iv vc investment criteria-libre

In partial fulfilment of the

Full time Masters of Business

Administration degree

Business Mastery Project

Presented to

Guy Fraser-Sampson

Visiting Lecturer in Finance

Cass Business School

City University

Venture Capital Investment Criteria An analysis of criteria and their relative importance

Izindi Visagie, #100058177

Word count: 14,458

Venture Capital Investment Criteria

Izindi Visagie Page 1 of 116

The graphic on the front cover illustrates the main industries Venture

Capitalists invest in, i.e. Cleantech, IT, Telecoms and Biotech. The team

picture illustrates the underpinning of Venture Capital by people, the

entrepreneurial team and the Venture Capitalists.



Table of Contents

Abbreviations ................................................................................................... 8

Executive summary .......................................................................................... 9

1. Introduction .............................................................................................. 14

2. Background ............................................................................................. 18

2.1 Main VC markets .............................................................................. 18

2.2 Main industries .................................................................................. 20

2.3 Recent changes ................................................................................ 21

3. Research Methodology............................................................................ 23

3.1 Literature review and desktop research ............................................ 23

3.2 Interview sample selection ................................................................ 23

3.3 Interview methodology ...................................................................... 25

3.4 Ranking and rating of criteria and elements within criteria ................ 27

3.5 Coding of responses ......................................................................... 28

4. Ranking of criteria ................................................................................... 30

4.1 Management team ............................................................................ 34

4.2 Market Drivers .................................................................................. 35

4.3 Unique and disruptive product .......................................................... 35

4.4 Scalable Business Model .................................................................. 36

4.5 Commercial Proof of Concept ........................................................... 36

4.6 VC specific factors ............................................................................ 36

5. Ranking of elements of criteria ................................................................ 39

5.1 Team................................................................................................. 39

5.2 Market ............................................................................................... 51



5.3 Product ............................................................................................. 53

5.4 VC specific factors ............................................................................ 57

6. Effect of the stage of the investment company on ranking of criteria ... 60

7. Effect of phase of fund on ranking of criteria ........................................ 62

8. Effect of VCs experience on ranking of criteria .................................... 64

9. Effect of size of the VCs fund on ranking of criteria ............................. 67

10. Effect of types of VC investors on ranking of criteria ............................ 70

11. Effect of the country/culture within which the VC operates .................. 73

12. Other factors ........................................................................................ 77

12.1 VCs evaluation of unsolicited proposals........................................... 77

12.2 Negotiating anti-dilution measures .................................................... 78

13. Limitations ............................................................................................ 80

14. Suggestions for further research .......................................................... 81

15. Conclusions and recommendations ..................................................... 82

Appendices .................................................................................................... 94

Appendix 1: Analysis of VC returns: UK, USA and S&P500 ....................... 94

Appendix 2: Five year progression of VC investment ................................. 96

2.1 The United States of America ........................................................ 97

2.2 The United Kingdom ...................................................................... 98

2.3 Switzerland .................................................................................. 101

2.4 China ........................................................................................... 103

2.5 Germany ...................................................................................... 104

2.6 Israel ............................................................................................ 105

2.7 Canada ........................................................................................ 106

2.8 France ......................................................................................... 107



2.9 A selection of other countries ...................................................... 108

Appendix 3: VC investment by industry and expectations of future

investment by industry .............................................................................. 110

Appendix 4: Interview questions ............................................................... 112

Appendix 5: Methodology for division of firms between stages ................ 115



List of Tables

Table 1: List of questions developed and explained in this paper ............... 16

Table 2: Investment criteria with brief explanation and evidence for use .... 30

Table 3: Results from VC interviews on the relative importance of criteria . 33

Table 4: Average of VCs ratings of the importance of the elements of VC

specific criterion ........................................................................... 37

Table 5: Elements/characteristics within the Management Team criterion . 39

Table 6: Summary of the order of relative importance of criteria, as found by

Franke et al (2008) ........................................................................ 41

Table 7: Results from VC interviews on relative importance of elements of

Team criterion ............................................................................... 45

Table 8: Elements of the Product criterion, together with justification for their

use ................................................................................................ 53

Table 9: Results from VC interviews on the relative importance of the

elements of the Product criterion................................................... 54

Table 10: Elements of VC specific criterion, together with justification for their

use ................................................................................................ 57

Table 11: Results from VC interviews on the relative importance of elements

of the VC specific criterion ............................................................ 58

Table 12: Order of criteria for Later (20% seed and

early investments as proportion of portfolio) ................................. 61

Table 13: Comparison of relative importance of criteria by later stage

investors and VCs from firms who manage funds in excess of 100

million ............................................................................................ 68

Table 14: Comparative rankings of investment criteria by Privately backed

VCs, Government backed VCs and VCTs .................................... 72

Table 15: Comparison of ranking of investment criteria by VCs operating in

different cultures. (UK average is an average of 14 responses) ... 75



List of figures

Figure 1: The Constellation of Venture Capital Investment Criteria ............... 10

Figure 2: Private Equity as a percentage of GDP .......................................... 19

Figure 3: Summary of order of importance of investment criteria ................... 32

Figure 4: Relative importance of criteria ........................................................ 34

Figure 5: Relative importance of elements of the Team criterion ................... 46

Figure 6: Preferences on market timing entry ................................................ 51

Figure 7: Illustration of importance of elements of the Product criterion ........ 54

Figure 8: Relative importance of elements of the Product criterion ................ 55

Figure 9: Ranking of elements of Product criterion according to experience . 56

Figure 10: Relative importance of elements of VC specific factors ................ 58

Figure 11: Relative importance of VC specific criterion elements .................. 59

Figure 12: Comparison of relative importance of criteria early and later stage

investors ........................................................................................................ 61

Figure 13: Traffic light of VCs indications on investment criteria in the later

phase of a fund .............................................................................................. 62

Figure 14: Comparison of rankings of criteria by VCs with less than 10 years

experience vs VCs with more than 10 years experience ............................... 65

Figure 15: The combined values VCs from the two groups (more and less

experienced) place on the characteristics of a team/entrepreneur ................ 65

Figure 16: Comparison of investment criteria by VCs in firms managing funds

smaller than 100m vs firms managing funds larger than 100m .................. 67

Figure 17: Ranking of criteria by the two groups of VCs: one group who

manage funds less than 100 million, and the other who manage funds larger

than 100 million ............................................................................................ 68

Figure 18: Comparison of average value of rankings by VCs with different

investors: private, government and VCTs ...................................................... 71

Figure 19: Returns of VC in UK and US, against that of the S&P 500 ........... 94



Figure 20: Returns of top quartile VC funds in UK and US ............................ 95

Figure 21: Returns of UK VC: Top quartile vs all funds .................................. 95

Figure 22: Number of all VC and PE investments .......................................... 97

Figure 23: Value of all VC and PE investments in the US .............................. 97

Figure 25: Value of VC and PE investments in the UK .................................. 98

Figure 26: VC investment in the UK by value and number ............................ 98

Figure 27: Switzerland VC investment statistics for the last 12 months ....... 101

Figure 29: Value of VC and PE investments in Switzerland ......................... 102

Figure 28: Number of VC and PE investments in Switzerland ..................... 102

Figure 30: VC investments by number and value ........................................ 102

