Venture Capitalists Investment Process, Criteria, and Performance

Frdric Martel*
Draft: November 2006

Abstract
According to previous studies on venture capital, deal selection skills are critical to financial
success. The objective of this study is to examine and validate empirically the venture capitalists
decision criteria (1) relevant for their investment decision that are (2) predictive of subsequent deal
success, and/or (3) survival outcomes.
Using the information collected by a successful European VC firm while evaluating its entire
deal flow of 2219 investment opportunities received between September 1996 and August 2001 (e.g.
ex-ante data) plus information gathered from a questionnaire answered in September 2001 by the
same VC (e.g. ex-post data), we observe that our analyses results differ significantly depending on
whether we use the ex-ante or the ex-post questionnaire answers. This observation is consistent with
the findings of recent cognitive psychology studies on ex-post research methodologies, as for
instance, interviews and surveys.
Focusing on our ex-ante data, we identify the criteria that are significant for investment
decision: Management and Financials. We also determine the criteria that are predictive of deals
future financial success: Management and Financials and/or predictive of company survival, such
as Resistance to Risk, Barriers to Entry, and Innovation. We note that a structured investment
approach may assist VCs to adapt their investment criteria to market conditions; thereby improving
their prospects of financial success.

*Frederic Martel, University of Lausannes Hautes Etudes Commerciales (HEC), e-mail: fmartel@gmail.com

Content
I. Introduction ........................................................................................................................... 3
II. Literature review .................................................................................................................. 5
2.1. Investment process: background................................................................................................................... 5
2.2. Data Sources: background ............................................................................................................................ 5
2.3. Criteria linked to investment decision .......................................................................................................... 6
2.4. Criteria linked to success .............................................................................................................................. 8
2.5. Criteria linked to survival ............................................................................................................................. 8
2.6. Limitations encountered in past research ..................................................................................................... 9
(1) Data accessibility issues.............................................................................................................. 9
(2) Reporting bias issues................................................................................................................. 10
(3) Investment criteria identification issues ................................................................................... 10
(4) Sample selection representativeness issues .............................................................................. 10
(5) Data pairing issues .................................................................................................................... 11
(6) Decision model construction issues.......................................................................................... 11

III. Research Method .............................................................................................................. 11

3.1. Empirical context ........................................................................................................................................ 11
3.2. Data Collection............................................................................................................................................ 12
(1) Interview Data ........................................................................................................................... 12
(2) Deal Flow Data.......................................................................................................................... 12
(3) Ex-ante data............................................................................................................................... 12
(4) Outcome data............................................................................................................................. 13
(5) Market Data............................................................................................................................... 13
(6) Ex-post data............................................................................................................................... 14
3.3. Validity, analysis and reliability ................................................................................................................. 14
(1) Data sample specificity ............................................................................................................. 14
(2) Data sample validation.............................................................................................................. 15
(3) Univariate analysis .................................................................................................................... 18

IV. Results and Discussion ..................................................................................................... 19

4.1. Representativeness Analysis....................................................................................................................... 19
4.2. Deal Flow Analysis ..................................................................................................................................... 19
4.3. Investment Process Analysis....................................................................................................................... 20
4.4. Investment Criteria Analysis....................................................................................................................... 20
(1) Interview Analysis..................................................................................................................... 21
Criteria analysis - Differences between 3 criteria types ................................................................ 21
(2) Enacted Criteria Analysis.......................................................................................................... 23
(3) What other VCs seem to do differently .................................................................................... 26
4.5. Decision models comparison ...................................................................................................................... 27

V. Conclusion and Future Research........................................................................................ 28

Acknowledgements................................................................................................................. 30
References............................................................................................................................... 31

I. Introduction
Venture capitalists (VCs) typically set up specially designed legal structures such as limited
partnerships, commonly called funds, to raise money and then to invest in a diversified portfolio
of companies via multiple rounds of financings. Only the most promising ventures receive followon investments. According to Venture Economics (1988), over a 16-year period, more than onethird of 383 investments made by a group of VCs resulted in an absolute loss, and about two-thirds
resulted in capital returns of less than double the original amount invested, with only a select
number of deals generating outstanding returns. Looking at the industrys reported returns, wide
gaps exist among the impressive returns generated by a few top-performing VCs, the industry
average returns, and the industrys worst performers.
Consistently delivering above-average returns while mitigating risks is crucial for VCs. It is
also a key challenge because, according to recent studies such as Kaplan and Schoar (2003) and
Cochrane (2005), on average, VC investing is not more profitable than investing in the stock
market, but is much riskier1 due to the high stochasticity of returns (returns come from few
financial successes), low liquidity, lack of transparency, and diversity (jurisdictions, industries,
market cycles, and financing stages differ). Yet the most successful VCs manage to deliver year-onyear and fund-after-fund consistently high above-average performance, typically thanks to
proprietary skills and/or experience (Kaplan and Schoar, 2003). While published research on the
possible nature of these proprietary skills is extensive, it is far from conclusive.
2

Research on performance generating skills is far from comprehensive because, in part, of

the complexity of the VCs tasks, the opacity of their operating procedures, and the lack of reliable
research data. To date, there has been practically no study published on VCs investment screening
capabilities that is based on unbiased data recorded live at the time of the deals evaluation (e.g.
ex-ante) on real VC deals over an extended period of time that are paired with their subsequent
financial performance. So far, most studies have used either experimental designs or ex-post
evaluations, where possible biases cannot be controlled or quantified.
The purpose of this study is to identify and validate empirically criteria (1) relevant for
VCs investment decision, (2) predictive of subsequent deal success, and/or (3) survival3 outcomes,
using principally ex-ante data, where identified biases are controlled for. In addition, our
investigations aim to identify and segregate some of the assumptions flaws underlying published
studies that rely solely on ex-post design and expose some of the potential biases in deal selection
(by showing that different criteria predict VC investment and success).

1
2
3

Shepherd (1999) defines a ventures risk as the potential for the venture failure or bankruptcy
e.g. individual and organizational skills, know-how, good practices, or processes.
e.g. Shepherd (1999) defines survival as the probability that this venture will continue to participate in the market.

To our knowledge, this study is unique because it is the first that combines (1) interview
data, (2) ex-ante data gathered on a single representative VCs complete deal flow of 2219 deals,
(e.g. this VC), (3) ex-post data on a subset of no less than 198 deals, and (4) performance data on
all 2219 deals present in the database. All this information was collected to analyze one VCs
investment behavior over a 4.5 years period of turbulent financial markets in the
Telecommunication, Information Technology, Media, Entertainment Industry, (e.g. TIME) industry
sectors.
Our data on deal flow and investment criteria is analyzed on 5 main axes. First, we use
interviews to review the VC investment process and identify the investment criteria this VC says it
used, or its espoused criteria. These are: (1) Management, (2) Scalability, (3) Barriers to Entry,
(4) Exit Opportunities. Second, we regress its investment decisions to the ex-ante information it
collected on deals in order to derive its enacted or actual investment criteria, which are more
related to the Management and the Financials of the venture. Third, also via a regression analysis
using information on other VCs decisions and our ex-ante data, we find predictors that can explain
other VCs investment decisions, which seem to be based also on Management and Financials plus
Product Development, Potential Partnerships, and Existing Customer base.
Fourth, we pair venture criteria to three possible deal outcomes: (1) financial success, (2)
low growth maturity (examined within this paper under survival), or (3) bankruptcy or venture
failure to identify the predictors linked to company survival (e.g. Barriers to Entry, Resistance to
Risk, and Management) and the predictors linked to financial success (e.g. Management and
Financials). Should these predictors be different from the investment criteria, it would imply that
VCs are not always using the right investment decision criteria needed to optimize their financial
success or the investments survival.
We note that this VCs significant investment criteria are highly correlated to the predictors
of venture success. This would lead us to conclude that this VC was following a strategy focused on
investing in deals with a higher probability of financial success where one or two deals in a
portfolio compensate for a high level of total write-offs with few just surviving firms in the
portfolio. This conclusion is further corroborated by the actual performance this VC published in
December 2005.
Also, expanding on Mainprize et al. (2002), we derive a decision model based on our
ex-ante data and evaluate its effectiveness as a decision aid in comparison to the performances of
other published investment models. We find that our model may be a better decision aid than some
of the models presented in other studies.
We also note that a structured approach to venture investing may assist VCs to stay flexible
and in tune with their constantly evolving market conditions when armed with the relevant
investment criteria.

II. Literature review

2.1. Investment process: background
The importance of the selection criteria can be best understood by first reviewing the
published research on the wider framework of which they are part of: the Investment Process.
In Table 1, the findings of 6 studies on the multiple-stage investment process are presented.
These investigations all point out that process efficiency combined with deal selection skills and the
relevant investment criteria are crucial for financial success. Especially since, according to Fried
and Hisrich (1994), the VC investment decision-making process is also designed to reduce the risk
of adverse selection.
However, two factors make previous research inconclusive. First, according to Hisrich and
Peters (2002), the evaluation process combines objective information gathering and analysis with
the VCs intuition, gut feeling and creative thinking that is difficult to capture via traditional
research methods. Second, recent research suggests that VCs lack a strong understanding of how
they make investment and divestment decisions (Zacharakis and Shepherd, 2001).
Nonetheless, past studies have made a number of important assertions on the links between
investment process and investment criteria that could be also observed in our data. Firstly, Hall and
Hofer (1993) presents different criteria used at each of the screening and due diligence stages,
thereby supporting our observation that VCs tend to adapt their criteria at each stage of the
investment process. Secondly, since Shepherd et al. (2003) states that most VCs also adapt their
decision process to include experience gathered, in support of Mainprize et al. (2002), VCs may
benefit from structuring their investment processes so as to limit certain inherent potential biases
discussed in Section 2.6, which hamper retrospection analysis and experience building.
2.2. Data Sources: background
Previous studies have relied on data gathered via multiple investigations methods. Table 2a
presents a taxonomy compiled from findings of past studies on the investment criteria and their
investigation methods. Almost all studies rely on data collected via ex-post information gathering
methods reporting only espoused4 selection criteria, while only Kaplan et al. (2005a) is based on exante (e.g. Enacted) data.
In line with Sandberg et al. (1988), Bar et al. (1992), Muzyka et al. (1996), and Shepherd
(1997), which all question the validity of ex-post questionnaire based research, we develop the
following proposal:

Hypothesis 1: Espoused4 criteria data are different from enacted5 criteria data and
a-posteriori reported6 criteria data, which leads to significant differences in
analyses results depending on the data source used.
Support for hypothesis 1 would also credit research presented in Zacharakis (1995) and
Zacharakis and Shepherd (2001), which asserts that VCs, like many experts, appear to be poor at
ex-post introspection. Indeed, a-posteriori, VCs seem to overestimate their ability to predict the
future financial performance of potential deals.
2.3. Criteria linked to investment decision
According to Fried and Hisrich (1994), the VCs investment decision is crucial and bears
serious adverse selection risk due to the investments illiquidity nature. While Table 2a provides an
overview of a number of studies that investigated the VC investment criteria and their method of
investigations, Table 2b summarises the investment decision criteria identified in some of these
studies. Past research defines mainly four types of selection criteria in order of importance: the
competency of the management team, the attractiveness of the market, the attractiveness of the
opportunity (service or product), and the deals terms.
From the criteria presented in Table 2b, we select the 14 criteria that are present in our
database to develop the following hypothesis:
Hypothesis 2a: The 14 selection criteria Management, Innovation Potential, Stage of
Product Development, Resistance to Risks, Scalability, Barriers to
Entry, Existing Customer Base, Customer Potential, Potential for
Partnerships, Market Potential, Competition, Financials, Exit
Potential, and Valuation Attractiveness are statistically significant
predictors of investment.
Supporting evidence for hypothesis 2a would further credit the research methods used by
past researchers presented in Table 2a. It would also support the findings of the studies presented in
Table 2b. However, only some of these 14 criteria might be significant predictors of VC
investment. This may support Clarysse et al. (2005) that states that financial investment criteria are
more important than human resource criteria.
In addition, Burch (1986) comes to the conclusion that VCs would prefer an average
product/service idea with a top management team rather than a good product/service idea with a

4
5
6

As per Shepherd (1999), espoused criteria are the criteria VCs report or state they use when evaluating new venture proposals
As per Shepherd (1999), enacted or in-use can be defined as actual or truly used
As per Shepherd (1999), a-posteriori reported can be defined as reported via questionnaire or interview after the event

bad management team. Kaplan et al. (2006) contradicts this finding by implying that this is a bad
strategy.
Rah et al. (1994) finds that Market Attractiveness is by far the most predictive investment
criteria (30% more predictive then management capabilities).
Wright and Robbie (1998) claims that VCs place considerable emphasis and scrutinize in
detail of all aspects of a business. This normally includes sensitivity analysis of financial
information, discussions with personnel, and assessment of a great deal of intangible and subjective
information.
Interestingly, two studies report that the criteria used in different stages of the due diligence
process vary. Wells (1974) found that different criteria were applied at the screening and the
evaluation phases, moving from broad questions, such as portfolio fit, etc., to more deal specific
ones. Whereas, Hall and Hofer (1993) also identifies the two key criteria most used for the initial
screening stage: a) fit of the venture seeking financing with the VC firm's investment guidelines,
and b) long-term growth and profitability of the industry in which the business will operate.
According to them, however, in the proposal assessment stages, the key criteria change to: 1)
source of the business proposal that played a role in the VCs interest in the plan, and 2) proposal
previously reviewed by persons known and trusted by the VC.
To verify these two studies findings, we formulate the following hypothesis:
Hypothesis 2b: Selection criteria importance change at each stage of the due diligence
process.
Supporting evidence for Hypothesis 2b would credit research that link the use of different
criteria to different stages within the due diligence process. The supporting evidence would also
cast some questions on the more encompassing studies that do not take this observation under
considerations when making their analyses.
More generally, although all these studies determine certain investment criteria, contrary to
this study, none actually validate whether the VCs are right to use these criteria to optimize their
success rate.
Furthermore, just thinking that only these selection criteria are the most significant for VC
investment may be too limitative. Other factors, such as changes in the environment or market
conditions, may influence the venture (Abell 1978, Aaker and Day 1986). Also, requirements for
market success are likely to change with market evolution (Abell 1978, Shepherd et al. 2000).
Besides, Guidici and Paleari (2000), Inderst and Mller (2002), and Rider (2005) all report that
Market Conditions influence all aspects of the relationship between the VCs and the venture, and
specifically Valuation, Investment Terms, and Risk/Return expectations. Further empirical research
is certainly necessary in this area.

