UNIVERSITEIT GENT FACULTEIT ECONOMIE EN BEDRIJFSKUNDE ACADEMIEJAAR 2009 – 2010 THE RELATIONSHIP BETWEEN VC EXPERIENCE, MANAGEMENT EXPERIENCE, AND PORTFOLIO COMPANY GROWTH. Masterproef voorgedragen tot het bekomen van de graad van Master in de Toegepaste Economische Wetenschappen Jan Willems Maarten Tollenaere onder leiding van dr. T. Vanacker
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UNIVERSITEIT GENT
FACULTEIT ECONOMIE EN BEDRIJFSKUNDE
ACADEMIEJAAR 2009 – 2010
THE RELATIONSHIP BETWEEN VC EXPERIENCE, MANAGEMENT
EXPERIENCE, AND PORTFOLIO COMPANY GROWTH.
Masterproef voorgedragen tot het bekomen van de graad van
Master in de Toegepaste Economische Wetenschappen
Jan Willems
Maarten Tollenaere
onder leiding van
dr. T. Vanacker
UNIVERSITEIT GENT
FACULTEIT ECONOMIE EN BEDRIJFSKUNDE
ACADEMIEJAAR 2009 – 2010
THE RELATIONSHIP BETWEEN VC EXPERIENCE, MANAGEMENT
EXPERIENCE, AND PORTFOLIO COMPANY GROWTH.
Masterproef voorgedragen tot het bekomen van de graad van
Master in de Toegepaste Economische Wetenschappen
Jan Willems
Maarten Tollenaere
onder leiding van
dr. T. Vanacker
PERMISSION
Ondergetekenden verklaren dat de inhoud van deze masterproef mag geraadpleegd en/of gereproduceerd worden, mits bronvermelding.
ABSTRACT (NEDERLANDS) In deze studie wordt er empirisch onderzoek gedaan op een kleine exploratieve steekproef bestaande
uit 43 portfoliobedrijven die we kunnen linken met hun respectievelijke hoofdinvesteerders uit de
eerste durfkapitaalronde. Op basis van enquêtes werd er gedetailleerde informatie verzameld voor een
selectiemodel dat enkele veelbelovende indicaties oplevert in verband met tweezijdige selectie op
gebied van specifieke ervaringsniveaus. Bovendien, aangezien er voor 41 van de 43 portfoliobedrijven
boekhoudkundige informatie verkregen is, wordt het onderzoek uitgebreid naar een groeimodel om de
mogelijke impact te meten van specifieke ervaringsgebonden selecties. Naast het vinden van
significante positieve groeiassociaties met de ervaringsniveaus van durfkapitalisten (zowel algemeen
als industriespecifiek) en de ondernemerservaring binnen portfoliobedrijven, denken we te kunnen
wijzen op mogelijke synergetische of verstorende effecten tussen bepaalde ervaringstypes in de
periode na de investering. Desalniettemin dient deze studie beschouwd te worden als zijnde van een
sterk exploratief karakter en wij willen er op wijzen dat onze resultaten zeker niet tot een exhaustieve
conclusie kunnen leiden.
ABSTRACT (ENGLISH)
In this study, we empirically investigate a small exploratory sample of 43 portfolio companies (PFCs)
that we can trace back to their initial lead venture capital (VC) investors. Using survey data, we get a
relatively in-depth view of experience types and levels of the PFC‘s management team at the time of
investment relationship formation. We use these detailed experience measures in a matching model
and find promising indications for specific experience-based matching. Furthermore, as we were able
to collect accounting data for 41 out of 43 PFCs, our research is extended towards a growth model that
allows for the empirical analysis of post-investment growth levels across experience-based
subsamples. Apart from significant positive associations with VC (both general and industry-specific)
experience and PFC entrepreneurial experience, we believe to have found potential synergetic as well
as interfering experience types in the post-matching (i.e. post-investment) stages. Nevertheless, we
acknowledge the fact that our results are far from exhaustive or conclusive, and should be seen as of a
rather exploratory nature.
III
Acknowledgements
This paper is the result of combined efforts from various people to whom we wish to offer our
deepest gratitude. First of all, we wish to thank our promoter, dr. Tom Vanacker, for giving us the
opportunity to explore the fascinating entrepreneurial setting. Without his professional guidance, it
simply would have been impossible for us to capture such a rich and complex research domain.
