Abstract
This book takes as its starting point the claim that venture capital and buy-out finance – private equity in the broadest sense – has become a sizeable and influential part of the global economic landscape over the past two decades. The authors’ purpose in writing it is to describe the players, dynamics and incentives behind the industry. The book provides a clear and detailed account of the contemporary venture capital/private equity (VC/PE) industry landscape, describing in detail how it works in terms of processes, practices and procedures, and how it creates (and on occasions destroys) value. As a textbook, based on a course first offered at Harvard in 1993–1994, this book is pitched at a wide audience, including those interested in careers in private equity, investment banking and other financial intermediaries, and in entrepreneurial management. Given the structure of the book and the extensive use of case material to illustrate the argument, the book will find a place on MBA and more specialist master’s level and senior undergraduate courses on entrepreneurial finance.
The book is constructed in two sections. In the first, comprising Chapters 2 to 7, the focus is on understanding the nature of the VC/PE process or investment cycle: how funds are raised and structured; the nature of the investment process; the often arcane process for the valuation of deals; the structure of transactions and key features of VC/PE term sheets; post-investment monitoring and governance issues; and the exit process. This is a valuable and detailed guide to key processes and terminology that serves as a very useful handbook. The remainder of the book addresses a wider range of issues and themes in VC/PE research and practice. Chapter 8 examines the internationalisation of VC/PE, recognising that previous chapters have drawn almost exclusively on US data and examples. Chapters 9 and 10 examine the performance and impact of VC/PE, in terms of both the approaches used to measure an illiquid asset class, and perspectives on the impact of VC/PE on society as a whole. Chapters 11 to 13 address the issues involved in discussing the business of private equity as a class of professional service firms. This moves from discussion of career paths through detailing the issues involved in developing, growing and maintaining a firm, to discussion of how firms can respond to the ‘boom-and-bust’ cycles characteristic of the industry. This final block of three chapters is perhaps the least satisfactory part of the book: in its instrumental focus on the ‘how to’ aspects of the business of VC/PE, appropriate for the target clientele of the course from which it derives, it does not provide a wider reflective analysis of the evolution and challenges of this class of professional service firms, and that story remains to be told.
While this is overall a very valuable and detailed volume, especially on the technical aspects of VC/PE, it raises a number of issues for wider consideration (the authors acknowledge in their concluding chapter that there are key challenges, many of them not yet identified, for the industry over the next decade). Stimulated by their analysis, there are a number of themes and issues that warrant further reflection. First, in emphasising the connection between VC/PE and the emergence of household-name companies (e.g. Google, Facebook, etc.), the book draws attention away from the wider issue that VC/PE-backed companies are a very small percentage of all start-up and growth ventures, and there is much entrepreneurial activity that is both impactful (in value added, innovation and employment terms) and not VC/PE-backed – as examination of the annual Inc500 and other similar lists would show. This is not to deny that VC/PE-backed companies are disproportionately impactful; rather, to accept that there is more to financing entrepreneurship than just VC/PE as an asset class.
Second, and following from this, VC/PE funding is not the main source of finance for most entrepreneurial ventures: the authors present data to suggest that since the tech crash at the start of the millennium, VC/PE has placed on average $30 to $35bn into around 4000 ventures annually – most of it in later-stage expansion and development capital – while angel investors contribute around $25bn to around 50,000 ventures annually, much of which is still oriented to start-up and early-stage ventures. In other words, there is an argument that angel finance is the primary source of entrepreneurial finance in the USA – at least in terms of the number of ventures supported, and probably also in terms of their relative contribution to start-up and early-stage investment. A similar situation has been identified in the UK, but this may not be the case in more recently emerging and less mature risk capital markets. While acknowledging the difficulties of accessing information on the scale and performance of the business angel market (business angels only warrant three pages of discussion in the book, in the context of a review of different types of limited partner in VC/PE funds), the discussion in the book remains a discussion of one set of (important) actors in the market, rather than of the entrepreneurial finance market per se.
Third, there have been a number of structural changes in the risk capital market. The authors do identify and discuss the pattern of cycles in fundraising and investment activity in VC/PE over time. However, there is an argument, advanced originally by Bygrave and Timmons in Venture Capital at the Crossroads (1992), that the VC business model has been changing, from the so-called classic venture capital provided by VC partnerships focused on start-up and early-stage deals and run by general partners with an entrepreneurial business-building background, to merchant venture capital, which is focused more on the provision of development capital and replacement capital on the PE model by general partners more oriented to a corporate finance or executive rather than entrepreneurial background. If this structural change has continued, it has important consequences for the structure, organisation and investment focus of the industry, which go beyond the purview of this book (the title of the book and the fact that in both the USA and Europe the industry representative bodies – the NVCA, BVCA and EVCA – have revised their titles to include ‘private equity’ suggest that change has continued). In similar vein, the relationship has changed between angel investors and VCs, typically represented in terms of the relay race or funding escalator in which the angels provide the start-up capital before handing over to the VC to take the venture forward. Given the numbers involved, only a small number of entrepreneurial ventures ever would have followed this model (raising the question, which goes beyond the purpose of the book and this review, of why and how these metaphors came to such prominence). However, it is clear – and acknowledged briefly by the authors – that angel investors increasingly are taking ventures right through from seed to exit. If this continues there are likely to be significant implications for access to finance in terms of the availability, visibility and scale for entrepreneurial ventures, which will have significant implications for their growth prospects.
Finally, the book discusses one of the most important contemporary issues for the analysis of the VC/PE industry: the increased internationalisation of the industry in both developed economies and emerging states. This raises an important question, as the authors acknowledge: to what extent do, or should, we see the process of the internationalisation of this industry as the extension and replication of the US model? By contrast, to what extent do differences in governance structures, institutional environments and historical trajectories require the development of an industry patterned on very different lines? Certainly, some of the evidence cited by the authors suggests that in many emerging economies, PE is developing more rapidly than VC (or indeed angel finance). Given that this development in many cases reflects the dominant role in the financial systems of many of these economies of sovereign wealth funds, this points back to the question of the role of government in the VC/PE industry. As Josh Lerner recently pointed out in his Boulevard of Broken Dreams (2009), the major hubs of entrepreneurial activity – Silicon Valley, Tel Aviv, Singapore – all bear the marks of government investment, but not all government investment is judicious. The authors of the current volume leave us with the unanswered question: what kind of VC/PE industry business model, and what role for government, are appropriate to develop what kind of entrepreneurial ecosystem in these very different institutional environments?