The Venture Capital Cycle

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9780262071949: The Venture Capital Cycle

The venture capital industry in the United States has grown dramatically over the last two decades. Annual inflows to venture funds have expanded from virtually zero in the mid-1970s to more than $9 billion in 1997. Many of the most visible new firms—including Apple Computer, Genentech, Intel, Lotus, Microsoft, and Yahoo—have been backed by venture capital funds. Yet despite this tremendous growth and its visible success, venture capital remains a mysterious industry. Numerous misconceptions persist about the nature and role of venture capitalists.

Paul Gompers and Josh Lerner's extensive research on venture capital organizations is based largely on original data sets developed through close relationships with institutional investors in venture capital funds and investment advisors. The Venture Capital Cycle synthesizes their path-breaking work. After a historical overview, the book looks at the formation of funds, the investment of the funds in operating companies, and the liquidation of these investments. The concluding chapter provides a road map for future research in this growing area.

Three themes run throughout the book. The first is that all venture capitalists confront tremendous incentive and information problems. The second is that because the various stages of the venture capital processes are related, the entire process is best viewed as a cycle. The third is that, unlike most financial markets, the venture capital industry adjusts very slowly to shifts in the supply of capital and the demand for financing.

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Review:

In the last 25 years, the venture-capital industry has grown from a less than $1 billion to an over $60 billion business--growth that has far surpassed any other class of investment products. Today, the industry consists of several thousand professionals working at about 500 funds concentrated in California, Massachusetts, and a handful of other states. Despite the industry's size, there are many misconceptions about the nature and role of venture capitalists; their trade remains shrouded in mystery.

Paul Gompers and Josh Lerner's Venture Capital Cycle is an illuminating academic examination of the form and function of venture-capital funds. Gompers and Lerner are Harvard Business School professors who have researched extensive original data to analyze venture-capital fundraising, investing, and exiting methods. Beginning with a historical overview of entrepreneurial finance, the book examines how venture partnerships are structured, how venture capitalists are compensated, the staging of investments in operating companies, and the relative performance of venture-capital-backed offerings. There's also an interesting comparison of corporate venture organizations, such as Xerox PARC, with those of independent and other venture groups. Venture capitalists use industry knowledge and monitoring skills to finance projects with significant uncertainty, typically concentrating investments in early-stage companies and high-tech industries. Large information gaps between entrepreneurs and investors create conflicted interests, and the book looks at some of the novel checks and balances most often employed.

One of the book's themes is that the whole venture-capital process is best understood as a cycle: from the raising of a fund; to investing in, monitoring, and adding value to firms; then exiting deals; returning capital to investors; and finally renewing itself by raising additional funds. The need to exit an investment successfully shapes all aspects of the venture-capital cycle, from the ability to raise capital to the types of investments made. Another theme is that because venture funds must make long-term illiquid investments, they need to secure funds from their investors for periods of 10 years or more. The supply of venture capital consequently cannot adjust quickly to changes in the investment environment.

The authors conclude that increasing familiarity with the venture-capital process has made the long-term prospects for venture investment more attractive than ever. Entrepreneurs, venture capitalists, and investors will find this book a scholarly, well-documented examination of the industry. --Scott Harrison

From the Inside Flap:

"The venture capital industry has fueled the growth of the American stock market over the last decade. In this new edition, Gompers and Lerner ably chronicle the growth of this industry, but also provide a thorough and dispassionate analysis of its structure and conduct. For a serious student of venture capital, this is the book to read."
--Andrei Shleifer, Professor of Economics, Harvard University

"*The Venture Capital Cycle* provides an accurate, comprehensive, and insightful description of the economics and business of venture capital. This second edition is essential reading for entrepreneurs, venture capitalists, policymakers, and academics interested in the economics of venture capital and innovation."
--Steven N. Kaplan, Neubauer Family Professor of Entrepreneurship and Finance, University of Chicago Graduate School of Business

"Gompers and Lerner bring cutting-edge theory to bear on venture capital practice. The second edition of *The Venture Capital Cycle* belongs on the bookshelf of academics and practitioners alike."
--Ronald J. Gilson, Meyers Professor of Law and Business, Stanford Law School, and Stern Professor of Law and Business, Columbia Law School

"Gompers and Lerner cover the breadth of the venture capital world in an intellectually rigorous yet readily accessible manner. *The Venture Capital Cycle* will benefit every serious student of entrepreneurial finance."
--David F. Swensen, Chief Investment Officer, Yale University

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