Emerging social-economic institutions in the venture capital industry: an appraisal

American Journal of Economics and Sociology, The, July, 1995 by Steven J. Waddell

Several of the funds report important "learning curves." Of the core study group members, one reported the first investments (over a decade ago) representing 30 percent of the total dollars invested to date in equity were written off; since then it has made modest gains on its investments. One fund manager estimates making 15 percent per annum on average from investments, excluding a write-off representing six percent of the total invested. Based upon current estimated value another fund, with investments averaging 4.6 years, wrote off one investment representing one quarter of its portfolio, but nevertheless averaged an annual return of over 15 percent - in other words, after 4.6 years for each dollar invested in total there was a net return of about $0.87. A fourth member of the core study group, with investments averaging 1.6 years had no failures and averaged an increase in value of nearly 17 percent annually. The two extremes of the core study group were represented by one fund which lost about 10 percent of its original equity, and another which has averaged on its current holdings (only one holding has been sold, for an undisclosed profit) 30 percent annual returns with a weighted average investment period of 3.2 years - in other words, after 3.2 years each dollar had grown to $2.30.

Anticipating a 25 percent write-off rate, an average investment of seven years, and an average increase in investments of 15 percent, would result in an average annual increase of about 13.5 percent. If expenses are running seven to eight percent as some managers reported, this would result in a potential six percent net gain. However, most funds were not fully invested; anticipating 50 percent invested in equities averaging 13 percent return, and 50 percent in debt averaging five percent return would give an average net gain of nine percent. Both these scenarios anticipate a very low cost of capital in the expense ratio. There is no question that the finances are very "tight", dependent upon low capital costs and significant staff expertise.

VIII

Conclusion

Socially guided venture capital organizations have a very difficult task. They are trying to maneuver in an industry which is central to our economic system, and essentially reform it. They are still tiny in number and size. They have few resources and unsuccessful experiments can cost an organization its existence. The study investigations revealed several cases of this, and several cases of advanced initiatives that were halted because of difficulties. Nevertheless, the participants can claim some progress and their approach will continue to develop. These organizations clearly differ from other venture capital organizations. They have developed explicit missions, different investment profiles, and have emerging different associational networks. They exemplify what Granovetter (1985) called "social embeddedness" insofar as issues of ownership, employment, and business relationships to the community are very much part of their concerns. However, actual criteria for "socially-guided" equity venture investing remain incoherent and unclear. Stock market social investment funds in terms of their social criteria were at a similar stage of development in the early '70s. At that time the funds were just beginning to experiment with screens, more critical research about which organizations they should invest in, and how to leverage their influence upon companies.