One of the most serious challenges to new entrepreneurs in the innovation process is capital-or the lack thereof. Venture capitalists typically make investments in small, young companies that may not have access to public or credit-oriented institutional funding. Venture capital investments can be long term and high risk, and may include hands-on involvement by the venture capitalist in the firm. Venture capital thus can aid the growth of promising small companies and facilitate the introduction of new products and technologies, and is an important source of funds used in the formation and expansion of small high-tech companies. This section examines venture capital disbursements by stage of financing and by technology area in the United States and Europe.
The pool of capital managed by venture capital firms grew dramatically during the 1980s as venture capital emerged as a truly important source of financing for small innovative firms. (See figure 6-23 and appendix table 6-19.) By 1989, the capital managed by venture capital firms totaled $23.2 billion, up from an estimated $3.0 billion in 1980. The number of venture capital firms also grew during the 1980s-from around 448 in 1983 to 670 in 1989.
In the early 1990s, the venture capital industry experienced a recession of sorts, as investor interest waned and the amount of venture capital disbursed to companies declined-especially compared to the extensive venture capital activity of the late 1980s. The number of firms managing venture capital also declined during the 1990s. But the slowdown was short-lived; investor interest picked up during 1992, and disbursements began to rise again. Both investor interest and venture capital disbursements have continued to grow through 1995. The latest data show total venture capital under management rising to $37.2 billion in 1995, up from $32.7 billion in 1994 and $28.9 billion in 1993.
The number of venture capital firms in the United States did not rebound to the peak of 1989 (670), but after several years of firm rationalization, the number rose to 610 venture capital firms in 1995 from the 591 operating in 1994. California, Massachusetts, and New York together account for nearly 65 percent of venture capital resources. The top 10 states account for over 95 percent. It appears that venture capital firms tend to cluster around locales considered to be "hotbeds" of technological activity, as well as in states where large amounts of R&D are performed.
Several years of high returns on venture capital investments have stimulated increased investor interest. This interest soared from 1993 to 1995, with new commitments reaching $4.2 billion in 1995, the largest one-year increase in venture capital funds. Pension funds remain the single largest source for new funds, supplying nearly 40 percent of committed capital. Endowments/foundations are the next largest source, supplying 23 percent of committed capital in 1995. (See appendix table 6-20.)
Starting in 1994, new capital raised exceeded capital disbursed by the venture capital industry, thereby creating surplus funds available for investments in new or expanding innovative firms. Thus far in the 1990s, firms producing computer software or providing computer-related services received the largest share of new disbursements. (See figure 6-24 and appendix table 6-21.) In 1991, software companies received 25 percent of all new venture capital disbursements, twice the share going to computer hardware companies and three times the share going to biotechnology companies. In 1995, software companies continued to attract the largest share of venture capital. Medical/health-care-related companies have also attracted large amounts of venture capital during the 1990s, and edged out software companies for the lead in 1994. Other industries that received substantial amounts of venture capital in 1995 were telecommunications companies and consumer-related companies (e.g., leisure products, retailing, etc.).
The investments made by venture capital firms may be categorized by the stage at which the financing is provided: 
The first three may be referred to as early stage financing and the remaining three as later stage financing.
An examination of U.S. venture capital disbursements to companies since 1986 clearly shows that most of the funds are directed to later stage investments. Over the past 10 years, later stage investments captured between 62 and 76 percent of venture capital disbursements, with the high and low points both reached in the 1990s. (See figure 6-25 and appendix table 6-22.) Capital for company expansions attracted by far the most investor interest.
According to these data, very little venture capital goes to the struggling inventor or entrepreneur trying to prove a concept or to product development. Over the past 10 years, such seed money never accounted for more than 7 percent of all venture capital disbursements, and most often represented between 3 and 4 percent of the annual totals.
As in the United States, venture capitalists in Europe are attracted to young, small (under 500 employees), fast-growing companies in need of capital and management expertise. Europe now has venture-capital-backed investments all across the continent, including investments in many of the transitioning countries in Central and Eastern Europe. Data compiled by the European Venture Capital Association tracking venture capital activity in 17 countries record over 5,000 separate investments in 1996, with total disbursements exceeding $8.5 billion-an 18 percent increase over 1995. (See text table 6-14.) The United Kingdom leads Europe in both the number of venture-backed investments made and the amount invested in British companies during 1996 (33 percent and 44 percent, respectively). France, Germany, and the Netherlands follow, in that order. Together with the United Kingdom, they accounted for three-fourths of all European venture capital disbursed in 1996.
While computer-related and biotechnology companies in the United States garner the lion's share of U.S. venture capital, the types of firms attracting venture capital in Europe are less technology intensive. Europe has long held a reputation for excellence in industrial machinery and equipment, fashion, and leisure products (e.g., sporting goods).These same industries are among the top recipients of European venture capital. More than 30 percent of venture capital investments (both in number and as a percentage of the total capital distributed in 1995 and 1996) were made in companies providing industrial products such as machine tools, pollution and recycling equipment, and high-fashion clothing and other consumer products. By comparison, European computer-related companies received 7 percent of the venture capital distributed in 1995 and 5 percent in 1996. European biotech companies received even less attention, although both the number and size of the investments in this industry increased in 1996 over the previous year.
European venture capitalists, like their American counterparts, direct only a small portion of capital disbursements as seed money or startup capital. Investments for expanding an existing company's productive capacity, helping a company add a new product line, or enabling a company to acquire an existing business-later stage investments-account for about 85 percent of European venture capital disbursements. For the past five years (1992 to 1996), early stage investments (as seed or startup capital) stayed below 7 percent. In fact, seed money, often used to finance research or concept development, averaged less than 1 percent from 1992 to 1995; in 1996, startup capital for product development and initial marketing reached its highest point in five years, when it represented about 6 percent of venture capital disbursements. (See figure 6-26.)