Patient capital is vital to start-up companies which often struggle to access traditional finance. This article conceptualizes the conditions in which venture capital (VC) demonstrates patience in an effort to better understand the sources of patient capital available for start-up companies. VC investment stage is identified as a key determinant of VC patience. VC ‘seed stage’ investing demonstrates patience through its long intended investment horizon, engagement focused on long-term value and loyalty in the face of poor short-term performance. Companies receiving seed funding, then ‘follow-on’ funding, receive the most patient form of VC. An empirical analysis reveals that VC seed activity has proliferated across the USA, UK, Germany and Japan since the run-up to the Global Financial Crisis. The article concludes that VC is a growing source of patient capital for high-growth start-up companies, though several factors confound its intertemporal and intra-portfolio patience.

1. Introduction

The Wall Street Journal hailed venture capital (VC) as ‘humanity’s last great hope’ (Mims, 2014) for its provision of capital that start-up companies (‘start-ups’1) need to fund high-risk research and development (R&D). The National Venture Capital Association asserts that 40% of all the 1,339 companies that have gone public in the USA since 1974 received VC funding in their ascent; those 556 companies account for 85% of all R&D spending, 63% of the market capitalization and employ over 3 million people.2 VC—financing, expertise and network access provided to start-ups in exchange for equity stakes (Mathonet and Meyer, 2007)—is claimed, in light of these types of statistics, to drive entrepreneurship, innovation and job creation (OECD, 1996, 2003; Kortum and Lerner, 2000). Its role in Silicon Valley’s innovation cluster has motivated more than 40 countries to pursue purposive action aimed at building local VC markets (Klingler-Vidra, 2014a).

The widespread acclaim for VC comes in an era marked by a secular decline of ‘patient capital’ in equities markets (Kay, 2012) and banks (Hardie and Howarth, 2013; Hardie et al., 2013). Patient capital refers to finance whose providers ‘aim to capture benefits (both financial and otherwise) specific to long-term investments and who do not exit their investment or loan if non-financial company (NFC) managers do not respond to short-term market pressures’ (Deeg and Hardie, this issue). Financing for start-ups, in the form of seed stage VC, as well as crowdfunding and angel syndicates, is growing at an unprecedented rate (Baeck et al., 2014). But is it patient capital?

Venture capital has been under-conceptualized in comparative political economy (CPE) scholarship despite its widespread interest to policy-makers and purported impact on economic growth. VC has even been overlooked in CPE literature on small- and medium-sized enterprise financing due to its small size in relation to other financial services sectors (Deeg, 2009). CPE researchers have investigated how national financial systems differ in their provision of growth capital (Zysman, 1983; Aoki, 1995; Whitley, 1999; Amable, 2000, 2003; Deeg, 2010; Witt and Redding, 2013), but what about conceptualizing the suppliers of patient capital for the world’s high-growth start-up companies? In line with the aim of this Special Issue, this article conceptualizes how, and when, VC acts as a source of patient capital for high-growth start-ups. In so doing, it contributes to a growing understanding of non-financial institution sources of patient capital (e.g. Haberly, 2014).

VC funds invest at different stages of a young firm’s growth cycle, from the seed to early-to-late-stage investing (Gompers, 1995). VC’s seed stage form is identified as possessing the most patient capital characteristics.3 The seed stage refers to the first VC investment round in which equity investments of $500,000 or less are provided to start-ups, as illustrated in Table 1.4 Seed funding demonstrates patience, as it entails long investment tenures, engagement that focuses on long-term value creation and investments that are maintained despite poor short-term performance. The Gerschenkron (1962, p. 14) conception of patience as financiers that accompany ‘an industrial enterprise from the cradle to the grave, from establishment to liquidation’ describes seed funding in many respects. VC seed investment is made shortly after birth and is typically maintained until the management team liquidates their ownership.

Table 1.

Private company equity financing stages

Financing stage Period (years) Risk level Activity to be financed Typical investor 
Initial financing/ pre-seed round 7–10 Extreme For supporting an idea or R&D for product development Friends, family, government grants, crowdfunding 
Seed round 5–9 Very high Initializing operations or developing prototypes Angel, government grants, VC seed funds 
Early-stage (A round) 3–7 High Start commercial production and marketing VC funds 
Early-stage (B round) 3–5 Medium to high Expand market and growing working capital need VC funds 
Later-stage (Growth Capital) 1–3 Medium Market expansion, acquisition and product development Private equity or follow-on VC rounds 
Buy out-in/ Mezzanine/IPO 1–3 Low to medium Acquisition financing Multi-national companies, private equity, IPOs 
Financing stage Period (years) Risk level Activity to be financed Typical investor 
Initial financing/ pre-seed round 7–10 Extreme For supporting an idea or R&D for product development Friends, family, government grants, crowdfunding 
Seed round 5–9 Very high Initializing operations or developing prototypes Angel, government grants, VC seed funds 
Early-stage (A round) 3–7 High Start commercial production and marketing VC funds 
Early-stage (B round) 3–5 Medium to high Expand market and growing working capital need VC funds 
Later-stage (Growth Capital) 1–3 Medium Market expansion, acquisition and product development Private equity or follow-on VC rounds 
Buy out-in/ Mezzanine/IPO 1–3 Low to medium Acquisition financing Multi-national companies, private equity, IPOs 