2.4. Criteria linked to success

Studies based on a-posteriori collected information demonstrate that VCs are successful at
predicting new ventures future successes (Dorsey, 1979; Sandberg et al., 1988; Kahn, 1987).
Riquelme and Watson (2000) presents a taxonomy of criteria associated with small and medium
sized company success. These analyses tend to indicate that emphasizing the qualifications of the
management, intensifying cooperation between the VC and portfolio companies, and ensuring a
strong (minority) shareholder position of VCs coincide with above average success (Schefczyk,
2001).
In Table 2c, we summarize the success criteria identified in a number of studies on venture
investing. From the criteria presented, we select the 14 criteria that are present in our database and
formulate the following hypothesis:
Hypothesis 3: The 14 selection criteria Management, Innovation Potential, Stage of
Product Development, Resistance to Risks, Scalability, Barriers to
Entry, Existing Customer Base, Customer Potential, Potential for
Partnerships, Market Potential, Competition, Financials, Exit
Potential, and Valuation Attractiveness are statistically significant
predictors of venture success.
Support for Hypothesis 3 would credit research presented in Table 2c. It would also support
the only correlational study, from Schefczyk (2001), that points out a possible correlation of one
selection criterion, emphasizing portfolio companies' managers' qualifications, to success.
While most VCs try to invest in ventures with both strong businesses and strong
management, some VCs claim to weigh one or the other more heavily (Kaplan et al., 2006).
Although it is possible for founders to adapt their style and become successful at running a
larger business, these founders often have neither the interest nor the skills necessary to do so
(Jayaraman et al., 2000). Stevenson and Jarillo (1990) argue that different skills are needed to
effectively manage the entrepreneurial challenges of a start-up versus the later administrative
challenges of an established firm. Hambrick and Crozier (1985) finds that successful start-ups are
more proactive in adding managers with more experience.
2.5. Criteria linked to survival
Table 2d offers a summary of the research findings on the investment criteria predictors of
company survival or non failure. Taking from this table the criteria for which we have data, we
formulate the following proposition:

Hypothesis 4: The 14 selection criteria Management, Innovation Potential, Stage of

Product Development, Resistance to Risks, Scalability, Barriers to
Entry, Existing Customer Base, Customer Potential, Potential for
Partnerships, Market Potential, Competition, Financials, Exit
Potential, and Valuation Attractiveness are statistically significant
predictors of venture survival.
Support of Hypothesis 4 would further credit the research made by Shepherd (1999) which,
among others state in Table 2d, identifies survival predictors for ventures and ranks them in order
of importance: (1) industry related competence, (2) high educational capability, (3) competitive
rivalry, (4) key success factor stability (i.e. Barriers to entry), and (5) lead time as innovators.
Furthermore, in line with some of the criteria mentioned above, according to Brderl et al. (1992)
and Lee and Lee (2004), failure of technology based ventures could be categorized into three
groups: (1) personal traits of the entrepreneur; (2) strategies and resource capabilities of the
venture; and (3) environmental conditions of a new venture.
2.6. Limitations encountered in past research
A number of publications raise suspicions on the VCs conspicuously accurate predictive
skills captured via a-posteriori research (Hofer and Sandberg, 1987; Hall and Hofer, 1993). Recent
studies even exist on the research limitations and possible biases in the field of VC investment
criteria ex-post analyses (i.e. Muzyka et al., 1996; Shepherd, 1997; Rider and Tetlock, 2005). These
studies highlight 6 key potential research limitations:
(1) Data accessibility issues
Conducting large-scale studies by gathering data about the investment process, criteria, and
investment financial performance of many VC firms is challenging due to the scarcity of reliable
unbiased data.
This lack of information is not surprising since VCs have several incentives to keep their
data opaque, including, amongst other things, to protect their competitive edge, to mitigate greater
potential fiscal scrutiny from their local tax authorities, and to avoid easy benchmarking to their
competitors, not to forget the well documented survivorship bias resulting from unsuccessful funds
going into liquidation without ever having published performance data. Also to be mentioned is the
issue of the time required to fill-out questionnaires when much research agrees that the scarcest
commodity a VC has is time, not capital (see e.g. Gladstone, 1988 and Quindlen, 2000).
Furthermore, as pointed out by Muzyka et al. (1996) and Birley et al. (1994), in sharp
contrast to the United States where a tradition of answering candidly to detailed questionnaires is
well established, European VCs can be much more restrictive with respect to cooperating with
researchers. In addition, European VCs may be somewhat annoyed by the abundance in recent
9

years of questionnaires sent indiscriminately by researchers attempting to bring clarity and

transparency to what some VCs often view as trade secrets (Muzyka et al., 1996).
(2) Reporting bias issues
Most past studies are based on VCs retrospective self-reporting (e.g. Tyebjee and Bruno,
1984), interviews and verbal protocols, and statistical analyses (see Mainprize et al., 2002, for a
review), or questionnaire responses rather than actual evaluations (for example, MacMillan et al.,
1987 and Robinson, 1987), and observations in laboratory setting, where typically VCs are asked
by researchers to evaluate deals and decide if they would invest, (Beim and Lavesque, 2004;
Mainprize et al., 2002). However, Hofer and Sandberg (1987), and later Shepherd (1997) and Rider
and Tetlock (2005), have shown that results obtained using these methodologies may diverge from
reality as VCs may not report accurately what they do and how they think. Even fewer studies
address whether VCs are right to use the investment criteria they say they use.
Indeed, according to Shepherd et al. (2003), decision-makers, especially experienced ones,
tend to overlook established objectives and instead rely on intuition and various heuristics when
deciding. Cognitive biases that may affect the way VCs address decisions include overconfidence
and anchoring, one form of which is to follow past practice and shun innovative alternatives
(Keeney, 1992).
Self-reporting has been shown to overstate the number of criteria actually used and to
understate the weighting of the most important criteria when compared to more sophisticated
decision-making techniques (see Stahl and Zimmerer, 1984; Riquelme and Rickards, 1992).
Ex-post methodologies (e.g. interviews, questionnaires, or surveys) assume that VCs can
accurately recall and explain without biases their own decision process. Zacharakis and Meyer
(1998) propose that methods that use surveys to ask VCs to revisit previous choices and use those
choices as a base to assess their decision process are biased.
(3) Investment criteria identification issues
7

Depending on the scope of the studies the most salient investment criteria vary (see
Riquelme and Watson, 2000). In addition, investment criteria may vary with market conditions (see
hypothesis 4 presented in section 2.4), VC investment agenda, VC style, etc. Therefore, to identify
the relevant investment criteria is challenging.
(4) Sample selection representativeness issues
Another important issue is the potential for sample selectivity (or non-random) bias in the
data. Since we are using sub-samples of the full database, it is important to show that these

Including or not deal sourcing, initial screening, ratings of business plans, due diligence, etc.

10

subs-samples are representative of the average deals applying for finance in our data set. The
Heckman procedure tests if such potential bias is present.
Unfortunately, there is a large number of other potential selection biases (e.g. is the deal
flow we analyze representative of all VCs deal flows, are the deal rankings representative of the
way other VCs rank deals, etc.) that can not be controlled for within our data sample. These biases
have to do with heterogeneity, i.e. VCs are not all alike and do not all follow the same objectives
with the same risk/reward investment profiles. Such biases would also influence more general
studies. We only have data from one of them so we can not generalize our findings to the industry
as a whole.
(5) Data pairing issues
Researchers lack paired ex-ante data on VC deal selection skills and the resulting
investment performance (Schefczyk, 2001). Therefore, so far, no meaningful comparison between
relevant investment criteria and subsequent performance can be found in literature.
(6) Decision model construction issues
Past research on the modeling of investment decision suggests that VCs do not necessarily
have a strong understanding of their decision criteria (e.g. Shepherd, 1997; Zacharakis and Meyer,
1998) and, instead, rely heavily on intuition (e.g. Hall and Hofer, 1993; Zacharakis and Meyer,
1998); face environments that are not conducive to learning and/or improving judgment (e.g.
Shepherd and Zacharakis, 2002); and may need to use decision aids to significantly improve their
judgment and decision making (e.g. Zacharakis and Meyer, 2000; Shepherd and Zacharakis, 2002).
However, decision models found in previous studies, such as Mainprize et al. (2002), are
limitative in their capacity to encompass all elements affecting VC decisions. Also, to present the
diversity of VCs individual and organizational deal-selection practices with a common model is an
issue.

III. Research Method

3.1. Empirical context
Our source
Most of our unique data comes from one VC company that was established in September
1996 in Switzerland. In 1998, it employed about 10 professionals, including staff. By August 2001,
its team was composed of 5 partners, 8 investment managers, plus assistants, accountants and
secretaries; a total of 25 professionals. Section 4.1 should demonstrate the representativeness of this
VC.

11

3.2. Data Collection

This study relies on the combination of analyses done on the following six data sources:
(1) Interview Data
Our first source of data consists of interview data on how the VC structured its investment
process and on its modus operandi. This data was collected via multiple interviews with its
investment managers and partners between 1999 and 2001. These interviews were intended as very
open discussions in order to capture a maximum of information. Subsequent interviews helped
obtain any necessary clarifications.
These interviews serve as the basis for Section 4.2 that describes a VCs investment process
and which is presented in Table 3. The VCs feedback to our studys preliminary findings also
helped us to further develop our understanding of investment process and investment criteria by
providing some

reality checks and an opportunity to collect additional information and

perspectives.
(2) Deal Flow Data
The second source consists of the empirical data collected at the time of the due diligence
on the 2219 deals it screened between September 1996 and August 2001; all in all about 20
columns of potential information for each deal. Much information on the deal flow specifications
can be found in Table 4.
The quantity of deal flow information available for each 2219 observations varies
somewhat, as the investment opportunities that were more carefully evaluated have more complete
information (see Table 5). To improve the completeness of our database, in some cases, additional
information was hand-collected from the ventures websites, public and private databases, etc.
(3) Ex-ante data
The third data source consists of the ratings on 14 evaluation criteria selected and defined
by the VC in 1999, gathered on the deals at the time of their individual due diligence. The criteria
can be best illustrated by the 14 main questions the VC asked itself for each investment
opportunity:
Investment Criteria and Description Questions
Criteria
Management
1 Management
Product / Service
2 Innovation Potential
3 Stage of Product Development
4 Resistance to Risks
5 Scalability
6 Barriers to Entry

Description question
How capable is the management to execute its business plan?
How innovative is the product or service?
What is the current stage of the product development?
How risky is the project and what is the worst case scenario?
How scalable is the business?
How much is the product or company protected from copiers?

12

7
8
9

Existing Customer Base

Customer Potential
Potential for Partnerships

Market
10 Market Potential
11 Competition
Financials
12 Financials
13 Exit Potential
14 Valuation Attractiveness

What is the quality of the current customer base?

How attractive/large is the potential customer base?
What is the potential for this VC to create value added for the company
via partnerships with vendors, other portfolio companies, etc.?
What is the market potential for the product or service?
What is the status of the competitive landscape?
Are the financial plans reasonable and attractive?
What is the likelihood of having a successful exit via trade sale or IPO?
How attractive is the investment proposition for the VC?

Source: our reference VC

In our database, these ratings are available for a sub-sample of 198 deals.
The VC ascertained that the grades recorded for each project are the grades attributed to it
at the last stage reached within the due diligence process. Hence, if a project was defined as having
a management team with a grade of 2 (not very good) at the first evaluation stage, but then, during
the due diligence process, this VC revised its opinion on the management (for example because it
was strengthened by the arrival of an experienced CFO), the deal may have ended with a grade of 5
for Management (which would be captured in the database).
This VC also allocated to each criterion an investment decision weight. All criteria
multiplied by their respective weight could be added to compute a deals overall attractiveness
score. Unfortunately, as this VC was still experimenting with its evaluation model, it did not
actively modify the weights from deal to deal so that the variation of the weights in the ex-ante
database can not be properly analyzed. During our interviews, this VC informed us that it intended
to analyze these weights at some later date to refine and improve its decision process, provided
enough quality data was then available.
(4) Outcome data
The fourth data source consists of information collected on the performance of the deals,
the number of successive financing rounds, and financial outcomes (i.e. trade sale, IPO, still
private, or bankruptcy) on the 2219 deals between September 2001 and December 2004. The
outcome data was collected by consulting a number of VC specific databases (e.g. Venture One,
Venture Economics, Capital IQ, etc), company websites or web page archives (such as
web.archive.org) in order to establish whether the firm became a successful investment, is alive but
not a successful VC investment, or was bankrupt by December 2004. The financial outcomes of
the ventures are used in Section IV to evaluate whether certain investment criteria could be
predictive of performance.
(5) Market Data
Because stock market indices and deal flow are highly correlated, our data set does not
allow us to discriminate among (1) quarterly variations in market conditions measured by European

13

IT stock index, deal flow (as a proxy for demand for VC money), other VCs investment rate (as a
proxy for offer of VC money, survival, and success rates), (2) variations in this VCs activity
measured by the number of deals encountered every quarter, and (3) variations in the VCs
experience (as a function of time, the cumulated number of investments realized or exited).
As shown below, four time periods have been defined. Between September 1996 and
August 2001, the TIME industry, this VCs industry focus, underwent first a major expansion until
end of 1st Quarter 1999. A boom period followed from the 2nd Quarter 1999 to the 2nd Quarter 2000.
The boom period lead to a correction period between the 2nd Quarter 2000 and the 4th Quarter 2000.
Finally, the bust period started in the 1st Quarter of 2001, which is the last quarter for which we
have deal flow and/or ex-ante data.

1996

1997

1998

1999

2000

2001

our VC's TIME industry focus

EXPANSION
BOOM
FALL
BUST

Figure 1: TIME Industry Chronology

(6) Ex-post data

The sixth data source consists of 98 answers to an ex-post multiple-choice survey 8 with 32
questions completed in August 2001 by the VCs investment managers. These 98 deals, 79 rejected
projects plus 19 investments, are all part of the 198 deals in the deal flow for which ex-ante
investment criteria ratings are available. The questions include the 14 investment criteria answered
ex-ante at the time of due diligence. The 98 deals were initially screened between the first quarter
of 1999 and the second quarter of 2001; e.g. 1 to 5 years before the questionnaire was answered.
The 19 ventures in which the VC invested involved in some cases multiple rounds of financings.
3.3. Validity, analysis and reliability
(1) Data sample specificity
As data from only one VC is available to us, our findings can only be specific to this VC
and no generalization is possible. The two main questions that can not be answered are: (1) Is the
VC representative of successful VCs in general and therefore can this studys findings be

For more information on our ex-post questionnaires design and an initial analysis, please review Birrer (2002). Alexander Birrer is the
author of the questionnaire also used in this study.

