Moneymen are risking more cash than ever on daring entrepreneurs
The most elite club among American financiers is the strong fraternity of some 1,000 people running venture capital firms. These are the investors who typically will give $1 million or more to often untried businessmen to form companies in microelectronics, genetic engineering, robotics or other industries. The field is highly risky; an estimated half of all such initial investments are eventually written off as tax losses. But for winners the payoff can be huge: a $1 million investment might return $100 million.
Venture capitalists prefer to tell tales of their big scores: the $1.5 million stake in Apple Computer in 1978 by Venrock Associates that grew to $100 million or the $25 million investment in 1974 by New Court Securities Corp. and others in Federal Express, the airfreight company, that is currently valued at $1.2 billion.
Buoyed by those and similar recent successes, venture capitalists are investing money ever more rapidly on ever more exotic business proposals. Last year 145 new companies were started with venture capital, 53% more than in 1979. By year's end, according to Stanley Pratt, editor of Venture Capital Journal, these companies will have poured a record $1.1 billion into infant businesses. Says Pratt: "This is still a minor blip in the capital structure of this country, but it is a critical amount for the American economy."
Venture capitalists provide much of the seed money for U.S. business. By giving out start-up cash to farsighted entrepreneurs, they can open whole new areas of business enterprise. Venture money has fueled the development of the computer industry through investments in Prime Computer, Cray Research, Tandem and other companies, helped spark airline industry diversification with People Express and Air Florida, and bankrolled infant gene-splicing companies like Genentech and Biogen.
Usually, venture capital firms take a block of stock in exchange for start-up money in a new company. The venture capitalists may own as much as 60% of a firm's outstanding shares, which then often jump in value when the new company goes public.
Sometimes, though, the venture money disappears. Some recent failures: Ruben Engineering Corp., a Cambridge, Mass., office equipment firm that cost its backers $4 million in losses; Ontrax, which went through $1.5 million trying to make computer disc drives; and Environmental Development Corp., which spent at least $1 million in venture capital trying to sell waste-water-treatment services to cities.
The bold moneymen look for entrepreneurs who cannot get funding from bank loans, new stock issues or other conventional sources. They also usually seek out firms in the forefront of a new industry. The odds may be long, but the return can be high. Says Donald Ackerman, 47, senior partner of New York's J.H. Whitney.& Co.: "One large winner takes care of a lot of mediocre situations and even an occasional loser. This is not a game for little investors."