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Venture Capital: A Catalyst for Innovation and Growth

This article studies the development of the venture capital (VC) industry in the United States and assesses how VC financing affects firm innovation and growth. The results highlight the essential role of VC financing for U.S. innovation and growth and suggest that VC development in other countries could promote their economic growth.

Jeremy Greenwood is a professor of economics at the University of Pennsylvania. Pengfei Han is an assistant professor of finance at Guanghua School of Management at Peking University. Juan M. Sánchez is a vice president and economist at the Federal Reserve Bank St. Louis. We thank Ana Maria Santacreu for helpful comments.

INTRODUCTION

Venture capital (VC) is a particular type of private equity that focuses on investing in young companies with high-growth potential. The companies and products and services VC helped develop are ubiquitous in our daily lives: the Apple iPhone, Google Search, Amazon, Facebook and Twitter, Starbucks, Uber, Tesla electric vehicles, Airbnb, Instacart, and the Moderna COVID-19 vaccine. Although these companies operate in drastically different industries and with dramatically different business models, they share one common and crucial footprint in their corporate histories: All of them received major financing and mentorship support from VC investors in the early stages of their development.

This article outlines the history of VC and characterizes some stylized facts about VC's impact on innovation and growth. In particular, this article empirically evaluates the relationship between VC, firm growth, and innovation.

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How Venture Capitalists Make Decisions

• Paul Gompers,
• Will Gornall,
• Steven N. Kaplan,
• Ilya A. Strebulaev

For decades now, venture capitalists have played a crucial role in the economy by financing high-growth start-ups. While the companies they’ve backed—Amazon, Apple, Facebook, Google, and more—are constantly in the headlines, very little is known about what VCs actually do and how they create value. To pull the curtain back, Paul Gompers of Harvard Business School, Will Gornall of the Sauder School of Business, Steven N. Kaplan of the Chicago Booth School of Business, and Ilya A. Strebulaev of Stanford Business School conducted what is perhaps the most comprehensive survey of VC firms to date. In this article, they share their findings, offering details on how VCs hunt for deals, assess and winnow down opportunities, add value to portfolio companies, structure agreements with founders, and operate their own firms. These insights into VC practices can be helpful to entrepreneurs trying to raise capital, corporate investment arms that want to emulate VCs’ success, and policy makers who seek to build entrepreneurial ecosystems in their communities.

An inside look at an opaque process

Over the past 30 years, venture capital has been a vital source of financing for high-growth start-ups. Amazon, Apple, Facebook, Gilead Sciences, Google, Intel, Microsoft, Whole Foods, and countless other innovative companies owe their early success in part to the capital and coaching provided by VCs. Venture capital has become an essential driver of economic value. Consider that in 2015 public companies that had received VC backing accounted for 20% of the market capitalization and 44% of the research and development spending of U.S. public companies.

• PG Paul Gompers is the Eugene Holman Professor of Business Administration at Harvard Business School and a research associate at the National Bureau of Economic Research.
• WG Will Gornall is an assistant professor at the University of British Columbia Sauder School of Business.
• SK Steven N. Kaplan is the Neubauer Family Professor of Entrepreneurship and Finance and the Kessenich E.P. Faculty Director of the Polsky Center for Entrepreneurship at the University of Chicago.
• IS Ilya A. Strebulaev is the David S. Lobel Professor of Private Equity and a professor of finance at the Stanford Graduate School of Business. He is also the founder of the Stanford GSB Venture Capital Initiative and a research associate at the National Bureau of Economic Research.

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A Systems View Across Time and Space

• Open access
• Published: 05 March 2022

Empirical examination of relationship between venture capital financing and profitability of portfolio companies in Uganda

• Ahmed I. Kato   ORCID: orcid.org/0000-0002-1811-6138 1 &
• Chiloane-Phetla E. Germinah 1  

Journal of Innovation and Entrepreneurship volume  11 , Article number:  30 ( 2022 ) Cite this article

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In recent times, venture capital (VC) financing has evolved as an alternative feasible funding model for young innovative companies. Existing studies focus on whether VC enhances profitability. While helpful, this body of work does not address a critical question: whether VC firms are more profitable than non-VC firms. The co-existence of both VC and non VC firms in Africa provides an opportunity to address this question. Accordingly, this paper sought to extend the understanding of the relationship between VC financing and the profitability of portfolio companies in Uganda, a rapidly growing VC market. We utilised a mixed methods approach, which involved quantitative data collected from 68 key VC stakeholders, and qualitative data collected from 16 semi-structured face-to-face interviews. The results confirm the superior performance of VC-financed enterprises when compared to non-VC-financed enterprises. The study makes a vital contribution by offering a diversified framework for enterprise success. The framework will assist VC firms in evaluating and customising funding programmes that can propel early-stage firms’ success in Uganda, and in similar emerging economies. Secondly, our results contribute to extant knowledge about recent developments in Uganda’s VC industry and how it influences the profitability trends of SMEs, also in similar emerging economies.

Introduction

In recent times, venture capital (VC) financing has evolved as the most feasible funding model for young innovative companies. VC firms provide the needed capital in exchange for equity shares in the portfolio companies (Amornsiripanitch et al., 2019 ; Gompers & Lerner, 1999 , Gompers et al., 2020 ; Hirukawa & Ueda, 2008 ; Kato & Tsoka, 2020 ; KPMG & EAVCA, 2019 ; Li & Zahra, 2012 ; SAVCA, 2011 ). Seen from a different standpoint, the contribution of VC to the profitability of early-stage enterprises has not been extensively deliberated among scholars in developing countries, therefore, inadequate evidence is available to acknowledge its impact on the growth of small firms (Ernst & Young, 2016 ; Shanthi et al., 2018 ). In this context, this paper sought to extend the understanding of the role VC in boosting the profitability of portfolio companies in Uganda.

Tykvova ( 2018 ) disclosed that the VC finance framework is not a one-size-fits-all framework. Venture capitalists (VCs) select only companies with high growth potential, and consequently, only a few start-up firms qualify for VC investment. While several studies highlight the benefit of VC investment to young companies, the relationship between VC financing and the profitability of the portfolio companies has been under-researched. As a result, a review of previous research offers inadequate conclusions to account for these differences in performance, moreover, many of these studies focused mainly on developed economies.

VC firms and practitioners typically utilise profitability as the principal financial measure to project the success of the portfolio companies (Emerah & Abomeh, 2020 ). However, some scholars criticise this approach to measuring business performance, because it is restricted to past performance. In addition, it is regarded as an unrealistic technique of treating depreciation and amortisation as part of the company expenses, yet it does not involve direct cash outflows. That said, small and medium-sized enterprises (SMEs) with demonstrated profits find it easy to inspire VC investors that are experienced in financing high-risk entrepreneurial firms. VCs make investments in portfolio companies in which they earn returns of between 20 and 30% from the invested capital (Gompers & Lerner, 1999 ). Nevertheless, the concept of VC financing has remained misunderstood in Uganda, despite the vital role it can play in the country’s economy.

Although VC has surged globally in the last 20 years, in, for instance, the United States of America (US), Europe, Canada and China, it has largely focused on the technological sectors, with a nominal allotment of funds to the manufacturing and agro-business sectors that form a colossal share of the SME ecosystem, especially in developing economies, such as Uganda (AVCA, 2020 ; Kato & Tsoka, 2020 ; SAVCA, 2014 ). Thus, only a few portfolio companies have the opportunity to be financed by VC investors, hence, widening the financing gap. Likewise, Ekanem et al. ( 2019 ) observed that VCs transplanted the Silicon Valley model to emerging markets without making meticulous adjustments to reflect the needs of their business environment. This VC myopia has been identified as hampering SMEs’ growth.

Furthermore, few empirical studies have engaged the mixed technique for data collection, moreover, a significant number of empirical studies were conducted 20 years into the past (Gompers & Lerner, 1999 ; Lerner, 2010 ). Prior literature suggests that most of the research assessing the impact of VC on the performance of SMEs essentially engaged business owners/ managers as the key respondents (Biney, 2018 ; Kwame, 2017 ). Therefore, the present study is distinct as it focuses on all the key players in the VC market. The research adopted a mixed method approach and presents a current understanding of the impact of VC on the profitability of the portfolio companies in the public domain. Worse still, these studies largely present results from advanced economies, henceforth, widening the literature gap that compels demand for future research in Africa. In addition, Uganda’s VC market is under-explored, with little evidence to explain how VC financing has influenced SMEs’ performance (Kato & Tsoka, 2020 ; UIA, 2016 ).

Therefore, we reviewed the current literature to identify existing gaps in our current understanding that may provide a foundation for this study. We also reviewed the successful experiences of the VC landscape from developed economies, and conflicting experiences of duplications globally. The paper was guided by two fundamental research questions:

Does venture capital financing spur the profitability growth of the portfolio companies?

How does the venture capitalists’ involvement influence the success of the portfolio companies?

This paper makes four major contributions: firstly, the paper highlights the demand for government to enhance VC supply to early-stage firms, as well as to create a favourable investment environment which will inspire foreign VC firms to invest in the country. This may involve government support to reduce the taxes levied on capital gains on the disposal of business assets during initial public offerings (IPOs) or trade sales. Secondly, the results from this study will benefit the VCs in their efforts to make ideal investment decisions to enhance VC market development. Thirdly, the study makes a vital contribution to knowledge by offering a diversified framework for enterprise success in emerging economies. The framework is expected to benefit the key players in the VC market in their efforts to evaluate and customise sufficient funding programmes that can propel the success of early-stage firms. Finally, this paper also extends our knowledge about recent developments in the VC industry and how it influences the profitability trends of SMEs in emerging economies, such as in Uganda.

