Venture capitalists' decision criteria in new venture evaluation

What criteria do venture capitalists use to make venture investment decisions? The criteria venture capitalists use to make their venture investment decisions are of interest for several reasons. First, venture capitalists are conspicuously successful in their investment decisions. The success rate of venture capital-backed ventures is significantly higher than the success rate of new ventures generally (Dorsey 1979: Davis and Stetson 1984). A better understanding of the criteria used could lead to a better understanding of the reasons for this success.Second, a better understanding of the criteria for successful new ventures could lead to an improvement in the success rate of new ventures. Although there is no clear agreement on the precise rate, the failure rate among new ventures is generally viewed as significantly higher than the average failure rate (Dun and Bradstreet 1984; Van de Ven 1980; Shapero 1981).Finally, venture capitalists' investment criteria are of enormous import to entrepreneurs seeking venture funding. Such entrepreneurs require a significant infusion of capital in order to grow their businesses, and knowledge of the criteria sought by venture capitalists can aid entrepreneurs in gaining the necessary financing.This study attempts to uncover the criteria used by venture capitalists through semistructured interviews and verbal protocol analysis of venture capitalists' evaluations of actual venture proposals. Sixteen verbal protocols—in which the participants “think aloud” as they review business proposals— were made of venture capitalists' venture evaluation decisions.The findings of this study suggest that venture capitalists screen and assess business proposals very rapidly: the subjects in this study reached a GO/NO-GO decision in an average of less than six minutes on initial screening and less than 21 minutes on proposal assessment. In venture capitalists' initial proposal screening, key criteria identified include fit with the venture firm's lending guidelines and the long-term growth and profitability of the industry in which the proposed business will operate. In the second stage of proposal assessment, the source of the business proposal also played a major role in the venture capitalists' interest in the plan, with proposals previously reviewed by persons known and trusted by the venture capitalist receiving a high level of interest.In addition to the specific criteria identified and how they were used in reaching GO/NO-GO decisions, the findings of this study also were surprising for the lack of importance venture capitalists attached to the entrepreneur/entrepreneurial team and the strategy of the proposed venture during these early stages of the venture evaluation process.     

New venture strategy and profitability: A venture capitalist's assessment

This study uses theoretically justified criteria from the industrial organization (IO) strategy literature and applies it to a new domain, namely, venture capitalists' decision making. Specifically, the study investigates the types of information venture capitalists utilize when evaluating new ventures and how venture capitalists use this information to assess likely new venture profitability. In the interest of advancing our understanding of the decision making policies of venture capitalists, this study addresses many of the limitations of previous research.A review of IO research suggests important relationships between a number of strategy variables and new venture profitability. Some of the relationships proposed by IO strategy research are contingent in nature. The strategy variables and their relationships with profitability are investigated in the domain of venture capitalists' decision making. Individual and aggregate decision making analyses identified those strategy variables (criteria) venture capitalists utilize in assessing likely new venture profitability, namely, timing, key success factor stability, lead time, competitive rivalry, educational capability, industry-related competence, timing × key success factor stability interaction, timing × lead time interaction, and timing × educational capability interaction.On average, the most important criterion for venture capitalists in their assessment of profitability is industry-related competence. The second tier of importance is competitive rivalry, timing, and educational capability. The third tier of importance is lead time, key success factor stability, and timing × lead time interaction. Other interactions are less important. Therefore, while venture capitalists use contingent decision policies, main effects dominate. If venture capitalists use a reported 8 to 12 minutes on average to evaluate a business plan (Sandberg 1986), then this study's findings may help the inexperienced venture capitalist allocate time towards assessing those attributes of primary importance. Although more complex relationships exist between the attributes, the inexperienced venture capitalist can take comfort from this study's findings that main effects dominant amongst senior venture capitalists. Senior venture capitalists may take less comfort from their importance placed on main effects in light of research from IO, which suggests the importance of contingent relationships. The results may also have practical application towards training.How should venture capital firms train their new employees? Should venture capital firms rely solely on experienced venture capitalists lecturing the inexperienced on the criteria they use in assessing a new venture proposal? Like most decision makers, venture capitalists have limited insight into their assessments and venture capital firms need to be aware of the gap between “espoused” policies and policies “in use.” The information being taught needs to be supplemented with venture capitalists' decision-making research that investigates decision policies “in use”, such as this study. Venture capitalist training could also involve experiential learning, in conjunction with cognitive feedback about the decision policies used, to accelerate the learning process. Experiential learning using cognitive feedback maximizes industry related learning while minimizing the cost of inexperienced decisions. For the entrepreneur seeking capital, this increased understanding of venture capitalists' decision making may help them better target their business plans and presentations at those criteria venture capitalists' find most critical to the profitability of a new venture.     