Secondly, we want to express our recognition for our dear colleagues, Jan Dufourmont and Jeroen
Baert, always in the mood for an interesting theoretical or methodological discussion. We were truly
fortunate to have such bright friends working on a similar subject. Thirdly, we strongly appreciate the
review efforts of Kirsten Timmermans, Arne De Smet and Michael Boschmans. Next, since this
dissertation provided us with many long days and nights, we want to thank our girlfriends for keeping
up with us all the time – we imagine that the financial lexicon can sometimes be somewhat less
attractive. Finally, as this master thesis can be seen as the result of several years of studying, we wish
to show our gratitude to our parents for supporting us throughout our academic studies and for
encouraging us to take up extensive extra-curricular activities.
1
1. Introduction
A great deal of previous academic research has led to an identification of both external and
internal factors that influence the growth of firms. Regarding the internal growth factors, it is
obviously impossible to rely on material assets only in order to explain the sustainable competitive
advantage of certain enterprises. In fact, strategic management research teaches us that it is vital for a
firm to possess difficult-to-imitate knowledge assets (Teece, Pisano and Shuen, 1997) and, more
specifically, numerous studies point out human capital as being one of the main contributors to
organizational performance (Brüderl, Preisendörfer, and Ziegler, 1992; Gimeno, Folta, Cooper, and
Woo, 1997; Pennings et al., 1998). Zingales (2000) even chooses to emphasize these statements by
proclaiming that the core of the ‗new firm‘ consists entirely of human capital.
If immaterial assets such as human capital are in fact able to explain or even predict
organizational performance, they are evidently of paramount importance to investors in the approach
of potential investments. A distinctive type of investors profoundly concerned with human capital
evaluation is to be found in the venture capital or private equity market. Indeed, for venture capitalists
(VCs), the assessment of a portfolio company‘s human capital is critical. First of all, during the due
diligence process, clear performance measures simply do not exist or are extremely difficult to detect
(DiMaggio and Powell, 1983; Podolny, 1993). In such circumstances, prior research has implicated
that human capital is one of the focal signals to which VCs direct themselves (Baum and Silverman,
2004). Secondly, the role of VCs is by any means broader than that of traditional financial
intermediaries in the sense that they are often actively involved in their investments (Gormann and
Sahlman, 1989). A particular aspect of this involvement is the professionalization of the portfolio
company (PFC) through the building of the management team (Hellmann and Puri, 2000). With
management turnover rate being positively associated with VC-backing (Hellmann and Puri, 2002), it
is clear that human resources are a serious issue during a VC‘s post-investment activities. More
specifically, as VC control increases, there appears to be a significant influence on the recruitment of
the senior managers (Kaplan and Strömberg, 2002). In fact, VCs even go that far as putting effort into
the search for professional managers in order to add value to the portfolio company (Hellmann, 1998).
To which point the selecting or building influence of VCs on top management teams (TMTs)
within their portfolio companies is valuable, is an interesting discussion. Some scholars believe that
human resources management is one of the key features to explain the success of the venture capital
industry (Gledson de Carvalho, Calomiris, and Amaro de Matos, 2008). However, the successful
selection or build-up of human resources is not straightforward with the venture capital industry as a
framework. Smart (1999) finds that – in a large number of deals – VCs are faced with significant
surprises regarding the outcomes of their assessments. Moreover, the ability for VCs to effectively
build a management team according to their preferences is defined by the financial contract, and the
latter document often prescribes several state-contingencies. Usually, as a portfolio company is
2
underperforming, VCs get more rights, thus upgrading their terms for exercising control in the field of
appointments or dismissals (Kaplan and Strömberg, 2003). However, it is sometimes possible that
state-contingencies exist, without being enforced by financial contracting. Since a substantial part of
the returns of venture capital funds is earned by exceptionally successful ventures (Sahlman, 1990)1, it
can occur that VCs will focus their value-adding services on those companies performing well
(Sapienza, Manigart, and Vermeir, 1996). In this case, we expect to see that high performing ventures
will get strong support to establish a suitable management team, whereas the bad performers will be
left aside.
