The composer of the term "venture capital" is unknown, and there is no standard definition of it. It is, however, generally agreed that the traditional venture-capital era began in earnest in 1946, when General Georges Doriot, Ralph Flanders, Karl Compton, Merrill Griswold and others organized American Research & Development (AR&D), the first (and, after it went public, for many years the only) public corporation specializing in investing in illiquid securities of early stage issuers.

One way to define traditional "venture capital," therefore, is to repeat General Doriot's rules of investing, the thought being that an investment process entailing Doriot's rules is, by definition, a venture-capital process. According to Doriot, investments considered by AR&D involved:

• new technology, new marketing concepts, and new product application possibilities;

• a significant, although not necessarily controlling, participation by the investors in the company's management;

• investment in ventures staffed by people of outstanding competence and integrity (herein the rule often referred to in venture capital as "bet the jockey, not the horse");

• products or processes which have passed through at least the early prototype stage and are adequately protected by patents, copyrights, or trade-secret agreements (the latter rule is often referred to as investing in situations where the information is "proprietary" (proprietary information));

• situations which show promise to mature within a few years to the point of an initial public offering or a sale of the entire company (commonly referred to as the "exit strategy");

• opportunities in which the venture capitalist can make a contribution beyond the capital dollars invested (often referred to as the "value-added strategy").

General Doriot's boundary conditions are to be treated with great deference because it is commonly agreed that Doriot is the single most significant figure in post-war traditional venture capital. Not only did he provide AR&D with its primary guidance (until it was acquired by Textron), but he also introduced a significant percentage of today's senior venture capitalists to the business through the courses he taught at Harvard Business School. And he showed the world how a traditional venture-capital investment strategy could produce enormous rewards when AR&D's modest investment in Digital Equipment Corporation (DEC) ballooned into investor values in the billions.

Parenthetically, in the eyes of the public of his day, Doriot's record at AR&D included only a few "home runs"- DEC in particular-and a bunch of losers, leading inexperienced observers to conclude that a well-managed venture portfolio should concentrate on the long ball, so to speak-the one investment that will return two or three hundred times one's money and justify a drab performance by the rest of the portfolio. This fallacious conclusion fostered the 1960s notion that an ultra-high-risk strategy is characteristic of venture-capital investing, with managers plunging exclusively into new and untried schemes with the hope of "winning big" every now and then. In fact, the AR&D strategy was never tied to the solo home run. Moreover, venture strategies have become highly varied. Some venture pools focus in whole or in part on late-round investments: infusions of cash shortly before the company is planning to go public, for example. Moreover, as outlined subsequently, buyouts involving mature firms are a popular venture strategy, as are so-called turnarounds, investments in troubled companies, including some actually in bankruptcy. And some funds are hybrids, sharing more than one strategy, even including a portion of the assets invested in public securities. The point is that a venture manager balances risk against reward; a "pre-seed" investment should forecast sensational returns, while a late-round purchase of convertible debt will promise a more modest payoff.

The term "venture capital" is grammatically multifaceted. General Doriot's exegesis specifies a certain type of investment as characteristic of the venture universe. He assumes, a priori, the proposition that venture capital involves a process, the making and managing (and ultimately selling) of investments. In addition, the phrase is sometimes used as an adjective applied to players in the game; that is, "venture-backed companies," meaning the portfolio opportunities in which the venture-capital partnerships or "funds" invest. The phrase becomes a noun when it describes the capital provided by individuals, families, and firms, which entities, along with the partnership managers, are called venture capitalists.

In terms of the people involved, venture capital is an intense business. The symbiotic relationship between the venture capitalist and his investment (assuming he is the "lead investor," meaning the investor most closely identified with the opportunity) is such that each professional can carry a portfolio of no more than a handful of companies. The investors are usually experienced professionals with formal academic training in business and finance and on-the-job training as apprentices at a venture fund or financial institution. Their universe is still relatively small; they and their advisers tend to be on a first-name basis, veterans of a deal or two together. And the work is hard, particularly since on-site visits impose an enormous travel burden.

The venture-capital process, before it was so labeled, has existed for centuries; antedating American Research & Development, it is as old as commercial society itself. In the last century, for example, Vanderbilt interests financed Juan Trippe in the organization of Pan American Airways, Henry Ford was financed by Alexander Malcolmson, and Captain Eddie Rickenbacker was able to organize Eastern Airlines in the 1930s with backing from the Rockefellers. However, the era of professionally managed venture capital-pools of money contributed by unrelated investors and organized into separate legal entities, managed by experts according to stated objectives, set forth in a contract between managers and investors, describing a structured activity, an activity that conforms to definite (albeit changing) patterns and rules-is a process that dates from the organization of AR&D.

