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Updated February 11, 2023Most businesses begin with an entrepreneur who holds a grand vision, invention, or idea. These ideas are shared with co-founders, team members, investors, and eventually the world when the idea materializes into a product or service offered to consumers at a price. It often requires external finance to fuel that growth as a business grows. To realize this capital, businesses create revenues from sales, borrow money from friends and family, and take loans from banks. These more traditional forms of capital are most suited for companies that will grow rapidly yet steadily in a linear fashion. They can break even within one to three years and provide steady profit and growth.
Venture-backed businesses tend to have a few additional components. They tend to be high-growth, high-risk, high-reward, and, more often than not, tech-enabled businesses that can demonstrate potential for massive scalability. Of the millions of companies that are started each year, only a fraction is considered to have the ability to disrupt industries and achieve the exponential growth required to create returns to investors that are equal to or in excess of the entire fund—often more than £100M—from which they were invested. There are a great many books that delve into the detail of how to create a venture-backable company; each provides overarching principles that determine there must be a robust initial team, a problem faced by a large and preferably ever-expanding market, and a “sticky” product that can solve that problem at a price point consumers are willing to pay, also known as product-market fit. With these components in place, many entrepreneurs create startups they deem to have the potential to achieve the billion-dollar valuations that will propel them onto the Forbes billionaire list.
However, ideas are just ideas without the critical component of capital. A sizable investment, often into the seven figures, is required to fuel early growth and is frequently provided through external funding. Given that these companies are high risk, more traditional forms of capital are out of the question. Startup entrepreneurs increasingly rely upon angel investors or venture capital to provide the boost they need onto the trajectory for exponential scale. Funds flow directly into the company as an equity investment rather than an interest-bearing loan. This is central for early-stage companies with limited track records and little income, for whom interest-bearing loans could be unobtainable, onerous, or even crippling.
While venture capital enables company expansion that is far less possible with other methods, there are many vehicles and strategies for funding an early-stage company, not least boot-strapping, which is the art of rapidly creating customer revenues that fuel the growth of the company. As we examine who can access venture capital in the modern era and look at those who are invariably excluded from the wealth that venture-backed businesses can create for entrepreneurs, their families, investors, and the communities these players belong to, we acknowledge just how skewed the industry is towards nurturing and perpetuating its existing flywheels. The consequences of these flywheels are explored in this book, along with the substantial returns available from historically overlooked market segments. Investors are missing opportunities for higher financial returns by undervaluing high-performing companies led by diverse groups or by overvaluing white-male-led firms. Moreover, capital allocators may well be infringing their fiduciary duty to generate the most significant possible returns for their investors by not investing in diverse companies that could produce returns as high or even higher than white-male-led companies they are most familiar with backing.
Venture capital (VC) is invested by general partners in venture capital firms, who use their domain expertise to allocate high-risk capital into entrepreneurial ventures to generate significant returns on behalf of limited partners, who are most commonly pension funds, university endowments, state funds, foundations, and insurance companies, who do not usually act as direct investors in startup companies. Venture capital firms are compensated in two ways: annual management fees (usually 2% of the capital pledged by limited partners) and “carried interest,” which is a percentage of the profits created by an investment fund (typically 20%). VC funds usually have a lifespan of seven to ten years, and the corporations that fund them frequently manage many funds simultaneously. In terms of payoffs, the venture capital model differs from other types of financing. Returns for venture capital investments do not often follow standard distribution curves but are skewed. The majority of the aggregate return is generated by a few exceptional investments, such as Tesla, Microsoft, Meta, Google, or Oracle.
Funding of this nature has proven pivotal for disrupting the way we work, produce, and live, as technology evolves and advances by investing in high-tech companies that promote the development of industries, support innovation, and drive economic growth. The benefits to society over the years have been described as immeasurable, while the casualties created by technological changes that disrupt labor markets and increase inequity are cited as necessary evils that are far outweighed by the essential innovation that leads to competitive advantage, productivity gains, and increased economic growth over the longer term. Yet, what are the long-term effects of capitalism at all costs? The cataclysmic impact on the environment, society, and governance structures over time are leading all too often towards climates in which wages are depressed as businesses compete on the price, over the quality, of goods; where unskilled workers are incentivized with punishments, over promotions; and where bubbles expand and eventually burst, usually to the detriment of those who are already the most vulnerable in society. Time and time again, these results demonstrate that existing models are not fit for purpose as inequality preponderates and poverty expands. Thus, were these premeditated, globalized, and impeccably organized models ever fit for purpose, or is a shift to a more sustainable modus operandi long overdue? Answering such a question effectively relies on accurate knowledge and examining the foundations upon which venture capital was built.