Syndicated investments by venture capital firms: A networking perspective

The networking of 464 venture capital firms is analyzed by examining their joint investments in a sample of 1501 portfolio companies for the period 1966–1982. Some of the factors that influence the amount of networking are the innovativeness, technology, stage, and industry of the portfolio company. Using the resource exchange model, we reason that the relative amount of networking is explained primarily by the degree of uncertainty associated with an investment rather than by the sum of money invested.Among the findings of our study about venture capitalists are the following:The top 61 venture capital firms that managed 57% of the pool of venture capital in 1982 had an extensive network. Three out of four portfolio companies had at least one of the top 61 venture capital firms as an investor. Those top 61 firms network among themselves and with other venture capital firms. Hence they have considerable influence.Sharing of information seems to be more important than spreading of financial risk as a reason for networking. There is no difference in the degree of co-investing of large venture capital firms—those with the deep pockets—and small firms. Furthermore, where there is more uncertainty, there is more co-investing, even though the average amount invested per portfolio company is less. That, we argue, is evidence that the primary reason for co-investing is sharing of knowledge rather than spreading of financial risk. Venture capital firms gain access to the network by having knowledge that other firms need.It is likely that there will be increasing specialization by venture capital firms. Knowledge is an important distinctive competence of venture capital firms. That knowledge includes information such as innovations, technology, and people in specific industry segments. Among the portfolios of the top 61 venture capital firms are ones with a concentration of low innovative companies, others with a concentration of high innovative technology companies, and others with a no particular concentration. As technology changes rapidly and grows more and more complex, we expect that venture capitalists will increasingly specialize according to type of companies in which they invest. Only the largest firms with many venture capitalists will be like “department stores,” which invest in all types of companies. The smaller firms with only a few venture capitalists will tend to be more like “boutiques” which invest in specific types of companies, or in specific geographical regions around the world.We think that the networking of venture capital firms has the following implications for entrepreneurs:Entrepreneurs should seek funds from venture firms that are known to invest in their type of product. It speeds the screening process. If the venture capital firm decides to invest, it can syndicate the investment through its network of similar firms. And after the investment has been made, the venture capital firms can bring substantial expertise to the entrepreneur's company.Entrepreneurs should not hawk their business plans indiscriminately. Through their networks, venture firms become aware of plans that have been rejected by other firms. A plan that gets turned down several times is unlikely to be funded. Thus it is better to approach venture capital firms selectively.The extensive network of the leading venture capital firms probably facilitates the setting of a “market rate” for the funds they invest. The going rate for venture capital is not posted daily. Nevertheless, details of the most recent deals are rapidly disseminated through venture capitalists' networks. Hence, that helps to set an industry-wide rate for the funds being sought by entrepreneurs.Lastly, we give the following advice to strategic planners:Venture capital firms share strategic information that is valuable to others outside their network. Since they often invest in companies with emerging products and services, venture capitalists gather valuable strategic information about future innovations and technological trends. Thus, strategic planners should tap into venture capitalists' networks, and thereby gain access to that information. It is sometimes information of the sort that can revolutionize an industry.     

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.     

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.     

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.     

Risk management in Indian venture capital and private equity firms: A comparative study

Venture capitalists and private equity funds are often considered experts at investing in high‐risk projects and firms. To be successful investors, venture capitalists and private equity funds must therefore manage the many aspects of risk associated with investing in unlisted small and medium‐sized enterprises. This study examines how Indian venture capital and private equity firms manage several dimensions of risk. We analyze risk management preferences in Indian venture capital and private equity firms. A comparison between Indian and U.K. funds is presented. The results are discussed in detail. © 2005 Wiley Periodicals, Inc.     

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.     