When exploring the relationship between venture capital and portfolio companies along
human capital dimensions, we should take caution as not to oversee important characteristics of both
parties. For instance, we must never forget that a VC is also a market actor which, for its actions, is
largely dependent on human capital. After all, whatever structure a VC firm chooses to organize itself
in, it is always governed by an investment committee – a board of directors in charge of making
investment decisions. Obviously, the more investments they make, the more skilled VCs become. In
some cases, the mere potential to learn from an investment can be an incentive for investing itself
(Sørensen, 2007). It is clear that, given this perspective, VCs are not a homogenous group of
investors. Nevertheless, a lot of prior research has neglected this possible heterogeneity, merely
inserting a dummy-variable to indicate whether the investment was made by a VC or not. This is of
course problematic if one would take into account differential financing offers. Since prior research
has shown that offers from reputable VCs have far better chances to be accepted by a portfolio
company‘s management team (Hsu, 2004), an interesting question arises regarding the extent and the
consequences of possible deliberate matching behavior.
This study investigates the influences and consequences of differences along human capital
dimensions through the principles of matching. We acknowledge the possibility of two-sided selection
by both VCs and portfolio companies during their deal search. By measuring multiple types of
experience on both sides of the venture capital allocation process, we will search for a deliberate
matching behavior based on experience. Furthermore, we will present some post-matching figures and
characteristics of several subgroups in order to provide an insight into what type of matching could
bring favorable outcomes. To guide our research design, we propose the following two research
questions:
The first research question is: do VC firm experience and PFC management team experience influence
the matching between the two parties?
The second research question is: does this matching materially contribute to growth?
1 An important note to this view is the fact that ―successful ventures‖ are mostly considered as leading to IPOs
in the US framework, while this is less the case in the European context (Schwienbacher, 2008).
3
The remainder of the paper2 is organized as follows. We will first convert our research questions into
testable hypotheses using a theoretical framework. Given these hypotheses, we will introduce several
variables, allowing us to conduct the necessary research. Evidently, all the variable choices or possible
constructs will be clarified. Finally, a detailed disclosure of the empirical results will be followed by a
conclusion and a discussion.
2 From this point on all through the paper, we will reserve the word ―firm‖ to the venture capital investor, and
the word ―company‖ to the investee or portfolio company. Furthermore, whenever we use the term ―management
team‖, we refer to the (top or senior) management team of the portfolio company. In order to keep the text clear,
we sometimes use the following abbreviations: ‗VC‘ for ‗venture capitalist‘, ‗PFC‘ for ‗portfolio company‘ and
‗TMT‘ for ‗top management team‘ (of the portfolio company).
4
2. Theory and Hypotheses
2.1. Matching Model
The evolutionary models of entrepreneurship state that selection is generated through the
allocation of capital from external resource holders among alternative firms (Aldrich, 1999). In the
entrepreneurial setting, resource holders such as VCs are often regarded as providing a powerful
means of selection (Anderson, 1999). While VCs usually receive a lot of requests to take into
consideration, it is also important to acknowledge a two-sided matching in the venture capital market,
implying that multiple financing offers can reach one PFC in the same financing stage. This two-sided
matching concept, although difficult to detect the dominant direction (i.e. who selects who), is said to
lead to a sorting behaviour within the market for venture capital (Sørensen, 2007).
Since the matching between VCs and PFCs leads to a financial agreement, both parties are
faced with a moral hazard problem, bringing forward principal-agent conflicts. In fact, the VC
(principal) delivers valuable resources to be managed by the portfolio company‘s TMT (agent) and, in
such circumstances, a great deal of attention needs to be focused on the assessment and monitoring of
the investment. Therefore, when VCs approach new ventures during the due diligence process, a lot of
attention is given to start-up characteristics (Baum and Silverman, 2004). Previous studies have found
that management team experience, skills and personality are one of the key selection criteria
(MacMillan et al., 1985; Zacharakis and Meyer, 2000). The quality of a portfolio company‘s TMT is
claimed to be of such a great importance because other possible indicators of (future) performance are
difficult to determine in the pre-investment stage (DiMaggio and Powell, 1983; Podolny, 1993).
Moreover, in the post-investment stage, VCs are usually not too keen on high monitoring or
involvement costs (Kaplan and Strömberg, 2002). Although the accurate assessment of human capital
has often been regarded as almost impossible in economical literature, adequate and thorough
procedures are proven to exist. What is more, it has been demonstrated that VCs who use meticulous
TMT screening procedures are rewarded by above average returns on their investments (Smart, 1999).
