VC Firms – Who and What Are They?

Well-known companies like Google, Apple, and many others had investors from the venture capital (VC) space. However, you may be asking yourself what exactly is venture capital? Who are venture capital firms and what do they invest in? In this episode we look to answer those foundational questions.

Summary – Cents of Security Podcasts Ep. 81

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement:

Welcome back to the Cents of Security Podcast. I’m Cassidy Clement, Senior Manager of SEO and Content here at Interactive Brokers and today I’m your host for our podcast. Our guest is Caleb Silver, Editor in Chief at Investopedia. Well known companies like Google, Apple, and many others had investors from the venture capital or VC space.

However, you may be asking yourself, what exactly is venture capital? Who is a venture capitalist, and what exactly do they invest in? In this episode, we’re going to look to answer those more foundational questions about the VC space. Welcome back to the program, Caleb.

Caleb Silver:

Good to be with you.

Cassidy Clement:

So, most people, especially in the finance space, have probably heard of venture capital or VC, but there’s definitely layers to it. ,I mean, it’s private equity at its core that’s looking for startup companies or smaller businesses that are going to hopefully have long term growth or potential. In your experience, I’m sure with that Investopedia, there’s so many different layers of coverage, commentary takes on venture capital. What exactly is a venture capital business? And how long has it, you know, been happening? It seems like the core of the American economy.

Venture capital is a key part of the American economy and really over the past 75 years or so. It was originally coined by a Harvard business school Professor George Doriad. And he’s considered to be the father of venture capital. This was back in the early forties. He started the American Research and Development Corporation raised about three and a half million dollars, which was a lot of money at the time, to invest in companies that commercialized technologies developed for World War II. A lot of these companies went on to become public companies, and he sort of gave birth to this idea of venture capital. And think about those words, venture, and that it’s almost an adventure.

You are speculating on the growth and the health of companies, new companies, mostly. You are infusing them with capital. You mentioned the definition being that it’s a form of private equity. Well, it is. It’s private capital, not public capital like when we invest in stocks, but private capital invested by private venture funds, high net worth individuals, banks, insurance companies, even trusts and even public companies have their own venture capital.They are betting and infusing companies, usually new companies with capital so that they can grow and develop and then exit as public companies or larger private companies.

So as I was saying about, you know, the economic factor, most people would think, okay, well, when we’re talking about small business to larger business, that seems like such a dominant force from an American economic perspective. You know, we’re talking about innovation, changes to how the economy itself works, employment, productivity, but what ways would people who maybe are new to finance see the impact of the venture capital world in the economy that they’re familiar with, or even the headlines of the news?

Caleb Silver:

Almost every single day, if you ever take an Uber, . The company was financed through venture capital. It was brought to the public markets eventually after years of infusing it with venture capital from some of the biggest firms in Silicon Valley that bet on this ride service becoming this dominant company that it is. Every time you order up an Uber you’re actually participating in a company that went into the public markets by the backing of venture capital. Same with Facebook, right? This was heavily backed by venture capital companies, Kleiner Perkins, and others out in Silicon Valley in the nineties.

That became one of the biggest public companies we have out there today. If you use Instagram, if you use Facebook, if you’re using any of the apps from that company, you are using, you know, products made by a company that was brought to the public markets through venture capital. As terms of the amount of money we’re talking about, venture capital is about a 3 trillion market globally. That sounds really big, but when you think about the public markets, especially the bond market, that’s an over 80 trillion market. The public equity market somewhere around 50 trillion. So it’s small relative to those, but it is big and it is usually high net worth investors and institutions, banks, sovereign, governments that are investing in venture capital firms, hoping that one of their bets is going to pay off.

Cassidy Clement:

Yeah, in my research, what I found interesting was I was looking at some of these companies that, now are considered behemoths. You know, you mentioned Uber, but like Apple, Cisco, Google, Facebook, Twitter, or now X, PayPal. I mean, these all had to start somewhere and there are venture capital companies that pull together, these large pools for the private equity investment and some you may have heard of, meaning our listeners, you know, Andreessen Horowitz, Sequoia Capital, Legend Capital, these companies or these venture capital groups, you know, they have an interesting portfolio of how they contributed to the businesses that we now see to be part of the daily financial news. What from your experience, are some common references that listeners may have for the venture capital companies or companies that came out of a venture capital structure?