Venture capital's role in financing innovation for economic growth

Previously, there has been little empirical evidence about the role of venture capital in fostering technological innovation. Recent research, sponsored by the National Science Foundation and Babson College and completed with our colleagues Stanley E. Pratt and Norman Fast (Venture Economics and Venture Capital Journal) shed some new light on the flow of venture capital to highly innovative technological ventures from 1967–1982. The evidence suggests that venture capital not only plays a significant role, but that it is a unique kind of investing in terms of when, where, and how it is done. Ironically, this research indicates that the “capital” in venture capital is the least important ingredient in fostering technological innovation. Rather, it is management intensive, requiring very early involvement by venture capitalists in nurturing budding innovators and technology, and thereby bird-dogging and accelerating the emergence of highly innovative technologies. Further, the post-1979 reduction of the capital-gains tax has led to unprecedented growth and development in the venture-capital industry. One result has been that a new industry structure is emerging, and along with it some new danger signals for the future flow and commercialization of technological innovation. Several lessons emerge from our findings that hold implications for venture capital investors and entrepreneurs alike.Successful venture-capital investing in technologically innovative firms requires more than just risk money. Savvy entrepreneurs seek out venture capitalists with noteworthy reputations for their nonmonetary, high value-added contributions to fledgling firms. Venture capitalists who can play a highly constructive role in emerging firms can attract higher-quality ventures. Qualities commonly cited by entrepreneurs are: helping to find the select key management-team members: providing credibility with suppliers and customers; and helping to shape strategy when the daily pressures postpone this vital task. As one put it, “It is far more important whom you obtain funding from than how much and at what price.”Investing in technologically innovative ventures is a more specialized business than suggested by the common stereotype of homogeneity among venture capitalists. Fewer than 5% of the 464 venture-capital firms in our study accounted for nearly 25% of all the investments in highly innovative technological ventures. Investors posses sepcialized know-how, including a web of contacts and networks, a great degree of syndication of deals, and a great intensity of involvement. The message for technology entrepreneurs is clear: focus on venture-capital firms with reputations for proven performance in your technology and market, especially with your targeted customers.Contrary to the notion that venture-capital investors sit and wait for business plans and innovative ideas to come to them and then simply write checks, many of the most active firms do just the opposite: they engage in active “bird-dogging” efforts to identify exceptional innovators with the relevant technical expertise and commitment to bring about the commercialization of promising technologies. They also team with innovators and entrepreneurs to create an “acceleration effect” by actually compressing the time span and increasing the velocity at which new technologies are brought to commercial maturity and societal utility. Founders and investors alike have related numerous examples of highly innovative technological ventures that became realities in what they believed to be one-fourth to one-half the time that would have been required within a large, established firm.Looking ahead, the new venture-capital climate of the mid-1980s offers both bane and blessing.As the pool of capital has exploded, the industry has become more diverse and specialized than even before. Sharp differences are visible in terms of investing objectives, criteria, and strategy, focusing on particular stages, size, and a technology-market niche. Megafunds of $100 + million have been raised, and as funds get larger the minimum investment escalates, typically $1 million or more now. Entrepreneurs in search of venture capital need to be more knowledgeable and focused than ever before.Significant portfolio problems continue to surface as the would-be “pearls” of 1982–1984 become “lemons” in 1985–1986. One results of this is the drying up of funds for seed and strat-up investments. Many venture capitalists are simply overburdened by cleaning up problems in their own portfolios and in replacing management. Fortunately, some innovative venture capitalists have seen opportunity in this adversity, and a handful of specialized seed and first-stage funds have been launched.Ironically, many of the trends and pressures in the venture-capital industry in the mid-1980s may inadvertently shift investing attention away from more innovative technological ventures. The implications of these changes are painful for entrepreneurs, investors, and the nations. How can technological innovation and international competitiveness be achieved of the venture-capital community is unable-or unwilling-to contribute as greatly to the funding of new innovations as it has in the past? Where will technology entrepreneurs find the risk capital and “value-added involvement” so vital to commercial success? And how can venture-capital pools provide the handsome yields on invested capital of the past if they shift investing to later-stage ventures?On the brighter side, we are still in an era of unprecedented opportunity for entrepreneurs and investors alike. Even with the sharp drop in new funds available in venture-capital pools to an estimated $2.5 billion in 1985, this is still 25 to 50 times greater than the annual flow of new venture capital during the dismal 1970s. The recent industry shake-up, coupled with a continuance of the favorable capital-gains tax, should foster a healthier, if not wiser and more disciplined, venture-capital industry during the remainder of the decade.     

