Note from Noam: This is the second part of the summary of a survey project by Matthew Louie and Cali Tran, who were 2nd-year MBA students at Harvard this past year. Part 1 was the project overview, Part 2 below summarizes the entrepreneur results, and Part 3 will compare the VC and entrepreneur results.
By: Matthew Louie and Cali Tran
Entrepreneur’s Perspective: Investor Value-Creation
The entrepreneur needs to rely on a variety of resources in order to successfully grow a business. One of the potential assets at their disposal is leveraging the value-add potential of their investors. However, survey data suggests that the entrepreneur does not value the investors’ intangible resources as much as the capital itself.
The data on the entrepreneur’s perception of the value-creation potential of investors is segmented into four categories: summary, industry, company size and financing round. By analyzing the data on a more segmented basis, a clearer picture of where the investor is most valued can be identified.
Summary
In general, the entrepreneur has a good relationship with their investor. Of the entrepreneurs interviewed, 82% indicated that they have an open and honest relationship with their investors. Moreover, 78% think that their investor tries to create a good relationship with the entrepreneur. When asked whether the entrepreneur believes that their company has grown in value because of the venture capitalist’s involvement, only 45% of the entrepreneurs interviewed indicated that they believe that was the case.
When asked why the entrepreneur took venture financing, 80% of the entrepreneurs indicated that it was primarily to grow or scale operations. Only 47% of the entrepreneurs took financing for the value-add potential of the venture capitalist.
Table 3: Entrepreneur’s Bias
(shows the primary reason why an entrepreneur takes venture financing
and highlights their bias toward the investor’s value-add potential)
Why did you take venture financing?
Which of the following is true?
Industry
Entrepreneurs in the life science industry have a higher disposition to value their investors than software / services entrepreneurs. For example, 70% of the entrepreneurs interviewed in the life sciences industry indicated that they took venture financing for the value-added potential of the investor vs. 36% of the software / services entrepreneurs. When asked whether the value of their business has grown because of the direct contribution of the investor, 60% of the life science entrepreneurs indicated that it has, whereas only 39% of software / services entrepreneurs agreed.
Table 4: Industry Segmentation
(highlights the difference between the two industries)
Why did you take venture financing?
Which of the following is true?
Company size
When evaluating the value-add potential of an investor, the size of the company affects the significance of the contribution. Understandably, when companies are smaller, the perceived value-add of investors is more significant then with larger, more established companies. Additionally, the reputation of a fund is valued more in smaller companies.
Table 5: Investor Value-Add vs. Company Size
(shows the downward trend of the perceived value-add potential of investors
as a company grows in size)
Financing Round
A majority of the entrepreneurs interviewed believe that their investors think that they add value. But actual investor value-add credit shifts depending on the stage of financing of the company. The gap in expectations is greatest in the 1st round of financing and is the narrowest between the 2nd and 3rd round of financing. After the 3rd round, however, the investors’ value-add potential returns to round 1 levels. Moreover, the entrepreneur’s expectation of investor value-add declines after the 2nd round. Of the entrepreneurs interviewed, 43% indicated that they took venture financing because of the value-add potential of the investor in the 1st round. That number grew to 50% in round 2 entrepreneurs and declined to 36% in round 4 entrepreneurs.
Table 6: Entrepreneur Expectations
(traces the trend between the entrepreneur’s perception and expectation of
the value-add potential of the investor throughout the various funding stages)
Entrepreneur’s perception of investor
Why did you take venture financing?
Matt,Very interesting results based on the demographic you surveyed. From reviewing your average company raised 3 rounds, this indicates that the companies you surveyed are already at the top 10% of companies that can raise subsequent rounds. Therefore, I would think the CEO’s would have experience some value creation, and made a decision whether the VC had any part in it. Obviously, if no value is create this is a non-issue. The overall % is probably much lower than 45%.That being said, many times it is the CEO’s job to extract value from a VC. While some of the best VCs pro-actively add value, a majority need to managed as you manage a Director of Marketing. This reality is something a CEO needs to realize sooner rather than later. In addition, in having VC backing hopefully you derive value without regardless of how active your VC partner is. The simple customer scenario of showing an augmented balance sheet or the ability to market ‘premier’ backing many times gives you a leg up. You can leverage a Venture firm’s good will by having its capital.In summary, the CEO’s relationship to his or her VC is a pro-active one if any value is to be generated.
Adam,Thanks for the feedback. I definitely agree with your comments - the entrepreneur-VC relationship works both ways, and based on my limited experience it usually helps if both parties walk the fine line of being both proactive and receptive. That said, I think you hit the nail on the head when you wrote, “some of the best VCs pro-actively add value”; in my short time in venture I always felt like the early-stage entrepreneur was swimming with endless tasks, and -whether right or wrong - sometimes did not have the time to adequately manage the VC…a topic that our study tried to cover. Of course, I have always sympathized more with the entrepreneur, so my bias is apparent!Thanks again for the feedback, and continued good luck at Menlo Ventures!Regards - Matthew
That being said, many times it is the CEO's job to extract value from a VC. While some of the best VCs pro-actively add value, a majority need to managed as you manage a Director of Marketing. This reality is something a CEO needs to realize sooner rather than later.
I define marketing as giving the customer exactly what he/she wants. VC savants have a sixth sense for this, or I've found, they are not long for this world. Give yourself some credit and take care of Foreign exchange.