Chapter 4 Part 1: Venture Capital and Growth Capital - Funding the Next Big Thing
Chapter 4 is where Demaria gets into the actual strategies private equity funds use to make money. He starts with the one everyone has heard of: venture capital. The stuff that turns garage projects into billion-dollar companies. Or, more often, burns through cash and produces nothing.
As of 2017, PE funds managed over $3 trillion. Venture capital makes up roughly 19% of that. Let us walk through how it works.
Venture Capital: From Idea to IPO
Venture capital funds companies at every stage from “I have an idea” to “we are going public.” Demaria breaks it into phases: seed capital (the idea stage), early stage (prototyping), mid-stage (manufacturing), and late stage (commercial launch and expansion).
The main sectors? Healthcare and IT. Always has been, probably always will be. Clean tech and nanotech tried to challenge that at various points, but never got big enough to matter.
VC is heavily concentrated geographically. The USA and Western Europe get most of the action. Emerging markets are underserved, so talented entrepreneurs in places like Eastern Europe often pack up and move west to get funded.
What Makes a VC Ecosystem Work
A country needs three things for healthy venture capital: fundamental research, a way to turn research into products, and an environment where starting a company does not feel like fighting city hall.
Invest Europe put together a wish list: unified stock exchanges, tax breaks for small businesses, less red tape for startups, proper IP protection, and please stop regulating VC like it is a systemic risk.
The legal environment matters more than people think. Countries with good legal systems saw PE funds return 19% better than average. Bad legal systems? 49% worse.
Myths About Entrepreneurs
Demaria shares research that kills some popular startup myths.
First, tech entrepreneurs are not 20-something college dropouts. A Duke University survey of 549 founders found the average age was 40. Twice as many were over 50 as under 25. And 43% had two or more kids.
Second, entrepreneurs are made, not born. 52% were first in their family to start a business.
Third, the “dropout genius” story is a bedtime tale. College graduates start companies with twice the sales and workforce of non-graduates. Elite school does not help much. What matters is the degree.
Fourth, and this is the one VCs do not love hearing: venture capital follows innovation, it does not create it. Less than 5% of VC money goes to truly early-stage companies taking real risks on new products.
Three Models of Venture Capital
There is no single way to do venture capital. Demaria identifies at least three distinct models.
The American model focuses on lean startups, mostly consumer-facing, burning little cash at first then raising massive amounts to grab users. The goal: IPO or a huge acquisition. Shoot for the sky. This needs big exits to work.
The European model is quieter. Startups focus on B2B IT, aim for profitability, and get acquired for somewhere between 50 and 150 million euros. Less flashy, but arguably more sustainable.
Israel built something unique. A small, highly networked country where military tech development fed directly into startup culture. Between 2003 and 2011, VCs invested $11 billion in Israeli high-tech. Impressive, but hard to copy.
Chile tried something different with “Start-Up Chile,” offering seed money and visas to foreign entrepreneurs. By 2019, they supported 1,616 startups from 85 countries. But as Demaria notes, it took 30 years to build Silicon Valley.
How Startups Actually Get Funded
The funding chain is predictable. Founder’s savings first. Then friends and family. Then angels. Then professional VCs. Then maybe public markets.
Demaria shows a typical IT company example. The founder starts with $25,000 and owns 100%. After rounds from family, friends, angels, two VC rounds, and an IPO, the founder owns just 20%. But that 20% is now worth $10 million. Dilution hurts, but the pie got a lot bigger.
Bootstrapping sounds great in theory. Keep all the control. But Demaria points out the downsides: no room for mistakes and a reputation problem. Ironically, not taking VC money can hurt your credibility.
Business Angels: The Unsung Heroes
Business angels are the real backbone of seed investing. In 2018, about 334,000 angels invested $23 billion in 66,000 US companies. Average deal: $300,000 to $350,000. Without them, many companies that later get VC funding would not exist.
They do not just write checks. They help structure the idea, find early partners, and make tough calls. As Demaria puts it, they are closest to the original spirit of venture capital, where profit was a goal but not the overriding purpose.
Crowdfunding and ICOs: Buyer Beware
Demaria is not a fan. His argument: crowdfunding is “dumb equity.” Angels and VCs bring advice, networks, board oversight. Crowdfunding platforms bring none of that.
Worse, the deals showing up on these platforms are often the ones professional investors already rejected. The truly profitable VC investments have been in technical B2B areas that retail investors cannot even evaluate.
The Exit Problem
Most VC-backed companies do not go public. They get acquired. Google, Yahoo, Cisco, those famous IPOs are the exceptions. Trade sales are the norm.
But IPOs matter a lot for returns. When the IPO window closes, even VCs with great portfolios produce mediocre returns. Europe feels this pain especially, since there is no real Nasdaq equivalent.
The 2000 dot-com crash, the 2012 social media crash (Facebook, Groupon, Zynga), and various European struggles all come back to the same issue: too much money chasing too few viable deals.
Growth Capital: The Quiet Middle Ground
Section 4.1.2 covers growth capital, which is probably the least exciting but most stable part of private equity. Growth capital funds invest in companies that are already profitable and growing but need money to expand production or enter new markets.
It sits in a weird space between VC and LBOs. Not high-risk startups, not debt-heavy buyouts. Growth capital represents about 12% of the PE fund universe.
These companies cannot get bank loans because they are too small or too uneven for banks. Stock markets are tough because listing costs keep rising and analyst coverage for small companies keeps shrinking. Some end up in what Demaria calls the “listing twilight zone,” too small for the stock exchange but too expensive to delist.
Growth capital is probably the least risky PE strategy. Lower returns than VC or LBOs, but lower chance of losing everything too.
This is a retelling of Chapter 4 (sections 4.1.1-4.1.2) from “Introduction to Private Equity, Debt, and Real Assets” by Cyril Demaria. The book is a solid academic overview of the PE world. I am summarizing it in plain language so more people can access these ideas.