Venture Capital: No Longer a Business of Small Investments in Early Stage Companies

Venture capital is very different today than it was in the 1980’s when the industry experienced a wave of growth in response to changes in tax and pension laws. Back in the days when Apple Computer and Genentech were young start-ups, venture capitalists made smaller investments in earlier stage companies with less follow on funding than they do now.

Today it’s not surprising to hear that companies like Facebook or Groupon have raised over $350 million in a single venture capital round. But back in the early 1980s no companies were raising those amounts ($150 million back then in real dollar terms).

Venture capital no longer early stageClick for larger chart (in new window)

Investment rounds are bigger now than they used to be. If we exclude the anomalous bubble years of 1999 and 2000 when the average venture capital investment round reached $20.6 and $36.1 million (in 2008 dollars) respectively, initial investment rounds are much higher now than they were in the 1980s and 1990s. National Venture Capital Association (NVCA) numbers reveal that over the ten year period from 1989 through 1998, the average venture capital round was only $3.8 million (in 2008 dollars). From 2001 to 2010, it was $5.9 million (in 2008 dollars). That’s a 55 percent increase in real dollar terms.

What led to this dramatic rise in the size of venture capital investment rounds? Two causes jump out from the data. The first is a sizeable increase in the amount of follow on funding provided by venture capitalists, which now dwarfs initial funding in a way that was not the case in earlier years. The NVCA data show that in 2010, venture capitalists made $4.10 in follow on investments for every dollar they initially invested in young, high growth companies. While this ratio is down slightly from its record in 2009, it remains far higher than it used to be. Before 2001, the ratio of follow on investment to initial funding had never even reached 3:1.

A second reason for the increased size of venture capital rounds has been a movement toward later stage investments. Although the share of early stage investments has inched back up over the past several years, it remains low by historical standards. From 2001 to 2010, seed and start-up stage investments averaged only 8.9 percent of the total. By contrast, for the period from 1991 to 2000 early stage investments accounted for 18.7 percent of all investments and for the decade from 1981 to 1990, they averaged 25.1 percent.

Although it once was, the venture capital industry is no longer about making small, early stage investments in high potential companies. Today venture capital is much more about larger, later stage deals involving much follow on financing.


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

5 Reactions
  1. Unfortunately this is the danger of VC funds having a lot of money and less patience. When you have hundreds of millions to invest, you just don’t have the time/effort to be making lots of little deals, so you make fewer, bigger deals. Basic economy of scale.

    This also makes sense since even VCs need to deliver results and investing in a later-stage startup is a “safer” investment that pays off in a shorter time span.

  2. Scott,
    The statistics related to VC funding today versus the 1980’s are interesting and a cause for concern for entrepreneurs looking for early stage capital.
    Often start up entrepreneurs ask me how to raise money from Venture Capital groups and I find myself telling them just what you shared with readers. The VC funding isn’t there until you have proven your business model and have hit a few bumps along the way–and survived. Unfortunately, today entrepreneurs starting a business have to source capital from friends, family and their own home equity line of credit.
    Thanks for sharing the statistics!
    All the best,
    Holly Magister, CPA, CFP

  3. I recently taught a Graduate Finance Course on raising venture capital. I found nine local companies that teams of my students worked with to put together: 1.) business plan; 2.) valuation; 3.) invested capital spend plan; and 4.) investor presentation deck.

    The experience was wonderful for both the students and the company itself as one of the nine was funded:

    The point of my contribution, don’t underestimate the value of angel investors. There are massive resources available to early stage growth companies. Additionally, geographic location can affect the selection of and potential amount of funding from an angel or vc firm. I have found in my interaction with firms across the US that the farther east you look, the more conservative the firms can be.

  4. Another point to remember is that the cost to start a new business, especially a tech company, has fallen dramatically since then as well. You can have a real business with hundreds of thousands of user before you need to raise any significant amount of funding.