According to traditional learning theory, it is likely that VCs will learn from successful behaviour and
repeat it in the future. Indeed, VCs learn from past investments (Sørensen, 2008) and it is reasonable
to believe that, as a VC gains experience, more qualitative TMT‘s will be selected. 3
In conventional financial markets, investors usually do not get closely involved with their
investments, at least not in the post-investment stage. To reduce the moral hazard problem, they count
on an initial risk assessment – comparable to a VC‘s due diligence process – and adequate financial
contracting. The venture capital market, however, is characterised by a far closer interaction between
the investor (VC) and investee (PFC) in the post-investment stage (Gorman and Sahlman, 1989;
Bygrave and Timmons, 1992; Sapienza, Amason and Manigart, 1994; Elango et al., 1995). In fact,
3 Although it is reasonable to accept that VCs learn from their investments, empirical evidence is sometimes
found to counter the traditional learning framework, especially in strategic contexts (Haleblian and Finkelstein,
1999; Shepherd, Zacharakis and Baron, 2003).
5
VCs are found to take up elaborate roles of monitoring, advisory and even recruiting senior executives
(Lerner, 1995; Sapienza, Manigart and Vermeir, 1996; Kaplan and Strömberg, 2002; Hellmann and
Puri, 2002; Baker and Gompers, 2003). From a competence-based perspective, it is then likely that, if
a PFC‘s top management team finds itself in a position to choose among several financing offers, it
will prefer an experienced VC to match with, hoping to create a sustainable competitive advantage.
However, VCs are not too keen on delivering all these ―extra-financial‖ services as they value their
time preciously and prefer not to be involved in a PFC on a day-to-day basis (Kaplan and Strömberg,
2002).4 This being the case, it is likely that only the highly experienced PFCs‘ top management teams
will be able to match with highly experienced VCs in order to get access to their valuable
competences.
For a matching between a VC and a PFC to take place, it is obvious that there needs to be an
opportunity for the two parties to meet and interact. Social networks, created and maintained by the
venture capital industry‘s widespread use of syndicated investing, are highly effective at information
diffusion (Sorenson and Stuart, 1999)5. Moreover, well-networked (i.e. high centrality) VCs are found
to outperform others and this can partially be explained by access to a better deal flow. Because
selecting skills are found to improve a VC‘s network position (Hochberg, Ljungqvist and Lu, 2007),
and investment experience drives selection skills (cf. supra), it is likely that more experienced VCs
will be able to match with better PFCs.6 Correspondingly to a VC‘s deal search, and because VCs are
renowned for their value beyond money, PFCs are also on the lookout to match with the best possible
partners. Since PFCs‘ management teams with prior (successful) experience have received visibility
through the years, it is reasonable to accept that they enjoy better negotiating positions (Hsu, 2007)
and thus are able to match with better VCs. Indeed, it is found that more experienced VC firms are
more likely to invest in serial entrepreneurs‘ start-ups (Gompers, Kovner, Lerner and Scharfstein,
2006). Evidence also supports that offers made by VCs with superior network resources are far more
likely to be accepted by a portfolio company (Hsu, 2004). The latter is of course not so surprisingly,
since network contacts can provide access to all kinds of resources such as information and the
recruitment of talented staff (Bygrave and Timmons, 1992; Hochberg, Ljungqvist and Lu, 2007).
Moreover, affiliation with reputable VCs is found to have a positive signalling effect (Megginson and
Weiss, 1991; Sorenson and Stuart, 1999).
According to classic financial theory, risk and return are positively correlated, implying that,
the higher the riskiness of the investment, the more return-on-investment an investor will expect and
4 The extent to which VCs get closely involved with their PFCs differs between the US or UK venture capital
market, and their counterparts in (Continental) Europe. It seems that in (Continental) Europe, VCs focus more on
monitoring than on other ―extra-financial‖ services (Sapienza, Manigart and Vermeir, 1996; Schwienbacher,
2008). 5 In the European context, portfolio diversification and risk sharing can be a more important motive to syndicate
than the access to a larger deal flow (Manigart et al., 2002). 6 Network effects are sometimes found to reduce or even eliminate investment experience as an explanation for
VC performance (Hochberg, Ljungqvist and Lu, 2007).
6
demand. During their risk assessment (due diligence process), VCs perform a thorough analysis where
the quality of the management team is an important asset (DiMaggio and Powell, 1983; MacMillan et
al., 1985; Podolny, 1993; Zacharakis and Meyer, 2000). Following the trade-off between risk and
return-on-investment, it is plausible that VCs will demand a higher return rate when the PFC‘s top
management team is less experienced. Furthermore, regarding the financial aspects of the contractual
agreement between VCs and PFCs, it is found that highly reputable VCs are able to obtain equity at
important discounts (Hsu, 2004). This implies that, if a less experienced PFC‘s top management team
would want to match with a highly experienced VC, it is likely to pay double for the disparity between
both parties. Therefore, it is reasonable to expect VC-PFC matches along equal experience levels.