Source: adapted from Klingler-Vidra (2015)

The article proceeds as follows. Section 2 conceptualizes VC in terms of patient characteristics, especially the intended investment horizon, engagement in pursuit of short-term or long-term value and the existence of loyalty when NFC management does not respond to short-term performance challenges. To gain a sense of the available supply of the most patient form of VC seed funding, Section 3 explores seed stage deal volume trends using PitchBook data. It reveals growth of seed funding in absolute terms and as a share of overall VC investment activity in key liberal market economies (LMEs) (the USA and UK) and coordinated market economies (CMEs) (Germany and Japan) over the period 2000 to May 2016. Section 4 identifies finance and political economy drivers of the temporal and cross-national rise of seed funding. The article closes by discussing the implications of the greater availability of VC seed funding for growth-firms and outlines areas for further research.

2. Conceptualizing VC in patient capital terms

Venture capitalists invest in high-technology start-ups (Casper et al., 2009, pp. 200–208) and ‘exercise voice in defence of existing activities’ (Hall and Gingerich, 2004, p. 32) with the aim of optimizing corporate value. Mention of VC by CPE scholars has been largely limited to attempts to classify VC as a component of a LME or CME financial system. Hall and Soskice (2001, p. 29) posit that venture capitalists are an exception to LME financial system’s short-termism. Because venture capitalists develop extensive relationships to ‘monitor [firm’s] performance directly’, Crouch (2009) contends that VC operates as a hybrid between a Hausbank and a stock market investor. Similarly, Zysman (1983, p. 64) equates venture capitalists with the activities of German universal banks, as they provide long-term capital, though in exchange for ownership stakes rather than interest payments.

The temptation to classify VC as an LME or CME component comes from its hybrid features: its origins are in the LMEs of the USA and the UK5 and VC aims for extremely high return on investment by investing in, nurturing and then selling positions in highly innovative companies through exit, yet VC investments constitute long-term, ‘insider’ block-holder positions that shield start-ups from the ‘short-term imperatives’ of public equities markets—characteristics associated with CMEs (Culpepper, 2005, p. 173). Venture capitalists’ engagement with management helps them access information in order to get comfortable with the risks inherent in investing in privately held start-ups. They evaluate the long-term potential of high-risk firms rather than assess short-term performance. Venture capitalists use ‘voice’ (Hirschman, 1970)6 to drive strategy and management decisions in order to maximize long-term corporate value on public equities exchanges (Hall and Soskice, 2001). In short, VC is in many respects a CME construct that has its roots (and wings) in LME bedrock.

This article goes beyond this attempt to classify VC according to the LME/CME dichotomy. It adapts Deeg and Hardie’s framework, as developed in this Special Issue, for identifying patient capital. Their framework delineates three parameters of patient capital: intended investment horizon, purpose of engagement as short- or long-term objectives and loyalty when there is poor short-term performance. According to these attributes, a critical category of VC—the stage of investment—shapes its propensity for demonstrating patience. Investment stages range from the seed stage—supporting a team with just an idea or prototype—through to late stages of growth capital—funding to expand product lines, geographic reach, etc. (see Table 1 and also Gompers and Lerner, 1999).

Applying the Deeg and Hardie framework, seed stage investment is the most patient form of VC. Seed investment entails the longest intended investment horizon, as fledgling companies need years to mature. Engagement is focused on long-term objectives, striving to maximize the corporate value of start-ups. Finally, loyalty is demonstrated by seed investors not exiting in the face of short-term performance tribulations. For VC, loyalty is a function of both the belief in the long-term potential of the firm and the fact that early exit options are limited (a lack of good exit options is what Harrison refers to as ‘patience by default’ in this volume). While seed investment is normally the most patient form of VC, it is not in itself sufficient to guarantee a high level of patience. The end of this section reveals how several factors might confound the patience exhibited by seed investment.

2.1 Intended investment horizon

VC funds are typically structured as limited partnership (LP) funds, which have set end dates (typically 10 years). In that timeframe, investments are to be made and exited so that all capital is returned to the investors (the limited partners) at the end date (Lerner, 2009). Limited partners in VC include pension funds, endowments and foundations, banks, corporations and governments (Gompers and Lerner, 1999). VC offers these investors the potential for returns that are not highly correlated to other asset classes, such as bonds and public equity markets, contributing to portfolio diversification (Mathonet and Meyer, 2007). VC investments also offer non-pecuniary returns, such as access to cutting-edge technologies and social development. Limited partners agree to have their capital locked up in VC funds for 10 years in exchange for these potential financial and non-financial returns on investment. At the seed stage, as detailed in Table 1, the expectation is that the investment tenure is between 5 and 9 years. Thus, seed investments have the longest intended investment horizon of all VC forms, but still need to produce exits within the fund’s 10-year time frame: this places an upper boundary on the patience of VC.

As indicated in Table 1, early stage investments refer to the A and B Rounds, where the expected investment period—3–5 years—is shorter than seed. Companies raising early-stage funds have developed products and established sales channels by this stage (Ernst & Young, 2014). Later-stage VC investments have even shorter intended investment periods—1–3 years—since companies at this stage have demonstrated an ability to make money and acquire customers. Late-stage companies fundraise in order to further develop products or expand to new markets.

