The Money of Invention

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The Money of Invention
Author Paul A. Gompers
Josh Lerner
CountryUnited States
LanguageEnglish
Subject Venture capital
Publication date
2001

The Money of Invention: How Venture Capital Creates New Wealth is a non-fiction book about venture capital, written by Paul A. Gompers and Josh Lerner, Professors of Business Administration at Harvard Business School. The book was first published in 2001 by the Harvard Business School Press. It is considered one of the best studies about the venture capital industry in United States.

Non-fiction or nonfiction is content whose creator, in good faith, assumes responsibility for the truth or accuracy of the events, people, or information presented. In contrast, a story whose creator explicitly leaves open if and how the work refers to reality is usually classified as fiction. Nonfiction, which may be presented either objectively or subjectively, is traditionally one of the two main divisions of narratives, the other traditional division being fiction, which contrasts with nonfiction by dealing in information, events, and characters expected to be partly or largely imaginary.

Venture capital start-up investment

Venture capital (VC) is a type of private equity, a form of financing that is provided by firms or funds to small, early-stage, emerging firms that are deemed to have high growth potential, or which have demonstrated high growth. Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an ownership stake, in the companies they invest in. Venture capitalists take on the risk of financing risky start-ups in the hopes that some of the firms they support will become successful. Because startups face high uncertainty, VC investments do have high rates of failure. The start-ups are usually based on an innovative technology or business model and they are usually from the high technology industries, such as information technology (IT), clean technology or biotechnology.

Paul A. Gompers is an American economist. He is the Eugene Holman Professor of Business Administration at the Harvard Business School. He is the co-author of three books.

Contents

Overview

The Money of Invention is a non-technical overview of the venture capital (VC), written for a general audience who wants to understand how VC industry works. [1] [2]

The book is composed of three major sections. The first section focuses on the perspective of the entrepreneurs, the second on the venture capitalists, and the third on what Gompers and Lerner call 'the emulators', organizations that try to copy the venture capital model.

In the first section, the authors identify the challenges entrepreneurs face when trying to raise capital: (1) uncertainty about the future; (2) information gaps about the new product and the market for it; (3) the predominance of soft assets (e.g. patents, trade secrets), in contrast to hard assets (e.g. land, equipment) that are easier to finance; and (4) the volatility of the product- and financial market conditions. The authors then explain how VCs addresses these problems: screening mechanisms, due diligence, staged financing, syndicated investment, executive compensation rules, financing covenants like convertible debt, and corporate governance mechanisms are some of the solutions employed and discussed in the book.

In economics, capital consists of an asset that can enhance one's power to perform economically useful work. For example, in a fundamental sense a stone or an arrow is capital for a caveman who can use it as a hunting instrument, while roads are capital for inhabitants of a city.

Uncertainty situation which involves imperfect and/or unknown information

Uncertainty refers to epistemic situations involving imperfect or unknown information. It applies to predictions of future events, to physical measurements that are already made, or to the unknown. Uncertainty arises in partially observable and/or stochastic environments, as well as due to ignorance, indolence, or both. It arises in any number of fields, including insurance, philosophy, physics, statistics, economics, finance, psychology, sociology, engineering, metrology, meteorology, ecology and information science.

Patent set of exclusive rights granted by a sovereign state to an inventor or their assignee so that he has a temporary monopoly

A patent is a form of intellectual property. A patent gives its owner the right to exclude others from making, using, selling, and importing an invention for a limited period of time, usually twenty years. The patent rights are granted in exchange for an enabling public disclosure of the invention. In most countries patent rights fall under civil law and the patent holder needs to sue someone infringing the patent in order to enforce his or her rights. In some industries patents are an essential form of competitive advantage; in others they are irrelevant.

In the second section, the authors focus on venture capital organizations. This section is part a historical account about the VC industry in United States, beginning with the founding of the first modern VC firm, American Research and Development Corporation, by MIT president Karl Compton and HBS professor Georges Doriot, in 1946. It also explores subsequent VC booms to the federally guaranteed Small Business Investment Companies Program in the 1960s and the 1974 Employee Retirement Income Security Act, allowing a "prudent man" to hold some high-risk investments and increasing the flow of institutional money into the VC business. This section also describes the ways in which venture capital is structured, connecting its success to the limited partnership structure (e.g. management fees, carried interests, contractual restrictions); the mechanisms to raise funds and the emergence of the fund of funds; and the challenges of the regulators to grapple with its information gap problems. The section closes with a detailed study of the overshooting phenomena that explains the volatility of the returns of the industry.

