How Venture Capitalists Can Accelerate Portfolio Company Returns

(This post co-written with Koen Bremer, Gyorgy Buslig, and Adham Hussein. Koen, Gyorgy, and Adham are all Columbia Business School MBA 2012 students and former consultants with McKinsey and BCG.  I’ve also posted this at Betabeat.)

Even the best VCs and entrepreneurs have a painfully high failure rate.  Lowering that failure rate would be highly impactful on venture capitalist returns, if we could figure out how to do it.  In addition, in light of increasing competition in the startup funding space, a methodology  for helping portfolio companies consistently is a strong competitive advantage.

In an effort to address this, we launched last year a formal study of best practices of VCs in improving portfolio company value. The objective of the research is to define a blueprint for how investors can help portfolio companies succeed through operational (non-financial) support, including  but not limited to facilitating shared services, recruiting, knowledge sharing, and enhancing management skills. To do so, we are working to understand what the best practices in the industry are, as well as what the correlation is between providing this kind of support and start-up success.

We’re now in the midst of surveying VCs and entrepreneurs for this research.  We’ll feature in our published work the most effective firms and practices we identify, subject to the interviewees giving us permission to use their names and data.  We’d greatly appreciate you taking a few minutes to fill out our survey:

VCs please click here.

Entrepreneurs please click here.

The value creation study draws on a wide range of research:  in-depth interviews with over 50 venture capital investors, entrepreneurs, startup incubators and advisory service providers; a proprietary database and survey of VCs’ portfolio value creation practices; a wide scan of academic and practitioner publications focused on the topics of entrepreneurship and venture investing; and the authors’ experience working in venture capital, early-stage technology companies, and strategy consulting.

This study is effectively a sequel to the study David Teten led with Chris Farmer of General Catalyst on best practices of venture capital and private equity funds in originating new deals, published in Journal of Private EquityHarvard Business ReviewInstitutional Investor, etc.  Similarly, we plan to publish this value-creation study in a few different major journals.

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If you have any questions, you can contact the team here.

We’ve summarized below some of our preliminary results. This is the first in a series of articles as our research findings unfold.

Are VCs a different breed of “investors”?

The conventional school of thought argues that investors –generally- should be creating value by selecting the “right” companies, business plans, and teams into which to invest. We argue that on top of that selection function, venture investors have a wider role to play beyond funneling financial resources with a high-risk appetite.

Venture capitalists are financiers of a special nature. They fund highly uncertain projects that usually operate within a very fast moving environment and within consistently shifting technological paradigms. The company teams they work with are usually highly motivated entrepreneurs trying to engage in extensive product and customer development efforts for a product they don’t typically have a full vision of, for a customer whose needs are opaque, and for a use case which is ambiguous. This is a very different world than traditional corporate lending.

Almost every VC will say, “I respond to the CEO’s requests, I put him in touch with someone in my network when he asks me to”.  We view that as the bare minimum.  We think that VCs can add tremendous value by systematically actively supporting their portfolio companies.

So how can VCs help their startups?

We have interviewed over 50 entrepreneurs and some leading VCs around the US about their experiences and pain points while building their companies. Our in-depth interviews have led us to define a framework (TOSCAN) for early-stage investors to systematically support their entrepreneurs, which we believe will in turn increase success and valuations.

–      Team Building: accelerating hiring to help startups build their most important asset; people

–      Operations: minimizing entrepreneurs’ burden in admin, accounting and legal

–      Skill Building: building the right skills, especially for top management, and ensuring they develop inline with the early-stage company’s life cycle

–      Customer Development: identifying the right customers and gaining access to them

–      Analysis: how entrepreneurs measure, understand and report the performance of their early-stage companies

–      Network: helping entrepreneurs building relationships with networks key to their company success

What is important, useful, new, or counterintuitive about your idea?
So far, there are two particularly innovative techniques we found VCs to be using:
–       Dedicated teams: Some of the investors we interviewed have started building dedicated business support teams, led by Partner-level experts. We are particularly interested in learning how these teams are organized, their interaction patterns with portfolio companies, and the company’s perception of their value-added.  Andreessen Horowitz, First Round Capital, and ff Venture Capital are all examples.
–       Portfolio companies’ networks: Many VCs said that the people who know the most about building a company are the portfolio CEOs.  In order to enable information-sharing, VCs must build very strong online and offline networks between portfolio companies, which organically provide a wealth of knowledge and support to each other.  All of the firms above have online networks for their portfolio executives.

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