How do venture capitalists add value?
What do VCs do after investing in a startup? More specifically, what do VCs do to add value to startups? To help answer this question I retrieved an industry survey from 1984 when the professional VC business was just shy of being 30 years old. The survey had 49 responses from VCs who represented around 40% of aggregate funds under management in the US venture capital industry at the time (Gorman & Sahlman, 1989). The following table highlights a few characteristics of the funds and individuals that took part in the survey.
When VCs were asked to rank the services they offered to portfolio companies, they identified the following three as the most important: (1) help obtaining additional finance, (2) strategic planning, and (3) management recruitment. The following table details how all the major services were ranked.
Of course, VCs also provide other valuable services. They help coach management and can sometimes help with operational matters. But out of all the services a VC can offer, many investors agree that help with fundraising, strategy, and recruitment is key. Entrepreneurs also agree. In a more recent survey — which involved 10 presidents and founders as well as more than 20 life sciences companies — entrepreneurs agreed that the most important areas where VCs could add value were financing, strategic focus, and recruitment of senior management (Dotzler, 2001). This is consistent with the research in 1984. A detailed ranking of value-add activities from the 2001 survey is listed below:
It’s important to note that these findings are generalised. An early-stage startup that is yet to find product-market-fit will have completely different needs to a startup with an established business model that needs help with scaling. Furthermore, different VCs appear to adopt different strategies when it comes to helping founders. Some investors are more operationally involved (e.g. platform funds hire functional experts in marketing, sales, legal, design, etc. that work with portfolio companies directly on these issues) while others, like Correlation Ventures, are more hands-off and don’t take board seats. Both strategies have their pros and cons but in both cases a VC adds value by ensuring that at the very least, a startup has access to capital, strategic insight, and the management talent necessary for success.
Sources:
Dotzler, F., 2001. What do venture capitalists really do, and where do they learn to do it?. The Journal of Private Equity, 5(1), pp. 6–12.
Gorman, M. & Sahlman, W. A., 1989. What do venture capitalists do?. Journal of Business Venturing, 4(4), pp. 231–248.
Update 11 Jun 2018:
I came across this new study which has some excellent insights on the topic https://medium.com/@fritjofsson/do-vcs-really-add-value-founders-say-sometimes-f27bb956eb8c
Update 6 Jan 2018:
The jury is still out on the value-add of VCs and whether it impacts returns significantly. A 2007 paper by Large and Muegge highlights the following:
“The empirical evidence to date suggests that operating, outreach, consulting, mentoring and recruiting may be the most influential categories [of value-add], but the evidence is far from definitive. We argue that future studies should examine ‘VC exit success’ as a high-impact dependent variable, and place greater emphasis on the measurement of directly observable events for both value-adding inputs and value-added outcomes.”
I’m hoping to find more data on this so if anyone comes across new research on this topic please get in touch.