14

generalized to successful VCs?, and (2) Are the subset of VCs deal flow for which we have data
representative of the entire deal flow of this VC?
(2) Data sample validation
To support our analyses and validate our findings, of the following tests are done.
First, a correlation analysis between the ex-ante and ex-post data is made to determine
whether any salient difference exists. Ideally the analysis of the ex-ante and ex-post data should
lead to the same conclusions. This can however only be the case if the correlations between the two
data samples are high. If the correlations are low, we need to concentrate our analyses on the exante data, which we deem less prone to some of the biases presented in Section 2.6.
Second, to address the possibility of selectivity bias, we use the Heckman two-step
estimation procedure, or Heckit model9, on our ex-ante data. This analysis enables us to eliminate
biases in regression weight calculation due to censorship.
As describe by ., the following conditions need to be fulfilled to built the Heckman
model: 1) create a probit model for the propensity u, 2) compute the Mills ratio (lambda ) from
u, 3) use the Mills ratio and the model variables x to build a regression model using only the
uncensored records, record with non-zero v, and iv) apply the model to the whole dataset
suppressing the dependence on x.
The Heckman model posits i) a value w for participating in an activity (working, stealing,
etc.), ii) a propensity u for engaging in this activity, and iii) a latent correlation between
participation and value. If the correlation between participation and value is model by explicit
variables, the correction is not needed and conveniently disappears. Nonetheless, censoring does
not always hurt a model. It is sometime possible to fit an accurate model using only the uncensored
records. Censoring hurts when it is biased in the sense that it is dependant on the independent
variable w. As previously said, the Heckman model eliminates bias caused by censoring on a
variable correlated to w and the scheme is defined as follows:
V = s(u) w
where:
V: censored value. It is a directly observable value censored by a biased selection process.
w: Value. Latent Gaussian r.v.
s( ): Step function. Equal to 1 for positive u; 0 otherwise. s(u) is observable
u: selection propensity. Latent Gaussian r.v.
Having described the scheme, the Heckman model is the following:
w = xt +

Heckman developed the Heckit model to investigate the value of womens wage (J. Heckman, 1974, 1979). It uses a binary probit
model, a kind of single-neuron neural Network.

15

u = xt +
where
X: vector of observable model variables possibly governing w and u.
(beta) and (gamma): vectors model of coefficients governing "w" and "u".

(epsilon) and (eta): latent variables governing w and u.

Having described the Heckit model, we can apply this rational to our data. Here, this
procedure allows the identification and isolation of any sample specific bias due to the potential
non-representativeness of our datas sub-samples on the total data sample. For this test, it is
necessary to segregate our data by dependent variables (i.e. invested/not invested, successful/not
successful, alive/bankrupt, etc.) and then compare each cluster groups so as to determine if
significant differences exist. The influence of the unbiased criteria (e.g. Predictors) on the possible
outcomes (e.g. Dependent Variables) is then highlighted as the inverse Mill's ratio.
So, in the first step, a probit regression selection model is estimated to calculate the inverse
Mill's ratio (because the error term of this model is normally distributed, which is one of the main
assumptions underlying the Heckman model) with a dummy variable (i.e. 1 if this VC invested; 0,
otherwise) as a dependent variable (Equation 1).
Our selection equation is as follows:
Selection equation 1:
Dependent variables (DVi)i = a0 + 1 n (exa1) + 2 n (exa2) + 3 n (exa3) + ei ...
Description of the variables
Control variables
a1
a2
a3
a4
a5
a6
a7
a8
a9
a10
a11
a12

Source
Age
Country of Origin
Industry
Develop. Stage
Raising first round
Known Founder
Serial Founder
Successful Founder
Financed
OtherVcLeads_AK
OtherInvestorCommitted_AD

Predictors (exai)
exa1
exa2
exa3
exa4
exa5
exa6
exa7
exa8
exa9
exa10
exa11
exa12
exa13
exa14

Financials
ExitStrategy
ValueAttractiveness
RiskResistance
MarketPotential
Competition
Innovation
Management
Scalability
PotentialCustomers
BarriersToEntry
Partnership
ProductDevelopment
ExistingCustomers

Dependent variables (DVi)

slctd
vcsbsq
sccss
srvl

Invested by this VC
Financed by other VCs
Successful investment
Live company in Dec.04

n = Lambda n

Note that in the Heckman procedure, the residuals of the selection equation are used to
construct a selection bias control factor, which is called Lambda (), which is equivalent to the
Inverse Mill's Ratio. is a summarizing measure that reflects the effects of all unmeasured

16

characteristics, which are related to observed selectivity biases to be isolated from our investment
criteria into and additional variable, Lambda..
In a second step, the estimated probabilities (Lambda n (n)) (including the inverse Mill's
ratio to account for selection bias) are used as regressor in an Ordinary Least Square (OLS)
regression model to estimate the probability that a venture will receive VC backing. This model
employs the White (1980) robust standard error procedure that accounts the sample selectivity
separately via a heteroskedasticity10-consistent covariance matrix estimator (Equations 2)11.
Equation 2 - regression or observation equation:
y* (unobserved)='w+u

u~N(0,1 )

where y is observed (equals 1) if and only if y* is greater than 0; and y is not observed if
smaller or equal to 0. The variance of u is normalized to 1 only because, not z*, is observed. The
error terms, u and e, are assumed to be bivariate, normally distributed with correlation coefficient,
, and and are the parameter vectors.
The Heckman 2-step procedure should indicate if any selectivity bias due to sub-sampling
is present.
(3) Univariate analysis
Using our ex-ante data, we derive the significance of each selection criteria used via linear
regression for 4 situations. This gives us a preliminary description or summarization of individual
criteria. Thanks to our univariate analysis of multivariate outcomes, we can explore each variable
separately. We look at the range of values, as well as the central tendency of the values. We also
describe the pattern of response to the variable. We are conscious that linear models are very coarse
approximations of the Boolean logic underlying the mental processes. However, they are very
parsimonious, which is a key advantage for small data sets.
Yet, because deal characteristics may be inter-correlated, these univariate analyses do not
say a lot about the independent contribution of each criterion to the decision. For instance, this
VCs preference for network deals may actually be a preference for deals with good management or
conversely.
When evaluating possible limitations of our analysis, we realize that univariate analysis
alone may not be sufficient, especially for our complex yet in some case limited data sets.
Additional, and sometimes even contradictory, results may be found using multivariate analysis.
During the course of data analysis, a common practice is to include in multivariate analysis only
those variables that are statistically significant in univariate analysis. Such a habit is risky as some
10
11

A sequence or a vector of random variables is heteroskedastic if the random variables in the sequence or vector may have different
variances. The complement is called homoskedasticity. Source: Wikipedia.
The results are reported with and without allowing for sample selectivity.

18

variables not significant in univariate analysis may become significant in multivariate analysis. In
this study, we identify, with examples, four possible scenarios in which the above situation could
occur: (1) the effect of unbalanced sample size; (2) the influence of missing data; (3) an extremely
large within group variation, relative to between group variation; and (4) the presence of
interaction.
Further analysis could include principal component analysis with multivariate regression
analysis. It is highly probable that these analyses would yield entirely different findings. However
such analysis will not be covered in this version of the paper but could be part of future research.

IV. Results and Discussion

Our data can be analyzed from four different perspectives: (1) Deal Flow analysis, (2)
Investment Process Analysis, (3) Investment Criteria Analysis, and (4) Decision Model
Comparison.
4.1. Representativeness Analysis
This VC invested about Euro 140 million via three funds and created more than Euro 342
million in capital gains for its investors, generating an audited internal rate of return (IRR) of more
than 30% with an average exit multiple of 3.4. It managed to raise a new fund in 2000-2001 when
fundraising conditions were not favorable, and is still a very active investor that has made a number
of successful exits between 2001 and end of 2004.
The deal flow followed the variations of the stock market with a time lag of about one
quarter. It ranged from about 25-50 deals per quarter to a peak at 250-350 mostly early stage deals.
By the end of August 2001, this VC had invested in 62 individual ventures and made 17
follow-on investments selected from within its deal flow of 2219 deals.
The 79 investments resulted in 16 IPOs and 15 trade sales. From the remaining
investments, by the end of August 2001, only 17 firms had ceased activity, while 14 were still
active portfolio companies that in some cases had received additional financing by December 2004.
4.2. Deal Flow Analysis
Table 5 divides the information collected by the VC on each potential investment according
to a) information about deal focus in terms of Country of Origin and Industry, b) information about
the companys development stage, such as its Financing Stage, if it was Raising 1st Round
financing or if it was a Follow-up Deal, its Age, and if it already Has Revenues; c) information
about the origin of the deal, its Source, and d) information about what other VCs did, if Other VCs
lead the deal and whether Other Investors Committed; and e) information about the entrepreneur,

19

whether he was a Known Entrepreneur to the VC, a Serial Entrepreneur, and/or a Successful
Entrepreneur with a positive track record.
Table 6a and Table 6b compare the survival and the financial outcomes of the deals
received by this VC, and whether they have been financed by this VC, other VCs, or not financed at
all. Overall, it shows that this VC, on average, made 52% of Good Investment Decisions (GID),
significantly better than other VCs (29%) active during the same period (Table 6c), which confirm
this VCs above average selection skills.
In addition, after formally implementing its structured investment process in August 1999,
this VC showed a relative resistance to worsening market conditions: its success rate decreased to
36% (14/35) from 69% (18/26) while, in parallel, that of the average VC decreased steeper to 3%
from 54% (35/65) (see Table 6a).
The potential success rate of other VCs, had they followed this VC investment schedule,
would have been between 31% and 36% depending on the method, leaving an over-performance for
this VC of 16% to 21% (52% minus 31% to 36%) (see Table 6b), whether we take into account all
deals or only deals that we know became successes. Besides, this VCs over-performance also
exists within the Boom (fraction of deals invested: 9/16 = 56% vs. 13/61 = 21%) and the Fall
(fraction of deals invested 4/11 = 36% vs. 1/32 = 3%) of the financial markets (Table 6a). This
would tend to show that this VC was more successful than other VCs in selecting future profitable
deals.
Overall, as demonstrated in Table 6b, this VCs performance should qualify it as a
successful VC worthy of being considered for an insightful academic study.
4.3. Investment Process Analysis
Within its investment process, this VC defined itself 7 due diligence stages. The most
selective stages were the Manager (only 27% of the deals passed through), then the Team (32%),
then the Screening (61%) and finally the Investment Committee (IC) (80%). Table 5d shows that all
due diligence stages except the IC were good at identifying future successes from future failures,
thereby making good investment decisions. It seems that the Investment Committee (IC) actually
made, proportionally, the worst rejection decisions.
4.4. Investment Criteria Analysis
Background
Researchers generally agree that the VCs espoused criteria are not the sole basis for the
VCs investment decisions (Pries and Guild, 2002). A priori, VCs decision to invest in a specific
deal, or to promote it to the next level of due diligence, is an obscure, implicit mental and social
process integrating information about deals, market conditions, and VCs fund requirements. Many
factors may enter into consideration when a VC makes an investment. The ultimate objective of

20

decision analysis is to translate a decision into a structured set of explicit rules. If we suppose that
financial success is a major objective of VCs, we can expect these rules to be predictive for success.
For VC investors, a great differentiation can be made between survival goals and success
goals, as companies pursuing survival goals may require different strategies and resources than
those aiming for a rapid financial success. Accordingly, VCs focused on the maximization of
financial profits for their investors and themselves may pursue different investment strategies as
they get relatively little rewards for creating strong stable businesses that can not be sold quickly
with a large profit
As discussed above, the investment criteria can be examined from at least 5 angles: (1)
What the VC, during our interviews, says it does its Espoused Criteria; (2) what it does its
Enacted Criteria, and (3) what other VCs do differently, (4) what it reports ex-post to have done via
an ex-post questionnaire, and (5) what this VC should do.
(1) Interview Analysis
From our interviews we obtain this VCs espoused investment decision rankings for its
14 criteria by order of importance, as follows:
High Importance:

(1) Management, (2) Scalability, (3) Barriers to Entry, (4) Exit

Potential.

Medium Importance:

(1) Financials, (2) Valuation (Attractiveness of Valuation),

(3) Innovation, (4) Potential for Partnerships, (5) Market potential.

Low Importance:

(1) Risk, (2) Competition, (3) Potential Customers, (4) Product

development, (5) Existing Customer Base.

We also learn that this VC explicitly considers as key investment criteria: a) how, at the
pre-screen/sourcing stage, the deal fits with its investment focus in terms of Country/Location,
Industry, and Financing Stage; and then b) how the deal scored on its 14 quantitative evaluation
scales, at all stages. Other information recorded in the database such as the age of the firm, the
source of the deal, the entrepreneur profile, and the investment round were not spontaneously cited
as investment criteria. We observe however that this VCs 14 investment criteria fall within 4 main
categories already identified in many previous publications (i.e. Vinig and de Haan 2001,
Zacharakis 1995).
Criteria analysis - Differences between 3 criteria types
Hypothesis 1: Espoused criteria data are different from enacted criteria data and aposteriori reported criteria data, which leads to significant differences in analyses results
depending on the data sample type used.
As described in Section 3.3, to test Hypothesis 1, we perform a comparative analysis of the
ex-ante/ex-post correspondences in order to evaluate the extent of potential biases. As presented in

21

Table 7, the low correlation between ex-ante and ex-post evaluation criteria based on their ability to
predict the VCs investment, deal survival and/or success shows that the data contained in the
ex-post questionnaire answers does not accurately reflect the VCs written deal evaluation at the
time of due diligence.
The scales that deviate the most between the ex-ante and the ex-post data are for the more
subjective criteria: Management, Financials, Exit Potential, Valuation, Potential Customers, and
Existing Customers. This observation is consistent with Dubini (1989), Goslin and Barge (1986),
and Gorman and Sahlman (1989) that assert that the evaluation of subjective criteria such as
Managerial Capabilities is challenging (see also Rah et al., 1994).
Looking at the potential causes for these deviations, from Table 6b, we observe that ex-post
knowledge does not help this VC to predict other VCs investment decision, suggesting that the
bias is specific to this VCs ex-post knowledge of its own decision, not of other VCs decisions. In
Table 7b, we test two potential reasons for this bias:
(1) Ex-post knowledge
Ex-post evaluation could be influenced by additional knowledge about the financial
outcomes of the deals. If so, lasting interaction with financed ventures should result in higher extraknowledge, and thus in more bias. Accordingly, Table 7a shows that the discrepancy between
ex-post and ex-ante ratings significantly12 decreases when only considering the rejected deals. This
tends to confirm that ex-post knowledge did bias retrospective questionnaire responses.
(2) Forgetting
Ex-post data could explain an increasing fraction of investment decision variance at later
due diligence stages. This suggests that ex-post information underestimates what happens at earlier
stages, probably because this VC better remembers deals it evaluated more in detail. Also, this VC
might be inclined to forget information about older deals and better recollect information on more
recent investment opportunities. Indeed, a majority of correlations get significantly13 better when
only recent deals are considered (Table 7a). In addition, the ex-post knowledge bias mentioned
above may not have taken affect yet since the outcome is still unknown for these younger deals.
Overall, the discrepancies between VCs ex-ante and ex-post evaluations seem to have
several causes, including forgetting and a posteriori knowledge. Although conclusions have to be
drawn carefully because our sample size is modest, it tends to support as Zacharakis and Meyer
(2001), which observes that when more or newer information becomes available to a particular
decision, the VC's ability to introspect about that decision process diminishes.
As Hypothesis 1 is supported, we decide arbitrarily to pursue our data analyses using
primarily our ex-ante data to reduce ex-post knowledge related biases.

