Added Value: What Venture Capitalists do after they invest in your startup

What investors will do to help your startup succeed?

When an entrepreneur decides to get outside money a partnership is created. Venture Capital firms know this very well and do whatever they can you ensure that their investment has good chances to succeed. On the other hand, the startup will accept whatever it can get from the investors. Just by looking at the numbers, one can understand that the chances for any startup are not good and the founders will need help to get where they want.

Monitoring

Monitoring is the most common approach to ensure that the investment is going as it is supposed to. This is the simplest way to check an investment, and it happens more often when the company is in its very first steps. Investors informally monitor through periodical, weekly or bi-weekly, check-ups and more formally through interim financial reports[1] that the startup is contractually obligated to produce.

Monitoring has the advantage of the professionalisation of the startup, which up to some time ago where a group of friends, and that of the accountability that was not the case before. Monitoring has some disadvantages too, such as that it can be a distraction when the startup team needs to be focused. A good VC knows how much time a company needs from them and the type of monitoring it requires. Even in cases where more monitoring could reduce some agency problems, VC’s might not have that much time to allocate[2][3] rendering the “baby-sitting” approach almost impossible.

The lead investors in a funding round take a board seat at the portfolio company. This allows them to monitor the company closely and to have a say in the strategy, especially if something diverges from the original plan. Having a good lead investor that can be the “monitor” and also the voice of the investors in the board is vital for the smaller investors, as they know that there is someone competent that will work hard to ensure that the startup will try its best to achieve its potential.

Having an all-star VC Board of Directors could boost the company’s chances, but entrepreneurs should be aware that there have been some all-star failures in the past.

Value-added

Except for the monitoring aspect, VC’s provide non-financial assistance to portfolio companies[4]. These are very important for the startup and help tremendously, especially in areas that the founders have no experience. The most common value-added benefits for startups are:

• Help with Recruiting.
• Help with Fundraising.
• Help with Finance and Accounting.
• Help with Legal aspects.
• Help with Marketing
• Help with Introductions
• Experience on Boards.

Some VC’s have functions in their firms such as dedicated recruiting, marketing or accounting while others have long-term contracts with top external firms. For a new startup, taping on the expertise of highly qualified professionals is a blessing, as it saves money but most of all precious time.

Another aspect of the “Value add” is that investors can have active roles[5] at a startup. The key functions the VC’s assume are strategic, operational and interpersonal.

• Strategic means that the VC’s help with key decisions about the product, the market, a pivot, or even the vision. This role is usually operated through board meetings, and it weighs more if the investor has the experience or the expertise for the particular strategy.
• The operational role is similar to the strategic but it is a day-to-day job until the right person is recruited. Usually, an investor will help in a specific aspect a startup for a period sharing his expertise and knowledge with the company.
• Finally, the interpersonal role is the social role that an investor assumes with startups. This can be that of the mentor, or the coach or that of the middleman in a dispute in the startup. The “interpersonal” is the most common role that a hands-on investor takes on a startup.

Venture capitalists see the strategic functions as the most important[6] and after that the operational and then the interpersonal. This also depends on the sector, the stage and the expertise and completeness of the entrepreneurial team. Investors add hands-on value only when they see that the startup needs their help, and if they believe that the company is growing as it was supposed to, they stick to the monitoring aspect.

Getting help from investors has high demand from the entrepreneurs. Indeed, Seppa[7] and Hsu[8] showed that entrepreneurs are willing to accept lower valuations when they expect the venture capitalist will contribute to the startup. Finding the right VC should be one of the top priorities for an entrepreneur, although it is not the only one.

A positive side effect of being a portfolio company of a VC firm is that of the “reputation”. Being backed by the same investors that had huge successes in the past is a big deal.

The reputation of the VC is one of the most valuable assets for the startup. Some of the most common benefits are:

• Attract (more) customers,
• Recruit highly talented employees,
• Bring more investors in the next rounds
• Certify the business to third parties and suppliers
• Raise media awareness

One thing that entrepreneurs should know is that VC reputation in not panacea. Some famous venture capitalists may devote less effort to their investments compared to their less well-known rivals assuming their reputation will be enough[9] and entrepreneurs are advised do a thorough due diligence before committing to an investor.

Note: This article has been appeared first in www.whydotheyfail.com and is based on the research for the project and dissertation named “Venture Capital failures. Why VC backed start-ups fail and how can we improve the failure rate” that was submitted to Warwick Business School on 05/03/2018 by Kostakis Bouzoukas.

[1] Gompers, P.A., 1995. Optimal investment, monitoring, and the staging of venture capital. The journal of finance, 50(5), pp.1461–1489.

[2] Barney, J.B., 1989. Asset stocks and sustained competitive advantage: A comment. Management science, 35(12), pp.1511–1513.

[3] Gorman, M. and Sahlman, W.A., 1989. What do venture capitalists do?. Journal of business venturing, 4(4), pp.231–248.

[4] Amit, R., Brander, J. and Zott, C., 1998. Why do venture capital firms exist? Theory and Canadian evidence. Journal of business Venturing, 13(6), pp.441–466.

[5] Sapienza, H.J. and Timmons, J.A., 1989, August. The roles of venture capitalists in new ventures: What determines their importance?. In Academy of Management Proceedings (Vol. 1989, №1, pp. 74–78). Academy of Management.

[6] Fried, V.H. and Hisrich, R.D., 1994. Toward a model of venture capital investment decision making. Financial management, pp.28–37.

[7] Seppa, M., 2002. Strategy logic of the venture capitalist: Understanding venture capitalism — -the business within — -by exploring linkages between ownership and strategy of venture capital companies, over time, in America and Europe.

[8] Hsu, D.H., 2004. What do entrepreneurs pay for venture capital affiliation?. The Journal of Finance, 59(4), pp.1805–1844.

[9] De Clercq,D. and D. Dimov (2003), ‘A knowledge-based view of venture capital firms’ portfolio investment specialization and syndication’, paper presented at the Babson College-Kauffman Foundation Entrepreneurship Research Conference, Babson College, Wellesley.

Originally published at www.whydotheyfail.com on April 22, 2018.

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