global Entrepreneurship Monitor, of the $18.2 billion in venture capital invested in 2003, only $304 million was invested in seed- or start-up-stage companies, the lowest level since 1980.”
“Lowest level since 1980”?? It must be a crisis in the making! But to understand this data, we need to understand that venture capital has been evolving over the past twenty five years. Venture capital in 1980 was nothing like venture capital today. As the venture capital market became larger, more complex, and more specialized, the investment strategies pursued by its managers has changed in focus from start-up to later stage investment.
In its wake there came a growth in angel investment. Wealthy individuals who preferred investing in start-ups pursued these opportunities directly, while the venture capital funds attracted investors interested in lower risk second and third stage investments (that is, established companies with a track record needing capital for growth rather than start-up).
In fact, the GEM data shows this trend as reported by Inc.com at the very end of the article.
“The Center for Venture Research estimated that angels invested $18.1 billion in start-ups last year, up from $15.7 billion in 2002, and that there are between 250,000 and 400,000 angel investors in the country, as well as 1 million to 5 million potential angels.”
Markets work and markets evolve, even if they are capital markets. Venture Capitalists are, in fact, very busy doing what they have done for years: investing in growing ventures. And they are doing so, as this web log has reported, at a brisk pace in 2004. If small businesses are fruitlessly chasing VC funds, we can probably thank academics and the media who continue to give too much focus on venture capital and lead them down this blind alley. VC money is important, but has become specialized and focuses on a very small part of the entrepreneurial economy. Keep it in perspective and put it in context.
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