Figure 33: Number of PE and VC investments in China .............................. 103

Figure 32: VC investment in China .............................................................. 103

Figure 31: Value of PE and VC investments in China ................................. 103

Figure 35: Value of VC and PE investments in Germany ............................ 104

Figure 34: Number of VC and PE investments in Germany ......................... 104

Figure 36: Number and value of VC investments......................................... 104

Figure 37: Value of VC and PE investments in Israel .................................. 105

Figure 38: Number of VC and PE investments in Israel ............................... 105

Figure 39: Number and value of VC investments in Israel ........................... 105

Figure 41: Value of VC and PE investments in Canada .............................. 106

Figure 42: Number and value of VC investments in Canada ....................... 106

Figure 40: Number of VC and PE investments in Canada ........................... 106

Figure 44: Value of VC and PE investments in France ................................ 107

Figure 43: Number of VC and PE investments in France ........................... 107

Figure 45: Number and value of VC investments in France ......................... 107

Figure 46: VC Investment statistics worldwide by industry .......................... 110

Figure 47: Anticipated level of investment change in sectors ..................... 111



Abbreviations

BVCA British Venture Capital Association

EVCA European Venture Capital Association

NVCA National Venture Capital Association (US)

PE Private Equity

VC Venture Capital

VCs Venture Capitalists

VCTs Venture Capital Trusts



Executive summary

Decision making criteria employed by VCs has been a source of fascination to

many; entrepreneurs seeking funding, VCs seeking comparability and

academics seeking wisdom. This paper considers investment criteria used by

Venture Capitalists (VCs). It reviews the available literature and, through an

entirely new data set collected for the purpose of this paper, sets out and

analyses the relative importance VCs attribute to the following criteria:

Management Team

Market Drivers

Product

Scalable Business Model

Commercial Proof of Concept

VC specific factors such as pre-existing portfolio and fund phase

Sixteen VCs ranked the above criteria in relative order of importance. Figure 1

below illustrates the findings of this paper that for the sixteen VCs interviewed,

Management Team is the most important criterion, shortly followed by Market,

then Product, Scalable Business Model, Commercial Proof of Concept, and

lastly VC specific factors.

The importance of Product, Commercial Proof of Concept and Scalability of

Business should not be underestimated, even though these rank lower

relative to Team and Market. Some VCs will not invest unless all of these

criteria are met.



Figure 1: The Constellation of Venture Capital Investment Criteria - summary of relative importance of criteria and elements within criteria

Within some of these six listed criteria, VCs consider certain elements more

important than others. This paper breaks down the elements and analyses

their relative importance. Within the Team criterion, Personal Motivation and

Industry Experience are the most important elements. General likeability

achieve a mid-ranking as a result of VCs polarised views on this criterion,

with some seeing it as crucial and others irrelevant. Field and Level of

Education is considered least important of the Team characteristics analysed.

Previous studies have found Field and Level of Education to be very

important, but this paper suggests that VCs do not consider it as important as

any of the other Team characteristics. The findings that Personal Motivation

ranks highest and Field and Level of Education lowest make new

contributions to the literature. The importance VCs attribute to General

Product Team Market Investment

decision making

Scalable

business model

VC factors Commercial

Proof of Concept


decision making

Scalable

business model


Proof of Concept

Product Team

First mover

Second mover

No preference

VC Factors

Investment

decision making

Scalable

business model

Commercial Proof of Concept Market



Likeability has never been tested and this paper contributes to the literature in

that respect.

Data analysed for this paper suggests that, within the Market criterion, VCs

generally prefer first movers over second movers when considering a

potential investment. Within Product, VCs consider Need or Want by far the

most important element, more important than Non-appropriability, Flexibility or

Persistence. In considering new investments, VCs consider the timeframe

within which the company will deliver a return on investment to be more

important than the phase of their fund or pre-existing portfolio.

The author considers whether the order of importance of the six criteria above

changes depending on the:

Stage of the company invested in. The group of VCs in which early

stage investments make up more than 20% of all investments, consider

Commercial Proof of Concept 5th in order of importance, whereas later

stage investors consider Commercial Proof of Concept the 3rd most

important criterion. The two groups consider the remaining criteria

similar in order of relative importance.

Experience of the VC . Although the order of criteria is not different for

VCs with more or less experience, the more experienced VCs appear

to place a higher premium on Team, Market and VC specific factors

relative to their less experienced colleagues. More experienced VCs

rank the characteristics of a good team (i.e. elements within the Team

criterion), in the same order as less experienced VCs, disproving

previous findings that less experienced VCs attached different

importance to criteria.

Phase of the VCs fund . The majority of VCs say that the order of

importance of criteria would change in the later phase of their fund with

VC specific factors increasing in relative importance.

Size of the VCs fund. VCs in firms managing larger funds considered

Market to be slightly more important than Team; VCs in firms managing



smaller funds considered Team much more important than Market.

Scalable Business Model is considered more important by VCs in

smaller firms, taking 3rd place whereas for VCs in larger firms, this

criterion falls to 5th place. VCs in larger firms appear to consider VC

specific factors almost twice as important as their counterparts in the

smaller firms do.

Country/culture within whi ch the VC operates. The limited sample

indicates that there is no marked difference between the relative

rankings of VCs in the UK, Canada and Europe. However, the author

considers that the small sample size does not provide sufficient

information on criteria employed by VCs in countries outside of the UK

and further research is recommended.

The paper also reflects on the following:

Whether VCs use a different process to assess the business proposals

received through referrals from within their existing networks than they

do if a proposal is received cold. It is found that in the large majority of

cases VCs do not use different processes, although VCs feel the

quality of referred business plans are universally better.

Whether UK VCs tend to use anti-dilution measures. It is found that UK

VCs tend to use anti-dilution measures more infrequently than their

American counterparts are reported to do.

Entrepreneurs should tailor their approaches to VCs taking account of their

own company stage, but also of the size of the VC firm they are approaching

and the phase of that VCs fund/s. Entrepreneurs should be aware that VCs

backed by different types of investors may consider criteria in different order

of importance. The country within which the VC operates may also have an

effect on their investment approach.

Entrepreneurs should try to be referred to VCs by someone within VCs



networks. VCs are of the view that referred business plans are on the whole

better than proposals received cold. In negotiating investment agreements,

entrepreneurs should not assume that all VCs used anti-dilution measures.

This paper is important for entrepreneurs seeking funding, VCs and the

academic investigation of VC decision making because it provides a new data

set, a considered refinement of existing criteria used in other studies and an in

depth statistical analysis of the importance VCs attach to those criteria. The

research undertaken for this paper is important and highly relevant, being the

only study (the author is aware of) that focuses on UK VCs.



1. Introduction

Decision making criteria employed by VCs has been a source of fascination to

many; entrepreneurs seeking funding, VCs seeking comparability and

academics seeking wisdom. VCs are considered experts in identifying

promising companies, as is evidenced by the higher survival rate of VC

backed ventures, compared to non-VC backed ventures (Kunkel,1990).

Although the success of VC-backed companies may simply be evidence of

the assistance and benefits a company receives by virtue of its relationship

with the VC, it may also be that VCs superior selection skills enables them to

spot the winners early on.