In sum, the term venture capital can be applied in a number of ways: to investments, people, or activities. With full appreciation for the multiple uses of the term, the thrust and emphasis of this book (although by no means exclusively) is on venture capital of the type which is compatible with the Doriot rules. First, venture capital is an activity involving the investment of funds. It ordinarily involves investments in illiquid securities, which carry higher degrees of risk (and commensurately higher possibilities of reward) than so-called traditional investments in the publicly traded securities of mature firms. The venture-capital investor ordinarily expects that his participation in the investment (or the participation of one of the investors in the group which he has joined, designated usually as the "lead investor") will add value, meaning that the investors will be able to provide advice and counsel designed to improve the chances of the investment's ultimate success. The investment is made with an extended time horizon, required by the fact that the securities are illiquid. (In this connection, most independent venture funds are partnerships scheduled to liquidate ten to twelve years from inception, in turn suggesting that a venture-capital investment is expected to become liquid somewhere around four to six years from initial investment.)

Since the most celebrated rewards in the past have generally accrued to investments involving advances in science and technology to exploit new markets, traditional venture-capital investment is often thought of as synonymous with high-tech start-ups. However, as stated earlier, that is not an accurate outer boundary, even in the start-up phase. For example, the technology of one of the great venture-capital winners-Federal Express-is as old as the Pony Express, and it would take a great stretch of the imagination to perceive of fast-food chains such as McDonald's as involving additions to our store of scientific learning. But, whether high or low tech, the traditional venture capitalist thrives when the companies in which he invests have an advantage over potential competition in a defined segment of the market, often referred to as a "niche." The product or service is as differentiated as possible, not a "commodity." Exploitation of scientific and technological breakdowns has, historically, been a principal way (but not the only way) for emerging companies to differentiate themselves from their more mature and better-financed competitors.

What is Wealth?

Wealth is something that most of us associate with money, our savings, our investments, our homes or other forms of “financial capital”. I am making an attempt to explain what “Wealth” is truly all about.

Did you know?

The word “WealTh” comes from the Old English words – Weal: Well-being and Th: Condition. This taken together is Wealth which means “Condition of Well-being”.

The word “Economic” comes from Greek word “Oikonomia” meaning the “Management of Household”. When have you heard economists talk about conditions of household living and management?

The “Mortgage” comes from Old French and it literally means “A Pledge unto Death” or what one can call “A Grip of Death”.

It is evident here, that we have simply twisted the meaning of words for our convenience or selfish benefits. And we have become immune to such strong language words.

The “Father of Accounting – Luca Pacioli” never defined the word “Wealth” nor did he give a definition to “Profit”. To this day, accountants have no clear definition of either of the words.

If Wealth really is not just about financial possessions and if accountants have no real understanding of how to either define or measure or account for “Genuine” Wealth then we all have a wonderful opportunity to both redefine and rediscover our real or genuine wealth.

Let’s try and define – Genuine Wealth

Genuine means having the qualities or values claimed authentic.

Wealth means condition of well being.

Genuine Wealth, then would mean as Robert F. Kennedy noted, those things that make life worthwhile. Now most of us can define these things in a few minutes.

I would leave your definition of “Genuine Wealth” to you with a note from Robert F. Kennedy in 1968...

“The Gross National Product includes air pollution and advertising for cigarettes, and ambulance to clear our highways of carnage. It counts special locks for our doors, and jails for the people who break them. GNP includes the destruction of the redwoods and the death of Lake Superior. It grows with the production of napalm and missiles and nuclear warheads. And if GNP includes all this, there is much that it does not comprehend. It does not allow for the health of our families, the quality of their education, or the joy of their play. It is indifferent to the decency of our factories and the safety of our streets alike. It does not include the beauty of our poetry or the strength of our marriages, or the intelligence of our public debate or the integrity of our public officials. GNP measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile.” – Robert F. Kennedy, March 18, 1968.

“It is said that we know the price of everything and the value of nothing.”

- Gaurav Shah, DeFinancial Times

I know this might sound stereotypic, but since we are facing the heat in one way or the other, I thought of starting here. Everyone today, is talking about the Credit Crisis. The best part is that each conversation has given this crisis either a new definition or a new dimension. I am following suit by compiling this one. Let’s add a more detailed dimension to it. The “Illusion of Wealth”.

Before the so-called Credit Crisis, the world was awash with wealth. And now central banks are pumping in more money than ever and yet everyone is short!!!

Gold Reserves

Ever since the central banks stopped pegging their currencies to the price of gold, money has been a nebulous concept; a Promise to pay the Bearer or a “Cheque” from the central bank, rather than a permanent store of wealth. Nevertheless, most central banks do still hold substantial reserves of gold foreign currencies as a buffer against financial turbulence.

