How venture capital firms differ

How venture capital firms differ

ELSEVIER HOW VENTURE CAPITAL FIRMS DIFFER B. ELANGO Baruch College, The City University o f New York VANCE H. FRIED Oklahoma State University ROBER...

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ELSEVIER

HOW VENTURE CAPITAL FIRMS DIFFER B. ELANGO Baruch College, The City University o f New York

VANCE H. FRIED Oklahoma State University

ROBERT D. HISRICH Case Western Reserve University

AMY POLONCHEK Oklahoma Department o f Vocational and Technical Education

Four potential sources of differences between venture capital (VC) firms were examined--venture stage of interest, amount of assistance provided by the VC, VC firm size, and geographic region where located. Through a questionnaire, 149 venture capitalists provided data about their firms, about what they look for in evaluating an investment, and about how they work with a portfolio company following an investment. Firms were divided into four groups based on venture stage of interest. The earlier the investment stage, the greater the interest in potential investments built upon proprietary products, product uniqueness, and high growth markets. Late-stage investors were more interested in demonstrated market acceptance. There were no differences by stage regarding the desired qualities of management. However, afier the investment was made, earlier stage investors attached more importance to spending their time evaluating and recruiting managers. Earlier stage investors sought ventures with higher potential returns---a 42% hurdle rate of return for the earliest stage investor versus 33% for the late-stage investor. Late-stage investors spent more time evaluating a potential investment. However, after the investment was made, there was little difference in the amount of time spent assisting the portfolio company. There were, however, differences in the significance that VCs attached to particular post-investment activities. Firms were split into three groups based upon the amount of time the VC spent with a portfolio company after an investment was made as lead investor. The most active group averaged over 35 hours per month per investment, and the least active group averaged less than seven hours.

EXECUTIVE SUMMARY

Address correspondence to Vance H. Fried, College of Business Administration, Oklahoma State University, Stillwater, OK 74078-0555. Journal of BusinessVenturing 10, 157-179 © 1995 Elsevier Science Inc. 655 Avenueof the Americas, New York, NY 10010

0883-9026/95/$9.50 SSD10883-9026(94)00019-Q

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The difference in assistance provided was not strongly tied to differences in investment stage of interest. There were major differences in the importance the VCs attached to their post-investment activities. Not surprisingly, high involvement VCs viewed their activities as more important. Based upon the amount of capital they managed, firms were also split into three groups. Average fund size varied from 278 to 12 million dollars. The larger firms had more professionals and managed more money per professional. The large firms provided the least, and the medium-sized firms the most, assistance to portfolio companies. Large firms also made larger individual investments. Even though they invested over half their funds in late-stage investments whereas smaller firms focused on the earlier stages, the large firms were still a major source of early stage financing. There were no differences between geographic regions in the proportion of investments where the venture capital firm served as lead investor. There were, however, major regional differences in investment stages of interest. Also differences were observed between regions that were not a result of differing size and investment stage.

INTRODUCTION Although the importance of venture capital to entrepreneurial firms and these firms' subsequent contributions to economic development has been well documented, most research on venture capital has treated the industry as homogeneous (Fried and Hisrich 1988). However, as Bygrave and Timmons (1992) point out, there is significant heterogeneity in the industry. Some research, e.g., Robinson (1987), Florida and Kenney (1988a, 1988b), Sapienza and Timmons (1989), has begun to examine these differences. These differences are not just of interest to academics. An understanding of the differences among venture capitalists (VCs) can be helpful to the entrepreneur in search of capital. By understanding what VCs are looking for in an investment, the entrepreneur increases his/her chances of finding capital. By understanding how VCs behave after an investment, the entrepreneur increases his/her chances of selecting the right VC investor. VCs can also benefit from a better knowledge of how other VCs operate. VCs both collaborate with, and sometimes compete against, each other. In addition, some of the differences are philosophical in nature. To the extent that the performance implications of differing VCs' philosophies can be evaluated, the overall performance of the VC industry can be improved. Finally, public policy-makers can benefit from an understanding of VC differences. This understanding can improve the availability of venture capital, a major concern of public policy-makers at both the regional and national levels.

Hypotheses The hypotheses tested in this study were formulated based on the results of previous research on the venture capital industry. These hypotheses can be grouped into four areas: venture stage, staff assistance per investee, firm size, and geographical differences. There is no overall theory driving the research on VC differences, but two perspectives run throughout much of the literature--stages of development (Ruhnka and Young 1987) and strategic choice (Robinson 1987). Stages of development explain VC differences by looking, not directly at the VC, but rather at the companies in the VC's investment portfolio. Companies develop in stages with the characteristics and needs of the company varying by stage. Very young organizations are less developed. As a result they are riskier and require more non-cash resources (e.g., business

HOW VENTURE CAPITAL FIRMS DIFFER 159 assistance) from the outside. In addition to explaining differences by venture stage, the stages-of-development concept significantly impacts the other three types of VC differences studied. Because early-stage companies require more assistance, VCs that provide a high level of assistance should invest in early-stage companies and those that provide a low level of assistance in late-stage companies. Because late-stage companies have greater needs for cash, large VC finns will invest in late-stage companies and small VC finns in early stage. Finally, the geographic location of the VC firm influences the developmental stage of companies in the pool available for investment. Thus all three types of differences are explained by the stage make-up of the VC's portfolio. Although the strategic choice perspective does not disagree with the basic concept of developmental stages, it argues that the concept does not explain all of the differences between VCs. Many exist as a result of deliberate choice by the VC. As MacMillan, Kulow, and Khoylian (1988) comment in their study of staff assistance per investee, "VCs exhibit different involvement levels solely because they elect to do so" (p.27).

Venture Stage Robinson (1987) found that venture capital firms differ significantly in the stage in the life of a new venture in which they invest. According to Bygrave and Timmons (1992), the differences between investing in early-stage and late-stage ventures are so great that investors focusing on late-stage investments, particularly small leveraged buyouts, should not be considered venture capitalists. Pratt (1989) has strongly disagreed with this position, arguing that the differences are not as great as the similarities. The stages-of-development literature describes the developmental process for new businesses in terms of sequential stages (e.g., Churchill and Lewis 1983; Galbraith 1982). Ruhnka and Young (1987, 1991) conducted an empirical study that showed that VCs viewed new businesses as developing in stages. They created a model of the development process based on the views of VCs with the stages of development based not merely on financial needs, but also on the strategic, marketing, and management characteristics of the venture. Similarly, Fried and Hisrich (1991) found that early stage investors looked for ventures based upon unique, proprietary products with high market growth potential, whereas late-stage investors were more interested in the capabilities of management. Based on this research, the following hypotheses were formulated: Hla: VCs investing at early stages of development place more emphasis on unique,

proprietary products and high growth markets than do VCs investing at late stages of development. Hlb: VCs investing at late stages of development place more emphasis on the management

characteristics of existing management than do VCs investing at early stages of development. According to financial theory, VCs should expect higher returns from higher risk investments. Early stage ventures generally face considerable management, market, and technological uncertainty. As a result, VCs feel that the risk of loss of their investment is much higher for early-stage investments. Ruhnka and Young found that VCs' demands for rates of return were 73% and 55% at the seed and start-up stages and declined to 35% for late-stage investments. Plumer (1987) found similar VC expectations. These findings are reflected in the following hypothesis:

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B. ELANGO ET AL. Hlc: VCs investing in early stages of development expect higher returns on investment than do VCs investing in late stages of development.