Many studies have considered VC decision making (Wells, 1974) (Tyebjee

and Bruno, 1984) (MacMillan et al, 1985) (Hisrich, 1990) (Hall and Hofer,

1993) (Muzyka et al,1996) (Shepherd, 1999 (a)) (Zacharakis and Meyer,

2000) (Silva, 2004) (Franke et al, 2008) (Hudson, 2005) (Gimmon and Levie,

2009) (Huyghe, 2011) (Petty and Gruber, 2011), but to the authors best

knowledge, no studies have to date been undertaken specifically on UK VCs

investment criteria. This paper aims to change that, with a focus largely on UK

VCs and their decision making. As a comparative control measure and sense-

test, a Canadian VC and a Pan-European VC were included within the

sample.

VCs decision making processes can be divided into five stages; origination,

screening, evaluation, deal structuring and post investment activities (Tyebjee

and Bruno, 1984)1

1 Other literature sometimes add due diligence and cashing out as stages in the Venture Capitalists

management process- as referred to by (Hudson, 2005)

. Proposals are received by VCs in the origination stage,

with numbers thinning out at every subsequent stage. Hudson (2005)

determined investment ratios to vary between 1.46% and 3.4% of proposals

seen. Most of the VCs interviewed for this paper estimate their investment



ratios to be even lower, at between 0.1% and 2%.

Academic sources suggest that VCs use different criteria in making their

decisions at different stages of the decision-making process, i.e. screening

and evaluation stages (Hall and Hofer, 1993). The author found that the

processes for screening and evaluation differ amongst individuals in practice2

.

Screening and evaluation stages of the VCs decision making process are

dynamic in nature, not static, and the process is being continually updated by

the firm over time (Petty, 2009). Activities in the VC decision-making process

arise simultaneously rather than consecutively (Huyghe, 2011) and for this

reason no distinction is made between decision making in the screening and

evaluation phases.

The large numbers of business plans reviewed by VCs necessitate the use of

shortcuts, engaging in selective perception according to the VCs interests,

backgrounds, experiences and attitudes. Intuition is relied upon heavily by

VCs: a non-conscious process created from distilled experience (Gilovich et

al, 2002). Gladwell (2005) describes this process as rapid cognition.

Explaining and justifying the considerations that inform such an intuitive

decision is difficult to pin-point.

The author will set out in this paper the results from interviews with sixteen

VCs and the aggregated ranking of criteria will be calculated and analysed.

The author will consider whether and to what extent VC fund phase, fund size,

VC investors, their experience, culture within they operate or stage of the

company they invest in, may have an effect on the relative importance of

2 Often the more junior VCs would screen business plans, but the threshold would vary across firms,

with some firms setting deliberately low thresholds and some setting stricter criteria. In other firms, the

experienced VCs would carry out the screening process themselves. Sometimes the individuals carrying

out the screening process would not consciously use different methods for screening as they would in

evaluation; screening would just be filtering the sensible plans. In the words of one of the VCs

interviewed: We weed out the nutters.



criteria and these possibilities are considered in this paper.

A list of the questions as they arise in the text below, are summarized here for

ease of reference:

Table 1: List of questions developed and explained in this paper

VC decision making is complicated by a variety of biases, including

overconfidence, gamblers fallacy3, risk aversion4, competitive irrationality5

3 When a VC feels that the reversal of bad luck in the form of a run of bad investments, is due soon

,

4 When a VC is risk averse when protecting gains in a current portfolio, or risk averse when responding

to losses, i.e. may make more conservative decisions in the later phase of the fund when some of the

earlier investments have already failed

No. Questions Chapter

1 In what order of relative importance do VCs rank investment criteria? 4

2 In what order of relative importance do VCs rank team characteristics? 5.1

3 Do VCs consider first movers more favourably than second movers when considering a potential investment?

5.2

4 Within the Product criterion, do VCs consider non-appropriability, whether the product satisfies a need or a want, or whether the product is flexible or persistent more important relative to the other elements within the Product criterion?

5.3

5 What is the relative importance to VCs of portfolio balancing, fund phase and timeframe within which the company will deliver a return on investment, within the VC specific criterion?

5.4

6 In making early stage investments, do VCs place more importance on Market and Product relative to other investment criteria? Do they place more importance on Team relative to other criteria in making later stage investments?

6

7 Do VC specific factors become more important relative to other investment criteria in the latter phase of a VCs fund?

7

8 Do experienced and less inexperienced VCs rank investment criteria in different orders of preference?

8

9 Do VCs managing larger funds consider criteria in different order of importance to VCs managing smaller funds?

9

10 Do VCs who are backed by different types of investors, i.e. Government backed VCs, privately backed VCs or VCTs rank investment criteria in different orders of importance?

10

11 All else equal, do VCs from different cultures/countries rank investment criteria in different orders of preference?

11

12 Do VCs use different processes to consider business proposals received through referrals from within their existing networks than they do when considering proposals received cold?

12.1

13 Do UK VCs tend to use anti-dilution measures in their investment contracts? 12.2



groupthink6, escalation of commitment7 and retrievability8

. Situational factors

could also influence the way the VC perceives a business plan, for instance

time pressures the VC is under when he/she considers a business plan or the

setting of a meeting. Characteristics of the target company could also affect

the decision making by the VC: novelty of the business plan or its

presentation, motion, sounds, size, background, proximity and similarity of the

team or the business plan (Robbins et al, 2010).

In asking VCs how much importance they attach to different criteria when

assessing new ventures, the retrievability bias may creep in and distort

results. VCs may also post-rationalise previous decisions; their reflections

may not be an accurate description of their actions at the time of evaluating

the investment. The Research Methodology in section 3 explains why the

interview methodology adopted by the author was considered appropriate to

elicit the relative importance of criteria despite the above limitations.

The author proceeds by providing background to the VC industry, setting out

the research methodology, analysing the rankings of criteria and elements

and suggesting further research. Limitations of the research methods and

findings are considered. The paper concludes with recommendations.

5 When a VC has a desire for higher returns on his investments than other VCs, and this desire makes

his decisions irrational

6 When decisions are made by a group of VCs who have lost the ability to think independently, sharing

an illusion of unanimity

7 Particularly in cases where a VC considers that keeping a certain investment or making further follow

on investments in the company is a good thing purely because of the commitment already made;

thereby unable to ignore sunk costs

8 Where a VC bases judgement on information most readily available; an example of this would be

where a VC wishes to make investment into a specific type of industry, and only recalls the last

successful exit, but does not remember the myriad of failures within the same industry



2. Background

2.1 Main VC markets

The first venture capital (VC) funds were created in the US back in 19469

, but

it was only in the 1970s, after the forming of firms like Kleiner, Perkins,

Caufield & Byers and Sequoia Capital that the VC industry in the US really

started developing. Today the US continues to be home to the largest venture

capital industry in the world, investing $22 billion in 2010 (National Venture

Capital Association, 2011).

In the UK, the VC market began to take off in the 1980s10

, but it was not until

the late 1990s that it started to take hold in the rest of Europe. Venture capital

in Asia is still relatively new, despite the fact that the first Asian VC firm was

set up in Japan in 1970.

