Trade-offs in the investment decisons of European venture capitalists

Abstract

Previous studies of venture capital investment criteria, which have tended to utilize traditional Likert-scaled survey methods, have produced some general findings which indicate that the “human factor” is of utmost importance. However, virtually all of these studies have been undertaken with U.S.-based venture capitalists. In addition, the studies have generally been exploratory and have assumed a single hierarchy of decision criteria in all cases and across all venture capitalists. We do not accept that this is valid; therefore, our study tested this assumption by investigating the trade-offs made by venture capitalists in Europe. Thirty-five investment criteria were identified from the literature and from experts in the field, and a questionnaire was developed that required the venture capitalist to make 53 pairwise trade-offs with multiple levels. Seventy-three venture capitalists from across Europe were interviewed and completed the questionnaire. Conjoint analysis was used to compute relative rankings, and overall rankings were computed to provide some general insight into the overall importance of the various criteria. After this, cluster analysis was used to identify different decision groupings. The trade-offs were randomized in the questionnaire but, for descriptive purposes, fall into the following groupings: financial, product-market, strategic-competitive, fund, management team, management competence, and deal. All five management team criteria (as opposed to management competence criteria) were ranked among the first seven, product-market criteria appeared to be only moderately important, and fund and deal criteria were at the bottom of the rankings. Overall, we conclude that the venture capitalists interviewed would, as a group, prefer to select an opportunity that offers a good management team and reasonable financial and product-market characteristics, even if the opportunity does not meet the overall fund and deal requirements. It appears, quite logically, that without the correct management team and a reasonable idea, good financials are generally meaningless because they will never be achieved. Cluster analysis identified three groupings of venture capitalists: those primarily concerned with investing nationally, those who focus solely upon the deal, and those mainstream investors who consistently and instinctively rank the five management team criteria at the top of their list. However, there was no evident country bias—a conclusion that is sustained if the countries are grouped by physical proximity (northern versus southern Europe) or by size of the local venture capital community, a surrogate for experience. Moreover, there was no relationship to the scale of the fund, the typical round of financing, or the apparent network. The article concludes by outlining the implications of the study for venture capitalists, entrepreneurs, and the research community.