12
13

p<0.06 , chi-2 test for equality of distributions of correlated scales (at 90% confidence level or more).
p<0.02 , chi-2 test for equality of distributions of correlated scales (at 95% confidence level or more)

22

(2) Enacted Criteria Analysis

Predictors of Investment
Hypothesis 2: The 14 selection criteria Management, Innovation Potential, Stage
of Product Development, Resistance to Risks, Scalability, Barriers to Entry,
Existing Customer Base, Customer Potential, Potential for Partnerships, Market
Potential,

Competition,

Financials,

Exit

Potential,

and

Valuation

Attractiveness are statistically significant predictors of investment.

Before presenting our data analyses results a word of caution is necessary. Indeed, our
results could be also biased by the VC specific investment motivation as it may not care about
ventures survival, but only about spectacular successes. In this case, for the VC, it may be optimal
to invest in deals with lower survival probability if the return (e.g. Internal Rate of Return or IRR)
probability is high. However, during our interviews, this VC did not specifically express this as a
strategic objective, although it was aware of its effect. The VC explained that at the time of
investment its return expectations were high for all deals and it was equally enthusiastic about all
initial investments without knowing which ones would be spectacularly successful.
As described in Section 3.3, via univariate analysis using our ex-ante data, we determine
the criteria that were both decisive (e.g. used by this VC for its investment decision), predictive of
survival, and/or of success, and encounter the following four situations:
Decisive and Predictive
As shown in Table 8, both the quality of the Management and the Financials of the
company are Decisive and Predictive since they are significantly correlated to this VCs decision to
invest, the subsequent investment by any VC, and the deals survival. In addition, they are also
decisive for other VCs, which suggests their universal value, in line with published literature (i.e.
Kaplan and Strmberg, 2004; Kaplan et al., 2005a). Finally, they correlate positively with our expost data, suggesting that this VC also perceives them as a decisive investment criteria ex-post.
Accordingly, it is cited as a moderately important espoused factor by this VC, congruent with the
fact that they are decisive factors also for others (ex-ante and ex-post), in line with studies on VCs
espoused criteria (i.e. Hall, 1989, and Fried and Hisrich, 1994).
Management is decisive, cited as highly-important by this VC, and almost all
espoused criteria studies (i.e. Tyebjee and Bruno, 1984; Hall, 1989; Fried and Hisrich, 1994; and
Boocock and Woods, 1987). This would tend to show that VCs may attribute deal
successes/failures to management rather than to other deal characteristics. If so, one would expect
the VC to upgrade ex-post its ratings of the management of successful ventures. This assumption
could not be tested on this VCs deals due to the limited sample size and was not verified on all
deals since ex-post management ratings also do not correlate to survival or success.

23

Another explanation could be that, although financial success is important for VCs, it may
not be their only objective. Highly-rated management would be decisive because it predicts easier
work partners, fewer critics from investors, or even learning from entrepreneurs. To solve this
mystery, we would need more cases of paired ex-ante/ex-post ratings of portfolio companies
(successes and failures) and alternative measures of success, beyond financial success, such as
VCs intellectual and social satisfaction from working with each company.
Decisive, but not predictive
Financials, Potential Customers are decisive criteria but seem not to be highly
predictive of venture survival, especially in comparison to other criteria. However, from this VCs
ex-ante data, it is not predictive at all, whatever the model and the period considered. It is even
negatively correlated with success, which is consistent with Kaplan et al. (2006).
Predictive, but not decisive
Although it was cited as a highly-important criterion by this VC in our interviews and is
also often cited by other VCs, Barriers-to-Entry was not significantly used by this VC for its
investment decision, although it is predictive for venture survival.
How could this VC know it is a highly important criterion and not apply it? One
explanation could be that this VC only realized the importance of Barriers-to-Entry later on. This
VC might have used this information to update its espoused criteria only at the time of interview.
Such an update would be possible since Barriers-to-Entry correlates to survival and success expost (see Table 7a).
Not predictive, not decisive
The criterion Scalability seems neither predictive nor decisive; but considered as a
highly important espoused criterion by this VC (see Table 9). Indeed, this VC does not use it
significantly for its decision, it is not useful as it is not predictive, but initially in our interviews the
VC claims that it is! When only looking at the ex-post ratings, Scalability appears predictive of
survival and success. Worse, ex-post, this VC has the right impression that it does not use this
criterion. During our feedback interviews, this VC could not give any explanation to this finding.
Therefore for Hypothesis 2, criteria Deal Value, Deal Source, and Follow-up
Financing are statistically significant predictors of VC investment, whereas Scalability is not
(even though this VC claims ex-post that it is).
Table 8 shows that the most significant predictors of the VCs investment are the quality of
the Management Team and the Financials outlook of the company. Next in line are the companys
Market Potential, Potential Customers, and Resistance to Risk. Therefore Hypothesis 2a could only
be partially supported since not all criteria were predictive of this VCs investments.
Not surprisingly, this VC preferentially selected deals that were: not from Eastern Europe;
in Financial Services and Telecom, but not in Telecom Services and Consulting; at a Public/Spin-

24

Off financing stage, but not at seed/start-up (even though the former were much rarer in the deal
flow); not raising their 1st round; sourced actively or from its network, not passively sourced; lead
by other VCs; in which other investors already had committed to invest; with a known, serial or
successful entrepreneur; and well rated on almost all 14 evaluation scales and factors.
Predictors of Success
Hypothesis 3a: The 14 selection criteria Management, Innovation Potential, Stage
of Product Development, Resistance to Risks, Scalability, Barriers to Entry,
Existing Customer Base, Customer Potential, Potential for Partnerships, Market
Potential,

Competition,

Financials,

Exit

Potential,

and

Valuation

Attractiveness are statistically significant predictors of venture success.

The univariate analysis in Table 5a shows some correlation between some deals
characteristics and success: Media industry; Pre-IPO stage; ratings of Risk, Competition (scale and
factor), and Partnerships. Among this VCs investments, we could also correlate Return on
Investments (e.g. ROIs) to deals; not from USA; not in Retail industry; Pre-IPO stage; not 2-3
years of age; and not with successful entrepreneurs. ROI was also correlated with ratings on
Financials, Competition, and Barriers scales, but only within the 80% confidence interval.
Therefore, Hypothesis 3a is supported, but only for a few criteria and with a lot of caution
due to the low sample size.
Although we suspect that Market Conditions may be a significant predictor of venture
success, we could not fully clarify our suspicion. Unfortunately, our 198 ex-ante rated deals only
contain 7 successes so the statistical significance is low, especially across periods.
While this VC decreased its investment size per deal with time, it kept its investment rate
per quarter almost constant. This was beneficial, since Market Condition was the best predictor of
success. For this VC, we cannot assess however if its good investment timing was the result of an
intelligent investment strategy or the automatic consequence of its funds inception dates.
First, VC-backed ventures achieve a higher survival rate than non-VC backed businesses
(Kunkel an Hofer, 1990, Sandberg, 1986, Timmons, 1994). Tyebjee and Bruno (1984) asks VCs to
evaluate previously examined plans on 23 criteria using a four-point scale and reduces these criteria
via factor analysis to five underlying dimensions namely (1) Market Attractiveness (size, growth,
and access to customers), (2) Product Differentiation (uniqueness, patents, technical edge, profit
margin), (3) Managerial Capabilities (skills in marketing, management, finance and the references
of the entrepreneur), (4) Environmental Threat Resistance (technology life cycle, barriers to
competitive entry, insensitivity to business cycles and down-side risk protection), (5) Cash-Out
Potential (future opportunities to realize capital gains by merger, acquisition or public offering). It
finds that investment decisions can be predicted from the perceptions of risk (e.g. new venture
failure) and return (e.g. financial performance).

25

Predictors of Survival
Hypothesis 4: The 14 selection criteria Management, Innovation Potential, Stage
of Product Development, Resistance to Risks, Scalability, Barriers to Entry,
Existing Customer Base, Customer Potential, Potential for Partnerships, Market
Potential,

Competition,

Financials,

Exit

Potential,

and

Valuation

Attractiveness are statistically significant predictors of venture survival.

Table 8 shows that Barriers-to-Entry, Resistance to Risk, Management, and Innovation
were the most predictive criteria, followed by Financials. Most of these criteria are related to risk
management so it could be logically expected to find them as greater determinants of venture
survival. Investors concentrating mostly on Resistance to Risk and Barriers- to-Entry
Company survival does not mean financial success, although they correlate across quarters
(coefficient .58, p<.001).
Taken together, the present results only partly support the Hypothesis 4.
Ex-Post Data Analysis
Similarly, looking at our ex-post data, one would conclude that this VC thinks it can predict
well survival. These findings support Zacharakis and Shepherd (2001), which observes that, in
addition to lack of introspection, VCs seem to be overconfident in their decision process, which
impacts negatively their performance.
Ex-post, this VC seems to infer that Barriers to Entry, Innovation, Competition and
Scalability are key predictors of survival and success. These findings to some extent contradict the
findings from the ex-ante data.
In support of Shepherd (1997) and Zacharakis and Shepherd (2001)s conclusions, our
studys findings would be substantially different had it not been for the availability of this VCs exante data.
(3) What other VCs seem to do differently
Using the same methodology as above, we can derive the criteria used by other VCs.
Univariate analysis shows us that many deal characteristics also correlate with investment by other
VCs. Deals financed by other VCs are also better rated by this VC on Competition factors and
reach higher stages of due diligence than the deals that did not get any financing. This suggests that
this VC and other VCs share some common opinions on what constitutes a good investment
opportunity.
Interestingly, during the boom, other VCs continued on average to invest more in
speculative deals, as rated by this VC: with big market potential, innovation capabilities, in the
telecom industry but with no existing products/partners/customers, with bad financial ratings, and
low scalability. More information on collective VC investment dynamics derived from the same
data set can be found in Kaplan et al. (2005a).

26

Therefore, we note that this VC seems to have different investment patterns than the
average other VCs and may have been more successful at adapting early to changes in market
conditions, a significant predictor of investment success. More research could be undertaken in this
area as well.
4.5. Decision models comparison
Zacharakis and Meyer (2000) focus on the task of screening venture proposals without
unduly rejecting high potential investments. Participants capacity to select the right investments is
compared to the predictions of (1) a bootstrap actuarial mode, structured to capture the cognitive
system of a decision-maker, which uses information factors previously identified by VCs as being
most important to making good investments decisions and (2) a second actuarial model based on
the findings of Roure and Keeley (1990), who identified predictors of success for technology
ventures. On predictions of success and failure, the bootstrap model outperformed all but one
venture VC (who achieved the same hit rate as the bootstrap model), and the Roure and Keeley
model outperformed over half of the VCs.
Zopounidis (1994) presents an overview of published VC investment decision models and
their relative performances. Mainprize et al. (2002) also presents an overview of the performance a
few models developed via conjoint analysis or plain bootstrapping. These two studies allow us to
compare the performance of this VCs actual decision model to other published models. The
outcome of this analysis is presented Table 9. It shows that this papers decision model fends
favorably to the decision models developed by researchers in laboratory contexts via various forms
of a-posteriori data collections and analyses.
Table 9 also shows that this VC, on average, made 52% of Good Investment Decisions
(GID), significantly better than other VCs (29%) active during the same period, which confirms its
selection skills. In addition, after formally implementing its structured investment process in
August 1999, it showed a relative resistance to worsening market conditions: its success rate
decreased to 36% (14/35) from 69% (18/26) while, in parallel, that of the average VC decreased
steeper to 3% from 54% (35/65).
A number of studies across a variety of decision contexts have found that such models often
outperform actual decision makers (see Camerer, 1981; Dawes, 1971; Osherson et al., 1997;
Zacharakis and Meyer, 2000). For additional detailed discussions on VC investment decision
modeling, please refer to Riquelme and Rickards (1994), Zacharakis and Meyer (2000), Shepherd
and Zacharakis (2003), Rider (2005), etc.

27

V. Conclusion and Future Research

This study analyses the investment process, investment criteria, and investment
performance of a single VC while attempting to limit known biases that have influenced the results
of previous studies. This study also attempts to tie its findings to the published theoretical
framework on VC investment criteria.
We show that, with access to ex-ante data, it is possible to explore and compare empirically
what a VC says it does, what it effectively does, what it should have done, and how it may differ
from what other VCs do.
Using our ex-ante data, we identify investment criteria that are both decisive for VC
investment, and/or predictive of deal future survival and/or venture subsequent success.
The comparison of the ex-ante data and the ex-post data highlights significant differences,
especially on the more subjective criteria. The differences confirm that our studys findings would
be substantially altered if they were solely based on the analysis of ex-post questionnaire answers.
This supports recent studies that highlight the poor introspection skills of VCs. Also, in support of
Zacharakis and Shepherd (2001), our findings confirm that in its ex-post questionnaire responses,
the VC displays overconfidence in its decision process and its predictive capabilities.
With regards to predictors of deal success, the criteria Business Potential and Barriers to
Entry were both significantly predictive. However, a deals financial success could have been
mostly determined by market conditions and/or country and industry, while the unique contribution
of the Deal Value factor to success prediction is nil. However, we feel that to support these findings
more research is needed with a larger dataset possibly from multiple VCs.
We note that most significant selection criteria of the VC were Management and
Financials and that the two criteria determining success were exactly the same. It proves that the
VC had correctly identified the right criteria to invest if it wanted to follow a strategy for success.
Although it did not directly admit it, it was obviously following such a strategy of success. This is
evidenced by its track record where few deals were outstanding success that more than
compensated for the numerous total write-offs in the portfolio.
With respect to predictors of deal survival, this study shows that a companys
characteristics could predict in part its survival 3 to 5 years later, irrespective of it receiving further
financing rounds and market conditions. Furthermore, Barriers-to-Entry was the most predictive
factor of company survival, followed by Business Potential (Market, Competition and
Innovation) and Deal Value.
The comparison of our investment decision model with those in published studies shows
that our model rates favorably with respect to investment successes, the main driver of a VCs
financial performance.