Within Europe, the UK has one of the most active VC markets. However, total

UK VC investment only represents 0.05% of UK GDP, just over a third of the

0.14% in the US (Lerner, 2011)11. Other European countries are well behind

the UK in PE investment12

9 With the formation of American Research and Development Corporation (ARDC) and J.H. Whitney &

Company in 1946 (Wilson April 1985)

as a proportion of GDP, with Sweden our closest

competitor.

10 This is despite the fact that 3i was also founded in 1946, the same time of the creation of the first VC

funds in the US.

11 In 2010 US GDP was $14,658 trillion and the UK GDP was $2,247 trillion (nominal, IMF data)

12 Note that Figure 2 represents Private Equity as a proportion of GDP, not just Venture Capital, which

is why the PE investments as a % of GDP is higher than stated in the text



Figure 2: Private Equity as a percentage of GDP for European countries in 2010 Source: EVCA website

Analyses of VC investments on a country level for the US, UK, Switzerland,

China, Germany, Israel, Canada and France are contained in Appendix 2.



2.2 Main industries

VC operates mostly in four industries:

IT

Telecoms and

Life Science13

Cleantech/Energy

and 14

For a breakdown of the investment statistics by industry and the VC industrys

expectation of future VC investment by industry, see Appendix 3.

13 Within Europe, private equity firms invested 5.7bn in 810 life science c ompanies during the course

of 2010, up from 3.4bn in 795 companies in 2009. Life science was the most inv ested sector in Europe

in terms of companies financed in 2010, and the second largest market in value terms. Of the

investment in life science, more than 80% of companies financed in this sector in the last four years

were venture-backed, equating to 24% of the total amount invested in life science (ECVA, 2011).

14 Fraser-Sampson (2010) refers to IT, Telecoms and Life Science. In the authors view

Cleantech/Energy deserves to be a category in its own right with a total deal value of 12,533.63 million

for the last 12 months as at 21 August 2011 (Data obtained from Thomson One Banker).



2.3 Recent changes

The financial crisis has affected every stage of VC operations by affecting

returns15 (see Appendix 1) and exits. Across the world, the time taken to

successfully exit a VC investment through flotation now averages almost 7

and a half years, the longest time seen over the past two decades (Yannis

Pierrakis, NESTA 2010). Over 80% of global VCs believe that current IPO

activity levels in their home countries are too low (Deloitte, 2011), indicating

that the VC market worldwide is having trouble exiting investments through

traditional means16. As a result of low returns and problems with exits, raising

new funds has become more difficult17

.

VCs are also changing in terms of where investments are made and who they

invest with. In what appears to be an effort to diversify their investment

portfolio or capitalize on more favourable markets, investors are increasingly

more inclined to invest outside of their home countries. More than half of

investors (57%) plan to increase their investment activity outside their home

countries during the next five years and an additional 35% plan to maintain

their level of investment (Deloitte, 2011). Syndication18

15 The impact of the financial crisis does not appear to be as severe as that of the dotcom crisis. During

the dotcom crisis in 2002, VC firms suffered a significant decrease (approximately 1.8x in terms of

multiples and 89% in terms of IRR). VC has shown no evidence of similar decrease in the current crisis

(Yannis Pierrakis, NESTA 2010).

is now commonplace

16 Private secondary markets are increasing in popularity; most prominently, Facebook private shares

were sold when the IPO was delayed (Financial Times, 2011)

17 In the years leading up to the financial crisis, between 70-85 new funds were raised each quarter in

the US. Since then, the number has fallen to around 35-50 (National Venture Capital Association, 2011).

In a study carried out by Deloitte (2009), 88% of 725 respondent VCs from the Americas, Asia Pacific,

Europe and Israel felt that commercial bank investors willingness to invest in VC from 2009 to 2012

would decrease. 87% were equally pessimistic about investment banks. About 60% were not optimistic

about corporate operating funds, insurance companies, corporate venture capital, and endowments

increasing their investments.

18 Syndicates are formed by a lead investor who finds other investors who are willing to co-invest in a

particular company. Syndication can prove useful for risk diversification of the VCs portfolio, information



within Europe, and corporate venture capital is increasing19

. The proliferation

of government backed VC funds, particularly in the UK, is further changing the

industry.

sharing amongst VCs, improved screening by providing a 2nd opinion, deal flow by reciprocation, etc.

(Soderblom, 2006)

19 In 2009 the most active CVC worldwide was Novartis Venture Funds. Other active CVCs include J&J

(Business Insights, 2010). Many CVCs are set up as evergreen funds that aim to operate independently

of their parent organizations on a commercial basis.



3. Research Methodology

3.1 Literature review and desktop research

A literature review was undertaken to draw up a list of investment criteria

accepted as criteria used by VCs in investment decision making. Research on

different methods of data collection informed the authors decision to employ

the interview method. A wide range of Venture Capital firms were investigated

in terms of size, industry specialization, company stage preferences, and

limited partners in order to devise an appropriate representative sample to

approach. Data on levels of investment by firms per country (as reported in

Appendix 2) and analysis of VC returns (as reported in Appendix 1) was

gathered from Thomson One Banker.

3.2 Interview sample selection

The author approached 20

venture capital investment managers in the UK,

continental Europe and Canada to obtain a sample of VCs representative of

the UK industry (in as much as the sample size allows). For Question 7 the

results from the interviews were divided by country/culture the VC operates in,

e.g. UK, Canada and Europe.

Care was taken to ensure that the VCs interviewed represented a cross-

section of types of limited partners. The majority of VCs interviewed are from

firms backed by Private Limited Partners; two VCs are with Government

backed funds; two VCs are from Venture Capital Trusts and one VC is from a

corporate venture fund. For Question 6 the results from interviews were

divided by investor type: Government backed, Private backed and VCTs.

VCs from all the major industries commonly targeted by the VC industry (IT,

20 Four interviews were arranged through referrals and one through the authors personal contacts. The

other 11 VCs were unknown to the author



Life Science, Cleantech and Telecoms) were included in the sample of

interviewed VCs. Due to some overlaps in industries, interview results could

not be isolated by industry.

Different stage investors from early to late stage were included within the

sample, and were isolated into two groups for Question 2 21

. This was

problematic as most of the VCs invest across a range of stages from early to

late, with the later stage investments tending towards larger amounts and

therefore slightly skewing the data. Some VCs did however tend to make

more early stage investments than others. The author calculated the number

of seed and early stage investors as a proportion of total number of

investments, and divided the group of 16 VCs into two, one group within

which the firm made seed or early stage investments in more than 20% of all

their investments, and the other group where seed or early stage investments

made up less than 20% of all their investments. Although a 20% proportion

does not sound very large, 20% seems to be a significantly high proportion in

the firms surveyed.

VCs with different lengths of experience were included in the sample, from

one VC with 5 months experience, to a VC with over 25 years experience.

For Question 4, the group was divided into 2 groups with 8 members each;

the first group contains VCs with less than 10 years experience22

, and the 2nd

VCs with more than 10 years experience.

The author was careful to ensure that a cross-section of VCs managing

different size funds, were included within the sample. For Question 5, the VCs

21 Thomson One Banker provides details of the different stage investments made by VC firms. The

definitions used by Thomson One Banker to capture the stage of each investment, are included at

Appendix 5

22 From the range of experiences, the natural half-way mark appeared to be 10 years, with the less

experienced VCs mostly ranging around the 5 year experience mark, and the more experienced VCs

well in excess of 20 years



were divided into two groups: Eight VCs who are associated with firms who

manage less than 10 million, and the other eight who are associated with

firms who manage more than 10 million.

