The role of venture capital in financing small business

Abstract

Venture capital is a primary and unique source of funding for small firms because these firms (with sales and/or assets under $5 million) have very limited access to traditional capital markets. Venture capital is a substitute, but not a perfect substitute, for trade credit, bank credit, and other forms of financing for small firms. Small businesses are not likely to be successful in attracting venture capital unless the firms have the potential to provide extraordinary returns to the venture capitalist. This study provides an analysis of a survey of venture capital firms that participate in small business financing. The survey participants are venture capital firms that were 1986 members of the National Venture Capital Association (NVCA), the largest venture capital association in the United States. The average size of the venture capital firms responding to the survey is $92 million dollars in assets, with a range from $600 thousand to $500 million. Twenty-three percent of the respondents have total assets below $20 million, and 27% have assets above $100 million. The venture capitalists' investment (assets held) in small firms delineate the supply of venture capital to small firms. Sixty-three of the 92 venture capitalists' have more than 70% of their assets invested in small firms. The venture capitalists were asked how their investment plans might change with changes in the tax law that were projected in the spring of 1986. Fifty-four percent expected to increase their investments in small firms, and 38% did not expect to change these activities. Venture capitalists are very selective in allocating their resources. The average number of annual requests that a venture capitalist receives is 652, and the median number is 500: only 11.5 of the respondents receive more than 1,000 proposals per year.

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