American Research and Development Corporation venture capital and private equity firm

American Research and Development Corporation (ARDC) was a venture capital and private equity firm founded in 1946 by Georges Doriot, the former dean of Harvard Business School and "father of venture capitalism", with Ralph Flanders and Karl Compton.

Massachusetts Institute of Technology research university in Cambridge, Massachusetts, United States

The Massachusetts Institute of Technology (MIT) is a private research university in Cambridge, Massachusetts. Founded in 1861 in response to the increasing industrialization of the United States, MIT adopted a European polytechnic university model and stressed laboratory instruction in applied science and engineering. The institute is traditionally known for its research and education in the physical sciences and engineering, but more recently in biology, economics, linguistics and management as well. MIT is often ranked among the world's top five universities.

Harvard Business School business school in Boston, Massachusetts

Harvard Business School (HBS) is the graduate business school of Harvard University in Boston, Massachusetts. The school offers a large full-time MBA program, doctoral programs, HBS Online and many executive education programs. It owns Harvard Business Publishing, which publishes business books, leadership articles, online management tools for corporate learning, case studies and the monthly Harvard Business Review. It is home to the Baker Library/Bloomberg Center.

The third section of the book looks at efforts to apply the principles of venture investing in corporate, public sector, educational, and international settings. The authors argue that the lack of adequate compensation schemes and organizational structures usually limit the success of the venture capital model in these settings.

Corporation separate legal entity that has been incorporated through a legislative or registration process established through legislation

A corporation is an organization, usually a group of people or a company, authorized to act as a single entity and recognized as such in law. Early incorporated entities were established by charter. Most jurisdictions now allow the creation of new corporations through registration. Corporations enjoy limited liability for their investors, which can lead to losses being externalized from investors to the government or general public, while losses to investors are generally limited to the amount of their investment.

The public sector is the part of the economy composed of both public services and public enterprises.

Executive compensation or executive pay is composed of the financial compensation and other non-financial awards received by an executive from their firm for their service to the organization. It is typically a mixture of salary, bonuses, shares of or call options on the company stock, benefits, and perquisites, ideally configured to take into account government regulations, tax law, the desires of the organization and the executive, and rewards for performance.

Reviews

Randall Morck, an academic in the field, says that the book is "accessible to undergraduates and MBAs with little economics and to the general reader", but recommends The Venture Capital Cycle (Paul Gompers and Josh Lerner 1999, Cambridge: MIT Press) from the same authors for a high-level academic treatment of the same issues. He further states that the book may be interesting to economists, explaining that "the familiar problems of agency cost, information asymmetry, adverse selection, and moral hazard assume overarching importance in the VC business." He praises the book for giving "clarifying to these problems", being useful to "counterweight the more traditional presentation of these issues". [2]

Reviewers also say that the authors "are strong supporters of the venture capital model", and hence "the reader is left with little doubt that the VC business has managed the trick at least tolerably well." [1] [2] George Kingston points out that the book was published prior to the stock market downturn of the internet bubble and "it does not address the impact of these events on venture capital". [1]

Publishing information

Related Research Articles

The economic calculation problem is a criticism of using economic planning as a substitute for market-based allocation of the factors of production. It was first proposed by Ludwig von Mises in his 1920 article "Economic Calculation in the Socialist Commonwealth" and later expanded upon by Friedrich Hayek. In his first article, Mises describes the nature of the price system under capitalism and describes how individual subjective values are translated into the objective information necessary for rational allocation of resources in society.

Finance academic discipline studying businesses and investments

Finance is a field that is concerned with the allocation (investment) of assets and liabilities over space and time, often under conditions of risk or uncertainty. Finance can also be defined as the art of money management. Participants in the market aim to price assets based on their risk level, fundamental value, and their expected rate of return. Finance can be split into three sub-categories: public finance, corporate finance and personal finance.

