Validation of the venture evaluation model in Korea

Abstract

This article examines the validity of the venture evaluation model in Korea by directly comparing the relative importance of evaluation criteria on the funding decision with the relative importance of factors influencing venture's empirical performance. Specifically, we first identify the relative importance of evaluation criteria based on whether a deal is accepted or rejected (current evaluation model). Next, we derive the relative importance of those criteria revealed in the empirical performance, based on the success/failure of ventures that overlap with the deals originally used as accepted cases (performance-based model). Finally, to better understand the differences between the two models, we measure the general perceptions of venture capitalists on the importance of those criteria without regard to specific deals (normative model). To identify potentially important criteria, we reviewed the existing related studies on evaluation criteria, and we interviewed 10 venture capitalists. As a result, we selected 31 evaluation items. The questionnaire consists of two parts and deals with the following four cases: In part A: 1. 1. case 1: general perceptions concerning the 31 criteria. In part B: 2. 2. case 2: one of the most successful ventures. 3. 3. case 3: one of the least successful ventures. 4. 4. case 4: one of the rejected ventures. Using a five-point scale, we asked the respondents to rate the 31 criteria based on their general perceptions without referring deals (case 1), and on the specific deals they had handled (cases 2, 3, and 4). To prevent any firm or respondent from affecting the results more than it ought to, we distributed the questionnaire to each firm in proportion to the investment amounts; we also asked the respondents to fill out only one questionnaire including four cases. Seventy-four venture capitalists (including 10 interviewed) responded to this questionnaire. They have worked as investment directors or managers in the top-rated 20 venture capital companies, selected according to investment amounts. On the basis of the ratings of 31 criteria for the previous four cases, we developed three investment models. First, the current evaluation model reveals which criteria are more important in deciding whether or not to fund. The model measures the relative importance of evaluation factors in discriminating between the accept (case 2 and case 3) and the reject (case 4) decision. Second, the performance-based model consists of the relative weights of evaluation factors influencing the two performance categories—success (case 2) and failure (case 3). This model shows the relative importance of evaluation criteria that are reflected in the venture's empirical performance. Finally, we identify the normative model, revealing the venture capitalists' general perceptions concerning the importance of individual criteria in light of their past field experiences (case 1). By comparing the three models, we find that the importance of these criteria revealed from venture capitalists' perceptions and empirical performances is fairly similar but not sufficiently reflected in the actual deal evaluation. In particular, the entrepreneur-related characteristics are not considered the most important in evaluating venture proposals according to the current evaluation model, but they do turn out to be the most important factors in evaluating empirical performance. This is in strong contrast to the findings of some existing studies, which contend that the entrepreneurrelated criteria ultimately determine the funding decision. Instead, the result confirms the previous assertion that the evaluation of managerial capability is the most challenging task in the venture selection process. In the current evaluation model, financing ability is considered more important than either superiority of product and technology or production capability, contrary to venture capitalists' perceptions and empirical performance results. Therefore, it seems necessary to raise the level of specialization of venture capital firms through the acquisition of managerial skills from developed countries and by enhancing the technical background of individual venture capitalists.