Limited attention and the role of the venture capitalist

This research analyzes the venture capitalist's incentives to maximize the profits of the entrepreneurs of ventures and the limited partners of a venture fund. Venture capital is a professionally managed pool of capital invested in equity-linked private ventures. Entrepreneurs turn to venture capitalists for financing because high-technology startup firms have low or negative cash flows, which prevent them from borrowing or issuing equity. In addition, venture capitalists are actively involved in management of the venture to assure its success. This solves the problem of startup firms that do not have the cash flows to hire management consultants.Venture capital contracts have three main characteristics: (1) staging the commitment of capital and preserving the option to abandon, (2) using compensation systems directly linked to value creation, and (3) preserving ways to force management to distribute investment proceeds. These characteristics address three fundamental problems: (1) sorting the venture capital among the entrepreneurial ventures, (2) providing incentives to motivate venture capitalists to maximize the value of the funded ventures, and (3) providing incentives to motivate entrepreneurs to maximize the value of the ventures. Venture capitalists fund only about a dozen projects a year out of a thousand evaluated. Each project may receive several rounds of financing. Payoffs to VCs can be very high or be a complete loss.The typical venture capital (VC) firm is organized as a limited partnership, with the venture capitalists serving as general partners and the investors as limited partners. General partner VCs act as agents for the limited partners in investing their funds. VCs invest their human capital by placing their reputation on the line. The goal is to begin to convert the investment into cash or marketable securities, which are distributed to the partners. VC management companies receive a management fee equal to a percentage (usually 2.5%) of the capital of each fund. They also receive a percentage (15–30%) of the profits of each fund, called carried interest. Periodic reports are made by the VC firm to the limited partners. Usually these are only costs of managing the fund, and so revenues are negative. Most contracts specify the percentage of time that the VC will devote to managing the fund.The analysis of this research deals with the incentives of the VC who has limited attention to be allocated between improving current ventures and evaluating new ventures for possible funding. The analysis shows that the VC, as agent for both the entrepreneur and the general partners, does not have the incentives required to maximize their profits. The VC allocates attention among ventures and venture funds less frequently than required to maximize the entrepreneurs' and limited partners' profits. However, the VC does maximize the total profits of all ventures. Because the VC considers the opportunity cost of attention, the VC's allocation of attention is efficient. The implication of this result is that, although the entrepreneurs and limited partners could be made better off with a different allocation of the VC's time, this would be an inefficient use of the VC's time.     