28

The use of checklists, scorecards, and templates for rating potential investments could be an
important initial step into formalizing an investment process. This area would benefit from further
definition of robust scales based on empirical results, as suggested by our findings in Section IV.
According to our results, scales should be constructed from ex-ante findings, since ex-post findings
do not give similar information structures. While ex-post introspection may help VCs improve in
the long term their performance, systematic recording of investment decision justifications live
(ex-ante) may bring more accurate results.
Our analyses also confirm that VCs could probably benefit from being able to
retrospectively analyze its deal flow to refine its investment criteria, as we have done, thereby
improving its effectiveness at selecting successful investments more systematically. However, a
cross-sectional study on many VCs would be necessary to get more information on the potential
added value of each element. Unfortunately, access to similar ex-ante cross-referenced data from
multiple VCs is difficult to obtain.
Indeed, it is logical that VCs update their criteria on the basis of the information they can
remember on deals at the time they learn about the outcome, typically 2 to 5 years after investing. If
this ex-post information differed from the ex-ante information used at the time of the investment
decision, VCs would not be able to improve their criteria. If we suppose that VCs can learn from
the outcomes of their decisions, we also expect that VCs increase their predictive power with
experience. Finally, if we suppose that VCs have strategic intelligence, they should adapt their
investment criteria to changing market conditions. However, until now, little research evidence
exists that demonstrates that specific deal selection skills impact performance.
Further research is also needed on VCs investment strategies with respect to the fact that a
fund has a defined number of years within its lifespan when it can make investments. The time
window of a funds investment opportunity should influence investment managers investment
appetite and investment strategy. Intuitively, one could expect that VCs invest in earlier stage
ventures at the beginning of a funds life and then gradually invest more in later stage transactions
(including follow-on investments for early deals) as the investment period ends. VCs would be
motivated to do this because during the second part of their funds life, the harvesting period, they
would want to exit all their investments. If they had invested at the end of their investment phase in
early stage deals, VCs would probably not be able to do follow-on investments with the same fund,
due to investment guideline restrictions. Unfortunately, the data set used for this study did not allow
for extensive or conclusive analysis of this phenomenon.
Unfortunately, this study does not show the interactions between selection criteria and
market conditions. Future research using a large enough sample size per period and covering a
whole investment cycle could be very revealing.
It is important to mention that while the actual criteria included the criteria that were
significant for the survival and/or the success of venture, the selection of the investment was only

29

part of the beginning of the value creation process aimed at generating outstanding returns for its
investors. This value creation, while crucial, falls outside the scope of this study, but could certainly
benefit from further in-depth research.
Although many questions still remain open for future study, researchers are making
progress towards unraveling the VC investment process and investment success/survival predictors.
These efforts should assist investors in avoiding poor investment decisions in the future; especially
in booming markets when irrational behavior may occurs (see Kaplan et al. 2005a).

Acknowledgements
No paper is solely the effort of its author. For their valuable inputs and support, I am also
grateful to all VCs who participated in the study and provided essential insights. Finally, I want to
thank Professor Didier Cossin, Professor Autio Erkko, Professor Benoit Leleux, Professor Per
Stromberg, and Professor Steve Kaplan for their academic support.

30

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38

39

Cashing out

Deal origination

n/a

Post Investment
Activities
n/a

Deal Structuring

n/a

n/a

Evaluation

n/a

Screening

n/a

Post Investment
Activities
n/a

Deal Structuring

Due Diligence

n/a

n/a

n/a

Initial Screening

Search

(1985)

Silver

Source: Hall and Hofer (1993), Boocock and Woods (1997) and our Reference VC

n/a: not applicable

(a) Venture Board

Meetings
(b) Venture Operations

n/a

n/a

Evaluation

n/a

n/a

Screening

Search

(1984)

(1974)

Tyebjee and Bruno

Wells

Stages of
decision
makingprocess

n/a

n/a

n/a
Cashing out

n/a

Closing

Second phase
evaluation

n/a

First phase evaluation

Generic screen

Firm-specific screen

Deal Origination

(1994)

Fried and Hirsch

Venture operations

Deal Structuring

Due Diligence

n/a

Evaluation

Proposal Assessment

Screening

Generating a deal flow

(1989)

Hall

Comparison of the Venture Capitalists investments process stages described in 6 studies and from this VC.

Table 1 VC Investment management process

Cashing out

On-going monitoring of
investments
n/a

Deal structuring

Due Diligence

Board Presentation

Second Meeting

First Meeting

Screening

Generating a deal flow

(1997)

Boocock and Woods

Cashing out / Exit

Screening Stage (Investment

manager/Assistant)
Investment manager Stage
(Manager/Challenger)
Team Stage (no costly Due
Diligence approval)
Investment Committee (IC) Stage
Formal Due Diligence
Approval
Investment Committee Investment Approval Stage
On-going monitoring / Value
Creation
n/a

Pre-Screen Stage (Assistant)

Deal Origination

(2006)

Our Reference VC

Appendices

Table 2 Summary of Past Studies: Overview of the Investment Criteria

A) Overview of research method, sample sizes, data sample and analysis method
Wells Poindexter
STUDY 1974
1976
Type of research
Criteria research
Processual Research
Sample size
VCF
VCs
Investments
Proposals/applications
Profiles
Type of proposals assessed
None in specific
Proposals under consideration
Successful investments
Unsuccessful investments
Hypothetical ventures
Context of the study
Developed equity market
Cross-national comparison
Transition economy
Emerging equity market
Small equity market
Data gathering method
Interviews
Questionnaires
Archival records search
Verbal protocols
Experiment (full profile)
Experiment (trade-offs)
Participation observation
Data analysis method
Descriptive statistics
Content analysis
Factor analysis
Discriminant analysis
Cluster analysis
Conjunctive modelling
Disjunctive modelling
Regression analysis
Conjoint analysis

Tyebjee
Bruno
1981

Tyebjee
Bruno MacMillan MacMillan Khan
1984 et al. 1985 et al. 1987 1987

Robinson Timmons
1987
et al. 1987

Sandberg et Riquelme
al.
Rickards
1988
1992

Hall
Hofer
1993

Fried
Hisrich
1994

Knight
1994

Muzyka
et al.
1996

18

429

73

Boocock
Woods
1997

Karsai
et al.
1997

Tan
1997

Zacharakis
Meyer 1998

Bliss
1999

Shepherd
1999

51

6
6

47
66

Boehm
(2002)

Silva
2004

X
X
8

97

41
46

100
14

67

36

150

104

53

1
1

90

13

16

31
9

232

16

40
X

50

X
X
X

X
X

X
X

39

X
X

X
X

1
9

X
X

X
X

X
X
X

X
X

X
X

X
X

X
X

X
X

X
X

X
X

X
X

X
X

X
X
X
X

X
X

X
X

X
X

X
X

X
X

X
X

X
X

X
X
X

X
X

VCF: Venture Capital Fund; VCs: Venture Capitalists

40

Table 2 (continued)
B) Overview of investment criteria identified in past research

Study

Wells
(1974)

personal
Method interviews
Sample Size
Entrepreneur/Team Characteristics
Mgmt. skills/Leadership
Completeness of team
Marketing Skills
Mgmt. Financial skill
Mgmt. stake in firm
Articulate about venture
Personal motivation
Capable of sustained effort
Ability to evaluate risk
Relevant track record
Market familiarity
Entrepreneur personality
References
Product/Service Characteristics
Product attributes
Proprietarity
Uniqueness/differentiation
Technical edge / Innovation
Stage of development
Technology life cycle
Expected profit margin
Project Growth in Turnover
Resistence to risk
Scalability
Barriers to entry
Product superiority
Existing customer base
Market acceptance/interest
Potential for partnerships
Prototype / R&D Level
Market Characterisitics
Market size
Market growth/potential
Projected market share
Competitive strength/ number
Sensitivity to business cycles
Buyer concentration
Venture creates new market
Financial Characteristics
Cash-out method
Expected rate of return
Expected risk
Percentage of equity
Investor provisions
Size of investment
Funding base
Liquidity of investment
Valuation
Other
Continuity of company
Geographic location

Poindexter
(1976)

Ruby
(1984)

questionnaire

97

Siskos &
Tyebjee & MacMillan et MacMillan et Zopounidis
Bruno (1984)
al. (1985)
al. (1987)
(1987)
phone survey
&
questionnaire questionnaire questionnaire
46 (study 1)
41 (study 2)
100
67
1
X
X
X
X
X
X
X
X

Information Factors used in VC decision

Hisrich &
Robinson
Timmons et Jankowicz
(1987)
al. (1987)
(1990)

questionnaire
53
X
X
X

Roure &
Keeley
(1990)

unstructured
interviews
47
X
X

X
X

Hall &
Hofer
(1993)

Interviews

verbal
protocol

36

30

X
X
X

X
X

Dixon
(1991)

16
X
X

X
X

X
X
X
X
X

X
X
X
X

X
X

X
X

X
X

Boehm
(2002)

Beim
(2004)

Kaplan &
Stromberg
(2004)

OUR
DATA
(2006)

X
X

Fried & Hisrich Muzyka et al.

Boocock &
Zacharakis &
(1994)
(1996)
Woods (1997) Meyer (2000)
personal
personal
personal interview & interview &
interview &
Personal
questionnaire
questionnaire questionnaire
Interview
10 interviews 74
questionnaires
18
73
1
X
X
X
X
X
X
X
Rah et al. (1994)

X
X
X
X
X
X

X
X
X
X

X
X
X

X
X
X

X
X
X
X
X
X
X

X
X

X
X

X
X
X
X

X
X

X
X

2
3

X
X

X
X

4
5
6

X
X

X
X
X

X
X

X
X

X
X

X
7
8
9

X
X

X
X

X
X

X
X

X
X

X
X

X
X

X
X

X
X

10

X
X

X
X

X
X

11

X
X
X

X
X

X
X
X
X
X

X
X

12

X
X

13
14
X
X

mgmt: management ; mkt: marketing ; entr: entrepreneurial

Source: Zacharakis and Meyer (2000,

41

Table 2 (continued)
C) Overview of success criteria identified in past research
VC investment criteria predictors of venture success
Freeman
et al.
Study (1972)

Method

Sample Size
Entrepreneur/Team Characteristics
Mgmt. skills/Leadership
Completeness of team
Marketing Skills
Mgmt. Financial skill
Mgmt. stake in firm
Articulate about venture
Personal motivation
Capable of sustained effort
Ability to evaluate risk
Relevant track record
Market familiarity
Entrepreneur personality
References
Product/Service Characteristics
Product attributes
Proprietarity
Uniqueness/differentiation
Technical edge / Innovation
Stage of development
Technology life cycle
Expected profit margin
Project Growth in Turnover
Resistence to risk
Scalability
Barriers to entry
Product superiority
Existing customer base
Market acceptance/interest
Potential for partnerships
Prototype / R&D Level
Market Characterisitics
Market size
Market growth/potential
Projected market share
Competitive strength/ number
Sensitivity to business cycles
Buyer concentration
Venture creates new market
Financial Characteristics
Cash-out method
Expected rate of return
Expected risk
Percentage of equity
Investor provisions
Size of investment
Funding base
Liquidity of investment
Valuation
Other
Continuity of company
Geographic location

Dorsey
(1979)

Hambrick
Gorman &
& Corsier MacMillan et MacMillan et
Sahlman
(1985)
al. (1985)
al. (1987)
Kahn (1987)
(1989)

questionnaire

questionnaire

100
X
X
X

67
X
X

Stevenson &
Jarillo
(1990)
Rah et al. (1994)
personal
interview &
questionnaire

Zacharkis
(1995)

Zacharakis
(1997)

Gartner et
al. (1998)

Riquelme
& Watson
(2000)

Schefczyk
(2001)

Pries
(2001)

Mainprize et Molander Kaplan et

al. (2002)
(2005) al. (2006)

OUR
DATA
(2006)

10 interviews 74
questionnaires
X

X
X
X

X
X
X
X
X
X

X
X

X
X
X

X
X

X
X
X
X
X
X

X
X
X
X

2
3

4
5
6
X
X

X
7
8
9

X
X

X
X
X

X
X

X
10

11

X
X

12

13
14

mgmt: management ; mkt: marketing; entr: entrepreneurial

Source: Zacharakis and Meyer (2000)

42

Table 2 (continued)
D) Overview of survival criteria identified in past research
Information Factors used in VC decision

Study

Wells
(1974)

personal
Method interviews
Sample Size
Entrepreneur/Team Characteristics
Mgmt skills
Completeness of team
Mgmt stake in firm
Articulate about venture
Personal motivation
Capable of sustained effort
Ability to evaluate risk
Relevant track record
Market familiarity
Entr. personality
Product/Service Characteristics
Product attributes
Proprietarity
Uniqueness/differentiation
Technical edge
Technology life cycle
Expected profit margin
Product superiority
Mkt acceptance/interest
Time to development
Prototype
Market Characterisitics
Mkt size
Mkt growth
Barriers to entry
Competitive threat/ number
Sensitivity to business cycles
Buyer concentration
Competitor strength
Venture creates new market
Financial Characteristics
Cash-out method
Expected rate of return
Expected risk
Percentage of equity
Investor provisions
Size of investment
Liquidity of investment
Other
References
Venture development stage

Poindexter
(1976)

questionnaire

97

X
X

X
X

X
X
X

Tyebjee &
MacMillan MacMillan
Robinson Timmons et
Bruno (1984) et al. (1985) et al. (1987)
(1987)
al. (1987)
phone survey
&
unstructured
questionnaire questionnaire questionnaire questionnaire interviews
46 (study 1)
41 (study 2)
100
67
53
47
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X

X
X

X
X

Roure &
Keeley
(1990)

Hall &
Hofer
(1993)
verbal
protocol
16
X
X

Fried &
Muzyka et al.
Hisrich (1994)
(1996)
personal
personal
interview & interview &
questionnaire questionnaire
18
X

73
X
X
X

X
X

Boehm
(2002)

X
X
X
X

X
X

X
X
X
X

X
X
X

X
X
X
X

X
X

X
X

X
X

X
X

X
X
X
X
X
X
X

X
X

X
X

X
X
X

X
X

X
X

mgmt: management; mkt: marketing ; entr: entrepreneurial

Source: Zacharakis and Meyer (2000)

43

Beim
(2004)

Table 3 - The reference VCs investment process nine stages

1.

Deal Origination 1

(1) Passive Deal Flow : this VC received

A number of broadly distributed investment opportunities via its membership
- in its national Venture Capital Association
- in the European Venture Capital Association .
Investment opportunities via a link on its website.
These three sources were all deemed to be unsolicited requests and filed as passive deal flow.
(2) Network sourced deal flow
Sourced through the VCs network came via the investment managers and partners
extensive network of contacts within the TIME industry and the VC community.
Other VCs often referred deals in an effort to syndicate investments.
This VC also originated deal flow via the investors in its funds and the entrepreneurs that it
had already financed, Angel Investors, other VCs, managers in portfolio companies, etc.
(3) Actively sourced deal flow
Generated via the investment managers participation in TIME trade fairs, VC seminars,
portfolio companies, and university sponsored events.
Deals where the VC took a pro-active role in obtaining access to the investment opportunity
were considered active deal sourcing for the purpose of our analysis.
2.

The Pre-Screening Stage (Assistant)

Assistants review the material forwarded by the entrepreneurs.

If the project is considered to be in this VCs investment scope
st
- assistants ensure that all the information required for a 1 screening was collected
- Investment criteria templates would begin to be filled at this level.
Common reasons for deal rejection at this stage would include:
1) Project/company not in the focus of this VC
2) Technology deemed uninteresting or dj-vu
3) Non scalable business relying on charging its clients by the hour (i.e. consultants,
lawyers, etc.)
4) Complex technology not presenting a clear business opportunity.
3.

The Initial Screening Stage (Investment manager/Assistant)

Investment Managers
- Review the business plan
- Assess the investment opportunity.

This process entails

- Completing the templates within the VCs electronic archiving of the deal,
- Contacting the company to answer company specific questions on business plan,
technology, and expectations.
This VC eliminated 61% of the deal flow within the Pre-Screen Stage and the Initial Screening Stage.