However, the size of these gold reserves (US$ 845 bn of gold in central bank vaults) is a sobering reminder of how much the value of money is an expression of confidence, or perhaps even a confidence trick. Centrals banks do not need to hold these gold reserves on a larger scale since their ultimate response to a severe crisis, like this one, is to print more money. This process is underway, primarily in the US and UK, through an intervention called "Quantitative Easing”. Critics have gone to extent to saying that this crisis has exposed the inherent weakness of paper or “fiat” money.

Cash in Circulation

The narrowest measure of money is known by economists as M0 and counts all the notes and coins in circulation plus the reserve which commercial banks are required to hold with the central banks. Because of the process of loan creation, this way of counting money can produce a much lower number than the amount of theoretical cash flying around the world in electronic form. The global M0 in October 2009 was roughly US$ 3.9 tn. This too has been growing though, especially led the increases in money supply in China and US.

Attempts to avoid the economic recession after the investment bubble burst at the turn of the century also led central banks to reduce interest rates to historically lower levels. Since interest rates effectively measure the “price” of money, this corrective action led to explosion of cheap debt which has caused the current meltdown.

Traditional Banking System

Ever since the queues formed outside the Northern Rock, it has been slowly dawning on the people that all the banks are inherently unstable. Under a system called “Fractional Reserve Banking”, the banks are allowed to lend many times the amount they take in as deposits – on the assumption that not all depositors will ever want their money back at once (Remember – loan creation). Instead, the banks are required to hold small core reserves with the central bank.

For example, $1 for every $4 they lend out. You put $100 in; they can lend out $80 to someone wanting a car. The car company puts that $80 back into the banking system, and its bank gets to lend out another $64 and so on; creating up to $360 of new money if taken to extreme, which in this case of crisis has happened.

As commercial banks found more and more sophisticated ways of luring customers in to taking loans and with historically low interest rates, as an icing on the cake for the borrowers, this process saw the assets of the world big commercial banks balloon to $39tn according to the Bank for International Settlements.

Shadow Banking System

Banking regulations have been heavily criticized during this crash, but the rules governing commercial bank lending were very stringent compared to the so-called “Shadow Banking System”.

Led by the Investment Banks and Hedge Funds, traders found even more exotic ways to escape limits on how much they can borrow to increase their returns. One financial instrument in particular, the credit derivative, grew to dwarf the value of the underlying debt on which it was based – peaking at US$ 62 tn according to the International Swaps and Derivatives Association.

Ostensibly, Credit Default Swaps (CDSs) and Collateralized Debt Obligations (CDOs) allowed lenders to insure themselves against the risk of any one borrower going bust and therefore lend greater amounts more safely. Instead, traders lost touch of who owed what and products like CDO squared took financial engineering into fantasy land.

The notional value of all derivatives reached US$ 863 tn – many times the value of all economic activity on the planet Earth.

The Great Asset Bubble

Easy money fuelled a series of gigantic bubbles in the price of key assets such as property. These bubbles are now bursting with violent consequences. Working out how much the world is worth is tricky, but the Economist made a stab at US 115 tn for developed economies in 2002 – including property, shares and bonds. In the subsequent boom, shares alone soared to a peak of US$ 51 tn.

Applying the same multiple to other asset bubbles suggests the total asset value of developed economies peaked at US$ 290 tn compared to with the Global GDP of around US$ 55 tn.

Asset prices matter more than usual because loose credit conditions previously meant that customers were able to borrow against the value of their homes or share portfolios to spend yet more money. We all felt wealthier, so we spent more.

An Unstable Pyramid

Viewed from the bottom up, the explosion in debt and asset prices that occurred during the boom years looks unstable and top-heavy. It even bears similarity to the pyramid or “Ponzi” schemes carried out by the fund managers like Bernie Madoff; all the time all the participants believed in the inexorable growth of the economy, rising debt levels sustainable. When the music stopped, the whole edifice began to wobble.

Why the BAIL OUTS are ineffectual?

Attempts to restore stability by pumping in public money have had some effect but the sums of money are tiny relative to the problem. The total value of state assistance to the banking system – either through direct spending or guarantees is estimated US$ 1.9 tn.

The next stage is seeing central banks’ attempt to re-inflate the bubble by injecting new money into the system through a process called “Quantitative Easing”.

Velocity of Money : mv = pq

As they dust down their economics textbooks, one equation is enjoying a revival among bankers trying to understand why the credit crunch is so powerful.

The quantitative theory of money can be expressed in just four letters that serve to explain much of what is happening to the world today: m, v, p and q. Put crudely; m = amount of money in circulation, v = velocity with which it zips around the financial system, p = price of goods and q = quantity of economic output.

During the economic boom, financial innovations sped up the flow of money through the system. Now the banks stop lending to each other and nervous customers stop spending, velocity is tumbling. Even though the money supply is being increased by the central banks, it is not enough to prevent steep falls in the prices and the output, or GDP, of the world economy.

Source: GFMS

- Gaurav Shah, DeFinancial Times