Introduction to Corporate Finance

ONLINE CHAPTERS

to obtain debt financing from banks or other

financial institutions. Table 20.1 provides

details of startup funding in the US. It suggests

that in 2014, self-funding was highly prevalent,

accounting for 82% of startup funding. In

contrast, venture capital only accounted for 1%.

Crowdfunding, a more recent source, accounted

for 3% of funding and was worth $5.1 billion.

Another emerging funding source is peer-to-peer

lending.

1 What are the most important ways that entrepreneurial finance differs from ordinary finance? What

special burdens confront financial managers of entrepreneurial growth companies (EGCs)?

2 Why must companies usually finance intangible assets with equity rather than with debt?

CONCEPT REVIEW QUESTIONS 20-1

20-2 VENTURE CAPITAL AND PRIVATE

EQUITY FINANCING

Venture capital is a professionally managed pool of money that is raised for the purpose of making

actively managed direct equity investments in rapidly growing private companies. Many of the

companies in which venture capitalists invest are involved in bringing new scientific discoveries to

market. Although the venture capital industry is often referred to as an industry originating from

the US, many countries have experienced rapid growth in venture capital financing over the past 15

years. By its very nature, this type of investment is considered far more risky than investments in

well-established companies.

Through the late 1970s, the total pool of venture capital in the US was quite small. Most of

the active funds were sponsored either by financial institutions (such as Citicorp Venture Capital)

or non-financial corporations (such as Xerox). Most of the money raised by these funds came from

their corporate backers and from wealthy individuals or family trusts. There are two features of

early venture capital funds that we still observe today: (1) these funds’ investments were mostly

intermediate-term, equity-related investments targeted at technology-based private companies; and

(2) the venture capitalists (VCs) played a unique role as active investors, contributing both capital

and expertise to portfolio companies. Also, from the very start, VCs looked to invest in those rare

companies that not only had the potential of going public or being acquired at a premium within a

few years, but also offered investment returns of 25% to 50% per year. Over the years, reductions

in tax rates and liberalised pension fund investment regulations resulted in rapid growth in VC

investment from about $68 million in 1977 to more than $30 billion in 2007. After a drop to just

over $19 billion during the economic downturn in 2009, VC funding rebounded to $23.7 billion

venture capital
A professionally managed
pool of money raised for the
purpose of making actively
managed direct equity
investments in rapidly growing
private companies

TABLE 20.1 2014 US SOURCES OF STARTUP CAPITAL

Source of start-up capital % of startup

companies accessing

one or more of these

sources

Self-funded 82%

Loans/lines of credit 41%

Crowdfunding 3%

Venture capital 1%

Source: Fundable, ‘A Look Back at Startup Funding in 2014.’ http://www.fundable.com/learn/

resources/infographics/look-back-startup-funding-2014.