Venture capitalists and serial entrepreneurs

Habitual entrepreneurship is receiving growing attention, much of which has focused on entrepreneurs who have started more than one venture. This paper examines the importance of habitual entrepreneurs to the venture capital industry, with particular emphasis on those who have exited from an initial investment in the venture capitalist's portfolio, termed serial entrepreneurs. As venture capital markets mature, increasing numbers of entrepreneurs are likely to exit from their initial enterprises, creating a pool of entrepreneurs with the potential for embarking on subsequent ventures. Venture capitalists making investments may invest both in entrepreneurs starting new ventures and those who purchase a venture through a management buy-out or buy-in. On this wider basis, the paper develops a classification of types of serial venture. A number of issues are raised for venture capitalists, notably the relative attractiveness of reinvesting in exited entrepreneurs and the policy they adopt in tracking and assessing such individuals.The paper addresses venture capitalists' perspectives on investing in serial entrepreneurs based on a representative sample of 55 UK venture capitalists (a response rate of 48.7%, and a follow-up survey of those who had more extensive experience of serial entrepreneurs (23 respondents). The results of the survey show that despite a strong preference for using an entrepreneur who had played a major role in a previous venture, the extent to which exiting entrepreneurs are funded from their own portfolio again is limited, though there is more extensive use of such individuals in a consultancy capacity. In screening entrepreneurs exiting from previous ventures for subsequent investments, venture capitalists scored attributes relating to commercial awareness, experience in a particular sector, and personal ambition of the entrepreneur most highly.Venture capitalists do make extensive use of serial entrepreneurs who have exited from other venture capitalists' portfolios, primarily to lead management buy-ins. Indications from the survey are that venture capitalists rarely assess entrepreneurs formally at the time of exit and that it is unusual to maintain formal links with entrepreneurs after they have exited. These apparent shortcomings suggest that perhaps investment opportunities are being missed. Those venture capitalists preferring serial entrepreneurs generally had a larger volume of funds under investment and were rather older than those venture capitalists who do not prefer to use serial entrepreneurs, reflecting the possibility that longer established venture capitalists have had more opportunity and experience in relation to second-time entrepreneurs.Investment appraisal factors were subject to a principal components analysis to identify underlying dimensions/relationships between them. With respect to the general investment appraisal factors, five factors were identified. Two factors were related to track record; one of these reflected ownership experience, while the other represented management experience. The third factor was related to personal attributes such as age, knowledge, and family background. The fourth factor represented links to the funding institution, and the final factor (a single variable factor) concerned financial commitment. The principal components analysis for screening factors on management buy-ins produced a single factor comprising all variables. These factors were then subject to a multivariate analysis of variance (MANOVA), with preference for use of a serial entrepreneur as the independent variable. The results suggest that there are significant differences between venture capitalists who prefer serial entrepreneurs and those who do not in respect to their business ownership experience, the length of their entrepreneurial careers, and the number of their previous ventures.The results of the study have implications for practitioners. First, the findings emphasize the importance of not considering previous venture experience in isolation but in the context of other key investment criteria. Second, the lack of strongly greater performance from serial, versus novice, entrepreneurs further emphasizes the care to be taken in assessing experienced entrepreneurs. Third, the relatively low degree of formal and rigorous post-exit assessment and monitoring by venture capitalists suggests that important opportunities to invest in experienced entrepreneurs may be missed.     

Hybrid conjoint analysis: An estimation probe in new venture decisions

How venture capitalists select start-ups for financing has been an interesting topic for many researchers and practitioners. The underlying assumption is that people who make money investing in new businesses by assessing the proposals should be experienced enough to distinguish losers from winners. Our research study tested three models (self-explicated, conjoint and a hybrid—comprising the two previous ones—conjoint) in order to find out: 1. if these models could be applied to venture capital decision making and if so 2. to demonstrate the potential of conjoint analysis as a practical research method. 3. To test whether or not the characteristics of the entrepreneur, the product and the market replicate the venture capital decision.This research study confirms what normative literature on decision-making emphasizes: that in the first stage of an evaluation (screening), venture capitalists focus on a small subset of criteria in a non-compensatory process (i.e., an unacceptable value on one criterion cannot be offset by a high value of another one). The important criteria in this phase appear to be the entrepreneur's experience and the existence of a prototype for some decision-makers or unique features of the product for others. The screening step is more judgemental than analytic.In a second stage (the evaluation phase), however, venture capitalists end a detailed examination (due diligence process) by choosing the most preferred ventures through processes approximating compensatory rules; that is, a low but acceptable value on one criterion can be compensated by a high value on another. The most important criteria identified by the research in this second stage are criteria found in the previous stage, product gross profit margin and patent.Our research demonstrates agreement among venture capitalists in terms of one criterion to evaluate research proposals: managerial experience. As to the rest of the attributes tested, there was variation in the weights assigned to them.The findings of this pilot study also confirm the applicability of conjoint analysis as a research method in venture capital decision. The approach helps shed light on the decision rules applied, and permits the testing of previously researched criteria for predictive validity. The method has the advantage of retaining individual preferences and clustering them around venture capitalists' demographic and psychographic backgrounds (i.e., years of experience, type of education, life-style, and the like) or other types of information such as venture fund policies (size of the investment, type of industry, etc.).The major implication of the study for entrepreneurs is the importance of previous experience in the industry where they expect to develop their ventures, and a deep knowledge of the product (advantages over competition, technical, production, and cost feasibility) they are to produce and market. These are the factors that have the greatest influence on venture capitalists' evaluation of such projects.     