The rest of the article is divided into five sections. The next section presents the theoretical literature review, while " Empirical literature review and hypotheses development " section discusses the empirical literature review and hypotheses development. " Research design " section describes the research design. Finally, " Empirical results and discussion " section presents the empirical results.

The theoretical literature review

Agency theory demonstrates the nexus between the VCs who are the principals in the VC contract and the business entrepreneurs (agents), delegated to work on behalf of the VCs. The principal–agent relationship (VC contract) is established when the entrepreneurs agree with VCs to invest in the start-up firms in exchange for equity shares (Bertoni et al., 2019 ; Cumming et al., 2017 ).

Hα1: The venture capitalists’ involvement in the portfolio companies influences their success

The principal–agent problem postulates interrelated conflicts of interest which could emerge in the execution of the contract. This often arises at the time when VCs exit the company through either trade sale or initial public offerings (IPOs), leading the agents into divergence from the best interests of the principal. However, VCs are aware of such barriers that may have behaviour or outcome-based impediments to their interests. Therefore, VC investors insist on stringent control measures and monitoring aspects to guard their business interests through secure minority seats on SMEs’ board of directors (BOD). They maintain a sound business and add value to portfolio companies to recover worthy return on investment (ROE) shares (Cumming & Johan, 2016 ). It is well documented that misunderstandings usually emerge at the exit of the VCs, particularly if this is not well managed from the inception stage. There is noticeable principal–agent conflict that emanates from information asymmetries and fear of the business owner losing control over their investments (Amit et al., 1998 ).

That being said, the VC contract is vital to guard against eventual disputes between the portfolio managers and VCs. The VC financing concept resonates well with the agency theory (Hellmann & Puri, 2002 . This certainly requires SMEs to agree with VCs in order to access the financing needed for their growth and expansion, thus, enforcing VC contracts to protect the interests of both parties.

Hα1: Venture capital financing model spurs the profitability growth of the portfolio companies

The principal–agent relationship concept has been proven to stimulate SMEs’ performance in terms of sales revenue profitability, return on equity (ROE) and return on assets (ROA). This theory provides a firm foundation for our research hypothesis. However, imperfections in the market indicate that this assumption is not fully valid. Pragmatic evidence has disclosed that start-up firms seek external financing sources only if their retained earnings are insufficient to meet their business needs (Myers & Majluf, 1984 ). In addition, some entrepreneurs may not welcome VCs in their business because it compromises their control power, hence they are compelled to depend on retained earnings although they may not sufficient to foster the SME’s growth. Therefore, it is not usually accurate for VCs to assume that the entrepreneur may not abide by the VC contract, and therefore, it may be unnecessary to set the stringent rules in VC contracts. That seemingly appears to be biased, having no consideration for the fears of the entrepreneurs, specifically in the appropriation of profits.

Empirical literature review and hypotheses development

This section delivers a detailed review of the extant literature that underwrites the relationship between VC finance and the profitability of portfolio companies to inform and elucidate our insights. The paper primarily describes the central concepts of VC and the theoretical framework underlying its influence on the performance of VC-financed companies, which provides the foundation for the study.

Venture capital and the profitability growth of portfolio companies

One of the very first studies assessing VC-financed enterprises’ performance, was piloted by the Venture Economics Incorporation for the US General Accounting Office in 1982. The study disclosed that VC-backed companies realised tremendous growth in sales turnover, employment creation, and tax payments, if compared to other companies. In line with the benefits of VC financing, the National Venture Capital Association (NVCA) ( 2021 ) discovered that the VC-backed companies grew faster than their national industry counterparts in terms of employment, sales, and wages. Similar results were also obtained in Europe (KPMG & EAVCA, 2019 ), where venture-backed companies achieved a yearly sales growth of 35%, compared to the 14% of other associated European public firms, and employment grew 30.5%. Therefore, such mixed conclusions necessitate a novel empirical study that would be able to fill these literature gaps.

Several researchers, mainly from technologically advanced economies, have confirmed that VC finance is a reality in augmenting the growth of SMEs (Deloitte & NVCA, 2009 ; Gompers & Lerner, 1998 ; Lerner, 2010 ). VC financing is connected to faster growth in early-stage firms, and that it is a precursor for innovation and the internationalisation of the portfolio companies (Kelly & Hankook, 2013 ; Mason, 2009 ; Bruton et al., 2015 ; Chemmanur et al., 2011 ). While there are various reasons for starting a commercial enterprise, profit maximisation is the primary objective (Kenawy & Abd-el Ghany, 2012 ). It is common knowledge that early-stage enterprises certainly need to earn profits to attract patient capital to ensure their continued commercial growth and expansion over time. Albeit VC finance has been extensively studied, its subsequent impact on the profitability of the portfolio companies is comparatively underexplored.

Profitability is a significant pointer to estimate the growth of SMEs, which is also a rising concern for VC investors. Audretsch and Lehmann ( 2004 ) and Chahine et al. ( 2012 ) discovered that VC-financed firms are highly associated with good profitability and market performance, if compared to non-VC-financed companies. However, some scholars present conflicting results, asserting that VC financing does not necessarily encourage enterprise growth. This is attributable to the selection criteria wherein VC investors identify high-growth potential firms that would probably have grown, even without receiving funding from the VC firms. Similarly, Tykvova ( 2018 ) reveals that the primary goal of the VC investors is to reap high returns from the funded companies, and SME growth is a spin-off to their primary purpose.

Furthermore, Puri and Zarutskie ( 2012 ), Kelly and Hankook ( 2013 ) and Paglia and Harjoto ( 2014 ) showed that VC financing positively influences the VC-funded companies’ profitability growth. Jaki et al. ( 2017 ) asserted that profitability growth changes progressively in the early stage of 3 to 5 years, and subsequently a decline is recognised when the VCs plan to exit. However, Harris et al., ( 2014 ) reported unsatisfactory results in terms of returns on invested capital. This ignited further studies of this kind to accentuate the critical role played by VC in enhancing the profitability of the investee companies.

While most literature paints an intriguing picture of VC investment, the reality is that VC is one of the riskiest investment models. VCs firms lose a third (1/3) on the entire investment, and then expect to get a third (1/3) of nominal investment returns, and expect to generate a third (1/3) on the bulk of the investment returns (Kato & Tsoka, 2020 ). Since many VCs do not want to expose their failed ventures, there is a lack of relevant data, especially in Africa. Therefore, such mixed conclusions necessitate a novel empirical study that would be able to fill these literature gaps.

Role of venture capitalists on the BOD and enterprise success

Several studies have documented that the VCs’ involvement on the BOD is fundamental for the success and growth of the VC-financed companies (Bertoni & Tykvová, 2015 ; Gompers et al., 2020 ; Hellmann & Puri, 2002 ).

Gompers & Lerner, ( 1999 ) and Hellmann and Puri ( 2002 ) disclosed that VCs enter into VC contracts with entrepreneurs as a way to deal with the moral hazards and information asymmetries. In addition, VCs bring with them technological transfers, coupled with superior skills in terms of human capital that would otherwise be inaccessible without their buoyant presence on the BOD. Similarly, Lerner ( 2010 ) and Gompers et al., ( 2020 ) reported VCs do not only provide VC funds, but also secure minority seats on the BOD to oversee their investments, detect financial risks to the companies at an early stage, undoubtedly close the knowledge gaps, and manage volatile markets. These findings conflict with the earlier conclusions of Gompers and Lerner ( 1998 ), where they submitted that the VC-backed industries are characterised by a potential conflict of interests that may compel the VCs to grandstand portfolio companies for IPOs or trade sale. This study was extended by Tykvova ( 2018 ) who alluded that the VCs aim to reap high returns on their VC investments.

Surprisingly, while several authors praise the VCs for their growing involvement in portfolio companies, Aldrich ( 2008 ) and Lee and Wahal ( 2004 ) disclosed that VC financing is not aimed at mediocre companies, nor is it designated for all commercial sectors. VC is not a one-size-fits-all framework because it only benefits a small number of the early-stage enterprises whereby, on average, two out 100 potential SME applicants qualify for VC funding (Deloitte & NVCA, 2009 ). The worst scenario is that VC investors target specific industries, for instance, high-tech industries, and concentrate in a few regions globally. Therefore, VC performance in emerging economies, such as in Uganda, has remained unclear.

In conclusion, prior literature confirms that VC financing stimulates the growth of start-up firms and is a sustainable solution for averting the problem of lack of access to external financing. However, there is little evidence to document VC performance in Uganda.

The literature review offered a firm foundation for crafting the research questions to assist in data collection and analysis. The next section discusses the research design approach.

Research design

Background to venture capital in uganda.

While the VC gauge has been exceptionally skewed to the US which by far is the leader in the VC industry, in the last decade, numerous countries including Uganda, have begun to tap into the possibilities that venture-backed companies can offer. In contrast, Uganda government has remained unclear about suitable policy frameworks to undertake (Kato & Tsoka, 2020 ), and considerable misapprehensions about this financial intermediary remain a big problem. Uganda’s VC market is under-explored, with little evidence to explain how VC financing has influenced SMEs’ performance (Kato & Tsoka, 2020 ; UIA, 2016 ). Against the backdrop of this discourse, we reviewed the existing literature and theoretical concepts to answer the research questions with a focus on Uganda.