Ruhnka and Young also found that VCs were very concerned with the risk of management failure in the early stages. As firms matured and management became more proven, this concern declined. Sapienza and Timmons (1989) found that early-stage investors were much more involved in management recruiting. Fried and Hisrich (1991 ) concurred and also found that after an investment had been made, early-stage investors were more involved in evaluating the management team. These results are the basis for the following: Hid: VCs investing at early stages place more emphasis on evaluating and recruiting management than do VCs investing at late stages.

Being less developed as an organization, early-stage ventures require more non-cash resources from outside. Because the management team is not established, the VC may need to be more involved in the operations of an early-stage venture than a late-stage venture. Rosenstein et al. (1993) found that early-stage VCs were more involved in negotiating employment contracts, contacting potential vendors, evaluating product/market opportunities, formulating and evaluating marketing plans, and contacting potential customers. Sapienza and Timmons (1989) found that the VC's role as a financier, professional contact, and industry contact was more important in the early stage than in the late stage. These results are reflected in the following two hypotheses: Hle: VCs investing at early stages attach more importance to making introductions to potential customers and service providers than do VCs investing at later stages. Hlf. VCs investing at early stages attach more importance to assisting management with operational planning than do VCs investing at late stages.

Because the management team can be incomplete in early stages and the VC is more involved with operations, Gomez-Mejia, Balkin, and Welbourne (1990) found that the early stage VC needs to spend more time with the portfolio company than the late stage VC. Similarly, Barney et al. (1989) suggest that VCs can better control the business risk associated with early-stage investing by remaining in close contact with the venture. However, MacMillan, Kulow, and Khoylian (1988) found that differences in the level of VC involvement are not stage-related. In addition, in an exploratory study, Fried and Hisrich did not observe any differences in time spent by stage. Because of the conflicting research, the following hypothesis is tentative: Hlg: VCs investing at early stages spend more time with a portfolio company than do VCs investing at late stages.

Staff Assistance per Investee Robinson (1987) and Gorman and Sahlman (1986) found large differences in the amount of time VCs spend with portfolio companies. Gorman and Sahiman attribute much of this difference to the investment stage composition of the VC's portfolio. It appears that assistance from a VC will be more useful to a venture at an early stage of development because it is more likely that the venture's management team is not well developed. VCs providing a high level of assistance should be willing to assume a higher level of business risk, because they can better control this risk due to their close contact with the business. Firms providing a high

HOW VENTURE CAPITAL FIRMS DIFFER

161

level of management assistance should therefore be interested in early-stage investments, as is reflected in the following tentative hypothesis, which, ignoring causation, is similar to H 1g: H2a: VCs who provide a large amount of staff assistance invest more at early stages of

development than do VCs who provide low levels of assistance. How do the activities that high involvement VCs undertake with their portfolio companies differ from those of low involvement VCs? MacMillan, Kulow, and Khoylian (1988) conducted a study in which VCs were grouped based upon the amount of effort they expended on an activity relative to the effort expended by the entrepreneur. High involvement VCs were more involved than low effort VCs in developing professional support groups and soliciting customers or distributors. They were also more involved in obtaining alternative sources of debt and equity financing. Searching for candidates for the management team, and interviewing and selecting the management team were also areas where the level of VC effort varied. They also found high effort VCs more involved in developing actual products or services, developing production or service techniques, selecting vendors and equipment, formulating marketing plans, and monitoring operating performance. Whereas MacMillan et al.'s study was based upon VC effort relative to entrepreneur effort rather than the importance attached to the activity, it is reasonable to assume that VCs put the most effort into activities that they view as most important, hence the following four hypotheses: H2b: VCs who provide a high level of staff assistance attach more importance to making

introductions to potential customers, suppliers, and service providers than do VCs who provide a low level of assistance. H2c: VCs who provide a high level of assistance attach more importance to seeking

additional financing than do VCs who provide a low level of assistance. H2d: VCs who provide a high level of assistance attach more importance to recruiting

management than do VCs who provide a low level of assistance. H2e: VCs who provide a high level of assistance attach more importance to assisting with

operational planning than do VCs who provide a low level of assistance. Sapienza (1992) found that there was a clear positive correlation between the frequency of VC-entrepreneur interaction and the friendliness of the relationship, suggesting the following hypothesis: H2.f. VCs who provide a high level of assistance attach more importance to serving as the

entrepreneur's confidant than do VCs who provide a low level of assistance.

Firm Size The amount of money the average VC firm has under management has increased dramatically since the late 1970s. However, the amount of professional staff in these finns has not increased proportionally (Fried and Hisrich 1991). Hence large firms must either be investing in larger increments and/or having each VC in the finn monitor more investments. Bygrave and Timmons (1992) found that large firms were making significantly larger investments. These research findings are the basis for the following: H3a: Large VC firms have higher minimum and maximum investment levels than do small

VC firms. Bygrave and Timmons feel that firms have managed this growth in investment size by making

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more late-stage investments where it is easier to invest large sums, which is reflected in the following hypotheses: H3b: Large VC finns invest more at late stages of development than do small finns. H3c: Small VC firms invest more at early stages of development than do large finns.

Geographical Differences Florida and Kenney (1988a, 1988b) indicate that there are differences between VC firms located in different geographic regions. They found three types of regional VC complexes: (1) technology-oriented complexes like Silicon Valley, which are located close to concentrations of high technology businesses and therefore invest most of their money locally; (2) finance-oriented complexes like New York, which are located close to major financial institutions and invest most of their money outside of their region; and (3) hybrid complexes like Boston. In Florida and Kenney's view, the finance-oriented VCs invest by participating in investment syndicates led by technology-oriented VCs. Thus, the VCs in technologyoriented complexes should be lead investors in a much higher percentage of investments than should VCs from finance-oriented complexes. Florida and Kenney's findings are the basis for the following hypothesis: H4a: The extent to which a VC serves as lead investor will vary by geographic region, with

VCs in technology-oriented complexes like Silicon Valley serving as lead more than VCs in finance-oriented complexes like New York. Florida and Kenney's work did not address the potential for regions to vary by investment stage of interest. However, Gupta and Sapienza (1992) found that early stage investors preferred to invest close to home. Therefore it appears that VCs from finance-oriented complexes are more likely to be late-stage investors and VCs from technology-oriented centers more likely to be early-stage investors. Given the close historical ties between VCs and financial institutions in the finance-oriented complexes, one might expect these VCs to be more comfortable with late-stage investments that are more similar in nature to traditional financial activities. In their exploratory study, Fried and Hisrich found differences in stage of investment between the three regions they studied, which is reflected in the following: H4b: Investment stages of interest will vary by geographic regions, with VCs from

technology-oriented complexes like Silicon Valley investing more in early stages and VCs from finance-oriented complexes like New York investing more in late stages. In the qualitative portion of their study, Florida and Kenney also argued that there were other geographic differences, such as Silicon Valley VCs having tighter networks than Massachusetts VCs. Fried and Hisrich (1991) developed this idea further, arguing that there could be differences between regions based upon regional characteristics (geography, history, and economy), industrial culture (risk-taking versus conservative, formal versus informal), and organization and management orientation (organizational commitment and management styles). Whereas numerous differences may exist, research on this topic has been quite limited. However, Florida and Kenney, Fried and Hisrich, and Bygrave and Timmons (1992) all feel that VC firms in Silicon Valley are part of much tighter networks than VCs in other regions. As a result, they can assist their portfolio companies by providing access to their network. The findings of these studies are the basis of the final hypothesis:

HOW VENTURE CAPITAL FIRMS DIFFER

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H4c: VCs in Silicon Valley attach more importance to making introductions to potential customers, suppliers, and service providers than do VCs in other regions.