2.2 Engagement for short-term or long-term objectives

Engagement refers to the extent to which financiers use voice to influence management (Hirschman, 1970; Deeg and Hardie, this issue). Seed stage investors engage deeply with their portfolio companies in order to shape the long-term direction of the business. Firms’ position in their ‘organizational life cycle’ affects the depth of their relationship with financiers, owing to VC engagement having palpable influence on fledgling management team’s decisions (Yitshaki, 2012, p. 55). Companies at the seed stage are reliant on external advice, whereas later-stage companies are less dependent. The relationship between venture capitalists and portfolio companies, especially ‘in the early stages of a firm’, is depicted as one in which the venture capitalists are ‘in weekly contact with the firm and help with a wide range of activities from recruiting to business development to customer contacts’ (Kuemmerle, 2001, p. 231). On the other hand, later-stage companies seek a narrower range of inputs from their financiers, as they have achieved some success, cohered as management teams and figured out many of their big issues (e.g. product launch and competitive positioning; Gomez-Mejia et al., 1990, p. 112).

Venture capitalists engage in order to drive management and strategic decisions towards long-term corporate gains (Colwell and Mowday, 2011).7 Strategic decisions include ‘pivoting’ the product or service in a different direction, marketing efforts and timing of a product launch. Management decisions include hiring decisions, R&D strategy, and replacing senior management (even the founder!). VCs institutionalize their engagement by employing formal contracts (Yitshaki, 2012), making sequential investments in multiple rounds of financing (Guler, 2007, p. 254), taking large equity stakes and assuming board seats (Gompers and Lerner, 1999).

At the seed stage VCs have a strong ability to affect management and strategic decisions. Their board seats endow voting rights and ‘oversight privileges, which range from the approval of budgets and advice on product development to the right to replace the management team should they consistently underperform’ (Lerner et al., 2014, p. 2). Further, start-up founders typically want venture capitalists to use their ‘voice’, unlike the antagonistic relationships that ‘activist’ investors have with management teams. The connotation that venture capitalists constitute ‘smart money’ comes from the operational expertise and valuable professional networks that they offer to start-up companies.

Venture capitalists are ultimately motivated to engage as a means of enhancing the start-up company’s value at the time of exit rather than maximizing ‘current profitability’ (Zysman, 1983, pp. 64–65; Hall and Soskice, 2001, p. 8). At the seed stage, nascent companies are still in the process of developing their product or service, or launching operations. Venture capitalists value these start-ups’ potential to compete in, or disrupt, markets in the long run, not for their current cash flow or short-term profitability (Lerner, 2009). Therefore, any increased engagement by venture capitalists should be seen as evidence of higher levels of patience.

2.3 Loyalty

Companies that raise seed funding normally need several more rounds of equity finance, including one or two early-stage rounds and a later-stage funding round (as illustrated in Table 1). Motivated to maintain (or grow) their equity positions in start-ups as they grow, VC funds allocate portions of their seed fund money for ‘follow-on’ funding so they can invest in the A, B or even later-stage funding rounds. VC funds normally provide follow-on funding to only the most promising firms in their original seed portfolio. This means they have a smaller number of firms to be engaged in, have invested a larger amount of capital and, in exchange, have a greater ownership stake. VCs who do not provide follow-on funding to a start-up have reduced ownership stakes (as subsequent rounds of investment capital dilute the value of their positions), meaning that they have less financial incentive motivating them to invest their scarce time and provide access to their prized personal networks. VC funds will be less engaged with firms not receiving follow-on funding, and potentially less loyal, i.e. exiting earlier than originally planned if an opportunity presents itself. While they keep their initial investment they are, because of the smaller financial stake, likely to offer limited engagement. According to Deeg and Hardie, this is still relatively patient capital, but a more passive form of patient capital.

In general, VC loyalty is demonstrated by choosing not to exit until some optimal point in time as agreed with the management team. Venture capitalists exit by selling their equity stake through an initial public offering (IPO) or trade sale within a 2- to 10-year window (Ernst & Young, 2011, p. 16).8 The historically complete set of exit routes available to venture capitalists are as follows (Kortum and Lerner, 2000; Mathonet and Meyer, 2007; Espenlaub et al., 2011):

  1. IPO: sale of ownership through the listing of ownership shares on a public equity market (e.g. stock exchange such as NASDAQ),

  2. Trade sale (also referred to as merger and acquisition (M&A): sale of ownership to another company (e.g. Facebook’s acquisition of WhatsApp for $19 billion),

  3. Sale to financial institution (such as a private equity firm): sale of ownership to a financial institution via a leveraged buy-out or other transaction, and,

  4. Stock buy-backs: the management team buys back the equity held by venture capitalists and other investors.

The first two exit paths—IPO and trade sale—entail the management team and investors selling their shares for (an optimal) profit. The second pair of exit paths—sale to financial institution and stock buy-backs—give venture capitalists liquidity, but they are not the preferred exit routes for investors because they typically mean a lower return on investment.