4. Investment stage (Manager/Challenger )

A different investment manager is designated as investment challenger whom role is
- To review the documents already received, including the investment manager and assistants
comments
2
- To find all the reasons why the project should not progress to the next stage
To best prepare the investment case before moving to the next stage or drop the investment
opportunity all together, both sides challenge each others position.

27% of the deals received at this stage3 were presented to the VCs Team for next stages.

1
2

This VCs motivation to generate a quality deal flow can be demonstrated by the 26% of investment opportunities that received some form of VC
financing (Table 5a).
i.e. business plan without enough information on the market potential, high degree of competition, the budget, potential market too small, late comer
in an established market, low margin business, etc.

44

Table 3 (continued)

5. Team Q&A presentation stage

This stage was meant to anticipate and answer the questions that could come from the Investment
Committee. It consists of weekly meeting in which all the VCs investment managers (partners
investment managers, plus sometimes junior analysts)
- review the entire deal flow pipeline
- discuss the current projects being worked on and the issues they had.
4
- considered the first deals with the highest priority deals
5
At this stage no expensive due diligence steps
Once the team felt that the deal was ready, the investment manager would present it to the
Investment Committee.

The Team forwarded 32% of the deals it received to the Investment Committee for further evaluation.
6. The Investment Committee - Due Diligence Approval

Monthly meeting: the Investment Committee (IC), composed of investors in the fund and senior
investment managers, meet to discuss the status of the current portfolio and new investment
opportunities.

Due diligence costs:

- Formal IC approval is necessary for charging these costs to the fund (as Transaction Specific
Costs), as opposed to being included in the VCs Management Fee for running the fund.
- These fees would also be charged directly to the fund if the potential investment was later
rejected (in which case they would be considered Break-Up Fees).
- The due diligence would include two parts:
1) A technical due diligence
2) A legal due diligence.

7. The Investment Committee - Investment Approval Stage

Once the due diligence is approved, the investment manager organize a meeting with the IC to
discuss the specific investment opportunity and review the completed due diligence.
At this stage IC:
- Is familiar with the potential investment
- Formalizes approval of the investment. This decision will be recorded in the minutes of the IC
meeting and would be added to the VCs file on the investment.
8. Monitoring and Value Creation
Once this VC was invested in a deal, the investment manager who had acted as the deals internal
sponsor was put in charge of the relationship with the entrepreneur and his company.
The investment managers responsibilities:
- Monitoring the progress of the company
- Pursuing the possible partnership opportunities that had been identified during the due
diligence, both with companies already in the VCs portfolio and outside
- Identifying opportunities for growth, generating sales leads, etc.
VCs also get deeply involved in follow-on financing rounds. It is in their interest that the
companies in which they have invested receive additional financing at attractive valuations, via
up rounds.

9. Exit
When an investment developed into an attractive acquisition target, the VC tends to orient the
company to an exit.

Already during the due diligence stage, the VC would have identified potential future buyers to
evaluate trade sales opportunities.
The VC plays an important role in negotiating the terms of the acquisition with the buyer. When the
IPO route was chosen as the value maximizing solution for the investors, the VC also took an active
role in managing the relationship with the investment banks involved

4
5

This stage would amount to at least 3 to 4 hours of time investment for the VC as the Investment Manager, the Challenger, and their assistants
would need to be prepared for their respective roles and contribute meaningful input in the review of the investment.
deals that have passed the investment manager/challenger stage and are ready for a presentation to the Team.
i.e. legal costs, travel and consulting expenses from industry experts brought in to review the technology and the entrepreneurs claims, etc.

45

Table 4 - Deal Flow of This VC

A) Quarterly flow of investment opportunities received by this VC (line), European stock market index (bars), and technology bubble phase. The
flow of deals received by this VC followed the index. Sample Size: 2'219; Source: Ex-ante.

1'000

350

900

800

Boom

250

700

Bust
600
200
500
150

Expansion

400

Euro Stock Index

Number of New Investment Opportunities

Fall
300

300

100

200
50
100

0
19963

19971

19973

19981

19983

19991

19993

Avg Of Euro Stock Index

20001

20003

20011

20013

Count Of Sample

B) Financing stage of the deals requesting financing from this VC. During the boom years, this VC was known in the market for his concentration on
start-up and expansion financing. Source: Ex-ante.

Number of Deals received, by Financing Stage at Reception

Market
Phase
Expansion

Boom

Fall
Bust

Entire cycle

Quarter
1996 Q3
1996 Q4
1997 Q1
1997 Q2
1997 Q3
1997 Q4
1998 Q1
1998 Q2
1998 Q3
1998 Q4
1999 Q1
1999 Q2
1999 Q3
1999 Q4
2000 Q1
2000 Q2
2000 Q3
2000 Q4
2001 Q1
2001 Q2
2001 Q3
2001 Q4
Total

Missing
0
1
5
5
5
0
3
3
1
4
8
5
4
2
8
18
4
2
17
15
2
0
112

Seed
Startup
1
3
9
6
11
10
12
16
16
17
31
14
38
67
88
170
174
142
148
55
42
1
1071

Expansion

Pre-IPO

Public

OTC-traded

1
6
24
9
11
10
11
18
25
26
37
14
40
43
53
102
123
100
150
67
55
2
927

1
0
3
1
1
0
0
1
0
0
3
4
0
1
2
4
2
0
3
2
0
0
28

0
0
14
3
1
2
2
2
12
1
1
2
2
2
0
4
4
2
3
1
3
0
61

0
0
3
0
0
1
0
0
0
1
0
0
1
1
0
0
0
2
2
2
0
0
13

46

Spin-off
Buy-out
0
0
1
0
0
0
0
0
1
1
0
0
0
1
0
1
0
0
1
1
0
0
7

Total
3
10
59
24
29
23
28
40
55
50
80
39
85
117
151
299
307
248
324
143
102
3
2219

Table 4 (continued)
C) This table shows 48 companies financed by this VC on a time line, with the time it took to complete its due diligence in yellow, the time this VC stayed invested in green or red. The investments ending in green ended as
successes. The months in red depict down rounds and exits with losses. The data also show that this VC was most frequently leading investments into companies looking for Series A deals, that it supported both organizationally
and financially until a successful exit through follow-on rounds. Sample Size: 65 deals; Source: Ex-ante and Follow-up.
Project
Entry
Deal Reception /Purchase Sale
#
Date
Date
Date Stage
1 10-Oct-96
Jun 98 Jan 99 Start-Up
2 1-Apr-97 1-Aug-98
Seed
3 1-May-97
1-Jul-97
Start-Up

4 5-May-97
5 1-Jun-97
6 1-Jan-98
7 1-May-98
8 11-May-98
9

1-Jun-98
1-Jun-97
1-Feb-98
1-Nov-98
18-Feb-99

1-Jun-98

1-Jul-98

10 26-Jun-98

1-Aug-98

Start-Up
Expansion
Start-Up
Start-Up
Pre-IPO

Our
VC
Series Lead
A
A
Yes
A

A
B
A
B
B

Yes

Expansion B

Yes

Jan-97

Feb-97 Mar-97

1 Due Diligence
3
1

2
1
1
1
1

Apr-97 May-97

Jun-97

Jul-97 Aug-97 Sep-97

Oct-97 Nov-97 Dec-97

Jan-98

Feb-98

Mar-98

Apr-98 May-98

Jun-98

Jul-98 Aug-98 Sep-98

Start-up Series A

Due Diligence

Expansion Series B

Due Diligence

DD

22
1-Jul-99 21-Dec-99
23
1-Jul-99
1-Jul-99
24 22-Jul-99 28-Jul-99
25 18-Aug-99 19-Oct-99
26 21-Sep-99 21-Dec-99

Start-Up
Seed
Expansion
Expansion
Expansion

B
A
D
C
C

27 14-Oct-99
28 14-Oct-99
29 1-Nov-99

Pre-IPO D
Expansion D
Pre-IPO D

30 1-Nov-99 11-Oct-99
31 8-Nov-99 12-Feb-01
32 1-Jan-00 1-Jan-00
33 4-Jan-00
4-Apr-00
34 20-Jan-00 20-Jan-00
35 1-Mar-00 1-Mar-00
36 1-Apr-00 21-Mar-00
37 12-Apr-00 20-Jun-00
38 18-Aug-00 23-Aug-00
40 1-May-00 3-Aug-00
41 10-Jul-00 20-Dec-00

Expansion
Start-Up
Expansion
Expansion
Expansion
Expansion
Expansion
Expansion
Expansion
Expansion
Expansion

D
A
B
B
B
B
B
A
C
B
A

42 31-Jul-00 29-Nov-00
43 14-Aug-00 8-Nov-00
44 6-Sep-00 1-Mar-01
45 28-Dec-00
5-Apr-01
46 5-Feb-01 28-Jun-01
47 6-Feb-01 11-Jul-01
48 1-May-01 1-Jun-01
39 13-Jun-01 10-Aug-01 -

Expansion A
Seed
A
Expansion B
Expansion B
Expansion B
Expansion
Expansion
Expansion A
Our VC Leads

Yes
Yes

1
1
1
1
1

Yes

2
3
2
1
1
1
1
1
1
1
1

Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
24

1
1
1
1
1
1
1
1
65

Yes

Mar-00

Apr-00 May-00

Jun-00

Jul-00 Aug-00 Sep-00

Oct-00 Nov-00 Dec-00

Jan-01

Feb-01

Mar-01

Apr-01 May-01

Jun-01

Jul-01 Aug-01 Sep-01

Oct-01 Nov-01

IPO

Start-up

Expansion

Series B

Series A

Due Diligence

Start-up June 1999

DD

IPO

SOLD

Series C

Series D

Seed

Due Diligence

Series C (A)

Series D

Series E

Bridge

Due Diligence

Expansion Series C

IPO

1
1
1
1

Due Diligence

Start-up Jan 2000 Seed

Expansion

Series B

IPO
Pre-IPO

Series C

IPO
DEAD
IPO
ALIVE
DEAD

IPO
ALIVE
IPO

EXIT
SOLD

Due Diligence

Seed

Series A

Start-up Series A

Series B

Due Diligence

DEAD

Expansion Series D

Seed

DEAD

Due Diligence

Pre-IPO

Due Diligence

Expansion Series B

Due Diligence

DD

Start-up Series B

Pre-IPO

IPO

Expansion
DueDiligence

Pre-IPO

Expansion Series C

Expansion Series D

Expansion E

Due Diligence

DEAD

Series A

Series B

Expansion Jan 2000

Due Diligence

Series D

Series C

SALE

Expansion

Pre-IPO
Start-up Series A
Series B

Series C

Due Diligence

DEAD

Expansion

DEAD
DD

SALE 1

Due Diligence

IPO
SALE
SALE
DEAD

SALE 1

Expansion

DD

IPO
DEAD
SALE
DEAD
DEAD

Series C

SALE

DEAD

Due Diligence

Invested
Exited Amount
in Euro
IPOs Sales Alive DEAD Total Amount in Euro
1
1
1

DEAD
SALE
SALE
DEAD
IPO
SALE
DEAD

DEAD

EXIT

Due Diligence

IPO
IPO
IPO
DEAD

SALE

SOLD

1
1
1

Yes
Yes

Feb-00

Pre-IPO IPO

Due Diligence

Yes
Yes

C
A
A
A

Jan-00

DEAD

1
1
2
3

Pre-IPO
Start-Up
Seed
Start-Up

Oct-99 Nov-99 Dec-99

EXIT

Yes
Yes

19-Mar-99
1-May-99 Dec. 99
6-Oct-99
1-May-99

Jul-99 Aug-99 Sep-99

Due Diligence

2
1
4
1
1
1
3

18 1-Feb-99
19 1-Mar-99
20 24-Mar-99
21 15-May-99

Jun-99

Seed

Due Diligence

Yes

Apr-99 May-99

Pre-IPO

DD

Yes

Mar-99

Series A

B
A
B
A
D
A
A

Feb-99

Start-up

Start-Up
Seed
Expansion
Seed
Expansion
Expansion
Seed

Jan-99

Start-up

Partly
Jan 99 Aug 99
7-Jan-99
7-Jan-99
1-Oct-98
1-Nov-98
1-Dec-98
15-Feb-00

Oct-98 Nov-98 Dec-98

Expansion
Due Dilligence

Start-Up

11 26-Jun-98
12 1-Aug-98
13 1-Aug-98
14 1-Aug-98
15 4-Sep-98
16 1-Sep-98
17 1-Jan-99

5-Nov-99
12-Oct-99
Feb 00

Yes

DUEDILIGENCE AND INVESTMENT TIMELINE

Rounds

Expansion Series C

DEAD

Due Diligence
Due Diligence

Due Diligence
Due Diligence
Due Diligence
Due Diligence
Due Diligence
Due Diligence
DD
Due Diligence

Expansion

DEAD
ALIVE
SALE
DEAD
IPO
DEAD
DEAD
DEAD
DEAD
DEAD
ALIVE

1
1
1
1
1
1
1

1
1
1

1
1
1
1

1
1
1
1
1
1
1
1
1
1
1
1
1

ALIVE
DEAD
ALIVE
DEAD
ALIVE
ALIVE
Post-IPO
DEAD

1
1
1
1
1
1

11

47

1
20

47

139,970,388

482,978,111

Table 5 - Deal Characteristics, Due Diligence Stage and Deal Outcomes

The following tables describe the characteristics and the outcomes of the 2219 deals this VC received between 1996 and 2001. Outcomes include: selection by this VC at various levels of due diligence (Screen, Manager,
Team and Investment Committee IC), investment by this VC (This VC), further investment by other VCs (Other VC) and further financial success (Success) as count and % of received deals with known outcome. We also
indicate this VC success as percent of this VCs investments. Source: Ex-ante and follow-up.

A) Qualitative deal characteristics. *: p<0.1, category frequency is significantly different from total frequency (using Paired T- Test). Return on Investment (ROI) and investment bias for the criteria (Bias) (Bias
= [% invested] / [% success]).