METHODOLOGY Data were gathered through a mail questionnaire in which VCs were asked about investment criteria using closed-end questions in the same manner as MacMillan, Siegel, and SubbaNarasimha (1985). Their responses were given on a four-point scale, with 4 being an essential criterion, 3 = important, 2 = desirable, and 1 = irrelevant. VCs were asked about the importance of various types of management assistance provided to portfolio companies. This topic was addressed through closed-ended questions in the same manner as Gorman and Sahlman (1986). Responses were given on a five-point scale, with 5 being very important and 1 being unimportant. Firms were also asked to indicate the composition of their portfolio by investment stage using Pratt's stages (Venture Economics 1989). An open-ended question asked VCs what they thought were significant differences in the industry. The questionnaire was sent to general partners of 491 firms listed in Pratt's Guide to Venture Capital Sources. Two mailings of the survey were made, resulting in 149 responses, a much larger sample than in any of the earlier studies. Venture stage was split in four groups based upon the following formulas: •

Earliest--More than 40% of investments in seed stage

• Early--Seed stage + first stage + second stage investments exceeded 80% percent of the portfolio, but seed was less than 40% • Late--Third stage + leveraged buyouts + other financings exceeded 80% of the portfolio. • The Mixed group consisted of firms that did not fit into any of the previous three categories. For each of the other dimensions being tested, the sample was split into groups depending on where a natural break occurred. When the venture capitalist was a lead investor, staff assistance was provided to the average investee. "High staff assistance" was provided if the assistance provided by the venture capitalist as lead investor was greater than or equal to 20 hours per month; "medium staff assistance" if the assistance provided was less than 20 hours per month but greater than 10 hours per month; and "low staff assistance" if the assistance provided was less than 10 hours per month. Firm size was also split into three groups. Large firms had total funds greater than 100 million dollars, medium-sized firms had total funds less than 100 million dollars but greater than or equal to 25 million dollars, and small firms had less than 25 million dollars. The geographic regions chosen for this study were Massachusetts; Illinois, Minnesota, and Michigan (hereafter referred to as Midwest); Palo Alto and Menlo Park (hereafter referred to as Silicon Valley); Northern California (San Francisco and its environs); New York: Southern California; and Texas. Means were computed for each variable, and an F test was used to test for differences between the various levels of each grouping. In some cases, two levels of a grouping were tested against each other using a Bonferroni t-test. Appendices 1-4 provide a detailed listing of the means and test results.

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B. E L A N G O

T a b l e 1.

ET AL.

Venture Stage Earliest Stage Investor

Early-Stage Investor

Mixed-Group Investor

Late-Stage Investor

Test Results

64.59 21.62 6.53 0.00 2.69 1.85

16.94 50.92 26.33 4.12 0.62 1.09

8.39 24.80 21.36 17.46 13.37 9.75

0.05 0.00 1.31 26 52 57.84 14.26

d d d

22.78

20.69

18.64

15.79

3.66

3.85

3.68

3.56

is able to evaluate and react well to risk

3.50

3.45

3.47

3 67

is articulate in discussing the venture

3.08

3.18

3.25

2.95

has demonstrated leadership ability

3.43

3.30

3.57

3.62

is thoroughly familiar with the market

3.70

3.55

3.72

3.56

has a track record relative to the venture

2.96

3.00

3.16

3.28

is ingenious

2.75

2.67

2.68

2.65

The Product: is proprietary is unique

3.58 3.60

3.24 3.06

3.02 2.88

2.53 2.28

a a

3.62

3.43

3.35

2.78

c

3.43

3.30

3.07

2.65

c

42.20

37.66

36.54

33.52

a

Percent of Investments 1. Seed stage 2. First round 3. Second round 4. Third round 5. Leveraged buyout 6. Other financing Average time spent when a lead investor (hrs/month) Investment Criteria The Entrepreneur(s): is capable of sustained intense effort

The Market: enjoys a significant growth rate The Investment: will return at least ten times my investment in 5-10 years Hurdle rate required (IRR): Importance of Services Provided: Evaluate management

d c

4.82

4.63

4.51

3.95

b

Make introductions to potential customers and suppliers

3.53

3.68

3 37

2.06

e

Make introduction to potential service providers

3.00

3.06

3.11

2.42

o

Recruit mangement

4.50

4.28

3.89

3.24

c

Assist m operational planning

3.69

3.38

2.99

3.06

~p <.10, bp <.05, ~p <01, ap <1)01.

HOW VENTURE CAPITAL FIRMS DIFFER 165

RESULTS Venture S t a g e Hypothesis la was supported (Table 1). The earlier the stage, the higher the interest in proprietary products, product uniqueness, and high growth markets. Late-stage investors were much more interested in demonstrated market acceptance. Hypothesis lb was not supported. Although several management characteristics were examined, the VCs' selection criteria for management did not differ by stage. Hypothesis 1c was only partially supported. Hurdle IRRs ranged from 42.2% for earliest stage investors to 33.52%, but the differences were significant to only the .1 confidence level. A two-way test between the earliest stage and late-stage groups was not significant at the .05 level. When returns were measured in terms of multiples of investment (how important is it that the venture will return at least 10× investment over five to 10 years?), the differences were significant at the .01 level. Hypothesis ld was supported. The earlier the stage, the greater the importance of the VC in evaluating and recruiting management. Hypothesis le was partially supported. Early-stage investors attach much more importance to making introductions to potential customers and suppliers. However, the difference was not significant for introductions to service providers. Hypothesis 1f was supported. Earliest stage investors viewed assisting with operational planning as important. Hypothesis lg was not supported. The differences between stages in the amount of time spent with a portfolio company were not significant. A two-way test between the earliest stage group and the late-stage group was also not significant. S t a f f Assistance Hypothesis 2a was not supported (Table 2). While high assistance VCs were involved in more transactions with firms in early stages of development (32.05% percent at seed and 32.02% Table 2. Staff Assistance per Investee Assistance Provided by the VC when a Lead Investor High

Medium

Low

Average time spent when a lead investor (hrs/month) Average time spent when not a lead investor (hrs/month)

35.65 9.84

12.75 4.39

6.76 4.03

Percent of Investments in. 1. Seed Stage 2. First round 3. Second round 4. Third round 5. Leveraged buyout 6. Other financing

32.05 32.02 18.40 7.54 12.27 5.20

18.47 28.13 18.62 13.54 12.88 6.21

18.46 26.25 16.07 13.68 15.51 7.93

3.52 3.15 4.80 4.33 4.25 3.65

3.21 2.96 4.78 4.54 4.10 3.08

2.98 2.69 4.39 3.73 3.66 2.98

Importance of Sevices Provided: Make introductions to potential customers and suppliers Make introductions to potential service providers Seek additional fmancing Serve as entrepreneur's confidant Recruit management Assist in operational planning ap<.10, bp< 05, Cp<.01. dp<.O01.