The value of a company at exit is almost always the sole determinant of what profits venture capitalists earn for their ownership stake. As an example, a VC firm that owns a 20% stake in a company that completes an IPO for $1 billion earns $200 million for their share in the company. Their profit comes from the difference between the size of their initial investment and this $200 million. If they invested $10 million for a 20% share in the business, they turned $10 million into $200 million—a 20-fold return on investment (assuming no dilution occurred). In contrast to Hirschman’s conceptualization of exit as an expression of discontent (often following unsuccessful engagement), exit by VC funds through IPO or trade sale signals the opposite: that the venture capitalist, along with other investors and the management team, believe the company has reached its optimal value. This reminds us that, as with other forms of private equity, exit within a certain timeframe was always the goal at the outset, and it is therefore a signal of a successful, rather than inferior, investment decision.

2.4 Factors potentially limiting the patience of VC seed funding

In recent years we observe VC seed stage investors’ intended holding period is shortening, in turn restraining the patience they extend to start-ups. Observed compression of time horizons is propelled by technological advances, the ability to scale to the world market (through technologies) and the lower costs of building a business (Ernst & Young, 2011). Founded in 1998, Google operated for 8 years before it became a ‘unicorn’ (a private company with a $1 billion valuation).9 Recent mega successes, such as Uber, achieved a valuation in excess of $40 billion within 6 years of existence (Wessel, 2014), and WhatsApp, which sold to Facebook in 2014 for $19 billion achieved this in 5 years (Satariano, 2014). Oculus Rift and Snapchat, founded in 2012 and 2011, respectively, reached unicorn status within 18 months. This shortening time frame for some mega successes fuels the belief among many investors that companies can go from seed to ‘unicorn’ in 5 years or less.

Venture capitalists who follow on seed funding with subsequent rounds of funding constitute the most patient form of seed investors. VC seed funds that do not participate in follow-on funding rounds are generally less engaged and potentially less loyal or patient. This stems from differences in investment models. The seed model entails investing in a larger number of companies—over 100 companies in the case of Index Ventures10 seed portfolio—and then selecting a sub-set for further investment. In contrast, early-stage VC funds invest in 8–10 firms at the outset. In an early-stage VC fund, each portfolio firm represents 10% or more of the portfolio; in seed funds, each portfolio firm accounts for 1–2% of the invested capital. Since the size of the investment team responsible for seed stage investments is not an order of magnitude larger than the staff managing early-stage VC funds, partners have less time for each start-up. If only investing at the seed stage, VCs are incentivized to invest less time in each portfolio company, as they have more dispersed portfolios and they do not have a large ownership share of the start-ups. Seed funds are more likely to exit early from these investments if an opportunity arises. However, the situation reverses when they do provide follow-on funding: they invest in a smaller number of companies and have a greater financial incentive to be engaged for the long-term.

Venture capitalists’ willingness to provide follow-on funding and thus, their motivation to remain engaged in driving long-term performance, can be constrained by market conditions. While follow-on funding decisions are made on an individual start-up basis, trends in valuations—the total value of a start-up’s equity, effectively the private market version of public market’s capitalization—affect venture capitalists’ determination of whether or not to follow-on. VCs arrive at valuations by considering start-up-specific metrics alongside the valuations of ‘comparable’ privately-held start-ups.11 The mark-to-market nature of VCs’ process for determining valuations lends to valuations increasing (and decreasing) systemically. Though seed funds may set aside 60–70% of their capital for follow-on funding, if start-ups’ valuations grow too large for them to provide their pro-rata share, they may struggle to participate in future funding rounds. For example, a seed fund may set aside $5 million for follow-on funding. If the start-up’s valuation would require $50 million investment in order to maintain the pro-rata, they do not have enough money to follow-on. In addition, venture capitalists contract their investment activity when their perception is that markets are ‘overheated’, feeling that start-up valuations are generally too high. Such broad-based funding contractions make it harder for start-ups to obtain follow-on funding. Analysts have attributed the slow-down in VC investment activity in the beginning of 2016 to this precise phenomenon.12

Historically, there were only four exit paths available to venture capitalists, informing venture capitalists’ patience by default due to limited exit options. Venture capitalists could not liquidate their position until company management chose to sell through IPO, M&A or to a financial institution—or to buy-out the venture capitalist through a stock buy-back. In the past 10 years, however, and especially since the US JOBS Act in 2012, private, or ‘secondary’, markets have proliferated. Secondary markets enable the buying and selling of privately-held ownership shares amongst investors. Seed stage investors can thereby liquidate their exposure—that is, exit—without having to wait for the sale of the entire company, as they had to do in the past (Ernst & Young, 2011, p. 16). The trend in private market transactions is positive; the total number of secondary programs grew by 33% between 2014 and 2015 (NASDAQ Private Market, 2016). By 2015, the NASDAQ Private Market reported that the value of its private market transaction volume exceeded $1.6 billion.

The private market exit option does not reduce the loyalty on offer to all the start-ups in a given seed portfolio, though it does reduce the likelihood of loyalty by default. When venture capitalists are confident that a portfolio company is capable of achieving a strong IPO or trade sale they would not pursue an exit via secondary markets. Secondary markets may reduce the patience venture capitalists extend to start-ups that they deem to offer poor, or even average, long-term potential. Rather than waiting for a modest exit, or waiting to realize a loss, the private market offers seed investors the opportunity to sell their shares when they choose. However, due to the small volume of trading on private markets,13 initiating a sale risks signalling trouble to other investors. This signal can reduce the value of their remaining equity stake and risk the health of the start-up. For this reason, the rise of secondary markets is only expected to erode the patience that VCs’ afford to start-ups deemed to be poor long-term performers.

