Venture capital (VC) is a key engine for growth in the U.S. economy. It has financed juggernauts such as Hewlett-Packard, Microsoft, and Apple, helping to make the U.S. the world’s most dynamic economy.
Venture capital firms finance young, private companies that they judge will grow, in exchange for an equity stake in the company. VCs and their limited partners harvest profits in one of two ways: either when the start-up is acquired by an established company or by selling shares in the company via an initial public offering, or IPO.
The details behind venture capital investments are elusive, at least to the public. When profits are unimpressive or non-existent, the VC firms are reluctant to publicize their missteps.
Institutional investors in VC funds—pensions, endowments, and foundations—also aren’t keen to publicize shortfalls. After all, investment managers may be apprehensive about paying lofty fees to VC firms with projected returns that are lower than the high returns they seek. Many of the examples of venture capital investments come from reported success stories.
Venture capital examples
VC success stories can provide a sense of the upside that a successful, early venture capital investment can generate.
In 2010, Uber’s seed round capital raised $1.5 million, valuing the company at just $4 million. First Round Capital invested $510,000 and Lowercase Capital kicked in $300,000, according to CB Insights.
Soon, the ride-sharing company became a venture capital favorite. Benchmark Capital invested $9 million in 2011 and TPG $90 million in 2013. The list continued: Menlo Ventures; Softbank’s Vision Fund; Toyota Motor Corp.; and Amazon.com’s Jeff Bezos. They all piled in along with two mammoth sovereign wealth funds, the Qatar Investment Authority and the Saudi Arabia Public Investment Fund.
Co-founders Garrett Camp and Travis Kalanick became rock stars to many VC investors—and villains to others who lambasted the company’s business model, which they claimed impoverished its contract employees. Kalanick was forced out before the company’s 2019 IPO.
First Round and Lowercase made out exceptionally well. By the time of Uber’s 2019 IPO, the former’s seed investment had grown to $2.5 billion and the latter’s to $1.1 billion. The compound annual growth rate for the two firms amounts to more than 400%. Ultimately, though, the company’s IPO performed below expectations.
In 2007, Union Square Ventures (USV) invested less than $5 million in the social network’s series A funding. Other venture capital firms steered clear, wary of the company’s ability to monetize the service.
USV subsequently participated in some, but not all, funding rounds led by rival VC firms. When Twitter raised $1.8 billion in its 2013 IPO, valuing the company at $14.2 billion, that initial round was worth $863 million, which generated a total gain of 17,160% on USV’s investment, or an increase of about 136% annualized.
Accel Partners and Breyer Capital in 2005 jointly led the $12.7 million series A financing round when the company was known as “Thefacebook,”—later simply “Facebook,” and now, “Meta Platforms.” The two VC firms together took on a 15% stake.
That valued Facebook at $100 million, an enormous figure at the time. A year after the series A funding, investors including Founders Fund, Interpublic Group, Meritech Capital Partners, and Greylock Partners invested in the series B round, raising $27.5 million and pushing the company’s valuation up to $418 million. It isn’t clear which of the subsequent funding rounds Accel and Breyer participated in, but their investment would eventually total $100 million, after various funding rounds.
Even after off-loading $500 million of its shares in 2010, the 2012 Facebook IPO pegged Accel’s investment as worth $9 billion. That’s an estimated annualized return of more than 580%, which would make the firm’s Accel IX fund, the vehicle it invested through, among the most successful venture capital fund investments in history.
The June 1999 series A funding round for Google, Alphabet’s predecessor, was led by what was then known as Kleiner Perkins Caufield & Byers, and Sequoia Capital. The $25 million raise valued the search engine at $75 million.
Many other people invested in the early funding round, including Tiger Woods, Shaquille O’Neal, Henry Kissinger, and Arnold Schwarzenegger.
Google went public in 2004, and shortly thereafter, Kleiner Perkins’ and Sequoia’s stakes in the company were worth $4.3 billion each. That amounts to an annualized return of more than 300% for each VC firm.
What are some examples of venture capital firms?