3.3 Interview methodology

The author carried out sixteen semi-structured interviews over the course of

the summer (2011); six were in person, nine by telephone, and one over

email. The interviews in person lasted on average 45 minutes (up to 2 hours

in one case, but no shorter than 30 minutes) and telephone interviews on

average 35 minutes. The questions posed to VCs are included in Appendix 4,

but scope was allowed for general discussion around the criteria and

weightings. Detailed contemporaneous notes were made of the discussions23

.

Early studies into venture capital decision making relied primarily on

interviews and surveys that are prone to post hoc recall and rationalization

biases (Zacharakis and Meyer, 1998). Findings that VCs actually employ

different criteria to what they say they employ, (Hall and Hofer, 1993) (D.

Shepherd, 1999 (a))24

have further placed in doubt the usefulness of post hoc

interview techniques.

Subsequently, different methods of analysis such as conjoint analysis (D.

Shepherd, 1999 (a)), repertory grid (Hisrich, 1990) (Zacharakis and Meyer,

2000), and verbal protocol analysis (Mason and Stark, 2004) have been used

to elicit VCs views on the importance of investment criteria. Although

valuable, the limitations of the small sample size (in the Mason and Stark

study), artificiality and the oversimplication of the context of the cases

presented to VCs in some of these studies cannot be ignored. Furthermore, in

23 These notes can be made available on an anonymised basis

24 Shepherd also found that VCs have a tendency to overstate the least important criteria and

understate the most important criteria when self-reporting post hoc



the authors view the Shepherd study is limited in its scope in that it only

includes two personal characteristics of the entrepreneur, namely industry

related competence and educational capability, which were both found to be

more important to VCs than the remaining criteria. The author finds the

remaining criteria tested by Shepherd (1999) useful in the sense that they

prove that VCs prefer certainty, long lead times, and low competition.

However, using conjoint analysis to assess a new venture defined by a list of

one-dimensional criteria fails to take account of VCs intuitive assessment of

nuances and intangible factors around a particular venture and its team.

Shepherds study also does not consider the degree of relative importance

VCs attach to Market, Product, Scale, Commercial Proof of Concept or Team.

Observation, as a method of determining the importance of criteria used,

paints a picture limited by the circumstances of the particular business plan

and is therefore also inappropriate as the basis for generalizations. Qualitative

analysis of longitudinal data, as applied by Petty and Gruber (2011), is

valuable to determine the reasons VCs reject proposals, but such data is

limited to the reasons for rejection recorded by the VC, which may or may not

be an accurate reflection of his/her thought patterns. In addition to all the

other limitations, the logistical difficulties of all of these methods were

considered to be prohibitive.

In contrast, the interviewees responses are based on real cases from their

experience and/or learnings. The author attempted to eliminate post hoc recall

and rationalization biases by structuring the questions such to require

respondents to both rank and rate separately25

25 Note that the paper only reports the ratings where the importance of a criterion/element may have

been in question, such as in section 4.6

the given criteria, akin to that

of a repertory grid. The interview set-up was also used as a method of

discussing the questions and responses rather than leaving it to the VC to

respond to a written questionnaire. The author has found this open ended and



questioning method of interviewing useful to get behind the heuristics

employed by the VCs in their decision making. To further overcome the

limitations of the post hoc interview method, VCs were asked specific

questions such as would the order of criteria be different if an investment is

considered in the later phase of a fund. Although the espoused criteria is a

product of the interviewed VCs experience and learning, it is likely that the

views presented during interviews are accurate indicators of how those same

VCs consider business plans at present or in future. Furthermore, the author

feels that VCs should be given some credit for self-awareness and ability to

recognize biases in their responses. In the circumstances, despite its

limitations, the author feels the interview method is appropriate for eliciting the

relative importance of VCs decision-making criteria.

The author experienced that interviewees were not always receptive to highly

structured measurement instruments and were not always prepared to rank

and rate criteria. Interviewees generally viewed every deal to be peculiar to

itself, and resisted generalizations (Tyebjee and Bruno, 1984). However, the

interview process allowed the interviewees to query the listed criteria, express

views on the criteria and the freedom to explain their thought process.

To avoid reticence by the interviewees to speak freely, the author did not

record interviews and results of the interviews are anonymised in this paper. A

separate document that includes names and fund details of the interviewees

has been submitted to Cass Business School on a confidential basis.

3.4 Ranking and rating of criteria and elements within criteria

All interviewees were asked to rank the criteria/elements in order of

preference relative to the criteria/elements within the group. As a mechanism

for establishing the degree of importance of the criteria, interviewees were

asked also to rate every criterion/element on a scale of 1-10, 10 being most

important. Rankings are reported in the paper, but ratings are only reported



where results were significant or important.

3.5 Coding of responses

Responses for all rankings were recorded, with 1 being most important.

Values were then attributed to each rank in accordance with the Borda count

method26

, i.e. for a list of 6 criteria/elements, where a criterion/element is

ranked 1st, it would acquire a value of 6. Fractional ranking was applied where

criteria/elements were considered equal by respondents, e.g. where the first

two ranked criteria/elements (in a list of 6) were considered equal, the value

attributed to both these criteria/elements would be (5+6)/2=5.5.

Where a VC considered a particular criterion/element to be unimportant, it

was allocated a value of zero (0). It was only within the Product and VC

Specific criteria that some VCs considered some elements to be unimportant.

In all other cases, criteria and elements were considered important and were

allocated a value according to their ranking in order of importance.

Excels Data Analysis Toolpak add-in was utilized to analyse the results from

the interviews, providing the mean, median, mode, variance for the sample,

skewness and kurtosis. The sum of the values attributed to the responses

formed the basis for the reported results, in accordance with the Borda count

method. It should be noted that, due to the small sample size of sixteen

26 The Borda count is a single-winner election method in which voters rank candidates in order of

preference. The Borda count determines the winner of an election by giving each candidate a certain

number of points corresponding to the position in which he or she is ranked by each voter. Once all

votes have been counted the candidate with the most points is the winner. Because it sometimes elects

broadly acceptable candidates, rather than those preferred by the majority, the Borda count is often

described as a consensus-based electoral system, rather than a majoritarian one. The Borda count was

developed independently several times, but is named for the 18th-century French mathematician

and political scientist Jean-Charles de Borda, who devised the system in 1770 (Wikipedia).



respondents, the distribution of the results cannot be assumed to be a normal

distribution.



4. Ranking of criteria

The criteria used within this paper, short explanations of their meanings and

literature source of previous use, are indicated below:

Table 2: Investment criteria with brief explanation and evidence for use

Investment criteria have been studied extensively over the years using

different methods, including interviews, conjoint analysis, verbal protocol

analysis, observation, etc. The relative importance of criteria have also been

extensively studied, with differences noted between VCs espoused criteria

(what they say they do) and what they actually do (Hall and Hofer, 1993).

Most sources indicate Management Team as the criterion VCs place

particular importance on (Muzyka et al, 1996) (Shepherd and Douglas, 1999)

(Silva, 2004) (Tyebjee and Bruno, 1981) with some finding Team to be the

Criteria Evidence for use

Means the entrepreneurial team and their characteristics.