The CEO,venture capitalists,and the board

An element in the never-ending debate about the process of funding highpotential businesses is the extent to which venture capitalists add value besides money to their portfolio companies. At one end of the spectrum, venture capitalists incubate start-ups and nurture hatchlings, while at the other extreme, so-called “vulture” capitalists feed on fledgling companies. A very important way in which venture capitalists add value other than money to their portfolio companies is by serving on boards of directors. Hence, by studying the role of outside directors, especially those representing venture capital firms, we were able to shed light on the issue of value-added.In the first phase of the research, we studied 162 venture-capital-backed high-tech firms located in California, Massachusetts, and Texas. In the second phase (with data from 98 of the 162 firms), the lead venture capitalists on the boards were classified according to whether or not they were a “top-20” firm.Board Size The average board size was 5.6 members, which was somewhat less than half the size of the board of a typical large company. Board size increased from 3 to 4.8 members with the first investment of venture capital.Board Composition and Control The typical board comprised 1.7 inside members, 2.3 venture capital principals, .3 venture capital staff, and 1.3 other outsiders. Insiders constituted 40% or less of the members of 82% of the boards, while venture capitalists made up over 40% of members of 55% of the boards. When a top-20 venture capital firm was the lead investor, then 55% of the board members were venture capitalists; in contrast, when the lead was not a top-20 firm, only 23% of board were venture capitalists.Value-Added Overall, our sample of CEOs did not rate the value of the advice of venture capitalists any higher than that of other board members. However, those CEOs with a top20 venture capital firm as the lead investor, on average, did rate the value of the advice from their venture capital board members significantly higher—but not outstandingly higher—than the advice from other outside board members. On the other hand, CEOs with no top-20 as the lead investor found no significant difference between the value of the advice from venture capitalists and other outside board members. Hence, in our sample, we could not say that there was a noticeable difference in the value of valueadded by top-20 boards and non-top-20 boards.The areas where CEOs rated outside board members (both venture capitalists and others) most helpful were as a sounding board, interfacing with the investor group, monitoring operating performance, monitoring financial performance, recruiting/replacing the CEO, and assistance with short term crisis. That help was rated higher for early-stage than later-stage companies.Our findings have the following implications for venture capitalists, entrepreneurs, and researchers.Venture Capitalist The main product of a venture capital firm is money, which is a commodity. It's impossible to differentiate a commodity in a martetplace where the customers have perfect information. As venture capitalists learned since the mid-1980s, their customers (entrepreneurs) now have an abundance of information that, while it may not be perfect, is certainly good enough to make a well-informed decision when selecting a venture capital firm. Hence, value-added may be the most important distinctive competence with which a venture capital firm—especially one specializing in early-stage investments—can differentiate itself from its competitors. If that is the case, then venture capital firms need to pay more attention to their value-added, because CEOs, overall, do not perceive that it has a great deal of value to their companies. The top-20 appear to be doing a somewhat better job in that area than other venture capital firms.Entrepreneurs If an entrepreneur wants outside board members who bring valueadded other than money, it appears that they can do as well with non-venture capitalists as with venture capitalists. The entrepreneurs we talked to in our survey gave the impression that board members with significant operating experience are more valued than “pure” financial types with no operating experience. If venture capital is an entrepreneur's only source offunding, then the entrepreneur should seek out firms that put venture capitalists with operating experience on boards. It also appears that an entrepreneur, will, on average, get more value-added when the lead investor is a top-20 firm, but there is a drawback: when a top-20 is the lead investor, it is more likely that venture capitalists will control the board. No entrepreneur should seek venture capital solely to get value-added from a venture capitalist on the board, because outside board members who are not venture capitalists give advice that is every bit as good as that given by venture capitalists.Researchers Value-added is a fruitful avenue of research. From a practical perspective, if valueadded exists it should be measurable. So far the jury has not decided that issue. Some finance studies of the performance of venture-capital-backed initial public offerings (IPOs) claim to have found valueadded, some claim to have found none, and at least one study claims to have found negative value- added. From a theoretical perspective, value-added is relevant to agency theory, transaction cost economics, and the capital asset pricing model. It also is relevant to strategic analysis from the viewpoint of distinctive competencies.     