Test Results d

c h c

166 B. ELANGO ET AL. TABLE3 Finn Size Fund Size Large Finn size (millions)

Medium

Small

Test Results

278.911

50.962

12.345

d

11.35 27.35 15.10 15.09 21.22 7.45

20.20 28.66 20.22 13.40 10.83 6,32

26.36 29.20 16.58 7.17 10.15 6.19

b

Minimum investment amount considered (in thousands)

1159.090

541.964

311.777

c

Maximum investment amount considered (in thousands)

9677.777

2847,413

1388.095

d

Percent of Investments in:

1. 2. 3. 4. 5. 6.

Seed Stage First round Second round Third round Leveraged buyout Other financing

b

ap<.10, bp<.05, Cp<.01, dp<,O01.

at the first stage) than were low assistance VCs (18.47% at seed and 26.25% in the first stage), the differences were not statistically significant due to large standard deviations. A two-way test between the high and low groups also did not show any significance. Hypothesis 2b was not supported. High involvement VCs did not attach more importance to making introductions to potential customers, suppliers, and service providers. Hypotheses H2c, 2d, 2e, and 2f were all supported. High involvement VCs attached more importance to seeking additional financing, recruiting management, assisting with operational planning, and serving as the entrepreneur's confidant.

Fund Size Hypothesis 3a was supported (Table 3). The minimum investment of the large funds was 3.7 times greater than that of the small firms' minimum. The large funds' maximum investment was 7 times greater than that of the small firms. Hypotheses 3b and 3c were supported. Large funds were not as interested as small funds in seed investments and were more interested in LBOs. There were no differences for first-stage investments.

Geographical Differences Hypothesis 4a was not supported (Table 4). There were no differences between regions in the proportion of investments where VCs served as lead investors. Hypothesis 4b was supported. There were significant differences by region in the percentage of investments in seed, first round, and LBO financings. Hypothesis 4c was partially supported. Although Silicon Valley VCs attached more importance to making introductions to potential customers and suppliers, they did not differ from the other regions on introductions to service providers.

DISCUSSION

Venture Stage There were four identifiable groups of VC firms based on investment stage. One group made almost 65% of its investments in the seed stage. Another, larger group also focused on

HOW VENTURE CAPITAL FIRMS DIFFER

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TABLE 4 Geographic Region

MA

IL, MN, MI

Palo Alto, Menlo

Northern California

New York

Southern California

Texas

62.79

47.50

54.40

47.50

68.76

59.21

58.86

Percentage of Investments in: 1. Seed Stage 25.67 2. First round 32.58 3. Second round 21.06 4. Third round 10.08 5. Leveraged buyout 5.40 6. Other financing 4.40

11.66 23.33 16.66 13.33 16.66 8.75

33.89 32.52 16.72 5.77 2.04 9.17

16.78 37.07 17.50 12.57 5.71 3.21

9.51 18.00 14.45 14.06 31.91 8.75

18.67 23.24 16.58 17.09 10.70 9.00

7.56 30.55 23.22 15.33 18.98 4.33

Importance of Services Provided Make introductions to potential customers and suppliers 3.36

3.67

3.91

3.00

2.58

3.65

2.67

d

3.60

3.05

3.17

2.62

2.85

2.60

d

Percentage of Investments where Lead

Make introductions to potential services providers

3.24

Test Results

b

d

"p<.10, bp<.05, ~p<.01, dp<.O01.

early-stage investments but were much less involved in the seed stage. Both of these groups ignored late-stage investments. A third group ignored early stage investments to focus on late-stage investments. The fourth group was interested in investments at all stages. The two early stage groups were composed of smaller firms, both in terms of capital under management and partners in the firm. Although the mean fund size was highest for the mixed-stage investor group, the size of an individual investment was much greater for the later stage group. The earliest stage investors reported being lead investor 69% of the time. In subsequent stages, there is more of a tendency to follow investors who had invested at the earliest stage. Financing at the LBO stage generally creates a totally different set of investors, making late-stage investors more likely to be lead. (The high response to this question throughout indicates that for one particular investment, more than one VC firm will view itself as the lead investor.) The earliest stage investor spends much less time (88.80 hours) evaluating a proposal than does a late stage investor (339.77 hours). Because the late-stage investment has more of a history, for both the investee and the industry, there is more information available for the investor to evaluate. Consistent with prior research, this study found that earlier stage investors are interested in unique, proprietary products with high growth potential, whereas late-stage investors demand a market-proven product. Whereas all VCs want high quality management, earlier stage VCs expect more problems with management, as indicated in the high importance they attach to evaluating management after an investment is made. The earlier the stage, the greater the return potential. However the differences by stage in hurdle rates of return--42.20% for earliest versus 33.52% for late--were not nearly as great as anticipated. Although the hurdle rates for investors focusing on late-stage investments were similar to those found by Ruhnka and Young (1987) and Plummer (1987), the rates for

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B. ELANGO ET AL.

earliest stage VCs were much lower. There are two explanations for this difference. First, we grouped firms by the composition of their portfolio. Although our earliest stage investors had a large percentage of their investments at the seed stage, they also had investments at later stages as well, which would reduce the average hurdle rate of return for their portfolio. Second, due to the poor performance many VC-backed start-ups experienced in the period between the earlier studies and this study, VCs' expectations for returns from early-stage investments may have declined (Fried, Hisrich, and Polonchek, 1993). The amount of time spent with a firm after investment did not vary by stage. Although contrary to the findings of Gomez-Mejia et al. (1990), our findings from a much larger sample are consistent with those of MacMillan et al. (1988) and S apienza (1992). There are, however, major differences in the significance VCs attach to their post-investment activities. Our findings here, coupled with the earlier research, give a clear picture of these differences. Earlier stage investors think that all their activities are important. The lowest score for any activity was a 3.0, which represented the midpoint between extremely important (5.0) and not important (1.0). Late-stage investors viewed some activities, such as making introductions to potential customers, as unimportant. Some other activities were viewed as important to late-stage investors, but not to the same degree as for earlier stage investors. For example, recruiting management was rated 3.24 by late-stage investors, indicating that they attached some importance to this activity, but rated 4.5 by seed investors. Some activities, such as assisting with strategic planning, evaluating management, and managing the investor group were seen as quite important at all stages.