Business plan

A business plan is a formal written document containing business goals, the methods on how these goals can be attained, and the time frame within which these goals need to be achieved. It also describes the nature of the business, background information on the organization, the organization's financial projections, and the strategies it intends to implement to achieve the stated targets. In its entirety, this document serves as a road map that provides direction to the business.

Private equity typically refers to investment funds, generally organized as limited partnerships, that buy and restructure companies that are not publicly traded.

Real options valuation, also often termed real options analysis, applies option valuation techniques to capital budgeting decisions. A real option itself, is the right—but not the obligation—to undertake certain business initiatives, such as deferring, abandoning, expanding, staging, or contracting a capital investment project. For example, the opportunity to invest in the expansion of a firm's factory, or alternatively to sell the factory, is a real call or put option, respectively.

A pre-money valuation is a term widely used in private equity or venture capital industries, referring to the valuation of a company or asset prior to an investment or financing. If an investment adds cash to a company, the company will have different valuations before and after the investment. The pre-money valuation refers to the company's valuation before the investment.

Seed money, sometimes known as seed funding or seed capital, is a form of securities offering in which an investor invests capital in a startup company in exchange for an equity stake in the company. The term seed suggests that this is a very early investment, meant to support the business until it can generate cash of its own, or until it is ready for further investments. Seed money options include friends and family funding, angel funding, and crowdfunding.

Venture capital financing is a type of financing by venture capital. It is private equity capital provided as seed funding to early-stage, high-potential, growth companies or more often it is after the seed funding round as a growth funding round. It is provided in the interest of generating a return on investment through an eventual realization event such as an IPO or trade sale of the company.

John T. Reed is an American businessman, author and former real estate investor. Reed has authored and self-published books on real estate investing, football coaching, baseball coaching, success, and self-publishing. He has been reportedly recommended by the National Association of Realtors as a serious investigator in the industry.

A series A round is the name typically given to a company's first significant round of venture capital financing. The name refers to the class of preferred stock sold to investors in exchange for their investment. It is usually the first series of stock after the common stock and common stock options issued to company founders, employees, friends and family and angel investors.

An angel investor is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. A small but increasing number of angel investors invest online through equity crowdfunding or organize themselves into angel groups or angel networks to share investment capital, as well as to provide advice to their portfolio companies.

A Business Development Company ("BDC") is a form of unregistered closed-end investment company in the United States that invests in small and mid-sized businesses. This form of company was created by Congress in 1980 as amendments to the Investment Company Act of 1940. Publicly filing firms may elect regulation as BDCs if they meet certain requirements of the Investment Company Act.

Corporate venture capital (CVC) is the investment of corporate funds directly in external startup companies. CVC is defined by the Business Dictionary as the "practice where a large firm takes an equity stake in a small but innovative or specialist firm, to which it may also provide management and marketing expertise; the objective is to gain a specific competitive advantage.

Entrepreneurial finance is the study of value and resource allocation, applied to new ventures. It addresses key questions which challenge all entrepreneurs: how much money can and should be raised; when should it be raised and from whom; what is a reasonable valuation of the startup; and how should funding contracts and exit decisions be structured.

Women in venture capital or VC are investors who provide venture capital funding to startups. Women make up a small fraction of the venture capital private equity workforce. A widely used source for tracking the number of women in venture capital is the Midas List which has been published by Forbes since 2001.

Unicorn bubble

A unicorn bubble is an economic bubble that occurs when unicorn startup companies are overvalued by venture capitalists or investors in an initial public offering.

William A. Sahlman is an American academic. He is a professor emeritus at the Harvard Business School. He has published research about entrepreneurship, including over 150 business cases. He is the co-author or co-editor of three books.

Josh Lerner is an American economist. He is the Jacob H. Schiff Professor of Investment Banking at the Harvard Business School.

References

  1. 1 2 3 Kingston, George (2003). "Review of The Money of Invention". Journal of Product Innovation Magazine. 20: 325–332.
  2. 1 2 3 Morck, Randall (Dec 2002). "Review: The Money of Invention". Journal of Economic Literature. American Economic Association. 40 (4): 1259–1261. JSTOR   3217345.
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