Sounds novel or familiar? Entrepreneurs' framing strategy in the venture capital market

This study offers a theoretical perspective from which to examine entrepreneurial ventures' linguistic strategies. Drawing on the framing perspective, we introduce two concepts—novelty frames and familiarity frames—and examine how the use of these linguistic frames may influence entrepreneurial ventures' ability to obtain funding from venture capitalists (VCs) in different industry contexts. Based on a sample of 2883 U.S. information technology (IT) ventures and 5849 investment events from 2003 to 2014, we show that novelty and familiarity frames individually and interactively shape the amount of funding. We also found that industry capital intensity enhances the positive effects of familiarity frames. These findings highlight the role of entrepreneurial ventures' linguistic frames in shaping their funding opportunities.     

The association between venture capitalists’ selection and value adding behavior: evidence from early stage high tech venture capitalists

Building upon self-efficacy and collective effort theories, we study the association between the selection behavior of venture capitalists and their involvement in value adding activities. We argue that investors, who prioritize different characteristics of a business proposal during selection, will be more or less confident of their own abilities and the abilities of entrepreneurial teams to effectively add value to portfolio companies and hence will be more or less involved in providing value adding activities. In order to test this claim, we use a stratified sample comprising 68 European early stage high tech venture capitalists. Results show that venture capitalists, who focus on entrepreneurial team characteristics or financial criteria during selection, are less involved in value adding activities compared to their peers, who focus on technological criteria. We discuss these findings from a theoretical and practical perspective.     

Linking prefunding factors and high-technology venture success: An exploratory study

This study reports on the exploratory phase of a research project on prefunding factors influencing the success of high-technology start-up companies. The study was done in collaboration with two major West Coast venture capital firms that allowed the authors full access to the due diligence files, investment proposals, and closing documents associated with eight ventures. Half of the eight ventures studied are currently public companies with sales that range from $65 million to $500 million and with an after-tax profit of about 10% of sales. The other half have either been dissolved or did not reach $3 million in sales within the five years following their funding.Information was obtained on those prefunding factors that were available for investor review prior to funding, such as the founders track records, the characteristics of the founding team, the nature of the target market, the technological strategy of the firm, the proposed composition of the board, and the deal structure.In spite of the small sample size, findings of this research revealed discernible differences between successful and unsuccessful firms. The founders of the successful ventures had more prior experience working together; tended to form larger, more complete teams; and had more extensive experience in the function they performed in the new venture. Successful founders also had experience in rapid growth firms that competed in the same industry as the start-up.The successful ventures targeted product-market segments with high buyer concentration in which, through technological advantage, their products could attain and sustain a competitive edge. Often this advantage was achieved by careful management of the product-development process, which resulted in early market entry and its corollary, reduced competition.On the other hand, some factors that the authors had predicted would allow them to distinguish between success and failure were not found to do so. Both successful and unsuccessful ventures targeted high growth markets, anticipated high gross margins, had founders with over five years of relevant experience, had experienced venture capitalists on their boards, and were characterized by a wide range of founder equity shares.     

Perceived risks and choices in entrepreneurs' new venture decisions

Though risk plays a central role in most entrepreneurial decision making, little empirical research has explicitly examined how the elements of risk, risk perceptions, and entrepreneurs' propensities to take risks influence choices among potentially risky entrepreneurial ventures. This experimental study asked a sample of entrepreneurs leading America's fastest growing firms to make choices among a series of hypothetical new ventures. The results indicate that such choices are influenced by the risks inherent in the new ventures, as evidenced by the pattern of outcomes anticipated in each venture, the entrepreneurs' differing perceptions of those risks, and differences in their personal propensities to take risks.The subjects in our sample of entrepreneurs tended not to choose ventures having a high degree of variability in their pattern of anticipated outcomes. This avoidance of outcome variability suggests that the sensitivity analyses commonly prescribed for examining new venture attractiveness may inhibit risk taking, and may deter potential investors from investing in their firms. New approaches to assessing and presenting new venture risk, other than the traditional best case/expected case/worst case approach, may be advisable, as well as sufficiently through market research to provide evidence of the degree to which market acceptance is likely for the venture's products or services.We also found an effect of differences in risk propensities among entrepreneurs on their new venture choices. This effect suggests not only that entrepreneurs should be wary of any biases they bring to their new venture decisions, but that prospective investors should consider the degree to which entrepreneurs in whom they choose to invest are well-matched to the investors' own risk-taking propensities.Finally, while our sample of entrepreneurs tended to shun high levels of variability in their new venture choices, they appeared willing to accept a considerable degree of hazard, or possible downside, in their new venture choices, presumably in pursuit of potentially significant gains. Entrepreneurs are advised to seek a clear understanding of the downside entailed in their proposed ventures, and develop strategies to mitigate the likelihood of adverse outcomes. Thus they will not jeopardize chances for near term success and attracting support of investors and others in later stages of the venture or in subsequent ventures.Our research did not attempt to examine how our subjects' choices would have played out in terms of performance, but the apparent biases which entrepreneurs' risk propensities bring to their assessment of proposed new ventures is a potentially important issue that merits further scrutiny. On one hand, such biases may lead to patterns of suboptimal decisions. On the other hand, our results suggest that investors should entrust their new venture investments to entrepreneurs whose risk propensities (and perhaps other personal characteristics) best match the needs of both the opportunity at hand and the investor's objectives. As many venture capitalists attest, the management of a proposed new venture should lie at the heart of their investment decision.     