Caleb Silver:

Sure. So, first of all, there’s been some very funny and famous TV series dedicated to venture capital. I think Silicon Valley was one of them that was on HBO for years and years but what we’re talking about, you know, these are the companies that are making basically bets. They are funding startup companies with capital and with management expertise in large part as well to help them develop into mature companies.

And there’s various stages that they go through. We’ll get to that in a second. But some of the biggest VC firms you may have heard of are the Kleiner Perkins of the world. The Anderson Horowitz. Anderson Horowitz, if that’s name sounds familiar, Mark Anderson was the founder of Netscape, the original web browser, that became a very big deal in the, in internet 1.0 and he went on to found one of the most successful venture capital firms of all time that back some of the biggest companies that we interact with on a daily basis. But also big firms like Apple, like Alphabet, Google, like Meta, they have their own venture capital wings inside them.

They incubate companies and infuse them with capital, their management expertise, and either fold them in to the broader company or set them public themselves. So venture capital takes on a lot of different manifestations, but you really see it as a global phenomenon. It’s not just Silicon Valley, it’s New York, it’s Boston, North Carolina has got a big venture capital. community down there, but around the world as well in the Asia Pacific, especially in Japan. You find some of the biggest venture capital firms out there. SoftBank is one of them. It’s a holding company, but it’s also a massive venture capital company that backs other companies. A lot of them are public companies in the United States today. So this is a big global deal just not as big as the stocks and bonds market.

Cassidy Clement:

Yeah, I mean, what’s interesting is the level of, we’ll say notoriety. And then the level, if you can try to imagine it, that, that market even is, I mean, I think you said 3 trillion and then you, you think in your head, wow, that’s huge. And then you go on and you mentioned one other fact, which is, I think the bonds market. And you’re like, but wait, there’s more, it’s even bigger in a larger scale. And this is just a portion of it and how it impacts all of the economy is very interesting. So for people who are thinking, well, that sounds great and that sounds really cool. It’s almost like you’re getting in on the ground floor within this type of investment. Is this investment for a certain type of an investor, or is it more for a company or a more exclusive investor? What exactly, you know, is the idea of who it’s for? And is it more for just the sense of driving an innovation? Because a lot of these investments obviously are not overnight successes.

Caleb Silver:

Yeah. And if you talk to any VC firm or anybody that’s worked in one, we’re talking about maybe one in 20 of the companies that it backs actually goes on to be successful, actually has what we call an exit when it goes public, or it’s sold to another company. So you’re talking about a kind of a high risk, But potentially high reward scenario when you’re investing in venture capital for individual investors, it’s hard to access the venture capital market unless you are what we call an accredited investor.

And what does that mean? It means you have to have a certain amount of an investible income, and probably money proven reserves to show that you can take the risk and invest alongside. Sovereign wealth funds, institutional investors, private venture funds that are putting money into these deals as well, as well as banks and insurance companies.

So you have to be an accredited investor. That means having a lot of money to be able to invest, but also being able to absorb the risk. So you have to also be a patient investor because venture capital, by definition takes time. This is not an overnight money by any means. This is money you should be expecting to invest for years, if not decades.

When you think about companies like Meta or Facebook, as it was known at the time, these companies took years to, to mature into companies that were ready to go public. through an initial public offering. So you got to be patient. It’s patient capital. So it’s not for everybody. And the returns are not guaranteed by any means. As I said, one in 20 is a great track record for a venture capital firm, but in any other business, that would be a losing business. You just hope that that one really ends up being a home run.

Cassidy Clement:

Before I go into my final question, I guess this is a little bit more of a commentary type question. But what are some common jargon or adjectives or nouns used within the space. I mean, when I was doing my research, like I come across a lot of, you know, the use of the word unicorn. The use of the word trend based, the use of the word, you know, IPO is obviously like that, but limited partnership or LPs, you know, what kind of floats around in this area?

I know that our listeners may be familiar with it from a surface level, but, you know, there’s a lot of acronyms and a lot of, uses that you have words that you need to. You know, look up in addition for the context.

Caleb Silver:

Yeah. Venture capital is full of great buzzwords. Let’s just start with limited partner because when you invest with a venture capital firm, you become a limited partner in that fund, right? You do not become necessarily an owner of shares. You become a partner. It’s a partnership. And that’s how venture capital firms are formed. And that’s important to know that. But also, there are various stages of venture capital you might hear when you’re talking about unicorns, you mentioned what a unicorn is. It’s that one in 20 company that actually goes on to be a billion dollar company valued at a billion dollars.