Research methods

To obtain a better insight of the nexus between VC financing and profitability of the portfolio companies, we conducted a case study using a mixed method because it provided the author with the opportunity to obtain a more comprehensive understanding of the research problem. The quantitative method was more predominant in this study. Previous researchers have also used the mixed-method research approach (Kato & Tsoka, 2020 ; Kwame, 2017 ) and commended it for yielding reliable and valid datasets.

Population, sample size, and data collection

The primary data were collected from the Uganda Investment Authority’s (UIA) database comprising SMEs classified as the top-performing SMEs in 2018 and 2019. Since UIA did not maintain a segregated catalogue for VC-backed firms, we also used the profiles of active VC firms in Uganda to track their portfolio companies. Stratified random sampling was applied to obtain a sample size of 90 respondents from a total population of 300 SMEs. Our sample respondents were selected from the central business districts (CBD) with the highest concentration of SMEs situated in the Kampala, Wakiso, and Mukono and Jinja districts. The manufacturing agribusiness sectors were preferred because they contributed 21.6% and 67% to the total national revenue collections than the fast-moving consumer goods sector (URA, 2018 ). The key respondents included VC firms responsible for financing SMEs; government agencies in charge of regulating the business environment; business entrepreneurs/managers as the recipients of VC finance; and non-VC-backed firms. This choice aimed to match the performance of the VC-backed firms against the non VC-backed firms.

As it can be seen in Table 1 , the VC-funded and non-VC-funded enterprises contributed a higher percentage of 89% combined, because the major aim was to measure the SMEs’ growth in terms of profitability, ROE, ROA, and how government regulations impact the portfolio companies. In addition, VC firms and government agencies were included in the study because they do provide risk capital and determine the direction of the funded companies. This helped to gather reliable data in terms of SMEs’ performance.

Primary data were collected using 5-point Likert scale semi-structured questionnaires that were administered to 90 key respondents. This data collection instrument offered the respondents an opportunity to complete the questions at their convenience, since they comprised a customarily busy class.

The survey questionnaire involved multiple questions ranging from strongly disagree (1) to strongly agree (5) and an average score for agreeing ≥ 3.5. Out of the 90 questionnaires administered, 70 were returned and 2 were found not suitable for data analysis. Consequently, 68 responses from the questionnaires were used for data analysis.

Furthermore, we purposely selected 30 participants ( S  = 10% of 300) for face-to-face semi-structured interviews.

Table 2 shows a higher composition of SME management staff of 66.7%, followed by a 20% share of VCs/Business Angels. These groups were chosen because they compose the highest decision-making body of SMEs, and possess a wealth of knowledge and are the custodians of the data required for the study.

Measurement of independent and dependent variables

To measure the interdependence between independent variables and the dependent variables, we used a multiple regression model, wherein VC finance and profitability are designated as independent and dependent variables, respectively. We extracted data from the 68 survey questionnaires, this was organised into an Excel worksheet, thereafter exported to the SPSS computer-aided program to run the results. We also computed the sales turnover, ROE, and net income using the ratio analysis with the assistance of the audited and unaudited reports provided by the respondents.

Table 3 shows that out of the 90 questionnaires administered, 68 completed and returned questionnaires were appropriate for data analysis. This produced a response rate of 76%, higher than the comparative study of Memba et al. ( 2012 ) which had a response rate of 65%. These results are supported by Mundy ( 2002 ), who maintained that the higher the response rate, the better: 60% would be marginal, 70% would be reasonable, 80% would be good, and 90% would be excellent. As such, there is no justification not to accept a response rate of 76%, because it conveys reliable and valid results, and is representative of the entire population under study.

In the regression model yi denotes VC finance and VCs role in POs as the independent variables, then the dependent variables are denoted as \({X}_{1}\) … \({X}_{n}\) . To measure profitability, we used the following performance metrics: sales turnover, EBIT and ROE. Government regulations come as an intervening variable.

The multiple linear regression model is illustrated as:

where Y : is % of profitability that is measured as (sales, ROE, ROA, and EBIT); β 0: is the y -intercept wherein the value of y when \({X}_{j1}\) , \({X}_{j2}\dots {X}_{jk}\) are equal to 0; β 1 and β 2 are the regression coefficients that represent the change in y relative to a one-unit change in \({X}_{j1}\) , \({X}_{j2}\dots {X}_{jk}\) , respectively; Βk : is the slope coefficient for each independent variable; \({X}_{1}\) : venture capital finance as one of the independent variable; \({X}_{2}\) : VCs involvement on the BOD as the second independent variable; ϵj : is the model’s random error (residual) term.

The predictor variables are specified as a j and k matrix.

where J : is the number of observations, and K : is the number of predictor variables.

Each column of X denotes one independent variable, and each row represents one observation, while y is the response for the corresponding row of X .

The null hypothesis is that all of the population regression coefficients are zero. The alternate hypothesis is that at least one of the coefficients is not zero. This test is written in symbolic form for three independent variables as:

H0: β 1 =  β 2 =  β 3 = 0,

H1: Not all the β s = 0.

The VC-backed companies and non-VC-backed companies are binary variables that were allocated 1 to indicate they received VC financing, and 0 if they did not receive VC financing.

To confirm the research questionnaire for validity and reliability, Cronbach’s Alpha coefficient was applied to test the results, with a 95% significant confidence level and a 5% margin of error. The results showed a 98.4% confidence level of the survey questionnaire and a margin of error of 1.6% which was much lower than the estimated 5%. The statistical tests relied on the two-sided tests represented as 0.05 level of significance.

The interview data were collected from 16 respondents. This paper is unique in that it conveys the thoughts of the different players in the VC market, something that has not been reported in earlier studies. The recorded interview data, videos, audited accounts, financial reports, narrative reports, and researcher’s observations were transcribed, reviewed, and later exported to Atlas.ti version 25. We generated memos, groups, and networking linkages which facilitated a coherent content analysis of the data. Thereafter, the data were validated and triangulation was performed until a point of saturation was attained after 16 interviews. Saunders et al. ( 2009 ) argued that when the point of saturation is attained, the results are adequate as a true representation of the sample.

Ethical considerations

The study received approval from the Research Ethical clearance committee of the University of South Africa (UNISA) in August 2019. We also received prior approval from UIA and USSIA to access their databases. We further obtained prior consent from all the respondents before commencing the study, and they signed informed consent as confirmation for their involvement in the study. We signed Non-Disclosure Agreements (NDA) not to share any information to any third parties without prior management approval. The respondents had the liberty to decline to respond to some of the questions they found disturbing or which they perceived as uncomfortable.

Empirical results and discussion

The capacity of an enterprise to generate sufficient profits defines its financial stability to primarily enlarge the value of invested capital to meet its financial obligation as a going concern. The profitability approach has been extensively used as a popular and dependable approach, if compared to other methods (Myskova & Hajek, 2017 ; Du & Cai, 2020 ), since fund managers frequently search for firms that have previously demonstrated growth potential.

Profit analysis of VC-financed and non-VC-financed enterprises

We specifically evaluated the firms’ profitability fluctuations considering the variability in the taxes charged to the varied sectors, and the different accounting principles used. The paper used EBIT for a rational comparison, because the outcomes may be relatively diverse when earning after tax (EAT) is used.

Figure  1 uncovers that the VC-financed companies realised much higher profits of between 30 and 50%, compared to 15% to 24% for the non-VC-financed enterprises. The highest profits were reported in year 3, whereby the VC-backed firms realised 50%, compared to 24% for the non VC-backed firms. In view of these results, the VC-recipient companies doubled the companies financed by other sources. A company that earns higher profits suggests better performance and efficiency compared to the rivals in a similar business sector.

However, the study of Memba et al. ( 2012 ) revealed much higher profits of above 60% for the recipient companies. We observe that her study was done over 10 years ago when the presence of the VC firms was still insignificant, suggesting less competition in the VC industry at the time. This potency contributed to reaping high returns in a virgin VC industry. In addition, current research discloses that while there might be other objectives for setting up a company, the major objective is to make reasonable profits. Accordingly, we can confirm that increasing the VC supply to start-ups firms contributes to profitability growth. These results are consistent with prior literature, for instance, Biney ( 2018 ), Kato and Tsoka ( 2020 ) and Du and Cai ( 2020 ).

Considering that the financial statements used for this study from 2016–2018, were prepared based on book value, they do not reflect the current reality in the business and direction of the firm. Consequently, we further ran an ANOVA F -test to assess if the differences in mean values between the VC-backed and non-VC-backed firms are due to chance, or if they are indeed significantly different.

Based on the results from the ANOVA test presented in Table 4 , the F -value (3, 2.145) = 5.536 and a significant value of 0.02, which is much less than the 5% level of significance for the regression. This offers irresistible evidence that our model is well fit and valid. The outcomes from the ANOVA test confirm that there is a positive significant relationship between profitability as a dependent variable, and VC finance as a predictor variable. As can be seen, the results confirm that VC financing escalates profitability for the funded companies because the regression coefficient is not equal to zero. In contrast, our findings conflict with the study of Rosenbusch et al. ( 2013 ), who found that VC finance does not enhance the profitability of the funded firms.

These results were augmented with 16 face-to-face interviews conducted with the key players in the VC market who generally revealed attractive results. More compelling results were obtained from the VC fund managers. ‘T o maximise profits it is mostly about structuring not having a routine or monthly payments, this is the real framework that enhances profitability , DRS05’. The profitability growth of the funded companies shows that about 50% of the projects are doing very well, 30% are struggling, and 30% of the projects are completely failing to grow. They endorsed VC financing for its contribution to the growth of the funded firms.