2.5 Summary

According to Deeg and Hardie’s framework for identifying patient capital, seed stage is the form of VC that is most likely to exhibit the greatest patience. Seed funding involves a long intended investment horizon, engagement focused on long-term value and the propensity for loyalty when faced with short-term performance issues. But patience is not equally distributed to all firms in the portfolio. The strongest propensity for patience is linked to firms chosen to receive follow-on funding, as the additional investment enhances venture capitalist’s level of engagement. In contrast, investments made only at the seed stage lack key characteristics that may strengthen patience: seed funding is distributed to a large number of start-ups. Small amounts of money are invested, and accordingly, the ownership stakes are small. Over time, seed investors who do not provide follow-on funding offer little engagement to their portfolio companies. Their engagement declines as ownership stakes are diluted towards zero by the entrance of new capital. Their loyalty to these start-ups that they deem to have low long-term potential may also be diminished. The potential financial upside from these diluted seed investments is limited, so venture capitalists seek to sell their ownership stakes, rather than wait for the management team to decide to sell or close down. Ceteris paribus, the companies that receive the most investment and the most engagement are the most promising start-ups in the portfolio. Finally, patience is constrained by the cyclical nature of the VC market and the contemporary trend whereby venture capitalists desire to either see start-ups ‘fail fast’ or become unicorns.

Table 2 offers a summary of the conceptualization of VC seed funding in patient capital terms.

Table 2.

VC seed funding in patient capital terms

Patient capital attributes VC seed funding characteristics 
Intended investment horizon 
  • Typically 5–9 years.

  • ‘Fail fast’ and unicorn trends forcing downward pressure on expected timeframe.

 
Engagement for short- or long-term objectives 
  • Actively involved in company management and strategy decisions through institutionalized means, such as board membership, as well as informal channels.

  • Optimizing the long-term corporate value of the company at the time of exit through IPO or trade sale.

  • Seed investors who provide follow-on funding to a start-up are incentivized to invest more time, expertise and access to networks.

 
Loyalty 
  • Strong ability to influence management, so instances of management not acting in accordance with venture capitalists’ preferences relatively low.

  • When discrepancies do occur, the venture capitalist does not exit due to patience by default (lack of exit options).

  • The rise of secondary markets inhibits the patience by default; when venture capitalists lose confidence in a management team’s ability to execute its long-term vision they may pursue exit via secondary market.

 
Patient capital attributes VC seed funding characteristics 
Intended investment horizon 
  • Typically 5–9 years.

  • ‘Fail fast’ and unicorn trends forcing downward pressure on expected timeframe.

 
Engagement for short- or long-term objectives 
  • Actively involved in company management and strategy decisions through institutionalized means, such as board membership, as well as informal channels.

  • Optimizing the long-term corporate value of the company at the time of exit through IPO or trade sale.

  • Seed investors who provide follow-on funding to a start-up are incentivized to invest more time, expertise and access to networks.

 
Loyalty 
  • Strong ability to influence management, so instances of management not acting in accordance with venture capitalists’ preferences relatively low.

  • When discrepancies do occur, the venture capitalist does not exit due to patience by default (lack of exit options).

  • The rise of secondary markets inhibits the patience by default; when venture capitalists lose confidence in a management team’s ability to execute its long-term vision they may pursue exit via secondary market.

 

3. Empirical investigation of seed stage investment activity

VC markets have grown significantly since the run-up to the Global Financial Crisis. In 2014, VC fundraising and deal volumes reached their highest levels in over a decade (Ernst & Young, 2014). The seed segment grew at a particularly remarkable rate; there was a 65% increase in the number of start-ups that received seed funding in 2012 alone (Zwilling, 2013). This is all the more remarkable given that venture capitalists provided little (in the USA, UK and Germany) or no (in Japan) seed funding 15 years ago, as Table 3 illustrates. In the run-up to the Global Financial Crisis, the number of VC seed deals ballooned in archetypal LMEs (USA and UK) and CMEs (Germany and Japan). Between 2000 and 2015, the number of VC seed deals had grown by a factor of 10, or more, in each country. Section 4 explores the drivers of this secular growth, including the decreasing costs of starting a business, the large capital inflows into the VC sector and public policies that promote entrepreneurship and the supply of entrepreneurial finance.

Table 3.

Number of seed deals per country 2000–2015

 Germany Japan USA UK 
2015 87 19 1,952 252 
2014 113 33 2,598 336 
2013 102 36 2,611 292 
2012 72 20 2,065 166 
2011 51 23 1,261 134 
2010 35 11 736 79 
2009 34 468 61 
2008 39 415 44 
2007 28 316 43 
2006 15 182 33 
2005 – 110 19 
2004 – 78 10 
2003 – 54 22 
2002 – 47 13 
2001 – 47 21 
2000 – 80 17 
Total 626 158 13,487 1,601 
 Germany Japan USA UK 
2015 87 19 1,952 252 
2014 113 33 2,598 336 
2013 102 36 2,611 292 
2012 72 20 2,065 166 
2011 51 23 1,261 134 
2010 35 11 736 79 
2009 34 468 61 
2008 39 415 44 
2007 28 316 43 
2006 15 182 33 
2005 – 110 19 
2004 – 78 10 
2003 – 54 22 
2002 – 47 13 
2001 – 47 21 
2000 – 80 17 
Total 626 158 13,487 1,601 

Source: PitchBook data on number of deals by stage; seed stage provided by venture capitalists (this seed data purposefully exclude angel or crowdfunding transactions).