Why do venture capital firms exist? theory and canadian evidence

This paper investigates the role of venture capitalists. We view their “raison d’être” as their ability to reduce the cost of informational asymmetries. Our theoretical framework focuses on two major forms of asymmetric information: “hidden information” (leading to adverse selection) and “hidden action” (leading to moral hazard). Our theoretical analysis suggests four empirical predictions.1. Venture capitalists operate in environments where their relative efficiency in selecting and monitoring investments gives them a comparative advantage over other investors. This suggests strong industry effects in venture capital investments. Venture capitalists should be prominent in industries where informational concerns are important, such as biotechnology, computer software, etc., rather than in “routine” start-ups such as restaurants, retail outlets, etc. The latter are risky, in that returns show high variance, but they are relatively easy to monitor by conventional financial intermediaries.2. Within the class of projects where venture capitalists have an advantage, they will still prefer projects where monitoring and selection costs are relatively low or where the costs of informational asymmetry are less severe. Thus, within a given industry where venture capitalists would be expected to focus, we would also expect venture capitalists to favor firms with some track records over pure start-ups. To clarify the distinction between point 1 and point 2, note that point 1 states that if we look across investors, we will see that venture capitalists will be more concentrated in areas characterized by significant informational asymmetry. Point 2 says that if we look across investment opportunities, venture capitalists will still favor those situations which provide better information (as will all other investors). Thus venture capitalists perceive informational asymmetries as costly, but they perceive them as less costly than do other investors.3. If informational asymmetries are important, then the ability of the venture capitalist to “exit” may be significantly affected. Ideally, venture capitalists will sell off their share in the venture after it “goes public” on a stock exchange. If, however, venture investments are made in situations where informational asymmetries are important, it may be difficult to sell shares in a public market where most investors are relatively uninformed. This concern invokes two natural reactions. One is that many “exits” would take place through sales to informed investors, such as to other firms in the same industry or to the venture’s own management or owners. A second reaction is that venture capitalists might try to acquire reputations for presenting good quality ventures in public offerings. Therefore, we might expect that the exits that occur in initial public offerings would be drawn from the better-performing ventures.4. Finally, informational asymmetries suggest that owner-managers will perform best when they have a large stake in the venture. Therefore, we can expect entrepreneurial firms in which venture capitalists own a large share to perform less well than other ventures. This is moral hazard problem, as higher values of a venture capitalist’s share reduce the incentives of the entrepreneur to provide effort. Nevertheless, it might still be best in a given situation for the venture capitalist to take on a high ownership share, since this might be the only way of getting sufficient financial capital into the firm. However, we would still expect a negative correlation between the venture capital ownership share and firm performance.Our empirical examination of Canadian venture capital shows that these predictions are consistent with the data. In particular, there are significant industry effects in the data, with venture capitalists having disproportionate representation in industries that are thought to have high levels of informational asymmetry. Secondly, venture capitalists favor later stage investment to start-up investment. Third, most exit is through “insider” sales, particularly management buyouts, acquisitions by third parties, rather than IPOs. However, IPOs have higher returns than other forms of exit. In addition, the data exhibit the negative relationship between the extent of venture capital ownership and firm performance predicted by our analysis.     

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.     

The informal venture capital market: Aspects of scale and market efficiency

Risk capital is a resource essential to the formation and growth of entrepreneurial ventures. In a society that is increasingly dependent upon innovation and entrepreneurship for its economic vitality, the performance of the venture capital markets is a matter of fundamental concern to entrepreneurs, venture investors and to public officials. This article deals with the informal venture capital market, the market in which entrepreneurs raise equity-type financing from private investors, (business angels). The informal venture capital market is virtually invisible and often misunderstood. It is composed of a diverse and diffuse population of individuals of means; many of whom have created their own successful ventures. There are no directories of individual venture investors and no public records of their investment transactions. Consequently, the informal venture capital market poses many unanswered questions.The author discusses two aspects of the informal venture capital market: questions of scale and market efficiency. The discussion draws upon existing research to extract and synthesize data that provide a reasonable basis for inferences about scale and efficiency.Private venture investors tend to be self-made individuals with substantial business and financial experience and with a net worth of $1 million or more. The author estimates that the number of private venture investors in the United States is at least 250,000, of whom about 100,000 are active in any given year. By providing seed capital for ventures that subsequently raise funds from professional venture investors or in the public equity markets and equity financing for privately-held firms that are growing faster than internal cash flow can support, private investors fill gaps in the institutional equity markets.The author estimates that private investors manage a portfolio of venture investments aggregating in the neighborhood of $50 billion, about twice the capital managed by professional venture investors. By participating in smaller transactions, private investors finance over five times as many entrepreneurs as professional venture investors; 20,000 or more firms per year compared to two or three thousand. The typical angel-backed venture raises about $250,000 from three or more private investors.Despite the apparent scale of the informal venture capital market, the author cites evidence that the market is relatively inefficient. It is a market characterized by limited information about investors and investment opportunities. Furthermore, many entrepreneurs and private investors are unfamiliar with the techniques of successful venture financing. The author's scale and efficiency inferences, coupled with evidence documenting gaps between private and social returns from innovation, prompt questions about public as well as private initiatives to enhance the efficiency of the informal venture capital market.The article concludes with a discussion of Venture Capital Network, Inc. (VCN), an experimental effort to enhance the efficiency of the informal venture capital market. VCN's procedures and performance are described, followed by a discussion of the lessons learned during the first two years of the experiment.     