Entrepreneurial risk-taking in crowdfunding campaigns

This paper examines how different sources of risk in reward-based crowdfunding campaigns influence the entrepreneur’s choice of targeted crowdfunding goal. This form of crowdfunding helps entrepreneurs to obtain feedback on market demand (next to raising money), since the pre-purchase decision of the crowd generates useful public information about product demand. However, it may also lead to project discontinuation if not enough money is raised during the campaign. We therefore derive conditions under which the entrepreneur sets a higher target. At other times, this leads entrepreneurs to raise sometimes even more money than necessary when there is a risk that the idea is quickly replicated by others, leading to even larger campaigns but also to fewer projects offered on platforms. Conversely, the increased presence of professional investors (business angels, venture capitalists) on platforms reduces the entrepreneurs’ incentives in their crowdfunding campaign, which leads to more but on average smaller crowdfunding campaigns.     

Specialization versus diversification as a venture capital investment strategy

Much important work has informed us of rates of return earned by venture capitalists, the importance of venture capitalists to the “going public” process, and the criteria venture capitalists use to evaluate deals. This paper seeks to add to the literature by testing hypotheses, based upon both the finance and strategic management literature, regarding certain venture capitalist investment practices.Venture capitalists seek to control or manage risk (Driscoll 1974; MacMillan, Siegel, and SubbaNarasimha 1985). Financing structure and investment strategy provide several means for venture capitalists to do this. Tools available to the venture capitalist include portfolio diversification to spread risk across different industries, firms, or hot/cold IPO markets to minimize unsystematic or investment-specific risk. Information sharing, networking, and specialization can also be used to control unsystematic risk.Several hypotheses are developed from these conflicting perspectives. Data used to test the hypotheses are derived from responses to a survey of venture capitalists. Three hundred surveys were mailed to venture capitalists; 98, or 32.7%,returned usable responses.Portfolio diversification is a well-known means to control risk exposure by reducing unsystematic or specific risks. However, Bygrave (1987, 1988), as well as financial intermediation theorists, argues that maintaining a high degree of specialization is useful for controlling risk as well as for gaining access to networks, information, and deal flow from other venture investors. The analyses of this paper build upon Bygrave's work. We construct more rigorous tests to resolve the conflict between the diversification and information-sharing hypotheses. Our hypothesis tests were usually resolved in favor of the information-sharing view. For example, venture capitalists in the sample that were heavily involved in seed round financing were diversified across fewer numbers of firms and industries.Further evidence in favor of information sharing is seen in investment patterns across different financing stages. Diversification would imply maintaining a portfolio of investments across the different investment stages. The information sharing/specialization view would argue that it is best to stay focused on a single stage or several “connected” stages. The empirical evidence from the sample once again favors the specialization perspective.This research provides information of use to venture capitalists, as they seek information on how best to control risk; to entrepreneurs, as they learn of the factors venture capitalists consider in determining their investment strategy; and to academicians, as such studies provide insight to general industry practice and thus help to form the basis of classroom discussion and future research endeavors.     