Although previous studies have painted an intriguing picture of the success of all the VC-backed firms, The Kauffman Foundation (2017) uncovered that 62% of portfolio companies failed to exceed returns from the stock markets. That explains why the number of VC funds has shrunk by 30% in the past decade, according to NVCA ( 2020 ). Above and beyond, the current research of Seth ( 2020 ) reported that 65% of investment rounds fail to return 1× capital and only 4% return greater than 10× capital. Ultimately, the difference between the best performing and average performing firms are incredibly wide. Comparatively limited investments in the portfolios of VC funds harvest huge gains.

However, we discovered that principal–agent relationship was more predominant in the VC-industry setting and everyday life due to the potential problems of adverse selection and moral hazard. The VCs enter into VC contracts to defend their interests wherein entrepreneurial work as their agents. Our findings revealed that 100% of the respondents confirmed signing VC contracts and allowing at least one VC fund manager on their board structures. Certainly such arrangement brings in play the agency theory to mitigate the moral hazards and information asymmetry related to early-stage enterprises.

All in all, early-stage firms that can demonstrate the capacity to generate worthy profits have higher chances of attracting VC financing because this is the area of interest for any prospective investors. Fund managers primarily depend on profitability ratios to determine the financial health of a firm (Myskova & Hajek, 2017 ).

Pearson correlation coefficient test

The paper employed the Pearson correlation coefficient tests to determine if there is any relationship between ROA and VC financing. The higher the ROA number, the better, because the company is earning more money on less investment.

As shown in Table 5 , the test results display a correlation coefficient of ( r  = 0.336, P  ≤ 0.05) designating that there is a positive relationship, as P  ≤ 0.05. It can therefore be concluded that 33.6% (0.336) of changes in ROA can be explained by the use of VC finance. Particularly, firms that received VC financing recognised higher ROA than their non-VC-financed enterprises. Kwame ( 2017 ) concurs with these results. A higher percentage of ROA depicts sound financial health of an enterprise represented by its asset base’s capacity to produce profits with each dollar invested. Similarly, a dwindling ROA might indicate over-investment in the assets, or evidence of some of the assets not being productive in supporting revenue growth, which is an indicator of a failing business (Bloomsbury, 2009 ). ROA is not a flawless metric for measuring a company’s performance, nonetheless it has been observed to be the most effective, since it captures the fundamentals of business performance in a holistic way. ROA captures how well a company uses its assets to create value, and this is a fundamental area of interest to the VC investors.

Hα2: The venture capitalists’ involvement in the portfolio companies influences their success

To satisfactorily identify the impact of VC on the portfolio companies, we also ran descriptive statistics involving mean scores, standard deviation and skewness scores, to illustrate statistically the role of the VC fund managers on the BOD of the portfolio companies.

As seen in Table 6 , the descriptive statistics show a mean score of 4.0, and with a standard deviation of 0.7754, suggesting that changes in ROE for the portfolio companies was influenced by VC funding. Precisely 80% (54 of 68) of the respondents confirmed that the growth of ROE was escalated by VC financing. Similar results were reported from the structured face-to-face interviews, wherein all the interviewees (100%) admitted to recognising growth of their firms due to the consulted efforts from the VC fund managers. We can therefore conclude that it is not enough to issue VC finance but the VC’s presence on the board of portfolio companies is fundamental for their success. In addition, we also discovered that 87% (59 of 68) of the respondents lacked adequate knowledge about VC financing. This partly explains why the VC industry in Uganda has remained small. Our findings are consistent with contemporary literature, supporting VC for yielding higher returns.

Moreover, 69% of the interviewees confirmed enhanced growth of their companies arising from the superior skills of the VCs. This was manifested in access to new markets, financial management skills, innovations, and expanding their networks to other potential investors. Consistent with above results, ‘the rigorous due diligence alone is enough to encourage the growth of the business even if VCs do not provide patient capital , respondent DRS05 reported’ ; whereas, respondent DRS09 observed that the VCs involvement on the BOD assisted to quickly discover the financial hurdles at an early-stage hence mitigating against financial risks. Our findings conforms to earlier scholars who contended that value addition to the portfolio companies is essential for VC investment because it differentiates it from other sources of funds (Hellmann & Puri, 2002 ; Lerner, 2010 ).

We also surveyed the interviewees to determine whether there was evolution in ROE of the VC-backed firms after VC financing. The outcomes exposed 25–35% average increase in returns. ‘We are not only there to bring the cash on the table, but we also bring bigger networks to talents to help these companies grow, we bring experience from other markets in terms of how we scale businesses, One of the fund managers DRS06 emphasised’. The results were similar to the findings of Lerner ( 2010 ).

Regardless of the appealing results, VCs encounter problems which may undermine the success and growth of the early stage firms. ‘ One channel of exiting is when we come out of the business and we are ready to sell our stake, either to the business owners or to the equity market where there is an opportunity to list on the stock market, for which there has not been a great channel , respondent DRS06 stated ’. The point to make here is that VCs find it difficult to exit due to the undeveloped financial market in Uganda. In addition, we discovered the presence of VC myopia as the entrepreneurs fear losing control of their companies, arising from the temporal sharing of ownership. This partially explains the gradual uptake of VC investment in Uganda. Therefore, some business entrepreneurs remain sceptical of entering into VC deals because they do not know their destiny. Similar conclusions were presented by Tykvova ( 2018 ).

As we continue filling in the gaps in literature, this paper makes a vital contribution to novel knowledge by offering a diversified framework for enterprise success (Fig.  2 ). This framework will benefit the key players in the VC market to manipulate VC financing to enhance enterprise success. Although VC has been extensively studied, no study has developed a diversified framework for enterprise success that integrates exclusive performance variables like VC finance, government involvement, human capital and credible business plans to assess enterprise success. Our findings reveal that these variables significantly impact enterprise success, and this motivated the authors to develop a framework of this nature to account for these variables which have not been yet used in prior literature.

Diversified framework for enterprise success. Source: Authors’ own compilation

Accordingly, the interaction of these variables proved indispensable in enhancing enterprise success. Firstly, government involvement in the VC market is essential for making supportive regulations and enhancing co-investment funds into private equity firms. Secondly, VC finance was identified as a significant variable for stimulating enterprise success matched to conventional bank lending. Thirdly, credible business plans for potential entrepreneurs is a turning point for SME success. These performance variables are supported by evidence from semi-structured interviews that disclosed that only 2% of business plans pass the due diligence process to qualify for VC financing. Finally, human capital, encompassing VCs on the BOD and senior management, were identified as instrumental variables in encouraging the enterprises’ success.

This framework is reinforced with our empirical evidence from the quantitative results and interview results (Sects. 5.1 and 5.2). Therefore, the interaction of all these variables as illustrated in Fig.  2 , translates into enterprise success manifested in improved profitability, ROE, ROA and sales turnover. To the best of our knowledge, no previous study has ever applied this set of integrated variables to examine the performance of SMEs. On this basis, this framework was necessary to contribute to the body of knowledge and also pave a way for future investigation.

To improve the framework, the study suggests future research to investigate:

‘To what extent does government’s involvement in VC financing, the entrepreneurs’ credible business plans and the presence of the venture capitalists on the BOD enhance early-stage enterprise success in Uganda?’

The study examined the nexus between venture capital finance and profitability of the portfolio companies. The results confirm the superior performance of VC-financed enterprises when compared to non-VC-financed enterprises. Moreover, 63% of the respondents reported a positive impact of government regulations on the development of early-stage firms. We also discovered that only 50% of the VC-backed companies were exceedingly operating as expected, while 30% were struggling and 20% completely failed. Our findings were consistent with results of NVCA ( 2020 ). On this basis, increasing VC investment in Uganda and similar emerging economies would assist to close the financing gap which inhibits the success and growth of SMEs.

Furthermore, this paper makes four major contribution; Firstly, the paper highlights the demand for government to enhance VC supply to early-stage firms, as well as to create a favourable investment environment which will inspire foreign VC firms to invest in the country. This may involve government support to reduce the taxes levied on capital gains on the disposal of business assets during initial public offerings (IPOs) or trade sales. Secondly, the results from this study will benefit the VCs in their efforts to make ideal investment decisions to enhance VC market development. Thirdly, the study makes a vital contribution to knowledge by offering a diversified framework for enterprise success in emerging economies. The framework is expected to benefit the key players in the VC market in their efforts to evaluate and customise sufficient funding programmes that can propel the success of early-stage firms. Finally, this paper also extends our knowledge about recent developments in the VC industry and how it influences the profitability trends of SMEs in emerging economies, such as in Uganda.

However, this study encountered some drawback which may not be overlooked. The study was confined to agribusiness and manufacturing SMEs largely in the four major cities of Uganda. Therefore, the results ought to be used with caution as they may yield subjective results in the different sectors, like Fintech industries and generally, the service sector. Although VC financing appears exciting and is widely accepted to spur enterprise success and growth, only a handful of studies have examined the impact of VC financing on enterprise success. Therefore, future investigations in this area would complement this study and improve the diversified framework for enterprise success.

Availability of data and materials

The datasets generated and/or analysed during the current study are not publicly available due to the Non-Disclosure agreements we signed with the respondents, but are available from the corresponding author on reasonable request.