Assistance Provided by the Venture Capitalist There are major differences in the level of assistance VC firms provide. The high assistance group reported spending an average of 35.65 hours per month with investees when serving as lead investors. This dropped to 12.75 hours for the middle group and 6.76 hours for the low assistance group. In responding to the open-ended question, VCs specifically mentioned time spent with investees as a major area of difference. Three levels of assistance were suggested: inactive ("just attends board meetings"), active advice-giver, and hands-on. This is quite similar to the three clusters found by MacMillan et al. (1988)--laissez faire, moderate, and close tracker. These differences are not primarily stage-related. There are high involvement VCs investing in LBOs and low involvement VCs investing at the seed stage. Our findings support MacMillan's position that differences in level of involvement are largely a matter of VC choice. Not surprisingly, the more time a VC spends with a company, the more important the VC regards the various post-investment activities. This was particularly true of assisting with operational planning. It should be remembered that the data were gathered from the point of view of the VC, not management. Thus it is not known whether the managers view the high involvement VCs as being very helpful or constantly in the way. Responses to the open-ended questions suggested that there are major differences in the amount of time spent on deals that were "losers" or "going sideways." Some VCs spend a lot of time trying to improve these deals, whereas others do not. In addition, some VCs tend to quickly fire managers in these circumstances, whereas others become heavily involved working with existing management.

HOW VENTURE CAPITAL FIRMS DIFFER

169

Firm Size Firms vary greatly in the amount of assets under management. There are also differences in the number of professionals (partners and associates) working at the VC finn, but these differences are of a much lesser magnitude. This results in the amount of money invested per professional increasing as fund size increases--from 3.21 to 10.84 to 29.77 million dollars per professional. Not surprisingly, the size of individual investments increases significantly with size. The big finns also spend less time providing assistance after the investment is made. How do the larger finns invest more yet spend less time with investees? As Bygrave and Timmons (1992) suggest, part of the answer may lie in the fact that they are less interested in seed stage investments (11.35% for large versus 26.26% for small) and more interested in LBOs (21.22% for large versus 10.15% for small). Although this may provide part of the answer, the differences in time spent were greater for finn size than they were when the finns were split by investment stage. In addition, many of the differences between early- and late-stage investors discussed earlier, such as market acceptance of product, do not hold for finn size. There are large finns making seed investments and small firms investing in LBOs. Large funds had 11.35% of their investments in seed stage. Although significantly less in percentage terms than small funds, the absolute amount of seed investment by the large finns was greater. In addition, there were no differences by finn size in the percentage of portfolio invested in the first round. Thus differences in stages of interest do not fully explain the different behavior of large VC finns. The middle-sized firms spent the most time providing assistance to investees. As previously discussed, large finns appear to have made a strategic decision to provide less management assistance. Small finns may be providing less assistance because they do not have enough funds under management to reach minimum efficient scale. The existence of some scale economies in venture capital is also supported by the fact that the time between initial contact by an investee and ultimate investment by the VC finn decreases as firm size increases. Two other interesting results emerged. First, large firms were the least concerned about having the ability to quickly exit an investment. This is inconsistent with the large finns' emphasis on LBOs because the late-stage investor group was most concerned about quick exit. Second, the medium-sized funds had a higher hurdle rate than the other groups.

Geographic Regions Consistent with earlier research, we found major differences in investment stages of interest. New York has minimal involvement at seed stage, whereas Massachusetts and Silicon Valley put a quarter to a third of their investments in this stage. New York is heavily involved in LBOs, whereas Massachusetts, Silicon Valley, and Northern California are not. Given the finance orientation of New York, this was expected. Interestingly, Texans are the least interested in seed investing, yet are quite active in first-round investing and net importers of venture capital. At the same time they are also interested in leveraged buyouts, even though the average VC finn is relatively small. These differences by region in investment stage of interest lead to a variety of other differences between the regions. For example, New York with its late-stage orientation places the most importance on market acceptance. In addition, this study supports the view of Florida and Kenney (1988a, 1988b) and Fried and Hisrich (1991) that there are differences between geographic regions that cannot be explained by differing investment stage. For example, Southern and Northern California VC finns are similar to each other in terms of size and investment stage. However, the Southern California VCs are more demanding of the

170

B. ELANGO ET AL.

entrepreneur and product when evaluating an investment. The Southern California VCs also reported spending twice as much time providing post-investment assistance. The nature and cause of these differences are unclear. How important is a local venture capital industry to regional economic development? Because New York and Chicago are clearly major exporters of venture capital to the rest of the United States, why is a local venture capital industry necessary? In Florida and Kenney's view, a local industry is vital since New York and Chicago VCs invest out of region in deals led by local VCs. However this study, combined with Gupta and Sapienza, presents a slightly different view. There appear to be three different types of venture capital markets. First is the market for early-stage capital, which functions much as described by Florida and Kenney. VCs invest in deals in their area. Investment is also made out of area, but only with a local VC as lead. Second is the market for small, late-stage investments. This is basically a local market. Finally, there is the market for large, late-stage investments, which is a national market. Thus having local VCs is vital if a region is to provide either early-stage or small, late-stage financing but not large, late-stage financing. VCs making large investments can spread the fixed transaction costs of travel and VC travel time over a larger investment. In addition, late-stage VCs are not as dependent upon tight networks as are early-stage VCs.

FUTURE RESEARCH This study points to several interesting questions that future research should address. We found that many VCs make investments at early stages yet do not provide a high level of assistance to these ventures. Existing theory suggests that this is a recipe for poor performance. What is the actual performance of these early-stage, low involvement firms? If these VCs are successful, how do they manage the relationship differently than the more involved early-stage VC? Currently the only explanation of differences by firm size is that large firms invest at later stages. However, we found that many large finns invest at early stages. In addition, there were differences independent of investment stage of interest. The nature and source of differences by size needs to be further examined. Not surprisingly we found that high involvement VCs attached more importance to their post-investment activities. The value of a high level of VC involvement needs to be examined from the point of view of managers. In addition, the impact on performance from high VC involvement should be examined. We also found major differences in how VCs deal with problems at their portfolio firms. This issue has never been formally researched. The behavior of a VC in times of trouble has profound implications for the portfolio company and its management. Many VCs feel that it also has a significant impact on their overall fund performance. Regional differences also merit further investigation. There are regional differences that cannot be explained by investment stage of interest. To the extent these differences are culturally driven, qualitative research is likely necessary. This study only looked at venture capital in the United States. Yet the venture capital industry outside the United States has grown explosively in recent years and is now larger than the U.S. industry. Although the subject of much less research than the U.S. industry, there appear to be differences by geographic region throughout the world (Bygrave and Timmons 1992).

