In the last few years, the bull market has made huge amounts of money
available for investment. Venture capital is no exception; venture
capitalists have continued to pump more cash than ever into startups. But
how much money they invest has become a bit controversial. Some industry
watchers fear that so much money is flowing through venture capital firms
that they are becoming too institutionalized, which could erode their unique
role as hands-on incubators of tomorrow's most innovative companies.
Two Stanford University Graduate School of Business faculty members have
recently offered evidence of venture capital's singular part in nourishing
new firms. Their findings serve as an indirect warning that venture
capital's special purpose should be preserved. Thomas Hellmann
[email protected], assistant professor of strategic management,
and Manju Puri [email protected], assistant professor of finance,
believe they are the first to use hard data to investigate the relationship
between the type of investor (venture capital rather than banks or others)
and the speed with which startups get their products to market. They drew
their data from the Stanford Project on Emerging Companies, an ongoing
Stanford Business School study that has compiled figures on hundreds of
young companies in Silicon Valley.
First, Hellmann and Puri looked at the types of firms that receive venture
capital funding. They found that firms pursuing an innovator strategy
(defined as companies aiming to be first in their markets) are more likely
to get venture capital financing and are quicker to do so than those
pursuing an imitator strategy (those with a product that has existing
competition). Second, they wanted to determine if the extra value venture
capitalists reputedly bring to a deal really makes a difference. For this
they looked at operational milestones, because financial landmarks, such as
how early a firm holds a public offering, may be affected by other factors.
In particular, they looked at what is widely perceived to be a critical
turning point in the development of new businesses -- the time it takes a
company to get its product to market. They found that among all innovator
companies, those with venture capital financing were faster to market.
Specifically, statistical analysis showed that venture-backed companies were
three times more likely to get to market in any given time period than those
with other sources of financing. Perhaps their most interesting finding is
that among imitator companies, the presence of a venture capitalist did not
speed up time to market. ``It is for innovators that time to market is
particularly important,'' says Hellmann. ``You are betting on the company
being first.'' An imitator's time to market is still important, but less so
because imitator companies already know they have to gain competitive edge
in ways other than just being first. These findings, say Hellmann and Puri,
are evidence that the venture capitalist plays a critical role in the life
of innovative companies.
The uncommon benefit a venture capitalist brings to a startup is twofold:
the ability to recruit key managers to the company and the monitoring and
discipline that the venture capitalist imposes. ``Keeping the founders on
track by reaching for key milestones, saying 'no' to distractions, and
focusing them on commercial success is tremendously important,'' says
Hellmann. If venture capital were to become just a money business, it would
be a commodity business -- another bank that hands out equity instead of
debt. The venture capitalist's traditional role could erode if the crush of
money shifts his or her focus away from highly involved early-stage
investments to safer, later-stage investments that rely on someone else to
hover over the critical first stage. Hellmann and Puri hope their research
serves as a reminder that the real value of venture capital is in its
nurturing of companies, not simply as a source of funding.
Contact: Stanford Business School, Barbara Buell, 650/723-3157
[email protected]
http://www-gsb.stanford.edu/
p.s. I've had the pleasure of reading this document, Research Paper # 1561,
"The Interaction between Product Market and Financing Strategy: The Role of
Venture Capital", published by Stanford GSB, in May, 1999. It's a
wonderfully practical document, and much of its emphasis is on 'applied
theory'. Also, it provides an excellent reference list.
You can request a copy by writing to
Pat Sandoval [email protected]
[email protected]
(include your name, mailing address, tel/fax numbers, email ID.
Tushar J. Mehta
email: [email protected]
voicemail: (206) 405-2335