Genetically engineered: why some venture capital firms are more successful than others

Entrepreneurship: Theory and Practice, Jan, 2009 by Jennifer M. Walske, Andrew Zacharakis

While venture capital has received a tremendous amount of attention, prior research has predominantly looked at venture capital firms (VCFs) post raising their first fund. In this paper, we move the point of analysis back further and ask what type of founding team experience best predicts VCF success, controlling for firm strategy, firm size, and the environment upon which the firm was born. Empirical results show that venture capital, senior management, and consulting experience aids VCF success, while entrepreneurial experience impedes it. None of the control variables affect a VCF's ability to raise subsequent funds.

Introduction

Venture capital is the "fuel" for high-growth firms, especially in the United States. While entrepreneurial firm survival is tenuous at best, those funded by venture capitalists (VCs) have higher survival rates than those that are not (Kunkel & Hofer, 1990; Sandberg, 1986). Reflecting its overall importance to entrepreneurship, venture capital has received considerable academic attention. Research has examined how VCs select their investments (e.g., MacMillian, Siegel, & Subba Narashima, 1985; Tyebjee & Bruno, 1984; Zacharakis & Meyer, 2000), syndicate their investments (e.g., Brander, Amit, & Antweiler, 2002; Bygrave, 1987; Lerner, 1994; Sorensen & Stuart, 2001), negotiate and value investment contracts (e.g., Cornell & Shapiro, 1988; Norton & Tenenbaum, 1993; Wright & Robbie, 1998), monitor their investments (e.g., Davila, Foster, & Gupta, 2003; Gorman & Sahlman, 1989; Hellmann & Puri, 2002), and facilitate liquidity events (e.g., Cumming & Macintosh, 2003; Shepherd & Zacharakis, 2001). However, the majority of venture capital research assumes that the venture capital firm (VCF) is in place. To date, there has been scant research on nascent VCFs, with prior research using qualitative samples (Burton & Scherschmidt, 2004). Given the number of new entrants in venture capital, (1) we believe that this topic warrants further study. We argue that just as the businesses that VCFs fund have a genesis, so do VCFs (Wasserman, 2002).

This paper focuses on the nascent VCF examining the founding team's impact on the VCF's success over time, with success defined as a VCF's ability to raise subsequent venture funds. Our research extends Stinchcombe's (1965) early work to argue that in highly changeable industries, the firm's founders leave a greater "imprint" than the initial strategies chosen. We propose that imprinting has a greater impact on newly founded VCFs for the following reasons. First, the embryonic and dynamic nature of the industries in which VCFs invest makes long-term strategic planning problematic, potentially lessening the impact of firm strategy. VCs typically invest in industries such as high technology (Bygrave & Hunt, 2005) and biotechnology (Lerner, 1994), which tend to have a high level of ambiguity, necessitating ongoing adjustments to investment strategy. Second, the culture of a VCF is highly reflective of its founders. VCFs have few employees, giving founders great influence in comparison with publicly traded firms. As Hannan and Freeman (1984) state: "... some organizations are little more than an extension of wills of dominant coalitions or individuals" (p. 158). Third, a VC's expertise is often based on tacit knowledge, which is gained through apprenticeship. A skilled VC is capable of finding, screening, and evaluating potential investments (Tyebjee & Bruno, 1984), relying on a "gut feel" when making investment decisions (Khan, 1987). While each step of the investment process is complex, experienced VCs navigate this complexity without "conscious volition" (Nelson & Winter, 1982). For these reasons, we believe that a founder's experience is likely to have a greater imprint on a VCF than either the firm strategies chosen, or the environment in which the firm was born (Child, 1972).

The purpose of this paper, therefore, is not to discuss adaptation as other studies have done (Baron, Hannan,& Burton, 1999; Beckman & Burton, 2008; Boeker, 1989; Romanelli & Tushman, 1994). Instead, we delve deeply into founders' prior experience. We assess many kinds of work experience and suggest that some experiences are more important than others in aiding firm performance. Previous research on founders only captured positions created or filled at the time of firm founding (Bamford, Dean, & McDougall, 1999; Boeker) or the years of prior experience in a single industry, such as the semiconductor industry (Eisenhardt & Schoonhoven, 1990). We capture a wide net of founder experience, suggesting that the most related experiences are most important to firm success. In essence, we expand and disaggregate a measure used by Bamford et al., which combined firm resources, strategies, and environmental factors to test the lasting effect of founding conditions.

This paper proceeds as follows. We begin with a review of the VCF, followed by a synopsis of our semi-structured interviews with both VCs and limited partners (LPs). We then empirically test if founder experience predicts nascent VCF success, controlling for the initial investment strategies used, the size of the VCF, and the business environment at the time the VCF was founded. The paper then concludes with a discussion of our findings, suggestions for future research, and implications for practice.