HOW VENTURE CAPITAL FIRMS DIFFER

171

In addition to the four areas we examined, there are other interesting differences that were not tested in this study. Several responses were received to the open-ended question asking how VC firms differ. More than one VC mentioned each of the following: whether the VC tries to be a partner or an adversary of management, whether or not the VC firm will invest when the management team is incomplete, whether or not the VC firm plans to exit the investment via an initial public offering or acquisition, whether or not the VC firm is an SBIC and limited by government regulation, and whether or not the partners in the VC firm have experience as managers of an operating company. Frequency of co-investing with other VCs (Bygrave 1987) was mentioned several times. Other research suggests that an important factor is whether or not the VC serves as lead investor (Gorman and Sahlman 1989). The two are related. If a firm invests by itself, it is automatically a lead investor. Thus there could be three types of VCs: those who invest by themselves, those who co-invest with other VCs and are often the lead investor, and those who co-invest and generally follow other VCs. Although responses of VCs to the open-ended question were supportive of this classification system, it is interesting to note that few VCs view themselves as followers. Several responses pointed to differences in level of industry specialization. Some finns focus on specific industries, whereas others do not. Although not tested in the present study, this appears to be a significant factor (Bygrave and Timmons 1992). Another difference suggested was the manner in which firms generate potential investments. Although most rely on referral networks, an increasing number of finns are actively creating investment opportunities (Fried and Hisrich 1994; Robinson 1987). The overall goal of firms may also differ. Most VCs manage money for traditional investors seeking direct monetary returns on investment. However, some of the VC firms indicated that they were different because they were "strategic investors." These finns are managing money provided by operating companies in furtherance of a particular strategic goal, such as having a window on new technology. (See Hurry, Miller, and Bowman 1992, for a discussion of venture capital investing as a means to purchase a shadow option.) This difference in overall purpose may lead to other differences in behavior. Finally, several VCs indicated that there were major differences in the ability of the VC firm to add value after the investment was made through such things as the VC's contacts and business knowledge. Although this concept is similar to amount of assistance provided, it focuses more on the quality of assistance rather than quantity. This result corroborates Rosenstein et al.'s (1993) finding that managers valued the assistance provided by "'Top 20" VCs more highly than the assistance provided by "average" VCs. In other words, all venture capitalists are not created equal.

REFERENCES Barney, J.B., Busenitz, L., and Fiet, J.O. 1989. The structure of venture capital governance: an organization economic analysis of relations between venture capital firms and new ventures. Academy of Management Proceedings 64-68. Bygrave, W.D. 1987. Syndicated investments by venture capital firms: a networking pe~pective. Journal of Business Venturing 2:139-154. Bygrave, W.D., and Timmons, J.A. 1992. Venture Capital at the Crossroads. Boston, MA: Harvard Business School Press. Churchill, N.C., and Lewis, V.L. 1983. The five stages of small business growth. Harvard Business Review 3:30-50.

172

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Florida, R., and Kenney, M. 1988a. Venture capital and high technology entrepreneurship. Journal of Business Venturing 3:30 i-319. Florida, R., and Kenney, M. 1988b. Venture capital, high technology, and regional development. Regional Studies 22:33--48. Fried, V.H., and Hisrich, R.D. 1994. Towards a model of venture capital investment decision-making. Financial Management (in press). Fried, V.H., Hisrich, R.D., and Polonchek, A. 1993. Venture capitalists' investment criteria: a replication. Journal of Small Business Finance 3:37-42. Fried, V.H., and Hisrich, R.D. 1991. Venture capital firms: Commonalities and differences. Management Research News 14(3): 17-33. Fried, V.H., and Hisrich, R.D. 1988. Venture capital research: past, present, and future. Entrepreneurship: Theory and Practice 13:15-18. Galbraith, J. 1982. The stages of growth. Journal of Business Strategy 3:70--79. Gomez-Mejia, L.R., Balkin, D., and Welboume, T.M. 1990. Influence of venture capitalists on high technology management. Journal of High Technology Management Research 1:103-118. Gorman, M., and Sahlman, W.A. 1986. What do venture capitalists do? 1986 Frontiers of Entrepreneurship Research 414-436. Gorman, M., and Sahlman, W.A. 1989. What do venture capitalist do? Journal of Business Venturing, 4:231-248. Gupta, A.K., and Sapienza, H.J. 1992. Determinants of venture capital firms' preferences regarding the industry diversity and geographic scope of their investments. Journal of Business Venturing 7:347-362. Hurry, D., Miller, A.T., and Bowman, E.H. 1992. Calls on high-technology: Japanese exploration of venture capital investments in the United States. Strategic Management Journal 13:85-101. MacMillan, I.C., Kulow, D.M., and Khoylian, R. 1988. Venture capitalists' involvement in their investments: extent and performance. Journal of Business Venturing 4:27-47. MacMillan, I.C., Siegel, R., and SubbaNarasimha, P.N. 1985. Criteria used by venture capitalists to evaluate new venture proposals. Journal of Business Venturing 1:119-128. Plummer, J.L. 1987. QED Report on Venture Capital Financial Analysis. Palo Alto, CA: QED Research, Inc. Pratt, S.E. 1989. The links between LBOs and venture capital investments. In J.K. Morris and S. Isenstein. eds., Pratt's Guide to Venture Capital Sources. Needham, MA: Venture Economics, Inc. Robinson, R.R. 1987. Emerging strategies in the venture capital industry. Journal of Business Venturing 2:167-184. Rosenstein, J., Bruno, A.V., Bygrave, W.D., and Taylor, N.T. 1993. The CEO, venture capitalists, and the board. Journal of Business Venturing 8:99-113. Ruhnka, J.C., and Young, J.E. A venture capital model of the development process for a new venture. Journal of Business Venturing 2:167-184. Ruhnka, J.C., and Young, J.E. Risk in venture capital investing. Journal of Business Venturing 6:115-133. Sapienza, H.J. 1992. When do venture capitalists add value? Journal of Business Venturing 7:9-27. Sapienza, H.J., and Timmons, J.A. 1989. The role of the venture capitalist in new ventures: what determines their importance? Academy of Management Best Paper Proceedings 74-78. Venture Economics. 1989. J.K. Morris and S. Isenstein, eds., Pratt's Guide to Venture Capital Sources, 13th edition. Needham, MA: Venture Economics, Inc.

HOW VENTURE CAPITAL FIRMS DIFFER APPENDIX

173

1 Test R e s u l t s W i t h a S a m p l e Split B a s e d on I n v e s t m e n t Stage Earliest Stage Investor

Early-Stage Investor

Mixed-Group Investor

Late-Stage Investor

Number of responses Firm size (in millions) Number of parmers Number of associates Percent of investments where lead

26 42.262 2.68 1.95 69.15

40 63.605 3.27 2.23 57.83

24 166.327 4.50 2.13 49.87

19 118.789 3.72 2.82 71.83

Percent of investments. 1. Seed stage 2. First round 3. Second round 4. Third round 5. Leveraged buyout 6. Other financmg

64.59 21.62 6.53 0.00 2.69 1.85

16.94 50.92 26.33 4.12 .62 1.09

8.39 24.80 21.36 17.46 13.37 9.75

.05 0.00 1.31 26.52 57.84 14.26

Minimum investment amount considered (in thousands)

424.400

287.435

635.874

1861.111

Maximum investment amount considered (in thousands)

1976.087

2278.750

5640.476

8789.473

Investment criteria The Entrepreneur(s): is capable of sustained intense effort is able to evaluate and react well to risk is articulate in discussing the venture has demonstrated leadership ability is thoroughly familiar with the market has a track record relative to the venture is ingenious The Product. is proprietary is unique has demonstrated market acceptance The Market: will be free of significant competmon for the next three years enjoys a significant growth rate The Investment: will return at least ten times my investment in 5-10 years

3.66

3.85

3.68

3.56

3.50

3.45

3.47

3.67

3.08

3.18

3.25

2.95

3.43

3.3

3.57

3.62

3.7

3.55

3.72

3.56

2.96

3.00

3.16

3.28

2.75

2.67

2.68

2.65

3.58 3.6 2.48

3.24 3.06 2.65

3.02 2.88 2.9

2.53 2.38 3.84

2.66

2.52

0.4

2.13

3.62

3.43

3.35

2.78

3.43

3.3

3.07

2.65

Test Results

Appendtx 1 eonttnue~ on p. 174.

