Some of the most popular blogs on the Internet deal with venture capital and the entrepreneur's pursuit of such funding. Google Analytics shows that many of the readers of this blog read at least one venture capital blog. A new academic paper shows that VCs may not be articulating their decision making criteria accurately! While they obviously understand their own methodology, they may be under weighting certain factors when they explain how they make their funding decisions.
The new paper is titled Uncovering Knowledge Structures of Venture Capital Investment Decision Making and was published by Pankaj Patel and Rodney D'Souza, two PHD candidates. This paper won the SBA Office of Advocacy award for the best doctoral paper in 2008 and was funded by them. (Yes-this may be a rare example of tax dollars well spent.)
Using 144 real technology business plans, half of which were actually funded by VCs and angels, a group of experienced VCs (average 18 years as VCs) were asked to evaluate each of the 144 plans for funding based on the criteria below. The criteria was developed by the VCs and vetted using some advanced statistical techniques (which basically eliminated bias). The 14 criteria were:
- Startup experience
- Industry experience
- Leadership experience
- Management experience
- Market size
- Customer adoption
- Revenue generated
- Entry timing
- Competition
- Technological advantage
- Strategy
- Intellectual property rights
- Value added
- Profit margins
(Nice checklist for an executive summary or Powerpoint for a VC or angel investor.)
Drum roll--the conclusions from the study were:
- Market opportunity (5,6,8 and 9 above) is the most important factor when VCs fund a business
- Management team (1,2, and 4 above) is the most important factor when a business does not receive funding
- Satisfactory team, great opportunity beats great team, so-so opportunity in the funding process
You need a decent management team to get through the first screen, but the quality of the market opportunity (market size, competitive landscape, customer buying behavior) largely determines if you will get funded. I always say that Michael Porter's Competitive Strategies: Techniques for Analyzing Industries and Competitors is one of only two books that every entrepreneur should read. Looks like the VCs may agree.
The complete paper can be downloaded through the link. Download rs315tot.pdf