Some factors that could be of importance during the investigation of matches between VCs
and PFCs are of a complete different nature than the traditional financial or organizational motives.
For instance, when we look at the interactions that take place in a market, an interesting aspect is the
preference of market actors to interact with similar others, called homophily. Using this rather
psychological approach, Franke et al. (2006) indeed find that, in the venture capital market, homophily
noticeably exists. Clearly, the otherwise relatively objective matching between VCs and portfolio
companies is distorted due to similarity biases. Because of the fact that VCs and portfolio companies‘
TMTs prefer to interact on the basis of similar characteristics, it is reasonable to expect once more a
matching between both parties along equal experience levels.
Many theoretical perspectives or empirical findings can be brought forward to support the
notion of a clear matching between VCs and PFCs along equal experience levels. Whether we use
financial, organizational, or even sociological and psychological motives, it seems that – in their deal
search – both parties are looking for the best possible partners to match with but sometimes find
themselves confronted with limitations, resulting in a rather intuitive sorting in the market or
equilibrium. Nevertheless, many of the above arguments are in fact double-edged swords and need
some nuance while some additional reasoning might explain a less clear-cut matching. As we explore
these alternative views, it becomes clear that questioning this ―deal search equilibrium‖ is far from a
trivial matter.
In any financial market, typical principal-agent conflicts can arise when the investor allocates
resources to the investee. Financial contracting theory, as a directive to mitigate these conflicts,
reveals that there are substantial contracting issues between management teams and external capital
providers. From the capital provider‘s perspective, it is clear that financial contracts are often
specifically aimed at providing incentives for optimal behaviour towards the management team.
Indeed, agency theory teaches us that it is important to align both parties‘ interests in order to
encourage corporate governance. Because of the specificity of the venture capital market with
complex situations where a substantial part of the venture‘s value is often tied up in human capital, the
nature of these financial agreements is particularly important (Kaplan and Strömberg, 2003). Apart
7
from resulting cash flow rights or managerial contingencies, these contracts often define extensive VC
control rights (Hellmann, 1998; Kaplan and Strömberg, 2003). More specifically, should a portfolio
company be underperforming, the VC will be able to upgrade its control rights, even to the extent of
dismissing or recruiting senior executives (Kaplan and Strömberg, 2003). Furthermore, when VCs
should exercise these vast control rights, empirical results show that they are actually able to attract
new, talented staff, thus building up an adequate top management team (Hellmann and Puri, 2000;
Baum and Silverman, 2004). This implies that, during the selection stage, the quality of the PFC‘s
initial top management team might not be of such extreme importance as often portrayed. It then
becomes clear that VCs might choose to match with less experienced PFC‘s top management teams
because the latter are expendable.7
The environment in which new enterprises face strategic, operational and financial challenges
is generally considered complex and many new ventures fail. Apart from their will and financial
power to boost young entrepreneurial companies, VCs are known to provide ―extra-financial‖
services. However, while a lot of studies have proven that VCs effectively possess the power to supply
all sorts of advisory or assistance, little is known about the exact costs of these services. Assuming that
more experienced VCs are better able to deliver such guidance, Hsu (2004) interestingly finds that
experienced VCs obtain large discounts on their acquisition of start-up equity. That being the case, an
essential question arises as to why PFCs‘ management teams with considerable experience should pay
a surplus for less indispensable VC servicing. In fact, from a competence-based approach it now
seems reasonable to expect highly experienced PFCs‘ top management teams to accept financing
offers from about any VC, or even from less experienced VCs if this should result in lower affiliation
costs.
When applying network theory to the venture capital industry, research has confirmed the
important role of social networks for information sharing and deal searching (Sorenson and Stuart,
1999). We can support the notion that PFCs will try to match with more experienced and thus well-
networked VCs in order to tap into their pool of information, expertise and contacts (cf. supra).