174

B. E L A N G O E T A L .

A P P E N D I X 1 Test R e s u l t s W i t h a S a m p l e Split B a s e d on I n v e s t m e n t Stage

can be exited quickly. Hurdle rate required (IRR) Time elapses between initial contact and final funding (days) Average Time finn spends evaluating before investment (hours) Number of firms monitored personally as lead investor Number of firms monitored personally when not a lead investor Average time spent when a lead investor (hrs/month) Average time spent when not a lead investor (hrs/month)

(Continued)

Earliest Stage Investor

Early-Stage Investor

Mixed-Group Investor

2.05 42,20 104,31

2.03 37.66 109.18

1.97 36.54 109.24

2,25 33.52 121.87

a

88,80

142.09

148.59

339.77

c

7.22

5.28

6.74

6.43

3.90

4.28

6.66

3.66

22.78

20.69

18.64

15.79

5.60

6.80

6.22

4.70

4.82 3.53

4.63 3.68

4.51 3.37

3.95 2.06

b c

3.00

3.06

3.11

2.42

a

4.82 4.28

4.76 4.46

4.65 4.11

4.24 3.95

a

4.5 3.29

4.28 3.36

3.89 3.42

3.24 3.12

c

4.55

4.41

4.16

4.00

a

3.69

3.38

2.99

3.06

4.55 4.46 3.55

4.69 4.11 3.18

4.07 4.04 3.94

4.00 3.95 4.12

Importance of services provided Evaluate management Make introductions to potential customers and suppliers Make introductions to potential service providers Seek additional financing Serve as entrepreneur's confidant Recruit management Resolve compensation issues Assist with strategic planning Assist m operational planning Help form and manage board Manage investor group Evaluate acquisitions ~p<.lO, bp<.05, ~p<.Ol, dp<.O01.

Late-Stage Investor

Test Results

HOW VENTURE CAPITAL FIRMS DIFFER APPENDIX 2

175

Test Results With a Sample Split Based on Assistance Provided by the Venture Capitalist Assistance Provided by the VC When a Lead Investor High

Assistance Provided by the VC When a Lead Investor Medium

Assistance Provided by the VC When a Lead Investor Low

Number of responses Firm size (in millions) Number of partners Number of associates Percent of investments where lead

40 58.425 3.10 2.19 59.08

50 167.010 4.80 2.01 50.16

23 101.803 3.21 2.40 57.38

Percent of investments in: 1. Seed stage 2. First round 3. Second round 4. Third round 5. Leveraged buyout 6. Other financing

32.05 32.02 18.40 7.54 12.27 5.20

18.47 28.13 18.62 13.54 12.88 6.21

18.46 26.25 16.07 13.68 15.51 7.93

546.666

630.102

757.631

2307.894

4901.000

5722.807

Minimum investment amount considered (in thousands) Maximum investment amount considered (m thousands) Investment criteria The Entrepreneur(s): is capable of sustained intense effort is able to evaluate and react well to risk ~s articulate in discussing the venture has demonstrated leadership ability is thoroughly familiar with the market has a track record relative to the venture is ingenious

3.80 3.50 3.05 3.55 3.55 3.15 2.70

3.76 3.38 3.34 3.46 3.66 2.98 2.66

3.59 3.42 3.09 3.44 3.71 3.16 2.64

The Product. is proprietary is unique has demonstrated market acceptance

3.13 2.93 2.68

3.22 3.07 2.78

3.02 2.92 3.09

2.50

2.36

2.49

3.33

3.32

3.38

3.27

3.10

3.14

2.00

2.00

2.10

36.96 l 14.70

38.19 103.69

35.87 112.87

196.96

119.56

158.76

5.51

6 51

7.02

5.01

4.45

6.05

The Market" will be free of significant competition for the next three years enjoys a significant growth rate The Investment will return at least ten times my investment in 5-10 years can be exited quickly Hurdle rate required (IRR) Time elapses between imtial contact and final funding (days) Average time firm spends evaluating before investment (hours) Number of firms monitored personally as lead investor Number of firms monitored personally when not a lead investor

Test Results

Appendix 2 conttnue~ on p. 176

176

B. ELANGO ET AL.

A P P E N D I X 2 Test Results With a Sample Split Based on Assistance Provided by the Venture Capitalist (Continued) Assistance Provided by the VC When a Lead Investor High Average time spent when a lead investor (hrs/month) Average time spent when not a lead investor (hrs/month) Importance of services provided Evaluate management Make introductions to potential customers and suppliers Make introductions to potential service providers Seek additional financing Serve as entrepreneur's confidant Recruit management Resolve compensation issues Assist with strategic planning Assist in operational planning Help form and manage board Manage investor group Evaluate acquisitions ~p<.lO, bp<.05, ~p<.O1, dp<.OOl.

Assistance Provided by the VC When a Lead Investor Medium

Assistance Provided by the VC When a Lead Investor Low

Test Results

35.65

12.75

6.76

a

9.84

4.39

4.03

c

4.63 3.52

4.62 3.21

4.31 2.98

3.15

2.96

2.69

4.8 4.33 4.25 3.26 4.53 3.65 4.20 4.28 3.95

4.78 4.54 4.10 3.52 4.28 3.08 4.4 4.26 3.88

4.39 3.73 3.66 3.21 4.07 2.98 3.89 3.80 3.75

c c b a c b a

HOW VENTURE

APPENDIX

3

CAPITAL FIRMS DIFFER

177

Test Results With a Sample Split Based on Fund Size Fund Size Large

Number of responses Firm size (in millions) Number of partners Number of associates Percent of investments where lead Percent of investments in: 1. Seed stage 2. First round 3. Second round 4. Third round 5. Leveraged buyout 6. Other financing Minimum Investment amount considered (m thousands) Maximum investment amount considered (in thousands)

45 278.91 1 6.12 3.25 60 51 11.35 27 35 15 10 15.09 21.12 7.45 1159.090 9677.777

Medium

Small

58 50.962 306

40 12.345 205

a

1 64

1 79

'

62 56

51.09

20.20 28.66 20.22 13.40 10.83 6.32 541.964 2847.413

26.36 29.20 16.58 7.17 10 15 6.19 311.777 1388 095

Investment criteria The Entrepreneur(s): is capable of sustained intense effort is able to evaluate and react well to risk is articulate in discussing the venture has demonstrated leadership ability Is thoroughly familiar with the market has a track record relative to the venture is ingenious

