VENTURE CAPITALIST INVESTMENT STRATEGIES

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Thesis Focus Evolves

The area of study largely effects appropriate method to use. Studying venture capitalists investing in the seed stage have been as interesting as it has been challenging. I have worked in the area appointed by PVA-MV AG in Rostock, Germany. My supervisor at the company, Sascha Höcherl, defined a broad area of interest. Decided from PVA-MV was for me to work in the area of venture capital fund management. The specific focus of the thesis was left open for me to decide. A couple of factors effected the decision. Firstly, of course, I would not choose to study an area that does not interest me. Secondly I did not want to study an area in which too much is already known. With the aim of finding a topic matching these criteria I extensively studied current venture capital literature. Lundahl & Skärvad (1999) regard studying prior knowledge in the area to be an effective way of practicing research. Doing so the researchers avoid squandering time and energy investigating what others have already concluded.
Reading about venture capital I soon found interesting results and patterns that I wanted to investigate further. Many findings conclude that entrepreneurial activity is a very important source of job creation and economic growth. Further, financing in the earliest stages of company development was decreasing. These two conclusions put together provided reason for distress signals about the future economy. Governments have reacted and intervened to support entrepreneurial activity. What I found is not as well explored as the reasons for lack of financing to the earliest stages, and specifically the stage often referred to as the seed stage. This is how the focus of my study evolved. Extensive insight into the venture capital research also provided great help for the work to be done ahead.

Type of Survey

Gilje & Grimen (1992) describe two different ways of conducting a study. They are the inductive and the deductive approach. In the inductive approach the researcher should enter the investigation with an open mind to study a number of cases. Information from these cases is concluded and used to come up with new theories. The deductive approach starts from current theories. The researchers set up hypothesis and thereafter try and falsify those using empirical studies. My starting point is empirical findings from the venture capitalists situation, which I use to try and provide broader conclusions. In the study venture capitalists are the sources of primary information i.e. information that have not previously been documented. (Ericsson & Weiedersheim- Paul, 1999) My study can not be seen as a pure inductive approach since my previous studies and literature readings to a large extent will effect my conclusions.
Ericsson & Weiedersheim-Paul (1999) separates a qualitative study from a quantitative study based upon whether the information desired is of quantifiable nature or not. In my study both types of data are important. The quantifiable data can be used when evaluating the information gathered. For example, in my study, the answer to what value VCs can provide to ventures is evaluated by; (1) asking how many investment managers per portfolio companies they apply and (2) asking what background the managers have. However, by itself, the qualitative information is the most important for my purposes. Therefore a methodology of information gathering which can provide this kind of information was essential.

Survey Approach

Form of Correspondence

To use face-to- face interviews, to the extent possible, was at no point questionable for me. Ericsson & Weiedersheim-Paul (1999) say face-to-face interviews provide benefits since the interviewees’ ways of expressing themselves, with body language as well as speech can be studied. This adds to the value and credibility of information.
For time and financial reasons I could not commit face-to-face interviews with all studied VCs. The Danish and German interviewees were instead offered the choice of either a telephone interview or an email questionnaire. The questionnaire is available in 8.1 and is largely same for face -to-face interviews as it is for telephone interviews and email correspondence. The questionnaire was discussed with my supervisor Sascha Höcherl before the first interview. Sascha is experienced in the venture capital field and could provide valuable input to my suggested interview guide and questionnaire.
Lundahl & Skärvad (1999) mean that using different methods of collecting data can damage the reliability of the investigation, since the surrounding of the interviewee do influence the answers from respondents. Standardizing the investigation is therefore preferred. I think it was helpful to have started with face-to-face interviews. I learned which questions were hard to understand and could enhance the accessibility of these questions. However, it was important for me not to change the meaning of the questions, since this would inhibit the possibility to do comparisons (Lundahl & Skärvad, 1999).

Scope of Study

Eisenhardt (1989) say the number of studied cases decides the balance between depth and scope of the study. For my purposes I believe the method of a relatively large number of cases was the better approach. Comparing different views provides good value for my thesis. Venture capitalist are also often employing only a few investment managers and the information you cannot get from one of them in the context of an interview, is probably information they do not want to share with you anyway.
In a case study you can acknowledge that a phenomenon exists and that processes etc. work. However, you do not know if they are common. (Wallén, 1993) Because of this the empirical information presented in the thesis and used in the study is probably not an exact picture of overall views. However, studying the number of venture capitalists investing in seed capital which I have, the study will hopefully reflect reality pretty well. I build this on the basis that the number of seed investing VCs is limited, and that I have interviewed quite a few of them. This is also in line with Lundahl & Skärvad (1999) and Wallén (1993) who mean that it is possible to draw some general conclusions from a limited number of observations. Wallén mean that detailed results of a specific case cannot simply be applied to other cases. However the basics of processes and procedures can.
According to Merriam (1994) the extra input of a case studied will be decreasing with an increasing number of cases. Prior answers are confirmed by new answers, but not much more comes out of the interview. I could feel this decreasing input effect, which tells me that my understanding for and information about the venture capital activity have reached far. After having studied cases in Sweden I studied a couple in Germany as well as Denmark in order to broaden the sample a little further, and hopefully increase the extra input of each case studied.

