These authors seek to better understand what VCs do and, potentially, why they have been successful.
It’s estimated that roughly one-half of all true IPOs are VC-backed even though fewer than one quarter of 1% of companies receive venture financing. It’s further estimated that public companies that previously received VC backing account for one-fifth of the market capitalization and 44% of the research and development spending of U.S. public companies.
They surveyed 885 institutional venture capitalists (VCs) at 681 firms to learn how they make decisions across eight areas: deal sourcing; investment selection; valuation; deal structure; post-investment value-added; exits; internal firm organization; and relationships with limited partners.
In selecting investments, VCs see the management team as more important than business related characteristics such as product or technology. They also attribute more of the likelihood of ultimate investment success or failure to the team than to the business.
Largely consistent with actual outcomes, VCs claimed they exited roughly three-fourths of their successful deals via acquisition rather than through an IPO. VCs also report a wide variation in the outcomes of their investments, with roughly one-quarter losing money and almost 10% earning ten times their investment.
While deal sourcing, deal selection, and post-investment value-added all contribute to value creation, deal selection emerges as the most important of the three for the sample VCs with roughly one-half of the VCs ranking it as such.
Furthermore, a recurring theme in the survey—particularly in deal selection and in understanding ultimate deal outcomes—is the pre-eminence of team in the mind of the VCs.
They view the team as more important than the business to the ultimate success or failure of their investments. The survey, therefore, finds that VCs, on the whole, favor the jockey view of VC investing over the horse view.
A potential future use of this data set is to see if cross-sectional variation in that view predicts future VC performance.
The survey reveals little evidence that VCs use the net present value or discounted cash flow techniques taught at business schools and recommended by academic finance. This contrasts with the results for CFOs, but is more similar to the results for private equity investors.
Like the private equity investors, the VCs rely on multiples of invested capital and internal rates of return. Unlike the CFOs and private equity investors, a meaningful minority of VCs do not forecast cash flows at all.