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Special thanks to the college of Economic and Managements for the financial support. We further extend our sincere gratitude to the handling editors and two anonymous reviewers whose intuitive remarks made this article superior.

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Ahmed I. Kato & Chiloane-Phetla E. Germinah

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Ahmed I. Kato is a Postdoctoral Research Fellow in the Department of Applied Management, University of South Africa, Pretoria. Ahmed has published several articles in accredited journals with special focus on venture capital, entrepreneurship and SME development. Moreover, he holds over 14 year’s vast experience in financial management and strengthening research capacity in the NGO sector.

Prof Chiloane-Phetla GE is a Professor of Entrepreneurship in Department of Applied Management, University of South Africa-Pretoria. Prof Chiloane has served in different academic position through her entire career and she has published several articles in accredited journals, written books and presented several papers in international conferences.

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Kato, A.I., Germinah, CP.E. Empirical examination of relationship between venture capital financing and profitability of portfolio companies in Uganda. J Innov Entrep 11 , 30 (2022). https://doi.org/10.1186/s13731-022-00216-5

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• Venture capital
• Profitability and small and medium enterprises
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Exploring the landscape of corporate venture capital: a systematic review of the entrepreneurial and finance literature

• Published: 15 March 2018
• Volume 68 , pages 279–319, ( 2018 )

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The influence of corporate venture capital (CVC) investments within the venture capital industry, that is, equity stakes in high technology ventures, has stimulated the academic literature on this specific research area. Generally, CVC is strongly associated with the concept of corporate venturing and plays a vital role in the strategic renewal of established companies. Owing to the multifaceted nature of the CVC phenomenon, the existing literature is rather fragmented. Therefore, the purpose of this article is twofold: first, bibliographic coupling is introduced to the field of CVC to reveal the underlying structure of the current research front. Second, a content-related review is conducted to shed light on nascent research streams and shortcomings within the CVC literature that indicate promising avenues for future research. The systematic review of a comprehensive set of 65 articles reveals that the prevailing CVC literature is mainly driven by two dominant logics, management and finance, that tend to separate themselves from one another. Moreover, nascent research streams are identified that will broaden and enrich the academic discussion.

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I thank Andreas Kuckertz and Andreas Köhn, University of Hohenheim, for the assistance in the interrater reliability proceeding and valuable comments on prior versions of this paper.

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Röhm, P. Exploring the landscape of corporate venture capital: a systematic review of the entrepreneurial and finance literature. Manag Rev Q 68 , 279–319 (2018). https://doi.org/10.1007/s11301-018-0140-z

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Standardization and Innovation in Venture Capital Contracting: Evidence from Startup Company Charters

This study examines the standardization of venture capital (VC) contracts since the release of the National Venture Capital Association (NVCA) model charter in 2003. Using nearly 5,000 charters issued in connection with a startup’s Series A financing, the paper finds a significant increase in the model’s adoption from less than 3% of charters in 2004 to nearly 85% by 2022. Adoption of the Delaware-oriented charter has also been accompanied by the growing dominance of Delaware incorporation, with Delaware charters growing from 54% of sample charters in 2004 to 100% in 2022. High adoption rates among the six most active law firms servicing U.S. startups largely explain the success of the standardization project.

While cosine similarity analysis reveals charters are overall more similar in 2022 than in 2004, the capital structures of Series A startups have also become substantially more complex. Series A charters authorizing only a single class of common stock and a single series of “Series A” preferred stock constituted 86% of charters in 2004 but constituted just 5% of 2022 charters, while 30% of 2022 charters had either 2 classes of common stock or 3 or more series of preferred stock. The additional complexity arises almost entirely from multiple securities reflecting prior seed stage financing. In contrast, efforts to add founder-friendly capital securities — such as dual class common stock and founder preferred stock — have made only modest inroads. Overall, the story of VC contracting over the past two decades is largely one of standardization, albeit with growing complexity around startup capital structures due to the increasing importance of seed stage capital and changing expectations regarding what constitutes a “Series A” startup.

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McKinsey Global Private Markets Review 2024: Private markets in a slower era

At a glance, macroeconomic challenges continued.

McKinsey Global Private Markets Review 2024: Private markets: A slower era

If 2022 was a tale of two halves, with robust fundraising and deal activity in the first six months followed by a slowdown in the second half, then 2023 might be considered a tale of one whole. Macroeconomic headwinds persisted throughout the year, with rising financing costs, and an uncertain growth outlook taking a toll on private markets. Full-year fundraising continued to decline from 2021’s lofty peak, weighed down by the “denominator effect” that persisted in part due to a less active deal market. Managers largely held onto assets to avoid selling in a lower-multiple environment, fueling an activity-dampening cycle in which distribution-starved limited partners (LPs) reined in new commitments.

About the authors

This article is a summary of a larger report, available as a PDF, that is a collaborative effort by Fredrik Dahlqvist , Alastair Green , Paul Maia, Alexandra Nee , David Quigley , Aditya Sanghvi , Connor Mangan, John Spivey, Rahel Schneider, and Brian Vickery , representing views from McKinsey’s Private Equity & Principal Investors Practice.

Performance in most private asset classes remained below historical averages for a second consecutive year. Decade-long tailwinds from low and falling interest rates and consistently expanding multiples seem to be things of the past. As private market managers look to boost performance in this new era of investing, a deeper focus on revenue growth and margin expansion will be needed now more than ever.

Perspectives on a slower era in private markets

Global fundraising contracted.

Fundraising fell 22 percent across private market asset classes globally to just over $1 trillion, as of year-end reported data—the lowest total since 2017. Fundraising in North America, a rare bright spot in 2022, declined in line with global totals, while in Europe, fundraising proved most resilient, falling just 3 percent. In Asia, fundraising fell precipitously and now sits 72 percent below the region’s 2018 peak.

Despite difficult fundraising conditions, headwinds did not affect all strategies or managers equally. Private equity (PE) buyout strategies posted their best fundraising year ever, and larger managers and vehicles also fared well, continuing the prior year’s trend toward greater fundraising concentration.

The numerator effect persisted

Despite a marked recovery in the denominator—the 1,000 largest US retirement funds grew 7 percent in the year ending September 2023, after falling 14 percent the prior year, for example 1 “U.S. retirement plans recover half of 2022 losses amid no-show recession,” Pensions and Investments , February 12, 2024. —many LPs remain overexposed to private markets relative to their target allocations. LPs started 2023 overweight: according to analysis from CEM Benchmarking, average allocations across PE, infrastructure, and real estate were at or above target allocations as of the beginning of the year. And the numerator grew throughout the year, as a lack of exits and rebounding valuations drove net asset values (NAVs) higher. While not all LPs strictly follow asset allocation targets, our analysis in partnership with global private markets firm StepStone Group suggests that an overallocation of just one percentage point can reduce planned commitments by as much as 10 to 12 percent per year for five years or more.

Despite these headwinds, recent surveys indicate that LPs remain broadly committed to private markets. In fact, the majority plan to maintain or increase allocations over the medium to long term.

Investors fled to known names and larger funds

Fundraising concentration reached its highest level in over a decade, as investors continued to shift new commitments in favor of the largest fund managers. The 25 most successful fundraisers collected 41 percent of aggregate commitments to closed-end funds (with the top five managers accounting for nearly half that total). Closed-end fundraising totals may understate the extent of concentration in the industry overall, as the largest managers also tend to be more successful in raising non-institutional capital.

While the largest funds grew even larger—the largest vehicles on record were raised in buyout, real estate, infrastructure, and private debt in 2023—smaller and newer funds struggled. Fewer than 1,700 funds of less than $1 billion were closed during the year, half as many as closed in 2022 and the fewest of any year since 2012. New manager formation also fell to the lowest level since 2012, with just 651 new firms launched in 2023.

Whether recent fundraising concentration and a spate of M&A activity signals the beginning of oft-rumored consolidation in the private markets remains uncertain, as a similar pattern developed in each of the last two fundraising downturns before giving way to renewed entrepreneurialism among general partners (GPs) and commitment diversification among LPs. Compared with how things played out in the last two downturns, perhaps this movie really is different, or perhaps we’re watching a trilogy reusing a familiar plotline.

Dry powder inventory spiked (again)

Private markets assets under management totaled $13.1 trillion as of June 30, 2023, and have grown nearly 20 percent per annum since 2018. Dry powder reserves—the amount of capital committed but not yet deployed—increased to $3.7 trillion, marking the ninth consecutive year of growth. Dry powder inventory—the amount of capital available to GPs expressed as a multiple of annual deployment—increased for the second consecutive year in PE, as new commitments continued to outpace deal activity. Inventory sat at 1.6 years in 2023, up markedly from the 0.9 years recorded at the end of 2021 but still within the historical range. NAV grew as well, largely driven by the reluctance of managers to exit positions and crystallize returns in a depressed multiple environment.

Private equity strategies diverged

Buyout and venture capital, the two largest PE sub-asset classes, charted wildly different courses over the past 18 months. Buyout notched its highest fundraising year ever in 2023, and its performance improved, with funds posting a (still paltry) 5 percent net internal rate of return through September 30. And although buyout deal volumes declined by 19 percent, 2023 was still the third-most-active year on record. In contrast, venture capital (VC) fundraising declined by nearly 60 percent, equaling its lowest total since 2015, and deal volume fell by 36 percent to the lowest level since 2019. VC funds returned –3 percent through September, posting negative returns for seven consecutive quarters. VC was the fastest-growing—as well as the highest-performing—PE strategy by a significant margin from 2010 to 2022, but investors appear to be reevaluating their approach in the current environment.