The proliferation of seed funding, VC’s most patient form, suggests that VC overall is becoming more patient and it is being provided to more start-ups internationally.

CPE studies have shown that VC markets often exhibit different preferences for early-stage investment activity (Mayer et al., 2005; Bruton et al., 2009; Da Rin et al., 2013). Table 3 data indicates that VC investment patterns roughly followed Varieties of Capitalism (VoC) expectations until the mid-2000s: there was more seed-stage investment activity in the core LMEs of the USA and UK. LMEs are the institutional setting that Hall and Soskice (2001, p. 29) expected early-stage VC to exist in as an ‘exception’ to the overall short-termism of the capital markets financial system. CMEs, in which relationship banking should provide this financing, had only modest amounts of seed funding. Since the run-up to the Global Financial Crisis, however, the number of seed deals increased in both LMEs and CMEs.

The number of seed deals gained an increasing share of total VC deals in each country. Figure 1 captures the growth in seed stage activity for the last 16 years.

Figure 1.

Seed stage investments as percentage of overall VC investment activity.

Source: Author analysis of PitchBook data on VC deals (by number). Percentage represents seed stage deals as percent of total number of VC deals per market. 2016 data is through 1 May 2016.

Figure 1.

Seed stage investments as percentage of overall VC investment activity.

Source: Author analysis of PitchBook data on VC deals (by number). Percentage represents seed stage deals as percent of total number of VC deals per market. 2016 data is through 1 May 2016.

Seed funding’s share of total VC deal volumes started in the range of 0–12% in 2000 and grew to somewhere in the range of 22–33% by May 2016. The pace of seed deal growth has not been uniform across the four countries, nor has it been linear. The trend line has, however, been unequivocally positive.

Seed stage activity is growing in terms of the number of start-ups obtaining funding. Figure 1 does not provide an indication of how much money start-ups are receiving at that nascent stage. Figure 2 reveals that the amount of money invested in each seed deal has been stable over time and cross-nationally.14 Over the period, the average seed investment has hovered around the $500,000 mark across the four economies (save for Germany’s $3.19 million average in 2004).

Figure 2.

Capital investment mean for seed stage deals 2000–2015.

Source: Author analysis of PitchBook data on capital invested mean for seed stage venture capital deals.

Figure 2.

Capital investment mean for seed stage deals 2000–2015.

Source: Author analysis of PitchBook data on capital invested mean for seed stage venture capital deals.

Seed deal volume is growing in absolute and relative terms across the USA, UK, Germany and Japan. The average size of a seed investment, as depicted in Figure 2, has remained stable. Together, the data indicates that more start-ups are receiving seed funding, not that each start-up is receiving more money. While VC seed funding is a growing source of patient capital for start-ups across core LMEs and CMEs, absolute volumes are still small outside of the USA. The direction of seed fund volumes in the UK, Germany and Japan is positive, but it is unclear whether VC seed funding could reach US levels.

4. Accounting for the intertemporal and cross-national rise of seed stage investment activity

How can we account for the cross-national rise of seed funding since the Global Financial Crisis? With this question in mind, this section explores finance and political economy explanations for the rise of seed stage investment activity. It identifies factors individually and also discusses how they act in concert with one another to fuel both the demand for, and supply of, seed funding.

The growing supply of capital invested in the VC industry is one key factor propelling the rise of seed activity. The low interest rate environment for the last decade—exemplified by the Federal Funds Rate, which hovered around 0.25% between 2009 and 2015—has caused dismal returns on traditional investments and motivated institutional investors to allocate more capital to risk-bearing assets, especially alternative asset classes (OECD, 2014). For example, in 2015 the Japanese Government Pension Investment Fund, in an attempt to improve its yield, added a 5% allocation to alternative investments for the first time in its history (Flood, 2015). On the back of these larger inflows to alternatives, in the first quarter of 2016 US venture capitalists raised approximately $13 billion—the highest amount for a decade and the third largest since the 2000 dot-com peak.15

Another factor driving increased seed funding from traditional VC firms is the rising displacement threat by competitors who offer similar support and capital for start-ups. Competitors include accelerators (cohort-based programs that offer mentorship and access to investors to fledgling start-ups in exchange for equity stakes), incubators (cohort-based programs similarly offering mentorship and access to investors, but to aspiring entrepreneurs with business ideas rather than already-formed start-ups, in exchange for equity in the start-ups they go on to form) and angel syndicates (networks of angel investors that form groups in order to make larger and more professionalized investments). For example, in 2010 Dave McClure, a prominent angel investor, launched 500 Start-ups, a California-headquartered seed fund and accelerator, that operates in several countries.16 The aim of 500 Start-ups, and similar accelerator-run seed funds, is to gain further equity exposure to the most promising ‘graduates’ of their programmes. Y-Combinator, a preeminent global accelerator, typically takes a 6% equity stake for start-ups participating in their program. The seed fund enables them to grow their ownership stake.