Tyebjee (1984), MacMillan (1985) Hutt (1985) Hisrich (1990) Kahn (1987) Muzyka et al (1996)

Tyebjee (1984) Hutt (1985) Kahn (1987) Hisrich (1990)

Tyebjee (1984), MacMillan (1985)

Means the development of a product to the point of a functioning prototype that has potential to generate profit. This criterion was included as a stand-alone criterion to ascertain its importance relative to the other criteria, and to ascertain whether early or late stage investors would view the importance of this criterion differently.

Fulghieri and Sevilir (2009) Petty (2009)

Market drivers

MacMillan (1985)

Management Team

Unique, disruptive product

VC specific factors

Commercial proof of concept

Scalable business model

(Tyebjee, 1981), (Goslin, 1986) (Hisrich, 1990), (Hutt, 1985)

Means the size of the market/industry, the market need, the access to market and taget market. Associated with the market, are competition considerations including barriers to entry

Means uniqueness of the product, attributes of the product or profit margins.

Could possibly form part of the Market Drivers criterion, but were included separately to ascertain whether certain VCs consider potential scale more important relative to the other criteria.

Means the factors specific to the VC such as the funds portfolio, fund phase or timeframe within which a return is required in order to fit in with the time horizon of the fund



most important reason for new venture success (Hutt, 1985) (Wells, 1974)

(Poindexter, 1976) (MacMillan, 1985). In the words of Arthur Rock, legendary

Silicon Valley VC:

I invest in people, not ideas. If you find good people, if

theyre wrong about the product, theyll make a switch, so

what good is it to understand the product that theyre talking

about in the first place? Arthur Rock

Shepherd (1999 (a)) carried out a survey on Australian VCs who ranked the

following criteria more or less equally: Industry related competence,

Competitive rivalry; Key Success Factor Stability; Lead Time; Timing of Entry;

Scope; Mimicry of entry wedge etc. However, using the conjoint analysis

method to show what VCs actually do (as opposed to what they say they do),

Shepherd showed that the same VCs ranked industry-related competence (a

Team characteristic) far higher than any of the other criteria. In another article

Shepherd (1999 (b)) explains that while market considerations (key success

factors, stability and timing) and competition considerations (lead time and

competitive rivalry) are important when assessing the survival chances of a

new venture, they are difficult to predict at new venture stage due to

uncertainties; VCs manage these uncertainties by choosing a management

team that will be able to cope with changes. If a VC felt confident in the

entrepreneurial team, he/she is more likely to invest, even if he/she was not

as confident in the venture itself (Payne, 2009).

The relationship between the VC and the entrepreneur is an essential

determinant of the success of ventures (Shepherd and Zacharakis, 2001) and

may be more important to the venture than the actual capital provided. It is

therefore important for the VC to choose the right team to invest in, and to

work on the relationship that is, in the words of one of the VCs interviewed for

this paper, likely to last longer than the average marriage.



However, some sources suggest that Management Team is not the most

important criterion. (Hall and Hofer, 1993) found that most VCs stated that the

entrepreneur is the most important factor in making their decisions, but in fact

market factors are most important in the screening phase of their decisions.

Mason and Stark (2004) found that, in a real time situation mimicking the

screening stage of the VC investment process, VCs gave greatest emphasis

to market issues (33%) and financial issues (21%), with entrepreneur (12%)

and strategy (11%) of secondary importance. In light of the conflicting views

on the relative importance of investment criteria, the author set out to elicit

VCs views on the relative importance of the criteria:

Question 1: In what order of relative importance do VCs rank investment

criteria?

VCs were asked to rank the six criteria in order of importance; the Borda

count method was used to allocate values to each ranking. Fig. 3 below

summarizes the findings of the paper on the relative importance of the criteria;

section 5 below considers the relative importance of the different elements

within some criteria.


decision making

Scalable

business model


Proof of Concept


decision making

Scalable

business model


Proof of Concept

Product Team

First mover

Second mover

No preference

VC Factors

Investment

decision making

Scalable

business model

Commercial Proof of Concept Market

Figure 3: Summary o f order of importance of investment criteria



A few of the VCs attributed equal rankings to some criteria because they felt it

was artificial to rank all the criteria, or more commonly that they would not

invest unless all six criteria were met. Most VCs felt that all of these criteria

were very important, and so although the criteria are ranked in order of

importance, it is not correct to assume that the lower ranked criteria are

unimportant. While the ranked criteria give a strong indication of what VCs

consider important, in evaluating a proposal with a view to investing (positive

action), some of the criteria may be more important as reasons for the VC to

not invest (negative action).

The sum of the values in Table 3 shows the highest sum value is attributed to

Management Team:

Table 3: Results from VC interviews on the relative importance of criteria

A histogram of the results paints a clearer picture, showing the relative

importance of the six criteria.

Mean 5.03 Mean 4.59 Mean 3.47 Mean 3.22 Mean 3.03 Mean 1.72Standard Error 0.35 Standard Error 0.29 Standard Error 0.32 Standard Error 0.22 Standard Error 0.32 Standard Error 0.31Median 5.75 Median 5.00 Median 3.25 Median 3.00 Median 3.00 Median 1.00Mode 6.00 Mode 5.00 Mode 2.50 Mode 3.00 Mode 3.00 Mode 1.00Standard Deviation 1.41 Standard Deviation 1.16 Standard Deviation 1.28 Standard Deviation 0.88 Standard Deviation 1.30 Standard Deviation 1.22Sample Variance 1.98 Sample Variance 1.34 Sample Variance 1.65 Sample Variance 0.77 Sample Variance 1.68 Sample Variance 1.50Kurtosis 0.92 Kurtosis 0.00 Kurtosis -0.95 Kurtosis 0.40 Kurtosis 0.87 Kurtosis 2.16Skewness -1.44 Skewness -0.66 Skewness 0.51 Skewness 1.01 Skewness 0.60 Skewness 1.66Range 4.00 Range 4.00 Range 4.00 Range 3.00 Range 5.00 Range 4.00Minimum 2.00 Minimum 2.00 Minimum 2.00 Minimum 2.00 Minimum 1.00 Minimum 1.00Maximum 6.00 Maximum 6.00 Maximum 6.00 Maximum 5.00 Maximum 6.00 Maximum 5.00Sum 80.50 Sum 73.50 Sum 55.50 Sum 51.50 Sum 48.50 Sum 27.50Count 16.00 Count 16.00 Count 16.00 Count 16.00 Count 16.00 Count 16.00Conf. Level(95.0%) 0.75 Conf. Level(95.0%) 0.62 Conf. Level(95.0%) 0.68 Conf. Level(95.0%) 0.47 Conf. Level(95.0%) 0.69 Conf. Level(95.0%) 0.65

Unique, disruptive Product Commercial proof of concept

Market drivers Scalable business modelManagement team VC specific issues such as own portfolio



4.1 Management team

As expected, Management Team comes out on top with the highest sum,

mean and median. The sample variance of 1.98 is explained by two

respondents considering this criterion of less importance, with two rankings of

5th place. Another VC who ranked Management Team third in her list of

criteria, explained that although team is very important for her, if an idea was

particularly strong, she would take a balanced view of the venture as a whole.

