Sunday, December 13, 2009

Experienced VC's Add Significant Value

Many experienced venture capitalists claim they add significant values to the ventures they invest in. Many entrepreneurs claim that their experienced venture capitalists are incompetent meddlers who might as well make decisions based on dartboards. (The word 'monkey' or 'vulture' often comes up in such discussions, depending on whether stupidity or evil is invoked as the main causal factor.) What does the scholarly literature claim?

First of all, active VC's tend to do better than passive VC's. According to Who are the Active Investors:

"After controlling for endogeneity, investor activism is shown to be positively related to the success of portfolio companies."
How does VC experience factor in? Let's revisit Skill vs. Luck:
"At the 75th percentile of VC EXPERIENCE and at the means of all the other variables, the predicted success rate is 19.0%, while at the 25th percentile, the predicted success rate is only 13.3%."
Is this solely because experienced VC's snap up the best startups, or are they also adding more value than less-experienced VC's? How Smart is Smart Money? uses a two-sided matching model, similar to Gale and Shapley's College Admissions Model, to compare VC ability to invest in better startups (sorting) with investor influence and concludes:
"If an investor without any experience were to make random investments, the probability of success would be 15.1%. The observed probability of success for an investor with an experience of 225 is 38.9%... The influence of the more experienced investor accounts for 10.0% of this difference... Sorting thus explains 58% and investors’ influence explains 42% of the total increase in the probability of a successful investment for the most experienced investors in the market."
So there appears to be a significant causal benefit of VC experience. Many entrepreneurs do understand the value of a good VC. What do Entrepreneurs Pay for Venture Capital Association:
"Offers made by VCs with a high reputation are three times more likely to be accepted, and high-reputation VCs acquire start-up equity at a 10–14% discount." (Caveat: For Internet-focused investments, the results are less clear, because finding a good reputation marker is more difficult given the relative youth of the industry.)