Venture capitalists adjusted their strategy in response to the expansion of these competitors. Some of the largest and best-known VC managers, including NEA and Index Ventures, launched seed funds (Blomquist, 2014). Investing at the seed stage gives venture capitalists pro-rata options to participate in the later rounds where they would normally invest (e.g. Round A or B). This critically improves their competitive positioning for getting into the most oversubscribed deals.17 The $500,000 seed investments endow venture capitalists with the option to participate in the most promising start-ups at the outset rather than trying to elbow their way into these deals later on.

Venture capitalists have subsequently embraced a seed model that constitutes investing a small amount of money in a large number of start-ups (e.g. 20+). Early- and late-stage funds, in contrast, invest large sums in a smaller number of companies. Figure 1 depicts the relative share of seed activity and reflects the fundamental difference between these investment models: as venture capitalists allocate more money to seed funding, the number of deals done at the seed stage outpaces the volumes of deals done at the early and later stages.

A third factor explaining the increase of seed funding is the trend in demand for VC, as start-ups are seeking smaller amounts of money (Blomquist, 2014). Technology-focused start-ups’ capital needs are decreasing as ‘open source software, such as GitHub, and cloud services, such as Amazon Web Services, slashed the cost of software development from millions of dollars to thousands’ (Blank, 2013). The product cycle is faster and more iterative, encouraging entrepreneurs to raise seed funding to establish proof of concept and market validation (the domain of accelerators and incubators) rather than wait for investment at the customer acquisition, sales ramp and market grab stages.18 Early-stage businesses raise modest amounts of money, and strive to give up less equity, in their ‘lean start-up’ approach.19

The policy factors fostering the advance of seed stage funding form a two-part dynamic. First, government policy drives more entrepreneurial activity, which increases the demand for seed funding. Policies that strive to advance job creation and economic growth have particular salience as policy-makers attempt to navigate the post-Global Financial Crisis environment. They promote entrepreneurship in a bid to build local Silicon Valley ecosystems and, in so doing, advance innovation capabilities and spur high-quality job creation (Klingler-Vidra, 2015). Among other efforts, states have bolstered regulations and have offered tax schemes to encourage entrepreneurship (Mason and Brown, 2014). In 2010, for example, the UK invested in, and promoted, Tech City as a cluster of high-technology start-up activity in East London. This push for entrepreneurship, especially in the technology sector, has led to more, and more qualified, start-ups seeking seed funding.

Secondly, states support seed funding as a means of supporting promoting financial sector diversification and entrepreneurship. Countries ranging on the LME–CME continuum from the USA to Japan have offered funding, tax incentives and regulatory improvements to encourage seed investors (Lerner, 2009; Klingler-Vidra, 2014b). The German government, as an illustration, launched the second High-Tech Gründerfonds in 2011 with a focus on seed stage technology companies (Ernst & Young, 2015, p. 4). In the same year, the UK launched the Seed Enterprise Investment Scheme (SEIS), giving investors a 50% tax relief on investments up to £100,000 (equivalent to approximately $133,500 as of August 2016) in start-ups with minimal track records and assets. As evidence of the uptake of the scheme, the SEIS saw more than £163 million (equal to $217 million in August 2016 rates) raised in 2014 alone.20

5. Conclusion

This article conceptualized VC, especially at the seed stage, in terms of patient capital attributes. It identified VC seed capital as having a long intended investment horizon and venture capitalists as engaged for the purpose of driving long-term value creation rather than short-term profits. Venture capitalists demonstrate loyalty by staying invested until companies decide to sell, and, in the best case, by providing subsequent injections of capital. The seed stage is identified as being a necessary condition for the highest level of patience in VC, but not sufficient, as several factors may limit the patience of seed stage investments.

The rise of VC seed funding across the USA, UK, Germany and Japan suggests that more high-growth start-ups—in LMEs and CMEs—are receiving patient capital. This comes as traditional sources of patient capital appear to be shrinking. While more high-growth start-ups are accessing patient capital in the form of seed funding, it is worth putting the volume of VC financing in context. Even amongst the 5,000 fastest growing companies in the USA in 2014, only 6.5% received VC (Wiens and Bell-Masterson, 2015). Despite its small size, the National Venture Capital Association statistics on the impact of VC, in terms of what the companies that receive VC go on to do (e.g. account for large portions of GDP, jobs and R&D spending), make clear its systemic importance. While VC seed funding should not be considered an important source of patient capital for a broad range of companies, VCcan be a key form of patient capital for the world’s most innovative high-growth firms, as it has been for the likes of Google, Facebook and Uber.

When VC seed investing is accompanied by follow-on funding it signals the most patient form of VC. The increased focus and greater financial incentives that come with follow-on investments encourage seed investors to increase their engagement on top of the already long intended investment horizon. VC is most patient for American high-technology start-ups viewed as having unicorn potential. For them, seed funding is accompanied with deep engagement in the form of weekly meetings to drive managerial and strategy decisions. When seed funding is supplied on its own, it does not necessarily engender such a high level of patience. With more companies in the portfolio, and smaller stakes in each of these companies, seed stage venture capitalists do not have the time or a significant financial incentive to engage with company management.

