On the Fundamental Role of Venture Capital

Thomas Hellmann and Manju Puri
Economic Review, Vol. 87, No. 4, 2002

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The venture capital industry experienced its biggest decline ever in 2001. The National Venture Capital Association reports that, in the fourth quarter of 2001, investments by venture capital firms were at approximately a third of the level the year before and the amount of money raised by these firms had dropped 80 percent. Many people question whether this trend signals the eventual demise of venture capital.

However, according to the authors of this article, it is important to put these numbers in perspective. In terms of total dollars invested, 2001 ranks as the venture capital industry's third-best year, and the developments of 2001 are simply an anomaly in an otherwise exceptional growth curve. The article examines the significance of this difference between short- and long-term performance.

Using the findings from the Stanford Project on Emerging Companies, an interdisciplinary research project that analyzed 170 technology start-up firms, the authors discuss the effects of venture capital on both the market position of the start-up and on internal operational issues. Their research supports the conclusion that venture capitalists provide value-added services that enhance the value of their portfolio companies. The article concludes with some thoughts on the evolution of the venture capital industry in the nineties.

December 2002