Venture capital or private equity? The Asian experience

Venture capital in Asia has exhibited remarkable growth over the last two decades. Researchers and practitioners have, however, expressed doubts as to whether what is being reported as venture capital in Asia can really be classified as such. Authors of scholarly studies often avoid this debate and, consequently, fail to caution readers about the applicability of their research findings. Through an exploration of the history, development, and composition of venture capital in Asia, this article not only confirms significant differences between Asian and traditional venture capital, but also finds that venture capital in Asia differs little from what is commonly called private equity. As such, a need exists within the venture capital literature to recognize this peculiarity of the Asian venture capital market. Moreover, venture capitalists considering expansion into Asia must comprehend the nature of the Asian market in order to avoid disillusionment and frustrations which may result from inadequate understanding.     

Agency costs,institutions, learning,and taxation in venture capital contracting

This paper introduces a data set on forms of finance used in 12,363 Canadian and US venture capital (VC) and private equity financings of Canadian entrepreneurial firms from 1991 to 2003. The data comprise different types of venture capital institutions, including corporate, limited partnership, government, and labour-sponsored funds as well as US funds that invest in Canadian entrepreneurial firms. Unlike prior work with US venture capitalists financing US entrepreneurial firms, the data herein indicate that convertible preferred equity has never been the most frequently used form of finance for either US or Canadian venture capitalists financing Canadian entrepreneurial firms, regardless of the definition of the term ‘venture capital’. A syndication example and a simple theoretical framework are provided to show the nonrobustness of prior theoretical work on optimal financial contracts in venture capital finance. Multivariate empirical analyses herein indicate that (1) security design is a response to expected agency problems, (2) capital gains taxation affects contracts, (3) there are trends in the use of different contracts which can be interpreted as learning, and (4) market conditions affect contracts.     

Venture Capital in Spain by Stage of Development

This paper examines the investment decisions of 51 Spanish venture capital firms by stage of development. The results showed that venture capitalists ranked evaluation criteria related to the characteristics of the entrepreneurs, manager background, and management team experience as more important than market and product characteristics. Factors affecting the required rate of return were more important for the early-stage firms than for late-stage firms. Discounted cash flow analysis is the most frequently used valuation method. Private venture capital firms invest more during late development stages, while public venture capital firms invest more during the early stages. The results can be used by firms seeking venture capital, venture capital firms, consultants, and support agencies that provide capital-acquisition assistance. By gaining insight into decision criteria and processes, firms can develop better and more targeted materials to attract capital. Venture capital firms can use the information from this study to better understand their decision processes, individually and relative to competitors. Consultants and support agencies can use the information to provide better advice to both firms and venture capital firms. Information is this study could easily be built into training programs for both new and existing businesses. Finally, the results can also be incorporated directly into university courses that include material related to venture capital.     

Structuring deals and governance after the IPO: Entrepreneurs and venture capitalists in high tech start-ups

In an effort to better understand the effects of venture capital investment on selected firm governance and financing structures, we examined the post-IPO experiences of 190 biotechnology and healthcare firms (see appendix). Our study revealed that in virtually all cases, the involvement of venture capitalists reduced the role of the founder-entrepreneur in strategic decision making. This was illustrated by the larger proportion of outside directors when venture capitalists invested and the smaller proportion of entrepreneurs who remained officers or in board positions after the IPO. We also found that venture capitalists rarely invested alone, and preferred to structure deals in which venture capital partners share both risks and rewards.     