VC firms are constantly morphing, with partners splitting off to create new firms with different areas of specialization. Among the most prominent ones in 2022 are:
- Sequoia Capital. Formed in 1972 by Don Valentine, the firm has provided the original, start-up venture financing for companies including Atari, Apple Computer, Cisco Systems, and Yahoo!, all of which went on to IPO. Sequoia Capital has also financed other companies that were eventually bought out including LinkExchange (acquired by Microsoft), AtWeb (Netscape), BillPoint (eBay). It’s currently one of the biggest VC investors in India.
- Kleiner Perkins. Originally formed in 1972 as Kleiner Perkins Caufield & Byers, the firm has been lead investor in Amazon.com, America Online, @Home, Excite, Healtheon, Intuit, and SportsLine. Its partners have included former Secretary of Defense Colin Powell, former Vice President Al Gore, and the so-called “Queen of the Internet,” Mary Meeker.
- Andreessen Horowitz. The firm was started by Marc Andreessen and Ben Horowitz in 2009. It holds a reputation for investing in social media companies with great success. One early hit was Okta, a cybersecurity company in 2010, followed by Facebook, Groupon, Zynga, Twitter, and Airbnb the following year. Former Treasury Secretary Lawrence Summers is a special advisor.
- Silver Lake. Founded in 1999 just before the collapse of the dot-com bubble, Silver Lake has made some of the seminal investments of the Internet. Among its investments are Airbnb, Alibaba, Dell Technologies, Ancestry.com, Twitter, and Skype. A co-founder, Glenn Hutchins, is also a noted philanthropist, helping to bankroll the Brookings Institution. The firm has also diversified into leveraged buyouts and public security investments.
Advantages and disadvantages of venture capital for founders
Start-up founders who are fundraising often consider the merits of venture capital versus traditional bank financing. The former involves parting with equity, and the latter, taking on debt. Start-ups might opt for a blend of the two, as there are pros and cons to each approach.
Advantages of venture capital for founders
- Gain access to expertise. Venture capitalists can offer connections, management advice, and even auxiliary services to a young business. Their network of past investments can be a source of personnel and market intelligence, too.
- No impact on profitability. Giving up a chunk of equity, regardless of how much a venture capitalist pays, doesn’t directly impact a startup’s profit and loss statement. Bank loans, on the other hand, necessitate interest payments, which are recurring expenses that can impair profitability and reduce the amount of money available for operations or capital expenses.
- No consideration of credit histories. Venture capitalists aren’t interested in founders’ negative credit histories, especially if they were incurred at a previous start-up, which founders are likely to consider a plus. Seeking bank credit will likely mean scrutiny of a founder’s personal and business records.
- Visibility. Despite the venture capital industry’s notorious secrecy, a major venture capitalist investment is often perceived as a stamp of approval, which is helpful for both future financing and attracting talent.
Drawbacks of venture capital for founders
- Dilution of equity. Each funding round will dilute founders’ equity in the company.
- VCs who have influence over the company. VCs, on the other hand, are likely to interfere in management and asset allocation decisions, sometimes going so far as to demand board representation, a new C-suite executive, or sale.
- Lack of transparency over valuation. With venture capital, entrepreneurs really aren’t sure how much they are paying for funding or what the company is truly valued at. That’s because the “price” is ultimately determined by what a company’s shares fetch in an IPO down the road.
- Inflexibility in spending. Banks typically aren’t too concerned with how the proceeds are spent as long as the company pays its interest on time. VCs, on the other hand, may seek to influence how money is spent.
The bottom line
The venture capital industry has generated an enormous number of high-paying jobs and vast profits that have boosted the U.S. economy. Some of the world’s biggest and most visible companies—such as Apple, Intel, and Amazon.com—all got support early on from VC firms. Names like Sequoia, Silver Lake, and Kleiner Perkins are now prominently embedded in the history of American capitalism. Still, even though a handful of VC investments pay off and yield impressive returns, most investments are in new companies that flounder or fail. Those failures produce losses for VC firms, offsetting much of their investment gains.