Lots of venture capitalists claim to add value to the companies in which they invest. But how do they do it? And does it really produce better returns for their investors?
My coauthors and I just published in the Journal of Private Equity the first-ever research study on best practices of venture capitalists in creating portfolio company value through operational support, exploring exactly these questions. We published a piece in TechCrunch summarizing our findings. Great thanks to my coauthors on the research, Adham AbdelFattah (CEO of CircleVibe and consultant on leave from McKinsey & Company in NY); Koen Bremer (consultant with the Boston Consulting Group in Amsterdam, Holland); and Gyorgy Buslig (consultant with McKinsey & Co. in Budapest, Hungary.) All 3 of them worked with me while MBA students at Columbia as part of ff VC’s ongoing efforts to work with students.
In our research, we found that certain VCs are aggressively building out a focused portfolio operations skill set and recruiting more people with operational backgrounds. Based on a range of sources, we believe that most funds with well-developed Portfolio Operator models have top-quartile returns (typically above 20% IRR in the relevant time periods). Given the mediocre median returns of the VC industry and the high failure rate of the typical entrepreneur, techniques to improve the odds of success are highly needed.
Our thesis that greater investor participation correlates with higher returns is consistent with two other formal studies. Both studies found that higher levels of angel participation in investments, as measured by number of hours per week interacting with a portfolio company, correlates with higher returns.
Some highlights include
– How VCs currently add value to their portfolios (using the “TOPSCAN” framework)
– VCs’ main resources with which to increase portfolio company value: cash, brand, industry network, funding network, and in-house expertise
– Three common categories of VCs, including financiers, mentors and portfolio operators
– A snapshot of various VC portfolio operators, and ways they offer their portfolio companies support, beyond just capital
In response, Stefano Bernardi, (Customer Development at Betable and a former VC/500 Startups alum) wrote a thoughtful blog post on the future of Venture Capital. “What I’m starting to envision is a not-so-distant future where venture capital firms will have to turn themselves more and more into operators in order to help their portfolio companies succeed against a rising number of crowd-funded competitors and clones.”
Stefano calls this VC turning into private equity, but I would instead say it’s VC following the same developmental path as PE. Today, PE firms are typically more institutionalized and the individuals who work there more specialized than is true in VC. That is because PE is a dramatically bigger and more competitive industry, and the biggest PE funds are orders of magnitude bigger than the biggest VC firms. Some $246b of private equity was invested globally in 2011, vs. VC at around $20b a year. So VC is just getting more institutional in the same way that PE has over the last few decades.
What are some other ways that VCs can help their startups?