Venture
Capital exists to fill a niche market for financing new, potentially
high-growth firms. These firms may be unable or unwilling to seek other means
of finance however Venture Capitalists provide both financing and management
expertise to firms in order to facilitate growth and gain a return on their
investment. Although this sort of financing has likely existed in some form or
another since the beginning of commercial activity it only rose to prominence
in the United States after 1940. Primarily this was because the legacy of the
Great Depression and Second World War left Venture Capitalists in America with
an unprecedented opportunity for financial success.
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| Seed Investment |
During the Second
World War the United States government facilitated huge investment in technological
research and development in order to create advances that arguably eventually won
the war. This was crucial for two reasons. Firstly it created a link between
Universities and firms. When seeking to commercialise innovations after the war
Venture Capitalists would exploit this link by having prominent scientists and
academic figures on their board. The heightened awareness of academia to the
potential commercial value of their innovations was crucial in starting the
Venture Capitalists movement. Secondly the financing during World War Two had
created a huge number of innovations with commercial value that hadn’t yet been
put on the market. Regulatory changes left traditional financing unsuitable to back
these innovations and therefore left a gap in the market for Venture
Capitalists to fill.
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| Scientific Advisory Board |
Regulatory
changes following the Great Depression castrated the power of traditional banks
to provide finance to this new wave of innovations. Restrictions on bank
lending and the ability of banks to take equity stakes in investments left the under-capitalised
entrepreneur unable to gain finance from banks. It also feasible that following
the liquidity crisis of the 1930s the banks would be particularly reticent in provided
fledgling firms with long-term largely illiquid investments. Furthermore the costs
of monitoring and even screening the wave of new innovations made investment uneconomic
for the major banks. It was into this gap that the Venture Capitalists poured.
SEC Regulations
Finally the
legacy of the Great Depression provided a huge impetus for Venture Capitalists.
During a decade of stagnation a large number of innovations had gone underfinanced.
These, added to the innovations created throughout World War Two, left the Venture
Capitalists with a sizeable number of attractive investments to choose from. In
addition, in order to avoid the country falling back into economic depression Congress
based the GI Bill allowing returning soldiers free tuition for American Colleges.
Following graduation this generation provided an unprecedented number of
skilled and educated workers who could provide further innovations that would
primarily be funded through Venture Capitalists.
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| GI bill poster post WWII |
The hangover
of World War Two and the Great Depression therefore left a market gap which the
Venture Capitalists could fill. Such was the magnitude of these changes that it
allowed the Venture Capitalists to become organised and operated on a scale
never before seen in America.
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