The onset of new exit options, especially the NASDAQ Private Market, can reduce patience by default by allowing venture capitalists to sell ownership stakes to other private investors, thus exiting without having to wait for management to decide to sell. This development limits the extent of patience by default. VCs are increasingly expected to liquidate positions in companies that they do not believe capable of being ‘big winners’ in the long run. Thus, when utilized, the rise of secondary markets decreases the patience afforded to start-ups believed to hold average or poor potential. It does not, however, impede the patience afforded the start-ups with the greatest potential. It is worth noting that private markets do not raise the propensity for venture capitalists to exit in the face of short-term performance challenges. Rather, the decision to exit or not via secondary markets is still based on the venture capitalist’s assessment of long-term potential. For a growing number of VC firms, start-ups are expected to achieve ‘unicorn’ valuations in increasingly compressed time frames. All that said, I conclude that, on balance, VC is increasingly more patient as the rise of seed funding volume outweighs the impact of greater early exit options for seed funds and compressed company lifecycles.

A number of conceptual and empirical research projects are needed to further our understanding of the provision of VC seed funding as patient capital. The rise of seed funding in both LME and CME contexts suggests that VC may operate according to ‘opposite institutional logics’ (Jackson and Witt, forthcoming). A view of VC, according to opposite institutional logics, can offer insight into how new financial markets adapt to different local settings. For example, Japanese VC funds rely on arm’s-length relationships in order to gain objectivity in follow-on funding decisions in their otherwise long-term relationship context. The financing backgrounds of Japanese venture capitalists may leave them unable to deeply engage in product and strategy discussions, contributing to the arm’s length character of the relationship. LME contexts, specifically the USA, thrive on extensive relationships. This may be due, in part, to the highly-trained, specialized labour in the American VC market. US VCs’ technical skills facilitate deep relations with start-up management teams in which they inform start-up strategy and product decisions. Further research can better conceptualize and test how these opposite institutional logics help LME venture capitalists avoid exiting in the face of short-term market pressures while ensuring that CME venture capitalists are able to exit losing positions.

Research is also needed into the means by which policy-makers can incentivize investors to engage with, and be loyal to, a broader range of start-ups. The American VC market benefited from public policy that enabled pension fund investing, low capital gains tax rates and the launch of the NASDAQ market in the late 1970s (Lazonick, 2009). The ‘Long-term Stock Exchange’ proposal currently being considered by the US Securities and Exchange Commission may be the future of public policy to promote the provision of patient capital across growth-firms’ equity financing lifecycle.21 Similar initiatives to encourage long-term equity holding across high-growth companies’ life cycles could be considered in other countries. In the more immediate future, research is needed to better understand how policy can encourage seed funding that offers follow-on funding. The aim is to design policy that encourages this most patient form of VC seed funding to a greater number of high-growth firms outside of the USA.

Acknowledgements

I would like to thank Sylvia Maxfield, Iain Hardie, Andrew Tylecote, Matt Bradley, Erik Jones, participants of the ‘What is Patient Capital, and Where does it Exist?’ Socio-Economic Review Special Issue workshop held in Berlin on February 18–19, 2016 and the ‘What Is Patient Capital and Where Might We Find It?’ Workshop held in Edinburgh on June 2–3, 2015 for suggestions and feedback on earlier drafts. Thanks also to attendees at the Patient Capital panel at the International Studies Association conference on February 19, 2015 in New Orleans for their comments. Finally, thanks to Daria Danilina and Antony Howard for their help with data.

1
‘Start-up’ is defined by Merriam-Webster as ‘a fledgling business enterprise’.
3
See Table 1 and discussion of venture capital stages in Section 2 for explanation of venture capital investment stages.
4
PitchBook labels investments as seed stage when ‘investors/releases state it is a seed, or it is for less than $500,000 and is the first round as reported by a government filing’ (statement from Senior Analyst in personal communication on 10 May 2016). Seed funding is defined according to different ranges, with the most generous range being up to $1.5 million.
5
The first professional venture capital management firms were formed in the USA and the UK around the time of World War II (Lerner, 2009: 9-12).
6
For Hirschman, voice and exit are the actions available to actors when they observe a decrease in quality or an opportunity to improve. By exiting or using voice they aim to influence the undesirable behaviour. The classic context in which Hirschman’s voice and exit concepts are applied is that of citizens responding to a political environment; a decrease in the provision of public services is either said to prompt protests or voting (both forms of voice) or emigration (exit) as a means of influencing future public service provisioning.
7
Venture capitalists also engage in order to access private information to help them get, and remain, comfortable with the investment risk.
8
In light of venture capitalists’ aim to sell their ownership within a set timeframe, family firms rarely raise VC funding, as they typically aim to remain family-owned, and therefore not list on a stock market or sell their business to another firm.
10
Index Ventures is a venture capital management firm that manages seed, early- and late-stage funds across the USA and Europe.
11
The other VC valuation methods are public company comparable (e.g. what similar publicly traded companies are valued at) and discounted cash flow (which is more relevant to later-stage start-ups that have revenue).
13
Volume of private markets is dwarfed by public equities markets. Compare NASDAQ Private Markets $1.6 billion with its public equities market cap of $8.5 trillion as of 2014.
14
It is worth noting that the average seed investment size in the UK has decreased while the German average has increased over the post-Global Financial Crisis period.
17
Pro-rata participation refers to the right to contribute to future funding rounds in order to maintain ownership in a company (see http://www.inc.com/mark-suster/the-authoritative-guide-to-prorata-rights.html for further explanation of pro-rata).

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