风险投资最优融资契约安排模型研究

风险投资中投资者与风险投资家之间的关系是一种委托与代理关系,投资者和风险投资家的目的都是实现收益最大化。融资契约收益的分配直接影响到风险投资家的努力水平,从而影响到最终的投资收益。因此,只有从投资者和风险投资家两个角度分析风险投资中的最优契约安排,才能给出最优契约安排的选择区间。     

The advantage of experienced start-up founders in venture capital acquisition: evidence from serial entrepreneurs

Entrepreneurs with prior firm-founding experience are expected to have more skills and social connections than novice entrepreneurs. Such skills and social connections could give experienced founders some advantage in the process of raising venture capital. This paper uses a large database of venture-backed companies and their founders to examine the advantage associated with prior founding experience. Compared with novice entrepreneurs, entrepreneurs with venture-backed founding experience tend to raise more venture capital at an early round of financing and tend to complete the early round much more quickly. In contrast, experienced founders whose earlier firms were not venture-backed do not show a similar advantage over novice entrepreneurs, suggesting the importance of connections with venture capitalists in the early stage of venture capital financing. However, when the analysis also takes into account later rounds of financing, all entrepreneurs with prior founding experience appear to raise more venture capital. This implies that skills acquired from any previous founding experience can make an entrepreneur perform better and in turn attract more venture capital.     

The structure of the investment networks of venture capital firms

Venture capital firms are linked together in a network by their joint investments in portfolio companies. Through connections in that network, they exchange resources with one another. The most important of those resources are the opportunity to invest in a portfolio company (good investment prospects are always scarce), the spreading of financial risk, and the sharing of knowledge. All venture capitalists operate in very uncertain environments, none more so than the one confronting high innovative venture capitalists, HIVCs,¹ that specialize in investing in high innovative technology companies. The most uncertain of all their investments is a high-technology start-up with nothing more than a product in the head of the founder. There is uncertainty about the talent of the entrepreneur, the market need for the product, the development of a saleable product, the raising of second-round financing for working capital and expansion; the manufacturing of the product, competitors' responses, and government policies such as capital gains tax and ERISA rules, to name some of the major components. It is a formidable list. Indeed, it is hard to name a segment of any other industry that bears more uncertainty than HIVCs.A venture capital firm copes with uncertainty by gathering information. This research shows that the amount of coinvesting by a firm depends on the degree of uncertainty it faces. The greater the uncertainty, the greater the degree of coinvesting.By examining how venture capital firms were connected by their joint investments, it was found that the top 21 HIVCs comprise a tightly coupled network. And of that group, none is more tightly bound than the nine HIVCs located in California. In contrast, the group of top 21 firms that invest mainly in low innovative technology companies, LIVCs, is more loosely bound. HIVCs are more tightly bound together because they shoulder more uncertainty and therefore have a greater need to share information with one another.The practical implications of this study are as follows: Venture Capitalists. It is vital to be well-connected to other venture capital firms. They are important sources of information and investment opportunities. For HIVCs, the California group is central in the network, so links to them are valuable. Communications in a tightly coupled system are swift, so it is likely that information is disseminated very quickly among members of the group. It probably facilitates the setting of a market rate for venture capital. A disadvantage of a tightly bound system is that information flowing among the members has a redundancy and sameness about it, so to ensure a supply of fresh information, members should have as many links as possible to other organizations and individuals besides venture capitalists. Entrepreneurs. When entrepreneurs submit a proposal for funding to venture capital firms, they can assume that news will spread fast to other firms. Thus, they should not use a bird-shot approach; rather, they should select their targets with rifle precision. The proposal should be submitted to a few firms that are known to specialize in the type of product or service that the entrepreneur is planning to make. Entrepreneurs should be concerned about more than the price of the deal. When the top 61 firms invest in a portfolio company, they bring information, contacts, and “deep pockets” to the companies in which they invest. Those factors are significant in nurturing a growing company. Policy Makers. The networks of HIVCs and UVCs are quite different. The HIVCs cluster around oases of high-technology entrepreneurship in the northeast and California, whereas the LIVCs are more evenly spread throughout the U.S.A. HIVCs are located almost exclusively in the so-called “bi-coastal regions of prosperity.”This study found cliques among the venture capital firms. But it found no evidence that the top 61 firms exclude other venture capital firms from their coinvestments of first-rounds of capital. More research is needed before conclusions can be drawn about the power and influence of the top firms. Researchers. In a recent article, Granovetter (1985) suggests that if we are to explain economic behavior, we must understand the networks in which transactions are embedded. This research shows that the networks formed by the syndicated coinvestments of venture capital firms may help us to explain their behavior. A general model for coinvestment networks that is developed in this article is applicable to analysis of syndicated coinvestments not only of venture capital firms, but of investors and lenders in general.     