Nevertheless, using the same logic, it is arguable that highly experienced PFCs‘ top management
teams will actually match with more experienced VCs. In fact, when these TMTs possess of sufficient
experience, it is likely that they have a lot of social capital of their own. Indeed, Hsu (2007) finds that
previous founding experience leads to a larger social capital that can be used for, e.g. the recruitment
of senior executives. That being the case, the need for affiliation with well-networked or reputable
VCs is partially eliminated. Actually, using social capital as an argument, we can also argue if
experienced VCs are truly scouting for experienced PFCs‘ top management teams. Since experienced
VCs are so well-networked, chances are that they will feel more confident to recruit senior executives
7 The fact that a PFC‘s initial top management team is expandable or easily replaceable also depends on other
factors than solely the financial contract between the VC and PFC. For instance, institutional aspects might add
illiquidity to the labour market, as is the case for (Continental) Europe (Schwienbacher, 2008). Next, for a VC, in
the management of their long-term reputation, we imagine it to be important not to treat TMTs as expandable.
8
should the initial TMT turn out to be inadequate. This means that the quality of the (initial)
management team might not be of such prominent importance.
An interesting discussion among scholars is whether or not one should look more at the top
management team of a PFC (―bet on the jockey‖) or at the business idea (―bet on the horse‖) as an
indicator of future performance. It is clear that some VCs do not strictly look for the best management
teams alone. Kaplan, Sensoy and Strömberg (2007) also find that it can be beneficial to invest in a
good business idea even though the management team is less experienced. In fact, especially in early
stage investments, financial, technological and market criteria can sometimes be more important than
a complete or highly qualified management team (Baeyens, Vanacker and Manigart, 2006).
Furthermore, apart from their selective power, VCs also have the power to build management teams
should they not fully fit the required profile or lack of essential capabilities (Hellmann and Puri, 2002;
Baum and Silverman, 2004). Knowing that, particularly in early-stage investments, factors relating to
the business itself can prove to be sufficient reasons for sound investing, we must take into
consideration a distortion of the matching pattern along equal experience levels.
Another argument that can be brought forward in this debate, is the concept of adverse
selection. Adverse selection in this context implies that, because of the very nature of PFCs seeking
financial support within the venture capital industry, it is likely that a VC firm – be it experienced or
not – will almost never match with truly experienced TMTs. This so-called ―lemons effect‖ 8 can be
explained by the fact that the venture capital market is often serving the entrepreneurial community
with (expensive) financing in cases where traditional capital providers will not sign in for the
considerate financial risks. If on the other hand, TMTs are highly experienced, the business risk is
likely to decrease significantly and, in combination with their vast social capital, they are more able to
find cheaper financing alternatives or get funding within the traditional financial markets.
After having offered several views above, it is clear that we should question the nature of
matching between VCs and PFCs. Although the sorting in the venture capital market along experience
levels seems intuitively correct, there are many reasons as to why we can see distortions in the pattern.
Be it financial, organizational, sociological or psychological arguments, almost none are able to firmly
stand ground using a theoretical framework alone. Therefore, in this study, we will make an attempt to
empirically explore the matching pattern along human capital dimensions. We hereby present the first
hypothesis:
HYPOTHESIS 1A: In the pre-investment stage, VC firms will match with PFCs’ top management
teams on equal experience levels; more experienced VCs with more experienced PFCs’ TMTs, and
less experienced VCs with less experienced PFCs’ TMTs.
8 While Akerlof (1970) wrote about information asymmetries and ―lemons‖ using a car market example, an
identical rationale was used within the venture capital market by Amit, Glosten and Muller (1990).
9
Now that we presented the first hypothesis, it is crucial to make some refinements in order to
capture underlying differences in experience. For, whenever one is willing to understand and
effectively assess the impact of human capital on organizational behaviour, it is crucial to recognize
the multidimensional nature of this resource. In general, Becker (1975) demonstrated a very helpful
distinction between the generic and specific components. While the generic component includes
general knowledge built up by education and professional experience, the specific component is
fuelled by industry-specific and leadership experience. Interesting for our study, is to explore whether
there is a differential influence of general and industry-specific experience on the matching between
VCs and PFCs. Many of the arguments brought forward to open the debate regarding general
experience (cf. supra) are still valid in the industry-specific context. However, it might be useful to
point out some additional motives or explore further details using an industry-specific framework.
Prior research has established that industry spaces give shape to informational and
transmission boundaries (Sorenson and Stuart, 1999).9 This obviously implies that, for the venture
capital market, the window of potential investments might be narrowed as VCs specialize themselves
in a particular industry. Therefore, it is likely that, as a VC accumulates more industry-specific
experience, their deal search will focus mainly on ventures within the same industry. Furthermore,
empirical results already exist that confirm industry-specific homophily where entrepreneurs have a
significant preference to match with VCs with parallel backgrounds (Sapienza, Manigart and Vermeir,
1996). Hence, it is reasonable to expect that industry-specific experience from both parties provides
matching incentives along equal experience types and levels.