Private equity entry multiples contracted

PE buyout entry multiples declined by roughly one turn from 11.9 to 11.0 times EBITDA, slightly outpacing the decline in public market multiples (down from 12.1 to 11.3 times EBITDA), through the first nine months of 2023. For nearly a decade leading up to 2022, managers consistently sold assets into a higher-multiple environment than that in which they had bought those assets, providing a substantial performance tailwind for the industry. Nowhere has this been truer than in technology. After experiencing more than eight turns of multiple expansion from 2009 to 2021 (the most of any sector), technology multiples have declined by nearly three turns in the past two years, 50 percent more than in any other sector. Overall, roughly two-thirds of the total return for buyout deals that were entered in 2010 or later and exited in 2021 or before can be attributed to market multiple expansion and leverage. Now, with falling multiples and higher financing costs, revenue growth and margin expansion are taking center stage for GPs.

Real estate receded

Demand uncertainty, slowing rent growth, and elevated financing costs drove cap rates higher and made price discovery challenging, all of which weighed on deal volume, fundraising, and investment performance. Global closed-end fundraising declined 34 percent year over year, and funds returned −4 percent in the first nine months of the year, losing money for the first time since the 2007–08 global financial crisis. Capital shifted away from core and core-plus strategies as investors sought liquidity via redemptions in open-end vehicles, from which net outflows reached their highest level in at least two decades. Opportunistic strategies benefited from this shift, with investors focusing on capital appreciation over income generation in a market where alternative sources of yield have grown more attractive. Rising interest rates widened bid–ask spreads and impaired deal volume across food groups, including in what were formerly hot sectors: multifamily and industrial.

Private debt pays dividends

Debt again proved to be the most resilient private asset class against a turbulent market backdrop. Fundraising declined just 13 percent, largely driven by lower commitments to direct lending strategies, for which a slower PE deal environment has made capital deployment challenging. The asset class also posted the highest returns among all private asset classes through September 30. Many private debt securities are tied to floating rates, which enhance returns in a rising-rate environment. Thus far, managers appear to have successfully navigated the rising incidence of default and distress exhibited across the broader leveraged-lending market. Although direct lending deal volume declined from 2022, private lenders financed an all-time high 59 percent of leveraged buyout transactions last year and are now expanding into additional strategies to drive the next era of growth.

Infrastructure took a detour

After several years of robust growth and strong performance, infrastructure and natural resources fundraising declined by 53 percent to the lowest total since 2013. Supply-side timing is partially to blame: five of the seven largest infrastructure managers closed a flagship vehicle in 2021 or 2022, and none of those five held a final close last year. As in real estate, investors shied away from core and core-plus investments in a higher-yield environment. Yet there are reasons to believe infrastructure’s growth will bounce back. Limited partners (LPs) surveyed by McKinsey remain bullish on their deployment to the asset class, and at least a dozen vehicles targeting more than $10 billion were actively fundraising as of the end of 2023. Multiple recent acquisitions of large infrastructure GPs by global multi-asset-class managers also indicate marketwide conviction in the asset class’s potential.

Private markets still have work to do on diversity

Private markets firms are slowly improving their representation of females (up two percentage points over the prior year) and ethnic and racial minorities (up one percentage point). On some diversity metrics, including entry-level representation of women, private markets now compare favorably with corporate America. Yet broad-based parity remains elusive and too slow in the making. Ethnic, racial, and gender imbalances are particularly stark across more influential investing roles and senior positions. In fact, McKinsey’s research  reveals that at the current pace, it would take several decades for private markets firms to reach gender parity at senior levels. Increasing representation across all levels will require managers to take fresh approaches to hiring, retention, and promotion.

Artificial intelligence generating excitement

The transformative potential of generative AI was perhaps 2023’s hottest topic (beyond Taylor Swift). Private markets players are excited about the potential for the technology to optimize their approach to thesis generation, deal sourcing, investment due diligence, and portfolio performance, among other areas. While the technology is still nascent and few GPs can boast scaled implementations, pilot programs are already in flight across the industry, particularly within portfolio companies. Adoption seems nearly certain to accelerate throughout 2024.

Private markets in a slower era

If private markets investors entered 2023 hoping for a return to the heady days of 2021, they likely left the year disappointed. Many of the headwinds that emerged in the latter half of 2022 persisted throughout the year, pressuring fundraising, dealmaking, and performance. Inflation moderated somewhat over the course of the year but remained stubbornly elevated by recent historical standards. Interest rates started high and rose higher, increasing the cost of financing. A reinvigorated public equity market recovered most of 2022’s losses but did little to resolve the valuation uncertainty private market investors have faced for the past 18 months.

Within private markets, the denominator effect remained in play, despite the public market recovery, as the numerator continued to expand. An activity-dampening cycle emerged: higher cost of capital and lower multiples limited the ability or willingness of general partners (GPs) to exit positions; fewer exits, coupled with continuing capital calls, pushed LP allocations higher, thereby limiting their ability or willingness to make new commitments. These conditions weighed on managers’ ability to fundraise. Based on data reported as of year-end 2023, private markets fundraising fell 22 percent from the prior year to just over $1 trillion, the largest such drop since 2009 (Exhibit 1).

The impact of the fundraising environment was not felt equally among GPs. Continuing a trend that emerged in 2022, and consistent with prior downturns in fundraising, LPs favored larger vehicles and the scaled GPs that typically manage them. Smaller and newer managers struggled, and the number of sub–$1 billion vehicles and new firm launches each declined to its lowest level in more than a decade.

Despite the decline in fundraising, private markets assets under management (AUM) continued to grow, increasing 12 percent to $13.1 trillion as of June 30, 2023. 2023 fundraising was still the sixth-highest annual haul on record, pushing dry powder higher, while the slowdown in deal making limited distributions.

Investment performance across private market asset classes fell short of historical averages. Private equity (PE) got back in the black but generated the lowest annual performance in the past 15 years, excluding 2022. Closed-end real estate produced negative returns for the first time since 2009, as capitalization (cap) rates expanded across sectors and rent growth dissipated in formerly hot sectors, including multifamily and industrial. The performance of infrastructure funds was less than half of its long-term average and even further below the double-digit returns generated in 2021 and 2022. Private debt was the standout performer (if there was one), outperforming all other private asset classes and illustrating the asset class’s countercyclical appeal.

Private equity down but not out

Higher financing costs, lower multiples, and an uncertain macroeconomic environment created a challenging backdrop for private equity managers in 2023. Fundraising declined for the second year in a row, falling 15 percent to $649 billion, as LPs grappled with the denominator effect and a slowdown in distributions. Managers were on the fundraising trail longer to raise this capital: funds that closed in 2023 were open for a record-high average of 20.1 months, notably longer than 18.7 months in 2022 and 14.1 months in 2018. VC and growth equity strategies led the decline, dropping to their lowest level of cumulative capital raised since 2015. Fundraising in Asia fell for the fourth year of the last five, with the greatest decline in China.

Despite the difficult fundraising context, a subset of strategies and managers prevailed. Buyout managers collectively had their best fundraising year on record, raising more than $400 billion. Fundraising in Europe surged by more than 50 percent, resulting in the region’s biggest haul ever. The largest managers raised an outsized share of the total for a second consecutive year, making 2023 the most concentrated fundraising year of the last decade (Exhibit 2).

Despite the drop in aggregate fundraising, PE assets under management increased 8 percent to $8.2 trillion. Only a small part of this growth was performance driven: PE funds produced a net IRR of just 2.5 percent through September 30, 2023. Buyouts and growth equity generated positive returns, while VC lost money. PE performance, dating back to the beginning of 2022, remains negative, highlighting the difficulty of generating attractive investment returns in a higher interest rate and lower multiple environment. As PE managers devise value creation strategies to improve performance, their focus includes ensuring operating efficiency and profitability of their portfolio companies.

Deal activity volume and count fell sharply, by 21 percent and 24 percent, respectively, which continued the slower pace set in the second half of 2022. Sponsors largely opted to hold assets longer rather than lock in underwhelming returns. While higher financing costs and valuation mismatches weighed on overall deal activity, certain types of M&A gained share. Add-on deals, for example, accounted for a record 46 percent of total buyout deal volume last year.

Real estate recedes

For real estate, 2023 was a year of transition, characterized by a litany of new and familiar challenges. Pandemic-driven demand issues continued, while elevated financing costs, expanding cap rates, and valuation uncertainty weighed on commercial real estate deal volumes, fundraising, and investment performance.

Managers faced one of the toughest fundraising environments in many years. Global closed-end fundraising declined 34 percent to $125 billion. While fundraising challenges were widespread, they were not ubiquitous across strategies. Dollars continued to shift to large, multi-asset class platforms, with the top five managers accounting for 37 percent of aggregate closed-end real estate fundraising. In April, the largest real estate fund ever raised closed on a record $30 billion.

Capital shifted away from core and core-plus strategies as investors sought liquidity through redemptions in open-end vehicles and reduced gross contributions to the lowest level since 2009. Opportunistic strategies benefited from this shift, as investors turned their attention toward capital appreciation over income generation in a market where alternative sources of yield have grown more attractive.

In the United States, for instance, open-end funds, as represented by the National Council of Real Estate Investment Fiduciaries Fund Index—Open-End Equity (NFI-OE), recorded $13 billion in net outflows in 2023, reversing the trend of positive net inflows throughout the 2010s. The negative flows mainly reflected $9 billion in core outflows, with core-plus funds accounting for the remaining outflows, which reversed a 20-year run of net inflows.