Emerging strategies in the venture capital industry

This article reports a study of the future direction of the venture capital industry by examining the basic strategies and strategic assumptions of a broad sample of venture capital firms. There are three main sets of results:First, the once homogeneous venture capital industry is rapidly dividing into several different “strategic groups.” Members of these “groups” are increasingly distinguishing themselves from other groups on four basic dimensions followed by member firms: 1. Financial Resources—Equity capital comes from a greater variety of sources (five major sources) resulting in fundamentally different demands on the mission of the receiving venture capital firm. 2. Staff Resources—The way venture capital firms use staff resources, particularly regarding investee management assistance, is becoming increasingly varied across different groups. Some firms provide fewer than 2-days per year, while others provide up to 450 man-days per year per client. 3. Venture Stages—While the overall industry retains a primary interest in stage 1,2, and 3 investment, specific firms vary considerably in the distribution of investment emphasis across these three stages. 4. Use of Financial Resources-Firms in the industry are becoming increasingly differentiated in the size of minimum investments they make ($100 M to $1000 M) and in their role as a direct investor versus a “broker” for institutional funds. Practicing venture capitalists should make use of this first set of findings in two ways. First, they may find it useful to compare their firm's orientation along these four strategic dimensions with those of the firm's that comprised this study. Second, they may seek to use these four strategic dimensions as a basis on which they might examine, clarify, and/or redefine the marketing strategy pursued by their firm.A second set of results identified three goals and priorities of venture capital firms that have neither changed over time nor across increasingly different strategic groups. Annualized, after-tax return on investments of between 25% and 40% remain the most common objective across all firms. A 5-to-6 year investment time horizon and a major emphasis on the quality of the management team in evaluating new deals were universal priorities across diverse venture capital firms.A third finding in this study was that venture capital firms profess greater “certainty” about the future direction of the venture capital industry than the direction of their firm. The most notable example of this is a strong sense that industry-wide rates of return are headed downward yet few senior partners expect their firm to experience this decline.Practicing venture capitalists may be interested to peruse these results to see what trends are predicted within the venture capital industry by this subsample of that industry. Second, they should consider the finding that industry-wide rates of return are headed downward in light of the first two sets of findings to develop their own opinion about the future performance of different strategic groups within the industry.It is important to note that the sample of venture capital firms on which this study was based did not include most of the larger, older funds. Some of these funds would be characterized as “industry leaders, pace-setters, and innovators.” The sample provides a solid representation of the “broad middle” of the venture capital industry and newer entrants into the industry. While larger, older funds are under represented, their impact on future trends and strategies in the industry is captured to some extent in the set of questions about “future direction of the venture capital industry.“Finally, the emerging strategic groups in the venture capital industry that were identified by this study may be useful information for investors as well as users of venture capital. For investors, the opportunity to participate in venture capital activity should become more clearly understood and varied. Basically, this study should help investors differentiate the strategic posture of different venture capital firms and funds on four factors rather than simply industry/geographic considerations.For users of venture capital, the results of this study suggest a possibility for multiple options that are both more accessible and more catered to specific needs. Users of venture capital should find a clearer basis on which to differentiate venture capital firms in terms of venture stage priorities, staff utilization orientations, sources and uses of financial resources. This should make for more informed “shopping” among different venture capital sources and provide a basis on which to “shop” for the most compatible firm.