Country
Germany, CH
USA
Western Eur.
Israel
Rest of World
Eastern Eur.
Missing
Total

Received
1007
594
445
62
46
37
28
2219

Deals (n) selected at DD stage

Screen
Manager
Team
503
135
49
341
101
28
222
48
13
44
15
5
11
3
3
11
2
0
5
0
1137
304
98

IC
36
25
10
4
3
78

Screen
62
65
58
79*
31*
34*
50
61

Fraction (%) of deals selected at

Manager
Team
IC
This VC
27
36
73
3.6
30
27
89
4.2
22
27
77
2.2
34
33
80
6.5
27
100
100
6.5
18
0
0.0*
0
0.0
27
32
80
3.5

Industry
E-commerce
Software
Financial Serv.
Telecom
Infrastructure
Other
Media
Retail
VC
Telecom Serv.
Consulting
Missing
Total

Received
722
445
121
82
173
191
133
71
25
104
122
30
2219

Screen
359
300
71
51
88
39
77
14
17
74
44
3
1137

Manager
90
83
32
21
20
9
19
2
8
16
4
0
304

Team
28
20
13
10
9
5
6
2
2
2
0
98

IC
20
18
11
8
7
5
4
2
2
1
78

Screen
58
82*
63
75*
63
27*
68
23*
68
90*
38*
23
61

Manager
25
28
44*
41*
23
23
25
14
47
22
9*
0
27

Team
31
24
42
48
45
55
32
100
25
12
0*
32

IC
69
76
69
80
56
80
67
100
100
50
80

This VC
2.8
4.0
9.1*
9.8*
4.0
2.6
3.0
2.8
8.0
1.0*
0.0*
0.0
3.5

Other VC
143
118
16
27
68
27
15
7
4
29
13
1
468

%
21
28*
14*
37*
43*
15*
12*
11*
17
29
11*
7
22

Financing
Stage
Expansion
Seed/Start-up
Public
Pre-IPO
OTC traded
Spin-off/BO
Missing
Total

Received

Screen

Manager

Team

IC

Screen

Manager

Team

IC

This VC

Other VC

927
1071
61
28
13
7
112
2219

556
497
47
18
9
4
6
1137

158
106
26
8
3
2
1
304

48
34
10
5
0
1
0
98

40
24
9
4
1
78

66*
54*
92*
77*
90*
60
43
61

28
21*
55*
44
33
50
17
27

30
32
38
62
0
50
0
32

83
71
90
80
80

4.3
2.2*
14.8*
14.3
0.0*
14.3*
0.0
3.5

Raising
1st Round
No
Yes
Missing
Total

Received

Screen

Manager

Team

IC

Screen

Manager

Team

IC

671
1481
67
2219

507
624
6
1137

172
131
1
304

59
39
0
98

51
27
78

81*
51*
50
61

34*
21*
17
27

34
30
0
32

86
69
80

48

Other VC
173
155
108
27
1
4
0
468

All deal outcomes

%
Success
18*
46
27*
91
25
22
46*
6
2*
2
11*
0
0
0
22
167

Outcome for this VC

%
ROI
48
+0.9
50
-0.5*
62
+0.7
50
-0.3
100
+0.1
52
+0.3

%
9*
29*
11
29
9
0*
0
16

Success
13
10
5
2
2
0
0
32

Bias
1.7
0.6
1.0
1.4
3.2
1.0

Success
41
54
9
8
16
5
10
1
3
15
5
0
167

%
10*
27*
13
18
25
6*
16
5*
23
28*
18
0
16

Success
11
6
2
4
2
2
4
1
0
0
32

%
61
46
22
67
50
67
100*
50
0*
0
52

ROI
-0.4
+1.4
-0.5
+0.1
+0.4
+1.6
+1.2
-0.9*
-0.6
+0.4
+0.3

Bias
1.0
0.7
2.6
2.1
0.9
2.1
0.9
4.3
1.4
0.1
0.0
1.0

Success

Success

ROI

Bias

273
174
8
6
4
0
3
468

31*
17*
16
23
31
0*
4.8
22

80
28
39
19
1
0
0
167

23*
5*
67*
83*
14
0*
0
16

15
7
6
4
32

56
33
67
100*
52

-0.2
+1.0
-0.2
+2.7*
+0.3

1.1
1.8
0.5
0.4
1.0

This VC

Other VC

Success

Success

ROI

Bias

7.6*
1.8*
0.0
3.5

273
195
0
468

43*
13*
0
22

113
54
0
167

33*
8*
0
16

23
9
0
32

56
45
0
52

+0.6
+0.1
+0.2
+0.3

1.0
1.1
1.0

Table 5A (continued)
Age
0-1
2-3
4+
Missing
Total

Received
1105
441
532
141
2219

Deals (n) selected at DD stage

Screen
Manager
Team
549
127
46
267
86
26
308
89
25
13
2
1
1137
304
98

IC
33
22
22
1
78

Screen
58
67
65
32
61

Revenues
Yes
No
Missing
Total

Received
1354
688
177
2219

Screen
829
296
12
1137

Manager
231
71
2
304

IC
58
20
78

Screen
66*
52*
43
61

Manager
28
24
17
27

Team
32
34
0
32

IC
78
83
80

This VC
4.3
2.9
0.0
3.5

Other VC
338
119
11
468

%
26*
18*
9
22

Source
Passive
Network
Active
Total

Received
1793
286
140
2219

Screen
804
235
98
1137

Manager
130
124
50
304

IC
5
48
25
78

Screen
55*
84*
80*
61

Manager
16*
53*
51*
27

Team
8*
45*
64*
32

IC
50
86
78
80

This VC
0.3*
16.8*
17.9*
3.5

Other VC
339
89
40
468

Other VC
leads
No
Yes
Missing
Total

Received

Screen

Manager

Team

IC

Screen

Manager

Team

IC

This VC

1436
375
408
2219

786
330
21
1137

134
159
11
304

37
57
4
98

26
49
3
78

55*
88*
36
61

19*
39*
19
27

28
36
37
32

70
86
75
80

Other
Investors
Committed
No
Yes
Missing
Total

Received

Screen

Manager

Team

IC

Screen

Manager

Team

1398
464
357
2219

705
416
16
1137

136
165
3
304

37
60
1
98

25
52
1
78

51*
91*
64
61

19*
40*
3
27

27
36
33
32

Team
74
24
0
98
Team
10
56
32
98

Fraction (%) of deals selected at

Manager
Team
IC
This VC
23
36
72
3.0
32
30
85
5.0
29
28
88
4.1
15
50
100
0.7
27
32
80
3.5

49

Other VC
217
122
126
3
468

All deal outcomes

%
Success
20
47
29*
42
25
76
3
2
22
167

Outcome for this VC

%
ROI
44
+0.8
50
-0.6*
73
+0.4
0
52
+0.3

%
8*
22
37*
3
16

Success
12
9
11
0
32

Bias
1.5
1.1
0.6
1.1
1.0

Success
150
13
4
167

%
27*
3*
0
16

Success
27
5
32

%
63
28
52

ROI
+0.3
+0.4
+0.3

Bias
0.8
3.3
1.0

%
20
35*
34*
22

Success
111
44
12
167

%
13
27*
20
16

Success
2
20
10
32

%
40
50
62
52

ROI
+0.4
-0.1
+1.0
+0.3

Bias
0.1
2.3
4.5
1.0

Other VC

Success

Success

ROI

Bias

1.8*
13.1*
0.7
3.5

226
179
63
468

16*
52*
18
22

68
75
24
167

11*
39*
10
16

9
23
0
32

45
57
0
52

+1.2
-0.2
-0.5
+0.3

0.8
1.4
0.3
1.0

IC

This VC

Other VC

Success

Success

ROI

Bias

67
87
100
80

1.8*
11.2*
0.3
3.5

222
206
40
468

16*
48*
14
22

56
88
23
167

9*
37*
11
16

9
22
1
32

39
59
100
52

+0.7
+0.1
-0.6
+0.3

1.0
1.3
0.1
1.0

Table 5A (continued)
Known
Entrepreneur
No
Yes
Missing
Total

Received

Screen

Manager

Team

IC

Screen

Manager

Team

IC

This VC

Other VC

Success

Success

ROI

Bias

1710
62
447
2219

993
53
91
1137

218
42
44
304

57
24
17
98

48
20
10
78

61
85*
52
61

22*
79*
48
27

26
57*
39
32

84
83
59
80

2.8
32.3*
2.2
3.5

366
10
92
468

22
20
24
22

138
16
13
167

18
37*
5
16

22
9
1
32

56
53
20
52

+0.5
+0.0
-0.6
+0.3

0.7
2.7
1.6
1.0

Serial
Entrepreneur
No
Yes
Missing
Total

Received

Success

1520
248
451
2219

858
174
105
1137

187
70
47
304

54
26
18
98

44
24
10
78

59
76*
57
61

22*
40*
45
27

29
37
38
32

81
92
56
80

2.9
9.7*
2.2
3.5

314
64
90
468

21
28
23
22

116
37
14
167

18
25*
5
16

22
9
1
32

61
45
20
52

+0.7
-0.1
-0.6
+0.3

0.8
1.4
0.7
1.0

Successful
Entrepreneur
No
Yes
Missing
Total

Received

Screen

Manager

Team

IC

Screen

Manager

Team

IC

This VC

Other VC

Success

Success

ROI

Bias

1680
97
442
2219

945
81
111
1137

209
43
52
304

61
16
21
98

51
14
8
78

60
88*
57
61

22*
53*
47
27

29
37
40
32

84
87
62
80

3.0
14.4*
2.9
3.5

348
29
91
468

21
33*
24
22

134
17
16
167

18
26
6
16

25
4
3
32

59
36
37
52

+0.7
-0.6*
-0.4
+0.3

0.8
1.8
1.1
1.0

Deals (n) selected at DD stage

Screen
Manager
Team
IC

Screen

Fraction (%) of deals selected at

Manager
Team
IC
This VC

50

Other VC

All deal outcomes

%
Success

Outcome for this VC

%
ROI

Bias

Table 5 (continued)
B) This table describes the sample statistics and the mean rating of deals. * shows significant differences at the 95 % confidence level between ratings of deals selected and rejected at different stage of due diligence at this VC; deals
financed vs. not financed by other VCs; deal surviving vs. extinct; deal success vs. failure.

All stages
Received

Rejected

Screen

Invested

Manager

Rejected

Selected

Rejected

Team
Selected

IC

Rejected

Selected

Other VC invested

Rejected

Selected

No

Survival

Yes

No

Success
Yes

No

Yes

Rating

Rating

Rating

Rating

Rating

Rating

Rating

Rating

Team

Rating

Rating

Rating

Rating

Rating

Rating

Rating

Team

Financials

165

3.1

16

2.9

149

4.1*

92

2.8

73

3.5*

28

2.9

45

3.8*

22

3.5

23

4.1

3.9

16

4.1

111

2.9

41

76

2.9

81

3.2*

75

2.8

3.2

Exit

174

2.9

15

2.8

159

4.0*

97

2.7

77

3.2*

30

2.6

47

3.6*

25

3.2

22

3.9*

3.7

15

119

2.8

43

2.9

85

2.7

81

3.1*

84

2.6

Valuation

174

3.3

17

3.1

157

4.8*

96

2.8

78

3.9*

30

3.2

48

4.3*

24

3.9

24

4.7*

4.6

17

4.8

117

3.1

43

3.3

86

3.1

81

3.5*

85

3.1

3.7
3.7*

Risk

171

2.9

15

2.8

156

4.0*

97

2.7

74

3.2*

28

2.7

46

3.5*

24

3.2

22

3.8

3.3

15

115

2.8

44

2.9

81

2.7

82

3.1*

80

2.7

Market

191

3.6

18

3.5

173

4.3*

108

3.3

83

3.9*

31

3.4

52

4.2*

27

4.2

25

4.2

4.1

18

4.3

128

3.3

48

4.0*

91

3.3

91

3.8*

90

3.3

4.2

Competition

183

2.9

18

2.8

165

4.0*

104

2.6

79

3.3*

28

2.7

51

3.6*

26

3.2

25

4.1*

4.1

18

126

2.7

42

3.2*

86

2.8

88

85

2.8

3.6*
3.5

Innovation

177

3.2

16

3.1

161

4.0*

100

2.9

77

3.5*

28

3.1

49

3.7

26

3.4

23

4.1

16

119

45

3.5*

83

2.8

86

3.5*

82

2.8

Management

188

3.6

18

3.5

170

4.9*

106

3.3

82

4.0*

31

3.7

51

4.2*

26

25

4.4

3.3

18

4.9*

125

3.4

48

3.7

87

3.5

92

3.7

86

3.5

3.6

Scalability

99

3.4

3.3

94

4.6*

62

3.1

37

3.8*

17

3.8

20

3.8

12

3.3

4.6*

4.7

4.6

67

3.4

29

3.1

45

3.2

50

3.5

44

3.2

3.6

Potential Cust

58

4.2

4.2

55

4.7

33

25

4.5

15

4.5

10

4.5

4.2

4.7

43

4.1

13

4.6

26

4.2

30

4.3

26

4.2

Barriers to Entry

103

3.3

3.2

98

4.8*

62

3.1

41

3.7*

17

3.6

24

3.7*

16

3.4

4.4*

3.7

4.8

70

3.2

30

3.6

45

53

3.6*

44

Partnership

103

3.1

3.1

98

4.4*

62

3.1

41

3.3

17

2.7

24

3.7*

16

3.4

4.3

4.4

70

3.1

30

44

54

3.2

43

3.6

Product Dev.

106

3.4

3.3

101

64

3.2

42

3.5

18

3.1

24

3.9

16

3.8

71

3.3

32

3.5

46

3.3

55

3.4

45

3.2

3.4

3.8*

Existing Cust.

58

2.6

2.4

55

4.7*

31

2.1

27

3.1*

17

2.9

10

3.3

3.8

4.7*

42

2.4

14

2.8

26

2.3

30

2.8

26

2.3

Quality

198

18

-0.11

180

1.14*

112

-0.31

86

.40*

33

-0.08

53

.70*

28

0.38

25

1.06*

0.87

18

1.14

133

-0.16

50

0.11

93

-0.25

96

.21*

92

-0.26

0.45

Valuation

198

18

-0.11

180

1.15*

112

-0.29

86

.37*

33

-0.17

53

.71*

28

0.41

25

1.05*

0.79

18

1.15

133

-0.18

50

0.1

93

-0.2

96

.19*

92

-0.21

0.39

Product Dev

198

18

-0.03

180

.31*

112

-0.08

86

0.11

33

-0.05

53

0.2

28

0.19

25

0.22

-0.01

18

0.31

133

-0.01

50

-0.01

93

-0.09

96

0.05

92

-0.11

0.07

Potential Cust

198

18

-0.01

180

0.1

112

-0.1

86

0.13

33

0.25

53

0.04

28

-0.11

25

0.22

0.55

18

0.1

133

-0.02

50

0.1

93

-0.11

96

0.09

92

-0.11

0.26

Financials

198

18

-0.09

180

.87*

112

-0.24

86

.31*

33

-0.01

53

.51*

28

0.28

25

.77*

0.49

18

0.88

133

-0.05

50

-0.15

93

-0.11

96

0.1

92

-0.12

-0.06

Competition

198

18

-0.05

180

.54*

112

-0.13

86

.17*

33

-0.25

53

.43*

28

0.29

25

0.6

0.75

18

0.54

133

-0.21

50

.38*

93

-0.19

96

.16*

92

-0.18

.69*

Product Dev

198

18

-0.02

180

0.16

112

-0.02

86

0.03

33

-0.22

53

0.19

28

0.24

25

0.13

0.05

18

0.16

133

-0.03

50

0.04

93

-0.04

96

0.01

92

-0.06

0.11
0.01

Potential Cust

198

18

0.01

180

-0.11

112

-0.04

86

0.05

33

0.15

53

-0.01

28

-0.1

25

0.1

0.63

18

-0.1

133

0.03

50

-0.01

93

-0.01

96

92

-0.01

Barriers to Entry

198

18

-0.03

180

0.32

112

-0.14

86

.18*

33

0.43

53

0.02

28

-0.16

25

0.22

-0.03

18

0.32

133

-0.03

50

0.08

93

-0.19

96

.16*

92

-0.18

0.28

Management

198

18

-0.07

180

.67*

112

-0.14

86

.17*

33

-0.01

53

0.29

28

0.14

25

0.47

-0.05

18

0.67

133

-0.01

50

-0.22

93

-0.01

96

0.02

92

-0.01

-0.14

Source: Ex-ante, 198 rated deals.