As a result, the NAV in US open-end funds fell roughly 16 percent year over year. Meanwhile, global assets under management in closed-end funds reached a new peak of $1.7 trillion as of June 2023, growing 14 percent between June 2022 and June 2023.

Real estate underperformed historical averages in 2023, as previously high-performing multifamily and industrial sectors joined office in producing negative returns caused by slowing demand growth and cap rate expansion. Closed-end funds generated a pooled net IRR of −3.5 percent in the first nine months of 2023, losing money for the first time since the global financial crisis. The lone bright spot among major sectors was hospitality, which—thanks to a rush of postpandemic travel—returned 10.3 percent in 2023. 2 Based on NCREIFs NPI index. Hotels represent 1 percent of total properties in the index. As a whole, the average pooled lifetime net IRRs for closed-end real estate funds from 2011–20 vintages remained around historical levels (9.8 percent).

Global deal volume declined 47 percent in 2023 to reach a ten-year low of $650 billion, driven by widening bid–ask spreads amid valuation uncertainty and higher costs of financing (Exhibit 3). 3 CBRE, Real Capital Analytics Deal flow in the office sector remained depressed, partly as a result of continued uncertainty in the demand for space in a hybrid working world.

During a turbulent year for private markets, private debt was a relative bright spot, topping private markets asset classes in terms of fundraising growth, AUM growth, and performance.

Fundraising for private debt declined just 13 percent year over year, nearly ten percentage points less than the private markets overall. Despite the decline in fundraising, AUM surged 27 percent to $1.7 trillion. And private debt posted the highest investment returns of any private asset class through the first three quarters of 2023.

Private debt’s risk/return characteristics are well suited to the current environment. With interest rates at their highest in more than a decade, current yields in the asset class have grown more attractive on both an absolute and relative basis, particularly if higher rates sustain and put downward pressure on equity returns (Exhibit 4). The built-in security derived from debt’s privileged position in the capital structure, moreover, appeals to investors that are wary of market volatility and valuation uncertainty.

Direct lending continued to be the largest strategy in 2023, with fundraising for the mostly-senior-debt strategy accounting for almost half of the asset class’s total haul (despite declining from the previous year). Separately, mezzanine debt fundraising hit a new high, thanks to the closings of three of the largest funds ever raised in the strategy.

Over the longer term, growth in private debt has largely been driven by institutional investors rotating out of traditional fixed income in favor of private alternatives. Despite this growth in commitments, LPs remain underweight in this asset class relative to their targets. In fact, the allocation gap has only grown wider in recent years, a sharp contrast to other private asset classes, for which LPs’ current allocations exceed their targets on average. According to data from CEM Benchmarking, the private debt allocation gap now stands at 1.4 percent, which means that, in aggregate, investors must commit hundreds of billions in net new capital to the asset class just to reach current targets.

Private debt was not completely immune to the macroeconomic conditions last year, however. Fundraising declined for the second consecutive year and now sits 23 percent below 2021’s peak. Furthermore, though private lenders took share in 2023 from other capital sources, overall deal volumes also declined for the second year in a row. The drop was largely driven by a less active PE deal environment: private debt is predominantly used to finance PE-backed companies, though managers are increasingly diversifying their origination capabilities to include a broad new range of companies and asset types.

Infrastructure and natural resources take a detour

For infrastructure and natural resources fundraising, 2023 was an exceptionally challenging year. Aggregate capital raised declined 53 percent year over year to $82 billion, the lowest annual total since 2013. The size of the drop is particularly surprising in light of infrastructure’s recent momentum. The asset class had set fundraising records in four of the previous five years, and infrastructure is often considered an attractive investment in uncertain markets.

While there is little doubt that the broader fundraising headwinds discussed elsewhere in this report affected infrastructure and natural resources fundraising last year, dynamics specific to the asset class were at play as well. One issue was supply-side timing: nine of the ten largest infrastructure GPs did not close a flagship fund in 2023. Second was the migration of investor dollars away from core and core-plus investments, which have historically accounted for the bulk of infrastructure fundraising, in a higher rate environment.

The asset class had some notable bright spots last year. Fundraising for higher-returning opportunistic strategies more than doubled the prior year’s total (Exhibit 5). AUM grew 18 percent, reaching a new high of $1.5 trillion. Infrastructure funds returned a net IRR of 3.4 percent in 2023; this was below historical averages but still the second-best return among private asset classes. And as was the case in other asset classes, investors concentrated commitments in larger funds and managers in 2023, including in the largest infrastructure fund ever raised.

The outlook for the asset class, moreover, remains positive. Funds targeting a record amount of capital were in the market at year-end, providing a robust foundation for fundraising in 2024 and 2025. A recent spate of infrastructure GP acquisitions signal multi-asset managers’ long-term conviction in the asset class, despite short-term headwinds. Global megatrends like decarbonization and digitization, as well as revolutions in energy and mobility, have spurred new infrastructure investment opportunities around the world, particularly for value-oriented investors that are willing to take on more risk.

Private markets make measured progress in DEI

Diversity, equity, and inclusion (DEI) has become an important part of the fundraising, talent, and investing landscape for private market participants. Encouragingly, incremental progress has been made in recent years, including more diverse talent being brought to entry-level positions, investing roles, and investment committees. The scope of DEI metrics provided to institutional investors during fundraising has also increased in recent years: more than half of PE firms now provide data across investing teams, portfolio company boards, and portfolio company management (versus investment team data only). 4 “ The state of diversity in global private markets: 2023 ,” McKinsey, August 22, 2023.

In 2023, McKinsey surveyed 66 global private markets firms that collectively employ more than 60,000 people for the second annual State of diversity in global private markets report. 5 “ The state of diversity in global private markets: 2023 ,” McKinsey, August 22, 2023. The research offers insight into the representation of women and ethnic and racial minorities in private investing as of year-end 2022. In this chapter, we discuss where the numbers stand and how firms can bring a more diverse set of perspectives to the table.

The statistics indicate signs of modest advancement. Overall representation of women in private markets increased two percentage points to 35 percent, and ethnic and racial minorities increased one percentage point to 30 percent (Exhibit 6). Entry-level positions have nearly reached gender parity, with female representation at 48 percent. The share of women holding C-suite roles globally increased 3 percentage points, while the share of people from ethnic and racial minorities in investment committees increased 9 percentage points. There is growing evidence that external hiring is gradually helping close the diversity gap, especially at senior levels. For example, 33 percent of external hires at the managing director level were ethnic or racial minorities, higher than their existing representation level (19 percent).

Yet, the scope of the challenge remains substantial. Women and minorities continue to be underrepresented in senior positions and investing roles. They also experience uneven rates of progress due to lower promotion and higher attrition rates, particularly at smaller firms. Firms are also navigating an increasingly polarized workplace today, with additional scrutiny and a growing number of lawsuits against corporate diversity and inclusion programs, particularly in the US, which threatens to impact the industry’s pace of progress.

Fredrik Dahlqvist is a senior partner in McKinsey’s Stockholm office; Alastair Green  is a senior partner in the Washington, DC, office, where Paul Maia and Alexandra Nee  are partners; David Quigley  is a senior partner in the New York office, where Connor Mangan is an associate partner and Aditya Sanghvi  is a senior partner; Rahel Schneider is an associate partner in the Bay Area office; John Spivey is a partner in the Charlotte office; and Brian Vickery  is a partner in the Boston office.

The authors wish to thank Jonathan Christy, Louis Dufau, Vaibhav Gujral, Graham Healy-Day, Laura Johnson, Ryan Luby, Tripp Norton, Alastair Rami, Henri Torbey, and Alex Wolkomir for their contributions

The authors would also like to thank CEM Benchmarking and the StepStone Group for their partnership in this year's report.

This article was edited by Arshiya Khullar, an editor in the Gurugram office.

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Generative ai venture capital investment globally on track to reach $12 billion in 2024, following breakout year in 2023, dublin, 16 may 2024: as the artificial intelligence landscape continues to rapidly evolve, investment is pouring into generative ai (genai), driving investment across traditional ai and the wider ai ecosystem, according to new research from ey ireland..

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EY Ireland, a leading global professional services organisation providing assurance, tax, audit, strategy and transactions and consulting services.

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• Global venture capital investment in Generative AI in Q1 2024 US$3 billion, forecasted to reach $12 billion for the year
• Total GenAI 2023 investment $21.3 billion, underpinned by three major investments - OpenAI-Microsoft ($10bn), Anthropic-Amazon ($4bn) & Inflection-Microsoft ($1.3bn)
• North America the location for overwhelming majority of GenAI investment to date, significant opportunity for Ireland and Europe in this rapidly expanding space.

Dublin, 16 May 2024: As the Artificial Intelligence landscape continues to rapidly evolve, investment is pouring into Generative AI (GenAI), driving investment across traditional AI and the wider AI ecosystem, according to new research from EY Ireland. Last year witnessed a remarkable surge in venture capital (VC) funds invested in the space ($21.3 billion), with $15.3billion of the 2023 total coming from mega investments made by Microsoft and Amazon. During the first quarter of 2024, $3 billion was invested globally and EY projects that, based on these trends continuing across the year, total global investment is on track to reach more than $12 billion in 2024. Excluding the mega investments noted above, this represents an increase of nearly 100% from the prior year.

