There is debate as to whether private equity and its early-stage cousin, venture capital, are a force for good in society. Both play an important role in a market-based economy, but that’s not quite the same thing. We believe that venture capital strategies can, and should, have a positive societal impact, as well as a financial one.
Entrepreneurs seeking capital for their ideas, innovations and enterprises have limited choices. At the very earliest stages, they can self-fund a business (‘bootstrapping’ it) or they can raise money from friends and family. Banks tend to avoid early stage and speculative businesses, with good reason. Fledgling businesses need equity and venture capital has stepped in, financing some of the most important new business models of the past 50 years, creating proportionate economic benefits in the process.
Together with the entrepreneurs that it supports, venture capital has put satellites in space and brought internet access and mobile applications to the global population. It has revolutionized retail and invented and reinvented digital technology many times over. As consumers, our lives have been immeasurably improved. There is also something Darwinian at work with venture capital. The collective experience of its practitioners, and the way they sort winners from losers (with losers failing fast, making way for better solutions), accelerates innovation. Venture capital is probably the most important source of finance for innovation the world has ever seen.
There are lingering questions as to whether venture capital, like biological evolution, is truly democratic. For example, female entrepreneurs are surprisingly underrepresented in the pantheon of venture-supported entrepreneurship. That major observation aside, if your idea or business solution is the most suitable for its industry, it tends to get selected. The school you went to, or your family’s connections, are mostly irrelevant.
Aside from being adept at picking winners, venture capital also aligns the interests of shareholders and business managers, the importance of which cannot be overstated. Shareholders are entitled to expect that the management team has shareholder interests in mind as they make decisions about the company’s strategy or operations. Venture capital is built on this premise by ensuring that all key executives in the enterprise have skin in the game, with something to gain or lose as the venture succeeds or fails. The result is that managers are fundamentally incentivized to increase investor returns and venture capital returns are frequently among the highest of any asset class.
Yet the real measure of venture capital’s capacity to be a force for good is not the financial returns it generates. Success in business involves much more than financial outcomes. The companies that focus exclusively on financial outcomes live fast but often die young. The examples are almost endless and defy the need for publication. There are additional dimensions to success and venture capital is well suited to their promotion.
Venture capital is adept and incentivized to bring best practice into business enterprise. On one end, that might mean establishing the best in class product or service available, for example, making the most cost-effective and reliable food delivery service or funding the clinical trials for a breakthrough medicine. On the other end, it may mean putting in place a wellness program for employees to ensure their long-term health or adopting a corporate social responsibility program. Across any number of dimensions, a venture capital investor can and should be seeking to invoke best practice within the company. This is not exclusive to venture capital, but it is germane to the industry. When the sector focus of the venture firm is targeted at socially important areas such as healthcare or education, the benefits to society can be increased further.
Venture capital may retain a slight hubris hangover from the dotcom boom bust, but it is now firmly established as an economic game changer with the capacity to effect profound positive change without conceding its high financial return credentials.