51

Table 5 (continued)
C) This rejected deals that were finally financed by other VCs. However, these deals were preferred at initial stages of due diligence. * shows
significant differences at the 95 % confidence level.
Invested by Other VCs
No
Yes
Missing
This VC
Total

Received
1364
420
379
56
2219

Screen
738
333
10
56
1137

Deals (n) selected at

Manager
Team
153
32
94
10
1
0
56
56
304
98

IC
19
3
0
56
78

Screen
54*
79*
59
100
61

Fraction (%) of deals selected at

Manager
Team
IC
20*
20*
59*
28
11*
30
10
0
100
100
100
27
32
80

All
1.0*
0
0
100
3.5

D) This VC had a preference for deals that were finally a financial success. Sample Size: 2219; Source: Ex-ante and Follow-up. * shows significant
differences at the 95 % confidence level.
Deals (n) selected at
Fraction (%) of deals selected at
Success
Received
Screen
Manager
Team
IC
Screen
Manager
Team
IC
All
No
882
370
100
34
29
54
27
34
85
3.3*
Yes
167
132
76
36
32
92*
58*
47*
89
19.2*
Unknown
1170
635
128
28
17
54
20
22
61
1.4
Total
2219
1137
304
98
78
61
27
31
72
3.5
% success in sub-sample
16.0
26.3
43.2
51.4
52.4

E) Analysis of this VCs deal flow as it was screened through this VCs due diligence process.
The table shows the number of deals being rejected at each stage and relates it to the known subsequent outcomes of the deals to determine this VCs
ability to correctly identify the future successful deals in its deal flow. * shows significant differences at the 95 % confidence level. Sample Size:
2219 deals.

Rejection Decisions
Good
Bad
Unknown
Not rejected
Total
% bad decisions in sub-sample
Source: Ex-ante and Follow-up.

Received
853
135
1153
78
2219
13.6

Screen
310
12
760
1082
3.7

Deals (n) rejected at

Manager
Team
270
66
56
40
507
100
833
17.1

206
37.7

52

IC
5
4
11
20
44.4

Screen
48
11*
39
0
39

Fraction (%) of deals rejected at

Manager
Team
IC
79*
93
100
56*
91
100
82
90
100
0
0
0
73
68
20

All
100
100
100
0
3.5

Table 6 - Deal Outcomes

A) Investment and liquidation outcome of the all the deals received by this VC. The fractions on deals invested, surviving and successful are also
indicated for this VC and other VCs. During the market cycle, the deal flow increased while the odds of success decreased. This VC did not increase
its number of investments, got pickier and could keep a reasonable success rate. By contrast, other VCs increased their number of investments and got
worse results. Sample Size: 2219 deals; Source: Follow-up.
Investment Outcome

Liquidation Outcome

Decision quality

Invested at
Quarter

96 Q3
96 Q4
97 Q1
97 Q2
97 Q3
97 Q4
98 Q1
98 Q2
98 Q3
98 Q4
99 Q1
99 Q2
Expand
99 Q3
99 Q4
00 Q1
00 Q2
Boom
00 Q3
00 Q4
Fall
01 Q1
01 Q2
01 Q3
01 Q4
Bust
Total

Total
number
of deals
in quarter
3
10
59
24
29
23
28
40
55
50
80
39
440
85
117
151
299
652
307
248
555
324
143
102
3
572
2219

This
VC

1
2
4
3
0
1
1
5
7
2
3
0
30
5
4
6
4
21
9
6
16
5
4
0
0
11
72

33
20
7
12
0
4
4
12
13
4
4
0
6.8
6
3
4
1
3.2
3
2
2.9
1
3
0
0
1.9
3.2

Surviving, %

Othe
r VC

IPO

Sale

Extinct

0
2
12
8
10
5
9
8
7
17
21
7
106
17
32
32
65
146
63
41
104
67
24
21
0
112
468

0
29
24
47
40
22
33
24
16
37
31
18
27
22
28
22
22
23
21
17
19
21
18
21
0
20
22

2
3
18
5
2
4
2
2
11
3
10
6
68
6
5
3
5
19
4
2
6
9
4
3
0
16
109

0
2
10
5
5
2
2
6
8
7
6
4
57
9
12
6
12
39
8
9
17
5
5
5
0
15
128

0
2
10
6
11
13
10
15
9
12
30
17
135
31
41
77
124
273
117
105
222
118
45
35
0
198
828

Not
yet
Liqui
dated
1
1
12
5
7
4
13
12
25
23
26
11
140
33
58
58
139
287
169
129
298
171
69
54
2
296
1021

Mis
sing

Sur
vival
%

Success
%

0
2
9
3
4
0
1
5
2
5
8
1
40
6
2
7
19
34
9
3
12
21
20
5
1
47
133

100
75
70
57
52
39
59
51
83
71
53
50
61
56
57
45
53
52
59
55
57
59
57
59
100
58
57

100
71
66
47
33
26
23
26
68
41
26
30
41
24
16
8
7
11
5
5
5
5
5
2
7
5
16

This
VC

100
68
68
100
100
0
60
86
50
67
73
60
80
83
25
65
56
57
56
67
0
36
62

Other
VCs

100
82
50
78
60
71
100
82
82
57
57
71
82
61
69
57
64
64
74
68
80
78
74
78
70

Success, %
This
VC

100
100
50
100
100
0
60
86
0
50
69
50
75
75
0
56
20
50
36
33
0
12
54

B) Outcome of the deals in relation to their financing. Comparison between this VCs success rate and the success rate of other VCs with access to
the same deal flow. Deals Sample Size: 2219; Source: Follow-up.
Deal Liquidation Outcome
Deal Investment Outcome
Any
Invested by This VC

Total
2219
72

Known
1049
61

Failure
882
29

%
84
47

Success
167
32

Rejected by This VC
- And invested by Other VCs
- And not financed
- And do not know

2147
468
1626
53

988
184
796
8

853
131
717
5

86

135
53
79
3

71

90
62

53

%
16

Comment

52

This VC had 52 % of financial successes

This is 29% 8 % better than Other VCs, p<0.001, t-test
This VC made 86 % of good rejection decisions.
Other VCs made 29 % of financial successes
Other VCs made 90 % of good rejection decisions

14

29
10
47

Other
VCs

100
80
33
50
60
25
50
100
62
40
50
54
70
21
18
4
21
4
0
3
19
17
0
15
29

Table 7 - Ex-ante / Ex-post Correlations

0.5**
0.5**
-0.4*

0.9***
0.8**
-0.6**
0.7**
0.8***

0.6**
0.7***
-0.6*
0.7**
-0.6*
0.7**

-0.6*
0.6*

-0.7***
0.6**

Innovation

ExistingCust

0.5***
0.4**

ProductDev

0.7**

Ex-post

Partnership

Barriers

0.7**

Scalability

0.3

Management

0.3

0.4
0.6**

Competition

PotentialCust

Financials
0.3
Exit
0.3
Valuation
Market
Competition
0.4*
Innovation
0.4**
Management
Scalability
Potential Cust
-0.3
Barriers
0.36*
Partnership
-0.3
Product Dev
-0.3
Existing Cust
Source: Ex-ante vs. Ex-post; Sample Size: 25

Market

Valuation

Exit

Financials

A) Correlation between deal evaluations ex-ante and ex-post. Low correlation can be observed for Financial scales and Management. Correlation
coefficients different from zero are shown at an 80% confidence interval (*90%, **95% and ***99%). Diagonal values are highlighted in grey. Beta
coefficients are not reported when they are not significant (i.e. not significantly different from zero).

-0.6*
0.4

0.4**

-0.7**

0.3

0.3
0.4**
-0.3

0.5**
-0.3
-0.4**

0.7***
0.7**
-0.5*
-0.6**

-0.5
0.5

0.8***

0.6**

0.8*
0.5*
-0.4

0.6*

0.7**
0.1

B) Correlation between deal evaluations ex-ante and ex-post. Knowledge or Forgetting Issues. Correlations for rejected deals and more recent deals
are generally higher and more significant than for invested deals and older deals (grey highlight).
Ex-post Knowledge
Scale
All
Rejected Invested
Financials
.32
.83**
Exit
.35*
.46*
Valuation
Market
.43**
.50**
Competition
.53*** .58**
Innovation
.48**
.65***
Management
.31
.43*
Scalability
.69**
.71**
Potential Cust -.56*
-.58*
Barriers
.76*** .71**
Partnership
.84*** .85***
Product Dev
.55*
.51
Existing Cust
Source: Ex-ante vs. Ex-post, Size: 25

Forgetting
Old
Recent
.38
.71**

.36
.45*

.82
.92*
.85

.88***
.87***
.70***

.82**
.55
.85**

54

Table 8 Investment Criteria Importance for Investment Decision, Predictor of Success or Survival
Deals sample size: 2219. Heckman 2-step procedure results and univariate significance of determinants of 4 states.
Ex-ante Determinants of Investment
by our VC

Financials
ExitStrategy
ValueAttractivity
RiskResistance
MarketPotential
Competition
Innovation
Management
Scalability
PotentialCustomers
BarriersToEntry
Partnership
ProductDevelopment
ExistingCustomers

Estimate Std. Error

0.12066 0.05567
0.02346 0.05921
0.00540 0.04652
0.09086 0.04500
-0.07121 0.03945
0.05166 0.04126
-0.04110 0.04190
0.10479 0.04233
0.07148 0.04472
0.07213 0.04031
-0.04058 0.04558
0.00631 0.04191
-0.03839 0.05046
0.02668 0.04908

invMillsRatio (Heckman Bias Ratio)

Multiple R-Squared:
Adjusted R-Squared:

-0.004751
0.303074
0.245635

Zeros
Observations:Ex-ante Rankings
Observations Total
Free parameters

t value
Pr(>|t|)
2.16736 0.04245
0.39627 0.69610
0.11602 0.90879
2.01928 0.05706
-1.80510 0.08614
1.25200 0.22501
-0.98083 0.33839
2.47543 0.02238
1.59849 0.12561
1.78958 0.08868
-0.89032 0.38388
0.15048 0.88189
-0.76080 0.45566
0.54370 0.59266

0.152218 -0.031215 0.975408

1975
198
2173
13 free parameters (df =2160)

Ex-ante Determinants of Subsequent

Investment by any VC

.
.

*
.

Estimate Std. Error

0.14816 0.07079
-0.07050 0.07500
0.12105 0.05882
-0.06285 0.05708
0.03990 0.05016
0.03546 0.05281
0.12540 0.05322
0.05688 0.05403
0.00966 0.05660
0.08029 0.05123
0.11784 0.05801
-0.15519 0.05299
-0.16463 0.06460
0.16102 0.06265

-0.19389
0.18094
0.11343

t value Pr(>|t|)
2.09297 0.04931
-0.93995 0.35846
2.05813 0.05285
-1.10105 0.28395
0.79560 0.43561
0.67150 0.50959
2.35604 0.02879
1.05278 0.30500
0.17058 0.86627
1.56732 0.13273
2.03130 0.05573
-2.92885 0.00830
-2.54862 0.01913
2.57005 0.01827

0.19914 -0.97363

1975
198
2173
13 free parameters (df =2160)

. = p<0.10, *:=p < 0.05 and **=p < 0.01 significantly different (Heckman 2-step procedure)
Std.: standard deviation; df: number of observations

55

0.34187

Ex-ante Determinants of Success

at our VC
Estimate Std. Error
t value
Pr(>|t|)
0.27073
0.02073 13.06252 0.04864
-0.33169
0.04280 -7.74917 0.08170
.
0.21001
0.02177
9.64866 0.06575
-0.10465
0.01389 -7.53670 0.08398
0.27438
0.02682 10.23056 0.06203
0.03716
0.01438
2.58386 0.23508
*
0.06472
0.01809
3.57824 0.17349
-0.11536
0.00807 -14.29823 0.04445
-0.17150
0.01829 -9.37482 0.06765
0.00753
0.02607
0.28874 0.82105
.
0.11919
0.02951
4.03906 0.15451
** -0.09862
0.01367 -7.21396 0.08769
*
0.00482
0.04261
0.11313 0.92829
*
0.02041
0.03667
0.55665 0.67664

0.134139
0.137876
0.015877

0.064313

2.085719 0.284616

1975
122
2097
13 free parameters (df =2084)

Ex-ante Determinants of Survival

by Our VC

*
.
.
.
.

*
.

Estimate
Std. Error
0.176634
0.092942
-0.243938
0.102408
0.12238
0.077742
-0.302428
0.080205
0.114024
0.067967
0.014901
0.072747
0.182723
0.070093
-0.265863
0.083388
-0.004982
0.073602
-0.016159
0.067227
0.224771
0.077621
0.142301
0.070345
-0.154155
0.090747
0.150754
0.087277

0.418929
0.096687
0.022238

t value
1.900483
-2.38203
1.574183
-3.770686
1.677638
0.204829
2.606868
-3.18826
-0.067693
-0.240365
2.895748
2.02291
-1.698731
1.727303

Pr(>|t|)
0.073508
0.028456
0.132857
0.0014
0.110696
0.840004
0.01784
0.005092
0.946776
0.812764
0.009633
0.058195
0.106588
0.101233

1.542459

0.14036

0.271598

1975
198
2173
13 free parameters (df =2160)

.
*
**

*
**

**
.

Table 9 Decision Models Performance Comparison

Model comparison from published literature and this VCs and other VC with the same deal flows Good Investment Decision (GID)
performance. This VCs deals sample size: 2219. (*90%, **95 % and ***99 % confidence level).

Basis of Decision

Good
Rejection
Decisions

Good
Investment
Decision
Successes

Good
Decision
Hit Rate

Significance
(P Value)

Source

This VC

86%**

52%**

84.31%**

.055

This VC, Table 8b

Other VCs with same Deal Flow

Attribute based on actuarial model profitability
and survival as dependent variables

90%**

29%**

78.57%**

.055

This VC, Table 8b

64.30%
51.90%

Mainprize & Hindle (2002)

VC Intuition
VC Using attribute based model

0.022

51.90%

VC Using bootstrap model

39.50%

0.003

17.10%

Zacharakis and Meyer 2000

Roure & Keeley 1990
Zacharkis and Meyer 2000

57.40%

0.191

Mainprize & Hindle (2002)

59.70%

0.11

Mainprize & Hindle (2002)

Mainprize & Hindle (2002)

VC Using Environmental Model

Attribute based actuarial Model using
profitability as the dependent variable
Attribute based actuarial Model using survival
as the dependent variable

56

Mainprize & Hindle (2002)