Industry specialization can certainly be beneficial for the performance of VCs (Sapienza,
Manigart and Vermeir, 1996; Gompers, Kovner, and Lerner, 2009). Nevertheless, it is also plausible
that too much industry specialization can lead to a very narrow perspective and ultimately to incorrect
judgements or suboptimal investment strategies. On the other hand, VCs that are aware of the
importance of a broad market scope might have a competitive advantage and are likely to reap rewards
of their exploratory behaviour. Indeed, empirical results confirm that VCs sometimes choose new
industries for the value of learning. Moreover, VCs that explore clearly appear to be more successful
(Sørensen, 2008).10
Evidently, building up axial positions in industry networks is a good choice for
VC firms that want to obtain valuable cross-boundary information (Sorenson and Stuart, 1999). Since
VCs have good incentives for keeping a healthy balance between specialization and exploration, it is
likely to expect quite a few matches outside a VC‘s focal industry. This implies that, if we use a
narrow, industry-specific framework, the intuitive matching pattern along equal (industry-specific)
experience levels might be distorted.
9 Sorenson and Stuart (1999) provide a more elaborate analysis of industry spaces and spatial distribution which
also includes geographical dimensions. 10
Although exploratory behavior can make VCs reap rewards, it is advised that this behavior is part of a sound
exploratory investment strategy instead of rather random investing (Sørensen, 2008).
10
It is clear that industry spaces cause several limitations and opportunities to arise in the
venture capital market. In our study, it is therefore useful to also focus on industry-specific matching
behaviour. Analogously to the theoretical and empirical foundation of the hypothesis regarding
general experience, it is not clear what kind of industry-specific matching pattern we should expect to
encounter. For this reason, we will test the following hypothesis:
HYPOTHESIS 1B: In the pre-investment stage, VC firms will match with PFCs’ top management
teams on equal industry-specific experience levels; more industry-specific experienced VCs with more
industry-specific experienced PFCs’ TMTs, and less industry-specific experienced VCs with less
industry-specific experienced PFCs’ TMTs.
2.2. Growth Model
When exploring the foundations of our Matching Model (cf. supra), we brought forward
various motives to provide an explanation for the matching behaviour between VCs and PFCs.
Clearly, if we accept a two-sided selection model, both parties will select each other during the pre-
investment stage on the basis of several characteristics and expectations, some of which are obviously
performance-related. In the post-investment stage, it is interesting to check how good those predictions
or choices turn out to be. Therefore, we will examine multiple rationales to explain PFC performance
(growth) as a result of experienced-based matching behaviour.
There are several reasons as to why VC and PFC experience levels matter in both the pre-
investment and post-investment stage. Obviously, the activities performed by both parties across those
two stages are likely to be reflected in the company‘s results. Intuitively, one can imagine a positive
relationship between VC or PFC experience and PFC performance. In reality, this reasoning has
certainly been supported by previous studies.
During the pre-investment stage, VCs focus themselves on deal flow creation, initial
screening, due diligence, valuation and financial contracting (Tyebjee and Bruno, 1984). Because it is
generally difficult for young companies to receive financing, VCs get offered a large number of
investment proposals every year. Consequently, it is crucial for VCs to be able to rely on adequate
routines to increase efficiency. Since these pre-investment activities can be handled in a chronological
order, it is less complicated to draw causal relationships between efforts and benefits (Zollo and
Winter, 2002). Therefore, the pre-investment process is likely to carry substantial learning potential
and more experienced VCs will probably have better selection skills. Thus, it is possible that an
experienced VC, mere by using superior ―scouting‖ abilities, will pick out a PFC with high-growth
potential.
Another pre-investment aspect that could potentially explain superior growth among PFCs is
due to a specific selection motive of a PFC‘s top management team. Obviously, if we acknowledge the
11
fact that PFCs can actually choose who they match with, it is reasonable that they will select a VC on
the basis of promising characteristics such as experience and reputation (Hsu, 2004). This is not
surprising, as new ventures often face a lot of credibility issues towards buyers, suppliers, employees,
and other potential investors. Indeed, the affiliation with experienced VCs can act as a proof of
legitimacy or an important ―signalling effect‖ that makes many stakeholders open up their doors
(Stuart, Hoang and Hybels, 1999). Thus, it is likely that the mere matching with an experienced VC
will cause growth within the venture.