New venture survival: Ignorance,external shocks,and risk reduction strategies

Although scholars have long recognized the increased mortality risk that new ventures face in terms of a “liability of newness,” most of the discussion around this risk has been in terms of the contextual constraints that new ventures face and the difficulties that managers have in overcoming them. This emphasis is in part a reflection of the perils of newness but also stems from the retrospective and aggregate perspective taken by researchers. Although the macro-level perspective of new venture mortality has made a significant contribution to our knowledge of mortality risk patterns, there has been little interest in identifying how venture managers can address the risks that all new organizations face.We argue that in order to make progress in explaining new venture survival, a theoretical model is required that uses a more micro-level perspective to explain new venture failure (and the flip side, new venture survival). In this paper we develop such a model. We establish a definition of mortality risk and argue that the liability of newness is largely dependent on the degree of novelty (ignorance) associated with a new venture. Novelty is viewed in three different dimensions, viz.: to the market, to the technology of production and to management. Novelty to the market concerns the degree to which the customers are uncertain about the new venture. Novelty in production concerns the extent to which the production technology used by the new venture is similar to the technologies in which the production team has experience and knowledge. Novelty to management concerns the entrepreneurial team's lack of business skills, industry specific information and start-up experience. We argue that mortality risk increases with the degree of novelty in each dimension and with the number of dimensions in which the new venture is novel.We propose that the decline in mortality risk occurs as the venture's novelty in each of the three dimensions is eroded by information search and dissemination processes. This allows the new firm to become an established business and explains what we term the “evolutionary” path of mortality—novelty and risk decline monotonically, after a period of adolescence, as ignorance decays over time due to `passive learning'. We also propose that there is a “strategic” mortality risk path that reflects the impact of positive and negative shocks (shocks are exogenous events that alter the overall degree of novelty at a point in time— positive shocks decrease overall novelty, while negative shocks increase overall novelty) and reversals (endogenous actions that increase the overall novelty of the new venture at a point in time) on the mortality risk of a new venture.If the incidence and effects of these disruptions can be managed, then venture managers may be able to mitigate the mortality risk for their venture. We argue that risk reduction strategies can be employed, most of which impact on one or more of the dimensions of mortality risk in order to increase the firm's chances of survival. A series of risk reduction strategies are proposed and their impact on the determinants of mortality risk is considered.     

Entrepreneur opportunity costs and intended venture growth

This study investigates how entrepreneur opportunity costs influence the intended future size of new ventures. In particular, using a survey of nascent entrepreneurs in the process of starting a venture, this paper examines how intended future sales revenue is influenced by entrepreneur current household income, education, and managerial experience. Consistent with opportunity cost and human capital arguments, it is found that individuals with higher current household income and greater supervisory experience have higher levels of intended firm size in 5 years time. While this study finds that entrepreneur stated preferences for growth also influence intended future sales of the venture, the association between nascent entrepreneur opportunity costs and venture scale is complementary to these stated preferences.     

A process model of entrepreneurial venture creation

The process model of entrepreneurial venture creation developed in this paper is based on interviews with entrepreneurs who started twenty-seven business in a range of industries in upstate New York. The venture creation process described here is an iterative, nonlinear, feedback-driven, conceptual, and physical process.The model includes internally and externally stimulated opportunity recognition, commitment to physical creation, set-up of production technology, organization creation, product creation, linking with markets, and customer feedback. For analytical convenience, the process has been divided into the opportunity stage, the technology set-up and organization-creation stage, and the exchange stage. Business concept, production technology, and product are respectively the core variables representing the three stages.Entrepreneurs introduce differing amounts of novelty at each core variable during venture creation, and the varying amounts of novelty qualitatively distinguish one kind of entrepreneurship from another.For the researcher, the model suggests a better method for specifying samples of entrepreneurial firms. It shows how studies on the context of venture creation can be more specific, and proposes that novelty at the core variables be operationalized as a step toward defining the entrepreneurial content of ventures.For the prospective entrepreneur, the model will serve as a useful road map. It will alert the entrepreneur to the strategic issues at each stage in the venture creation process, particularly when introducing significant novelty at any of the core variables.     

Trademarks and venture capital valuation

This study investigates the role of trademarks in the start-up valuations of venture capitalists (VCs). Our results show that the number and breadth of trademark applications have inverted U-shaped relationships with the financial valuations of start-ups by VCs. The findings also indicate that in later funding rounds, the value of trademark applications decreases when the start-up progresses into more advanced development stages. Start-ups should consider these findings when seeking funding from VCs and should stress their market and growth orientations and their willingness to protect their marketing investments by highlighting their trademark activities.     

Angels and non-angels: Are there differences?