As one of the most disruptive and transformative technologies in decades, interest in AI , especially GenAI, remains very strong, driven by an array of factors including unprecedented public interest and high early adoption rates of what is still a nascent technology. GenAI ’s potential applicability across a wide variety of sectors and industries, as well as adoption potential across the c-suite is also driving investment as the sector matures. With an increasing switch from horizontal AI (i.e. general purpose & Large Language Models (LLMs)) to Vertical AI (specific & niche) investments predicted, the number of deals and investment is projected to only increase over the coming years.

Despite a slowdown in investment in many other industries over recent years due to interest rate increases, inflation and the shift back to more familiar lifestyle patterns following the end of the pandemic, VC interest in GenAI remains robust and has been on an exponential rise with $21.3 billion invested in 2023, compared to just c.$1 billion in 2018. When compared with 2022, investment funds were circa three times greater last year. This can largely be attributed to notable investments by major technology companies such as Amazon and Microsoft, who injected a combined USD$15.3 billion into pioneering AI companies such as OpenAI, Anthropic and InflectionAI.

VC investment is also diversifying across sectors including healthcare, natural language interface, visual media, and vertical applications, growing from $77 million in 2018 to $5.1 billion in 2023 in AI Core (e.g. Large Language Models and Semiconductors) investments alone. Despite a handful of $100M+ mega-rounds in 2023, the GenAI space is still largely nascent, with more than 75% of GenAI start-ups being in early stages or not having raised any equity funding yet.

As 2023 progressed we saw some caution with regard to the business models of certain GenAI companies in particular those which had been surpassed quickly by next generation technologies, featurisation or a more efficient competitor. This led to a slight easing of VC deals in certain areas towards the end of the year. Investors and industry experts, however, have indicated the need for a long-term perspective, acknowledging that GenAI is still in its early stages and so this can likely be taken as a sign of an industry entering the next phase of its development.

North America is leading the way both in terms of deal count and deal value within the GenAI landscape, followed by Europe. US-based tech companies and hyperscalers are investing heavily in start-ups and emerging leaders in the field of Generative AI. Whilst the initial investment focus has been centred primarily in the United States, there have been signs that investors are increasingly looking at European companies to diversify and to find good opportunities that match their investment criteria. Ireland is in a very good position to attract such VC investment given its vibrant technology and life science ecosystem, business friendly policies and availability of talent.

Grit Young, EY Ireland Valuations Partner , said: “While investment in GenAI has been on a rapidly expanding trajectory since 2018, last year was a breakout year for the sector and this momentum is continuing in 2024. CEO surveys, investor calls and an increasing number of financial statement disclosures suggest that AI remains central to the future growth strategies of many and varied businesses. We are anticipating that this investment will accelerate in 2024, albeit a significant percentage of this investment will be spent internally and outside the public gaze. Moreover, the investment in GenAI is in turn driving investment across traditional AI and the wider AI ecosystem, including chips, data centres and underlying technology.

“In comparison to some other widely publicised technologies over recent years, GenAI has already shown that it can deliver tangible benefits over relatively short periods of time. Companies who were first to invest in embedding the technology are those that are on track to demonstrate gains to shareholders which in turn will create a virtuous cycle. When companies are under pressure to show progress or to respond to a truly disruptive technology, it can happen that some feel tempted to rush to implement the new technologies before they are fully ready to do so. This, in turn, could leave them exposed to significant risk, both regulatory and reputationally, and it is something that markets, regulators and customers will be watching closely.

“From a geographical perspective, Europe currently lags behind the US in terms of investment in AI, but there is real optimism about the potential here in 2024 and beyond. France has shown with Mistral that it can produce an AI unicorn that is looking to take on Open AI and other US incumbents. Deepmind, one of the pioneers of foundational models, was founded in the UK and just recently we saw an investment of more than $1 billion into UK-based AI self-driving startup Wayve. There is ample opportunity for Ireland and Europe to emerge as a frontrunner in GenAI innovation and development, particularly with its first mover advantage gleaned from the EU AI Act.

“As the market matures and LLMs become more sophisticated along with the financial investments required growing ever larger, attention is shifting from horizontal AI to Vertical AI. Recent announcements on European headquarters of a number of key AI players here in Ireland is very welcome in this regard. With start-ups increasingly focusing on vertical AI applications, it’s essential that we are providing the right supports and capital to nurture and retain the next generation of corporate technology champions here.”

EY exists to build a better working world, helping to create long-term value for clients, people and society and build trust in the capital markets. Powered by data, technology and an extensive partner ecosystem, our diverse EY teams in over 150 countries provide trust through assurance and help clients grow, transform and operate. Working across assurance, consulting, law, strategy, tax and transactions, EY teams ask better questions to find new answers for the complex issues facing our world today.

Methodology

In conducting this research, EY utilised a rigorous methodology to ensure accuracy and reliability. The data collection methodology employed is outlined below:

• Utilising reputable financial research platforms such as Pitchbook and S&P Capital IQ, we gathered comprehensive data on investment trends, market dynamics, and emerging technologies within the AI sector
• The GenAI companies have been considered and classified as per the report “Artificial Intelligence & Machine Learning Public Comp Sheet and Valuation Guide Q3 2023.” The data collected related to the following segments of AI:
• AI Core: These entities specialise in crafting and providing tools and platforms to oversee the model lifecycle, encompassing data management, infrastructure, and comprehensive platforms for model development, deployment, and administration
• Natural language interface: Enterprises within this sphere focus on developing software applications facilitating user-computer interactions through natural language. Utilising AI algorithms, these applications process, comprehend, and generate human language in real-time.
• Vertical Applications: These organisations concentrate on crafting generative AI solutions tailored to specific industries or applications, rather than broad, horizontal applications. Their software streamlines processes and enhances outcomes for businesses within these targeted sectors or functions.
• Biotechnology: Businesses in this field leverage artificial intelligence to analyse extensive biological data, identify novel targets, and optimize drug design. Harnessing machine learning algorithms, they expedite research and development of pharmaceuticals, biologics, and other products, aiming to accelerate drug discovery and reduce costs associated with pre-clinical testing and clinical trials.
• Audio: Entities operating in this sector specialise in recording, manipulating, and reproducing sound, speech, and music. Applications span human-machine interaction, music and film production, podcasts, audiobooks, and related content creation.
• Media: This category covers companies creating digital content for various applications including marketing, design, entertainment, e-commerce, virtual reality, gaming, and more. They produce immersive experiences in both 2D and 3D

About EY.ai

EY.ai is the unifying platform that brings together EY people, ecosystems and artificial intelligence (AI) to help drive business transformation through confident and responsible use of AI. It combines leading-edge AI capabilities, including the EY large language model, EYQ; is underpinned by the award-winning technology backbone, EY Fabric; and is supported by multi-disciplinary experience. All EY services and solutions, from strategy, transactions, consulting, assurance and tax draw on this capability, enhanced by a holistic ecosystem spanning technology, business and academia.

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Meet PayHOA, a profitable and once-bootstrapped SaaS startup that just landed a $27.5M Series A

PayHOA, a previously bootstrapped Kentucky-based startup that offers software for self-managed homeowner associations (HOAs), is an example of how real-world problems can translate into opportunity.

It just raised a $27.5 million Series A round in an environment where nearly $30 million Series A rounds are no longer common.

PayHOA founder and CEO Mike Bollinger has been putting his finance degree to good use. The entrepreneur started PayHOA in 2018 after selling two other companies — LegFi.com, a startup focused on fraternity and sorority financial management and File990.org, which catered to nonprofit tax compliance needs — to Togetherwork in 2018.

Bollinger says experience working with volunteer-based organizations fueled his desire to create PayHOA .

“While larger companies catered to professional property managers, self-managed HOAs struggled,” he told TechCrunch. “They were forced to cobble together solutions with unconnected tools or generic software not designed for their specific needs — some even came to us with shoe boxes of paper receipts.”

PayHOA’s SaaS offering acts as a “central hub” for association board members, handling finances, maintenance requests and communication with their communities, Bolinger says.

Notably, PayHOA says it is profitable (with positive EBITDA), which helps explain how it managed to land such a decent-sized Series A round in what remains a challenging fundraising environment, especially for non-AI startups. The 15-person startup notched year-over-over revenue growth of over 70%. It has more than 652,000 users, and makes money by charging a monthly subscription fee based on the number of units in the community. Prices start at $49 per month for HOAs with 25 units or less. Self-managed HOAs account for 30% to 40% of community associations , made up of 2.5 million volunteer board members.

The decision to raise outside capital for the first time stemmed from PayHOA reaching a critical inflection point, according to Bollinger. 

“We’d found product market fit and were growing at a rapid rate,” he told TechCrunch. “The additional capital and investor guidance will guide the business to the next level.”

The new funds will mostly go toward product development and hiring. PayHOA has plans to grow its team by 40% across engineering, sales and support. Today, the company also announced a Payables module, which Bollinger said uses Optical Character Recognition (OCR) technology to automatically scan and extract data from invoices. PayHOA has processed more than $1.6 billion in invoices since 2018.

Looking ahead, PayHOA doesn’t have plans to expand outside of community management, but Bollinger has noticed an increased number of property management companies signing up for the platform — opening up the company’s total addressable market. 

“Many HOAs manage their communities themselves, and for too long, their needs haven’t been fully addressed,” Peter Fallon, a general partner at Elephant Ventures, the firm that led the round, said in a written statement. “PayHOA recognizes this gap and provides a comprehensive platform designed specifically for self-managed HOAs. This empowers them to access powerful tools typically reserved for larger communities.”

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