3.80 3 65 3.29 3.58 3 63 3.18 2.54

3.65 3.39 3.09 3.63 3.6 3.16 2.61

3.68 3.48 3.14 3.44 3.74 2.94 2.83

The Product: is proprietary is unique has demonstrated market acceptance

2.92 2.87 2.89

3.20 2.93 2.83

3 23 3.12 2.91

2 23

2.57

2.53

3 32

3.34

3 60

2.96 1.80

3.29 2.06

3 17 2.24

34.94 96 16 117.22

40.28 108.62 168.48

35.07 125.26 169.67

5.97 4.23

6.29 4 58

6.89 6 85

13.63 4.44

25.35 7.39

17.37 6.10

4.62 3.29 3 13 4.66 4.36 3.92 1.49 4.13 3 00 3.98 4.16 3.90

4.54 3.17 2.86 4.79 4.20 4.13 3.28 4.37 3 62 4.20 4.24 388

4.40 3.23 3.03 4.48 4 10 3 90 3.28 4 28 3.50 4 33 39 38

The Market: will be free of significant competition for the next three years enjoys a significant growth rate The Investment: will return at least ten t~mes my investment in 5-10 years can be exited quickly Hurdle rate required (IRR) Time elapses between imtial contact and final funding (days) Average time firm spends evaluating before investment (hours) Number of finns momtored personally as lead investor Number of firms monitored personally when not a lead investor Average time spent when a lead investor (hrs/month) Average time spent when not a lead investor (hrs/month) Importance of ~rvtces provided Evaluate management Make introductions to potenttal customers and suppliers Make introductions to potentml service providers Seek additional financing Serve as entrepreneur's confidant Recm~t management Resolve compensation issues Assist with strategic planning Assist m operational planning Help form and manage board Manage investor group Evaluate acquisitions "p<.lO, bp<.05, ~p<.Ol,

dp<.O01.

Test Results

d

b

b ¢ a

b b t,

t,

will be free of significant competition for the next three years enjoys a significant growth rate

The Market:

is proprietary is unique has demonstrated market acceptance

The Product:

is capable of sustained intense effort is able to evaluate and react well to risk is articulate in discussing the venture has demonstrated leadership ability is thoroughly familiar with the market has a track record relative to the venture is ingenious

Investment criteria The Entrepreneur(s):

1. Seed stage 2. First round 3. Second round 4. Third round 5. Leveraged buyout 6. Other financing Minimum investment amount considered (in thousands) Maximum investment amount considered (in thousands)

2.27 3.43

3.20 3.00 2.39

3.76 3.47 3.20 3.31 3.54 2.93 2.77

25.67 32.58 21.06 10.08 5.40 4.40 331.153 3396.000

26 117.452 4.46 2.38 62.79

MA

2.32 3.19

3.13 3.07 2.63

3.88 3.44 3.32 3.57 3.69 3.13 3.00

11.66 23.33 16.66 13.33 16.66 8.75 1010.000 3090.625

17 132.21 3.31 1.23 47.50

IL,MN,MI

Test Results With a Sample Split Based on Geographic Region

Number of responses Finn size (in millions) Number of partners Number of associates Percent of investments where lead Percent of investments in:

APPENDIX 4

2.73 3.66

3.16 3.14 2.87

3.69 3.6 3.28 3.41 3.69 2.87 2.55

33.89 32.52 16.72 5.77 2.04 9.17 285.714 3281.818

22 160.619 4.77 2.02 54.40

Palo Alto, Menlo

2.50 3.43

3.00 2.70 2.54

3.86 3.22 2.50 3.00 3.58 2.86 2.54

16.78 37.07 17.50 12.57 5.71 3.21 350.000 2478.571

14 85.264 3.67 1.09 47.50

Northem California

2.60 3.26

3.14 2.83 3.33

2.75 3.39

3.48 3.43 3.10

3.62 3.53 3.43 3.58 3.67 3.39 2.86

9

67

3.71 3.71 3.20 3.71 3.71 3.07 2.49

18.67 23.24 16.58 17.09 10.70 9.00 411.904 2223.80

21 49.409 2.33 2.70 59.21

9.51 18.00 14.45 14.06 31.91 8.75 1405.172 11166.66

31 159.534 4.01 3.42 68.76

New York

Southern California

2.15 3.07

2.67 2.54 3.07

3.40 3.20 3.00 3.60 3.67 3.47 2.54

7.56 30.55 23.22 15.33 18.98 4.33 576.666 2214.285

15 51.686 2.85 1.27 58.86

Texas

"

'~ c "

a

a c b

c d

d

c b

,7 a

Test Results

>

0

> Z

t"

oo

4

ap <

10,

bp <

05,

Cp <

01. d p < 001

Importance of services provided Evaluate management Make introductions to potential customers and suppliers Make introductions to potential service providers Seek additional financing Serve as entrepreneur's confidant Recruit management Resolve compensation issues Assist with strategic planning Assist in operational planning Help form and manage board Manage investor group Evaluate acquisitions

Hurdle rate required (IRR) Time elapses between initial contact and final funding (days) Average time firm spends evaluating before investment (hours) Number of finns monitored personally as lead investor Number of finns monitored personally when not a lead investor Average time spent when a lead investor (hrs/month) Average time spent when not a lead investor (hrs/month) 4.58 3.36 3.24 4.90 4.71 4.15 3.67 4.20 3.77 4.39 4.20 3.62

34.37 107.50 126.15 5.18 3.42 14.73 7.91

3.27 1.85

MA

4.54 3.67 3.60 4.74 4.60 3.87 3.47 4.67 3.60 4.34 4.34 3.80

34.75 138.00 115.90 4.21 5.21 23.37 8.92

3.00 1.93

IL,MN,MI

4.19 3.91 3.05 4.44 4.23 4.46 3.23 4.41 3.46 4.19 4.16 3.96

42.50 87.09 103.15 6.19 5.34 19.02 5.27

3.41 2.05

Palo Alto, Menlo

Test R e s u l t s W i t h a S a m p l e Split B a s e d on Geographic R e g i o n (Connnued)

The Investment: will return at least ten times my investment in 5-10 years can be exited quickly

APPENDIX

4.31 2.58 2.62 4.43 4.35 3.62 3.31 4.20 3.16 4.08 3.77 3.89

4.53 3.65 2.85 4.70 4.10 4.10 3.58 4.25 3.55 4.15 4.35 4.15

4.54 2.67 2.60 4.60 3.87 3.74 3.07 4.00 2.94 4.14 4.07 4.34

37.00 125.33 255.00 7.86 4.40 16.18 4.54 39.00 103.33 186.66 7.68 5.61 34.27 9.26

34.80 114.00 180.44 7.16 5.57 13.40 3.18

37.22 102.54 121.25 5.63 7.45 17.60 3.95 4.17 3.00 3.17 4.70 4.25 3.92 2.75 4.17 3.09 3.75 4.00 3.00

3.08 2.20

Texas

3.37 2.16

Southern California

2.90 2.24

New York

3.22 1.75

Northern California

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Test Results

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