A few VCs felt that the function of a VC was to complete/replace a team if

necessary.

This finding does not disprove the findings of (Hall and Hofer, 1993) as they

themselves found that VCs espoused Management Team to be the most

important criterion, although they then subsequently found that VCs acted

differently. However, the authors findings echo the conclusion reached by

Shepherd (1999 (a)) that VCs consider Team characteristics of higher

importance than other criteria.

Figure 4: Relative importance of criteria with Borda count values as indicated



4.2 Market Drivers

Market Drivers is short on the heels of Management Team, with only 7 points

behind. This small gap between 1st and 2nd place is significant, as the next

criterion, Product, is 18 points behind Market.

According to Hall and Hofer (1993), VCs actions show that market factors are

the most important factor in the screening phase of their decisions. Mason

and Stark (2004) found VCs gave greatest emphasis to Market Issues with

Entrepreneur ranking much lower in order of importance. Zacharakis and

Meyer (2000) also found, using conjoint analysis, that the entrepreneur is not

as important as shown in previous studies, and that Market and competition

considerations were more important. The authors finding of a 2nd place

ranking for Market can be distinguished from that of Hall and Hofer (1993) and

Mason & Stark (2004) in that this study is not based solely on the screening

stage, but instead assesses the relative importance of criteria throughout the

entire selection process on a holistic basis. Equally, the authors finding that

Market ranks so high relative to other criteria is testament to the importance of

this criterion throughout the investment process and supports earlier studies

in that respect.

4.3 Unique and disruptive product

Unique and disruptive product is ranked 3rd in the list, quite far behind Market,

and shortly followed by Scalable Business Model and Commercial Proof of

Concept.

An explanation for a mid-ranking on Product well below that of Team could be

that in VC, the technology is rarely market-ready, and knowledge seated in

the Team is needed to modify or tailor the technology and associated

products/services to meet customer requirements. It makes sense for Market



considerations to be more important than Product considerations as the

Product may evolve over time, but a market for a product has to exist or be

anticipated at the time of making an investment in a new venture.

4.4 Scalable Business Model

Scaleable Business Model is ranked 4th, very close to Product. This indicates

a need for the VC to see that there is potential for the venture to increase in

scale. The ranking of this criterion ahead of Commercial Proof of Concept

indicates the VCs need to envision a large scale business even before a

commercial proof of concept is established.

4.5 Commercial P roof of Concept

Commercial Proof of Concept is the 5th most important criterion according to

the VCs interviewed, with only one VC ranking this the most important

criterion. The distances between Commercial Proof of Concept, Scalable

Business Model and Product are however very small.

The importance of this criterion should however not be discounted. One later

stage investor said he would not invest in a venture without a proof of

concept. His view, echoed by other VCs, is that all of the listed criteria are

important and he would not invest unless all criteria were met.

4.6 VC specific factors

VC specific issues are ranked by far the least important. Nevertheless, it is

still not unimportant, with a mean rating higher than 5 for all three elements27

27 On a scale of 1 to 10, 1 signifying least importance and 10 signifying highest importance

.



The average of the fifteen28

VCs who rated the elements of this criterion, are:

Table 4: Average of VCs ratings of the importance of the elements of VC specific criter ion

Confirmation of the importance of VC specific factors supports an earlier

finding by Petty (2009) that VC specific factors 29

, specifically the firms

portfolio, has an effect on the decisions made by VCs in assessing potential

investments. A subsequent report by the same author (Petty and Gruber,

2011) provides evidence for their finding that VC fund-related reasons are the

overall most important decision criteria with respect to rejecting a deal.

Two of the respondents are associated with VCTs. VCTs operate under

legislative constraints imposed by HMRC; as such the screening process

operated by VCTs necessitates discarding of business plans that do not fall

within the VCT criteria30

. Both VCs from VCTs considered VC specific factors

equally as important as the other factors (bar Market and Team, which were in

combined 1st place).

Some VCs said that they do not have hard and fast rules about the balance of

their portfolio or the fund phase and that they would always consider investing

in a business if it was a good business. Other VCs said VC specific factors

were rarely problematic for them due to the size of their funds.

28 One VC did not rate the elements of the VC specific criterion

29 VC specific factors were recognised by (Petty 2009) as including factors such as the fund phase,

the stage of the company and geographic region of the company. Geographic region within which

company is situated, was deliberately excluded as a criterion in the investment criteria proposed to

interviewees. This was done because not all the firms interviewed made investments outside of the UK

and as a result inclusion of this criteria would have skewed results.

30 http://www.hmrc.gov.uk/guidance/vct.htm#3 for guidance on VCT exclusions

Mean 6.7 Mean 6.9 Mean 6.1

PortfolioTimeframe for revenue

generation Fund phase
http://www.hmrc.gov.uk/guidance/vct.htm#3



The finding that VC specific factors rank least in order of importance should

be treated with caution, as a few VCs mentioned that VC specific issues

would be a gating criterion or a constraint or an override indicating that if

this criterion is not met at the screening stage, the business plan would not be

considered any further. At the stage where proposals are being seriously

considered, the VC specific issues are a given and as such not considered

as important relative to the other criteria. It emerges therefore, that VC

specific factors may be an important reason for VCs to reject a proposal.

Consequently, the importance of this criterion should not be underestimated.



5. Ranking of elements of criteria

5.1 Team

Having found that Management Team is the most important criterion for VCs

when considering investments, the relative importance of the following

characteristics of that criterion were considered:

Table 5: Elements/characteristics within the Management Team criterion

Entrepreneurs have to sell their venture to investors, employees and

customers. According to the unimodel of persuasion, which explains how VCs

respond to entrepreneurs presentations, the processing of the content of a

message and cues other than the message, share the same route to the

receiver in his processing of information (Chen, 2009). Separating out the

message from the person and the qualities of the person delivering it, is

therefore very difficult. For the same reason, it may be difficult for VCs to

pinpoint exactly why they choose to back a particular entrepreneur/team, or

whether their choice was influenced more heavily by the entrepreneurs

personality or experience or education.

VCs want to back good people; the question is how to spot them. VCs

perceptions of others are often wrong, (Gladstone, 1988) as revealed by VCs

failure to achieve accurate human capital valuation in 57% of deals (Smart,

Entrepreneur/Team Evidence of relevance

Industry experience Franke et al (2008) Gimmon & Levie (2009)

Experience- previous venture Flynn (1991) Gimmon & Levie (2009)

Field and level of education Shepherd (1999), Franke et al (2008)

Leadership experience MacMillan (1985), Franke et al (2008) Gimmon & Levie (2009)

Entrepreneur investing own money Writers addition- "skin in the game"

Acquaintance among team members Franke et al (2008)

Ages of team members Franke et al (2008) Gimmon & Levie (2009)

Personal motivation Muzyka (1996)

General likeability Writers addition



1999). Is it the case that VCs assess the wrong intangibles or do they attach

inappropriate degrees of importance to the intangibles?