The market for informal venture capital is an elusive and nearly invisible source of financing for entrepreneurial ventures. This market consists of a diverse set of high net worth individuals (business angels) who invest a portion of their assets in high-risk, high-return entrepreneurial ventures. The emerging consensus of the characteristics of the individual investor is that of a well-educated,middle-aged individual with considerable business experience and a substantial net worth. These informal investors appear to prefer investing in the early start-up stage of the venture and, if given a choice, prefer that their investments be located close to home. One consequence of this consensus is the tendency to assume that the traits of these business angels are as tightly clustered around the norm as are the traits of venture capital funds. They are not. In terms of their competence in the many areas of venture investing, these Individual investors range from the successful, cashed-out entrepreneur on the one hand to individuals with little or no experience with venture investing on the other. At the same time, little is known about the characteristics of high net worth individuals who never ventured where angels dare to tread, or about these non-angels' propensity to join the fold. Thus, this study seeks to fill the void by examining the characteristics of high net worth individuals regardless of their investment history or their interest in venture investing.An analysis of the data reveals three groups of high net worth Individuals: business angels with experience investing in entrepreneurial ventures, interested potential investors with no venture investment history but who express a desire to enter the venture investment market, and uninterested potential investors who under no circumstances would consider investing in entrepreneurial ventures as part of their investment strategy. Business angels and potential investors (both the interested and non-interested segment) share similar views about the economic significance of the entrepreneur and the difficulty in securing the equity capital for development of the venture. As the issues move from the general to the specific, divergence in investment attitudes takes place among the two groups, but this divergence is in terms of magnitude or intensity, rather than in contrasting or opposing views of the process. The potential investor tends to view investing in entrepreneurial ventures on a smaller scale than the active investor, especially in terms of the dollar amount committed to any one investment. While the business angel is more interested than the potential investor across all stages of financing, the interest for both groups increases as the type of financing progresses from the seed stage to expansion financing. In contrast, the potential investor is more likely to seek diversification as a motivation for venture investing than their angel counterparts.The potential investor pool is segmented into those potential investors who appear willing to take on the role of business angels and those individuals who have no desire to participate in the venture market. For the interested group to increase their interest in providing venture capital, these potential investors want assistance in monitoring the performance of the venture investment, followed by assistance in pricing and structuring. Both of these resources relate more to the technical aspects of venture investing and Indicate that these are the areas where the potential investor is least likely to have expertise. Other resources, such as finding and evaluating the investment opportunity, appear to represent less of a stimulus for the potential investor. In many respects, interested potential investors act like business angels across several dimensions. Both consider the later stages of the development of the venture as the preferred stage to invest. The business angel and interested potential investor prefer investments to be located relatively close to their primary residence and share similar views on the amount of the investment portfolio to allocate to venture investing. Where the interested potential investor and business angel clearly differ is on the scale of the commitment and the motivation for investing. The potential investor will commit a smaller dollar amount to any one venture, is more inclined to participate with other investors, and is more apt to see venture investing as a diversification strategy than is the seasoned business angel.     

Passion for entrepreneurship or passion for the product? A conjoint analysis of angel and VC decision-making

Passion is important to venture investors, but what specifically do they want entrepreneurs to be passionate about? This study theorizes that angel investors and venture capitalists consider both entrepreneurs' passion for activities related to the product or service the venture provides (i.e., product passion) and passion for founding and developing new ventures (i.e., entrepreneurial passion). We demonstrate that both types of passion become more appealing when the investor perceives that the entrepreneur is highly open and receptive to feedback, suggesting that openness to feedback mitigates potential concerns associated with passion in its extremes. We further find that venture investors differ in their consideration of passion; angel investors and venture capitalists with more investing experience place greater emphasis on the combination of product passion and openness to feedback, whereas those with more entrepreneurial experience emphasize the combination of entrepreneurial passion and openness to feedback.     

How venture capitalists respond to unmet expectations: The role of social environment

In this paper, we seek to explain venture capitalists' reactions to disappointments caused by entrepreneurs. Our basic assumption is that venture capitalists' social environment, defined as exposure to venture capital and business communities, will influence their responses to problematic situations. The results of our study suggest that venture capitalists with strong ties to their colleagues and with managerial experience are more inclined to use active and constructive approaches than venture capitalists with a lesser exposure to the venture capital and business communities.