So anytime somebody says, when’s the next unicorn company coming along, you’re looking for a company that is valued at a billion dollars before it goes public. And we’ve had examples of that over the years, and Facebook is one of them, before it went public. So you’re also going to hear about things like stages of venture capital. There are seed stages of venture capital, pre-seed or angel investing. This is money that is really just to develop a business concept, work on a partnership agreement, get copyrights. This is very early stage funding, and then you get to seed stage, and that is really creating a product or prototype.You can invest as a venture capital investor, as a limited partner in any part of the seeds, depending on where the company is in its evolution. Then you go through series A, B, and C. This is as the company’s maturing, growing, hiring more employees, maybe getting a legal team in there, expanding, its product list. And then you get to series C and beyond where companies are more mature, and they’re getting ready and then potentially mezzanine. You also hear that term a lot in venture capital.

That’s, when a company is ready to be acquired by another company, it needs some mezzanine, some bridge funding to get from one level to the next. and then ultimately the exit. That is when a company is either sold or goes public that has been backed by venture capital. That is usually a very big moment. That’s when the money’s made and that’s what you’re betting on as a venture capital investor. You’re hoping for that exit and you’re hoping it’s going to be a big exit.

Cassidy Clement:

Yeah. I mean, those words, especially the different letters, with the seeding and what amount of funding they have. I mean, that just rings in my head from business school, but also the show Silicon Valley it’s a great example. If you ever watch Shark Tank, that’s

Caleb Silver:

Shark Tank is all about venture capital.

Cassidy Clement:

Right where you’re at in there. It’s very interesting because, as much as people think sometimes they’re not involved with the business world or the nitty gritty of it, sometimes you’re just on your couch involved in it and you don’t even realize. But when we’re looking at this from the side of if you are that accredited investor, or if you’re just somebody looking at a company that maybe was once part of a venture capital firm and now is standing on their own, what are some things that investors should keep in mind when they’re looking at that? Or maybe if they are investing in the venture capital market?

Caleb Silver:

Yeah. Well, if you’re going to invest in the venture capital market, you have to have access to it and access really goes to the accredited investors. There are now some exchange traded funds and other products like interval funds that investors can participate in. They don’t give you direct access as you want, but they do give some exposure, especially to the private equity side of things, which is a little different for venture capital. Think of venture capital as really backing the entrepreneur or backing the firm that backs, you know, a bunch of entrepreneurs and ideas and hoping one or several of those end up being winners. So it’s hard to access that as individual investors, of course, unless you’re accredited.

But there are different, different ways where you can get some exposure to it. But when you’re thinking about it as this, as an individual investor know this, the venture capital industry has funded some of the greatest innovations of the last 75 years. If you think about Xerox, just being one of those coming out of Xerox Park in Palo Alto, in California, if you think about Meta, Facebook. If you think about some of the companies that have sort of transformed our industries, even Tesla took some venture capital at one point in its evolution. A lot of these companies have evolved because of the bets of venture capitalists and the belief that these ideas would become revolutionary. So we’re interacting with products or services or companies all the time that have been backed by this, but it also supplies that, that risk capital, so to speak.

And it allows these companies to take the chance to innovate, to try to develop something unique, grow and change the way we operate in our daily lives. And if you can go look at the iPhone and you can look at products all around us and many of those, especially in the last 50 to 75 years have been touched in some way by venture capital. So we need it for a robust economy. We need that infusion of capital and the venture capitalists willing to take the risk to back some of these companies that could end up being revolutionary.

Yeah, it’s so crazy when you look up the origin of a lot of these well known companies, you just, you think they’re almost too good, or too big of a company to have come from that type of beginning. But a lot of them have, because you were talking about Palo Alto, I mean, think about the Bay Area, how many of those companies started in a garage?

How many of those companies started out of a storage unit? They didn’t all just magically 100 people in the office and a legal team, you know, it had to start somewhere. This conversation I think is really good as we go into the new year to talk about all of these different, companies that come out of the woodwork as people start to say, you know, the new unicorns of 2025, et cetera, but you brought up some great points today. Thanks for joining us, Caleb.

My pleasure. Anytime.

Cassidy Clement:

Sure. So as always, listeners can learn more about an array of financial topics for free at interactivebrokers.Com/campus, follow us on your favorite podcast network and feel free to leave us a rating or review. Thanks for listening, everyone.

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