The most consistent finding across studies is the importance VCs place on

the ability of management31, whether it be management skill (Tyebjee, 1981),

quality of management (Goslin, 1986) characteristics of the management

team (Hisrich, 1990), or managements track record (Hutt, 1985). It is clear

that a variety of team criteria are important to VCs; as a starting point to

determine what these are, the author adapted the 7 criteria Franke, et al

(2008)32 found to be most important (in order of preference)33

:

31 Except for (Hall, 1993) and (Keeley, 1989) who strangely found the entrepreneur/entrepreneur team

not be important predictors of VCs decision policies.

32 The author adapted the criteria used by Franke et al by combining University degree with Field of

education to instead refer to Field and level of education. Prior job experience was changed to refer

to Prior Start-up Experience in order to test the importance of this specific criterion. In the authors

view, the Industry Experience criterion already used by Franke et al (2008) encompass ed previous job

experience and as such was superfluous.

33 Franke et al (2008) carried out this study by asking 51 VCs in Germany and Austria to rank 20

teams described in terms of 7 characteristics. The control teams against which the decisions were

measured, was the preferred upper quintile of all the VCs chosen teams.



Table 6: Summary of the order of relative importance of criteria, as found by Franke et al (2008)

Franke et al (2008) found

that it was not necessary

for all members of the

team to fulfil these criteria.

As such, heterogenous

teams may more easily

fulfil all of the criteria VCs

look for. However,

heterogenous teams are

more likely to not get

along in challenging

situations and so the author expects that VCs will consider this

interpersonality aspect when assessing new ventures.

Interestingly Franke et al (2008) found that a mixed team between ages 25

and 45 fares much worse than a team consisting exclusively of founders

between 35 and 45. During the authors first few interviews, VCs were asked

how important they consider age to be. After a few interviews it became

clear that it was difficult for VCs to weight age as an element without

specifying the age spectrum. Most VCs who were asked about age,

responded that age of the entrepreneur was not a factor unless on the outer

edges of the spectrum. The outer edges is highly subjective, (and

potentially age-ist!) and as a result the author decided to exclude age from

the list of characteristics.

1 Experience in relevant industry- all or some team members. This was found to be almost double as important as the field of education

2 Field of education- some engineering, some management

3 University degree- some or all team members

4 Leadership experience- all or some team members

5 Mutual acquaintance- for a long time professionally

6 Age of team members- between 35 and 45

7 Prior job experience- some start-up or some large firm

Order of importance of criteria- summary of findings by Franke et al (2008)*

* Each criterion consisted of the two elements stated in the alternative and were tested separately



Gimmon and Levie (2009) found 7 key capabilities34

that enhance venture

performance. Four of these capabilities were included in the authors list of

criteria, overlapping with the criteria of Franke et al (2008). Entrepreneurial

mind-set was not included due to the all-encompassing non-specific nature

and also because one may assume that an entrepreneur would naturally have

some degree of entrepreneurial mind-set if he/she had chosen that path.

Founders team compatibility was not included as such, but inter-team

acquaintance is considered similar and this criterion has been included.

Learning ability was not included within the authors criteria, again due to the

highly subjective nature of its interpretation and difficulties associated with

recognising this capability in a person.

The criteria chosen by Gimmon and Levie (2009) and Franke et al (2008) do

not encapsulate any element of personality or charisma. In search of the

appropriate expression for such an element, the author considered Passion.

(Baum 2001) found that entrepreneurs traits, including tenacity, proactivity,

and passion for work, exerted positive effects on venture growth. Passion

has been advanced as an essential criterion:

The first crucial sign Ive learned to look for is passion - Jon

P. Goodman, private investor and founder of E2.

There are many moments that are filled with despair and

agony, when you have to fire people and cancel things and

deal with very difficult situations... its so hard (to build a

34 Gimmon and Levie (2009) determined that the following means and capabilities enhanced venture

performance: Education; Entrepreneurial mind-set- this includes a wide range of entrepreneurial

personality, culture and sense factor; Founders team compatibility; General management experience;

Industry experience; Learning ability; Start-up experience (provided learning had taken place). They also

found that academic titles, age, ethnicity, gender and parents were entrepreneurs did not enhance

venture performance.



company) that if you dont have a passion, youll give up-

Steve Jobs, CEO of Apple Inc.

An entrepreneurs passion has been defined as intensive affective state

accompanied by cognitive and behavioural manifestations of high personal

value (Chen, 2009). In Chen et als study (2009) of the correlation between

passion and VCs funding decisions, the visible outward expressions of an

entrepeneurs passion was distinguised from the cognitive aspect they refer to

as preparedness. In the study, Passion was made to manifest through facial

expressions, body movement, tone of voice, and other nonverbal clues,

whereas Preparedness was made to manifest in content and substance of the

presentation. Perceived Preparedness was found to be positively related to

the VC funding decision, but the effects of perceived Passion was not

significant. This either shows that passion as perceived, is not important, or

that the definition of Passion is perhaps more nuanced than that defined.

Passion was not included as a criterion because the author simply did not

believe than outward expressions of passion is very persuasive without an

underlying preparedness. Preparedness was not included because the

author did not believe that preparedness in itself, or even combined with

Passion, would capture the personal characteristic required to persuade

investors.

An element of sincerity and credibility may be more valuable in persuading

VCs. If this is true, it could explain why Preparedness, manifesting in content

and substance, was positively related to the VC funding decision in Chens

(2009) study. It is on this front that entrepreneurs have particular difficulty to

persuade VCs that their new venture is plausible. The very newness of their

idea (desirable distinctiveness) may be considered undesirable to VCs by

virtue of inability of this distinctive idea to fit into institutionalised conventions

(Navis, 2011). Navis (2011) proposes that the nature of an entrepreneurs

distinctiveness is influenced by the market context; in an established market,



the entrepreneur has to fit within the category (legitimised) but has to be

distinctive; in a new market, the entrepreneurial identity has to be definitional

for the category with an emphasis of distinctiveness, but has to align with

institutionalised understandings about the entrepreneurial role, activities and

orientation to legitimise the distinctive idea.

Credibility was not included because the writer felt that credibility in itself was

insufficient35

.

General Likeability was added by the author, as a proxy for the X-factor, the

element of personality VCs have a gut feel for. General likeability is also

deliberately expressed as such to ascribe to it the subjective element of

judgment.

Question 2: In what order of relative importance do VCs rank team

characteristics?

The intention was to test whether VCs consider it important to like who they

invest in, and if they do, how this element fared relative to the other elements.

The aggregated results from the VC interviews, are included in Table 4:

35 Subsequently an interviewee suggested Credible Ambition. See discussion below.



Table 7: Results from VC interviews on relative importance of elements of Team criterio n

A histogram better illustrates the sum of the values calculated according to

the Borda method:

Mean 6.34Mean 6.34Mean 4.91Mean 4.13Standard Error 0.40Standard Error 0.34Standard Error 0.61Standard Error 0.42Median 6.75Median 6.50Median 5.50Median 4.00Mode 7.00Mode 8.00Mode 8.00Mode 4.00Standard Deviation 1.59Standard Deviation 1.38Standard Deviation 2.44Standard Deviation 1.69Sample Variance 2.52Sample Variance 1.89Sample Variance 5.94Sample Variance 2.85Kurtosis 2.78Kurtosis -0.17Kurtosis -1.66Kurtosis 0.45Skewness -1.54Skewness -0.73Skewness -0.11Skewness 0.7

iv vc investment criteria-libre

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