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

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

VCs

Each interview participant had founded a VCF with at least one other partner. Two VCFs had founders with venture capital experience; firm "A" was founded by two former VCs, one technology "guru" and an investment banker, and firm "B" was founded by a group of VCs that left an established venture firm. The other two VCFs were founded by teams with no venture capital experience; firm "C" was founded by a group of angel investors with operational backgrounds in entrepreneurial firms, and firm "D" was founded by a group of entrepreneurs with neither angel nor venture capital experience. The teams without prior venture capital experience had difficulty attracting institutional investors in their first funds. As a result, the majority of their LPs were individual investors and family foundations. In contrast, firms A and B scaled more quickly, garnering the largest percentage of institutional investors in their first funds. Firm B had enough demand to ensure that no one LP had too much control over the fund:

   We never wanted to have a single limited [partner] with more than
   10 percent of the fund ... because we always felt [that] we wanted
   a little bit of an audience that we had to perform for--not an
   individual ...

Limited Partners

From our interviews with LPs, we identified two important criteria for investing in a VCF: the quality of the team as expressed by the team's prior experience, and the investment strategy chosen by this team. The institutional investors that we spoke to rarely invested in first-time VCFs. Instead, they were more apt to monitor the new VCF through several funds, investing in its third or fourth fund if performance remained stellar over time. In the rare event that they did invest in a nascent VCF, the most important investment criterion was the experience of its GPs, with a bias toward investing in teams with venture capital experience. In particular, one LP emphasized that being a successful entrepreneur did not guarantee that the same individual would be a successful VC. In his view, an experienced VC knows how to manage a portfolio of investments, whereas an entrepreneur knows how to manage a single investment. To illustrate this point, we discussed hypothetically if the LP would invest in Steve Jobs's (Chairman and CEO of Apple, Inc.) new VCF:

   He [Steve Jobs] hasn't run a venture capital fund before so I think
   one of our key discussion points would be who he's working with ...
   who's gonna bring an institutional complement to the VCF to protect
   him from himself so that he doesn't fall in love with every
   project.

The second important criterion was the investment strategy of the nascent VCE Prior research has shown that VCFs' investment strategies differ by the PC' s industry, maturity, and geographic location (Tyebjee & Bruno, 1984). In our interviews, LPs also mentioned these categorizations, and their importance in diversifying across funds:

   So quality was sort of the number one criteria and behind that
   balanced by stage balanced by industry and to some degree
   geography ...