In the post-investment stage, unlike traditional investors, VCs are known to take up more
active roles with regard to their investments (Gorman and Sahlman, 1989; Bygrave and Timmons,
1992; Sapienza, Amason and Manigart, 1994; Elango et al., 1995).11
Generally, VCs can play a
significant role in monitoring the management team of their portfolio companies (Lerner, 1995).
However, in certain cases, VCs even take up more elaborate value-adding responsibilities than mere
continuous screening. For instance, VCs can provide advice to guide the venture in strategic or
operational decisions (Lerner, 1995; Sapienza, Manigart and Vermeir, 1996; Kaplan and Strömberg,
2001). What is more, VCs are willing to actively help with establishing a strategic alliances network
(Sapienza, Manigart and Vermeir, 1996; Lindsey, 2002), something which is highly important given
the resource providers‘ aversion to quality uncertainty regarding new ventures (Stuart, Hoang, and
Hybels, 1999) and start-ups‘ imperfect markets for information (Aoki, 2000). Finally, VCs are
sometimes able to impose professionalization within the portfolio companies by shifting the structure
and experience of the top management team (Hellmann and Puri, 2002; Kaplan and Strömberg, 2002).
Baker and Gompers (2003) even emphasize the role of VCs in outlining the board of directors and
found that VC-backed boards are slightly larger than others.12
Evidently, this recruitment aid can
prove to be quite helpful since Beckman and Burton (2008) find that low-quality founding teams fail
to attract broadly experienced executives. In summary, all these VC post-investment involvements,
also called ―coaching‖, are likely to have an impact on a PFC‘s performance. Indeed, Hellmann and
Puri (2000) show that VC-backed companies are able to bring their products faster to the market. Prior
research has also established that the post-investment value-adding ability of a VC is positively related
to previous investment experience (Sapienza, Manigart and Vermeir, 1996). Clearly, the post-
investment relationship with its PFCs enables a VC to develop critical expertise and knowledge
regarding technological matters or PFC development strategies (Gupta and Sapienza, 1992; Wright
11
Even though VCs are known to exhibit a deeper investment involvement than traditional investors, it seems
that (Continental) European VCs tend to have a more hands-off approach compared to their US or UK
counterparts (Sapienza, Manigart and Vermeir, 1996; Schwienbacher, 2008). 12
One should use caution in interpreting large board sizes as a positive factor. The optimal size of the board of
directors is a trade-off between costs and benefits of additional directors and evidence has been provided for
decreasing performance levels at suboptimal board sizes (Yermack, 1996; Eisenberg et al., 1998). In this case,
we assume slightly larger boards to be more effective in relation to governance issues.
12
and Robbie, 1998; Sapienza and De Clercq, 2000).13
Moreover, each additional investment adds to a
VC firm‘s powerful business network and extends its competences (Sorenson and Stuart, 2001)14
.
Consequently, it is plausible that more experienced VCs are able to drive higher growth within their
ventures by means of a more effective ―coaching‖.15
In order to explain PFC performance, it is obvious that we need to open up the ―black box‖
and look at internal company qualities. While the resource-based view stresses the importance of
identification and possession of critical assets, the theory of the firm puts emphasis on effective asset
organization. Eesley, Hsu and Roberts (2009) find that neither isolated theory is strong enough to
explain successful performance of entrepreneurial companies. In fact, they plea for a strategic
integrative theory in which, apart from idea assets, human assets are crucial. Evidently, new ventures
face the ―liability of newness‖ in the sense that it is complicated for a young company‘s management
team to identify the critical assets and to establish priorities and contractual structures when
commercializing those assets. Prior research has clearly found evidence for such entrepreneurial skill
as it seems that serial entrepreneurs are more likely to be successful in succeeding ventures (Gompers,
Kovner, Lerner and Scharfstein, 2006). Since experienced TMTs have accumulated such skills
(Becker, 1964), it is plausible that they will enable higher PFC growth. Furthermore, as a TMT gains
experience, they will dispose of a larger social capital (Beckman, Burton and O‘Reilly, 2007). In line
with VC network effects, a PFC‘s own social capital can prove to be highly important for resource
acquisition (Fried and Hisrich, 1994). Indeed, having business connections can help to access valuable
resources such as (follow-on) finance, customers or senior executive recruitment (Florin, Lubatkin and