Sample of Interviewees

When I decided for which venture capitalists to interview I used a couple of guides. Firstly I studied the homepage of the European Venture Capital Association (www.evca.com). Member companies of this association provide information of e.g. the stage of investments they do. This was therefore helpful in identifying some interesting companies. Secondly, my supervisor Sascha Höecherl could provide input to which seed venture capitalist in Germany and Denmark that would be of interest. Thereafter I searched for venture capitalists through accessing the homepages of Swedish universities, since most seed investing VCs are connected to universities. The methods I used to find appropriate interviewees may seem a little ad hoc but I hope that, by using different channels, I managed to reach a broad range of seed investing venture capitalists. I where aware of the risk that some venture capitalists might not want to participate in the study, therefore I contacted many venture capitalists from the beginning. I contacted about double the amount of which in the end was interviewed.
I contacted the venture capitalists asking if they agreed to an interview. The initial contact was generally via email. If I had got no response within a week I called the respective company. The sample was changed via the contacts with venture capitalists. After having explained the focus of my thesis I was several times provided with additional sources that they believed to be valuable for me. This method is by Lundahl & Skärvad (1999) referred to as the snowball selection. They also say that with a sample like this, which is not randomly selected, you can not in a statistical sense draw general conclusions. However as discussed before, due to the relatively small number of seed investing venture capitalists and a reasonably large number of interviews, I believe I will be able to draw some conclusions of value in a broader sense then only within the exact context of my study.
The study includes interviews of 13 organizations investing partly in early stages. All of them, except for one, consider themselves to be investing in the seed stage. The reason that an organization that is not investing in the seed stage was interviewed is that the distinction between seed stages and later stages is not always clear. Some information from this interview could still be used. All organizations but one, who is an incubator, are venture capitalists. I saw the incubator as an interesting organization investing at the seed stage and considered the denomination of the organization less important. In 7.4 Interviews only 12 organizations are included since an organization requested anonymity. This organization responded by e-mail questionnaire, which add up to four questionnaires, one telephone interview, and eight face-to-face interviews. Some of the organizations are entirely or in part owned by a government, while others are entirely private owned. All consider the commercial orientation in investing important.
Once the sample of venture capital organizations was set, deciding whom to interview within the organizations was for me a straightforward matter. Generally, all employed individuals were working with management of the fund and therefore any employee would be interesting. As seen in 7.4 many are CEOs.

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Interview Execution

During the interviews it would have been preferred to have a companion in order to absorb all the information. Still, I preferred taking notes to using a tape recorder because I felt that the interviews would be more relaxed. I would also save valuable time by taking notes at once. During interviews I discovered another advantage. The time I took notes worked as a break for extra consideration for the interviewees. Many valuable opinions where explained during this extra breather.
However there is still the problem that I can have missed information. To limit this risk I always took an hour directly following the interview to think trough all the questions. I tried to remember additional information and clarified my notes. Right after the interview I asked for permission to come back with additional questions. Everyone accepted this and the option have been used for clarification reasons as well as one time when time ran out before all questions were answered. Generally the interviews took a little more than an hour. The telephone interview took 45 minutes. There are a couple of effects that can skew the information acquired from interviews. One effect mentioned by Ericsson & Weiedersheim-Paul (1999) is that the interviewee can sometimes realize, by the way the questions are asked etc., what answers that are expected from them. Another effect, that adversely effects the information is when the interviewee provides a dishonest answer (Lekwall & Wahlbin, 1993). This can happen if the interviewee wants to give a positive picture of him or herself and the company. If this is the case the validity of the investigation can be questioned. Validity concerns whether or not the investigation is measuring what it is meant to (Lundahl & Skärvad, 1999). If venture capitalists are lying, then the answers are not a good indicator of what I, as the researcher, am investigating. In this case an interview and the questionnaire are the wrong instruments for the study.
Naturally, it is hard to see whether these two effects have played any role in my investigation. However, asking additional questions, controlling for answers as described above has been used to try and control for the latter effect.

Information Composition

After the telephone – and regular interviews were accomplished and email-questionnaires were received, I started to assemble the data. I used a method of focusing on specific areas reading through the selected information from each venture capitalist. On a separate sheet the information from all VCs were recorded. This information was then condensed to show general patterns as well as differences in venture capital views. I have chosen to provide the source of each opinion only in the case of quotations. The reason for this is that it would very hard for me to get access to interviews if I would not give respondents this degree of anonymity. I am also sure that some of the information from investment managers never would have been shared, if I were to provide sources continuously through the empirical chapter.
Hopefully the way I have managed the information from the beginning with formulating the questionnaire to last part of composing the information have guaranteed, to the extent possible, the credibility of presented information.

Table of contents :

1. INTRODUCTION
1.1. BACKGROUND
1.1.1. Innovation and the Economy
1.1.2. Sources of Finance
1.1.3. Venture Capital Funding
1.1.4. An Area of Great Importance
1.2. PROBLEM AREA AND RESEARCH QUESTIONS
1.3. PURPOSE STATEMENT
1.4. DELIMITATION
1.5. TERMINOLOGY
1.6. DISPOSITION
2. METHODOLOGY
2.1. THESIS FOCUS EVOLVES
2.2. TYPE OF SURVEY
2.3. SURVEY APPROACH
2.3.1. Form of Correspondence
2.3.2. Scope of Study
2.3.3. Sample of Interviewees
2.3.4. Interview Execution
2.3.5. Information Composition
3. VENTURE CAPITAL FRAMEWORK
3.1. DEFINING VENTURE CAPITAL
3.2. VENTURE CAPITALIST INTERVENTION
3.2.1. Venture Capitalist Activities
3.2.2. Frequency and Openness
3.2.3. Reasons for Intervention
3.3. VENTURE CAPITALIST INVESTMENT STRATEGIES
3.3.1. High rate of Return
3.3.2. Structuring Incentives
3.3.3. Staging of Capital
3.3.4. Stage Focus
3.3.5. Diversification
3.3.6. Syndication
3.4. VENTURE CAPITAL SOCIETY
3.4.1. Venture Capitalists as Insiders
3.4.2. Investors
3.5. RISK AND VENTURE CAPITAL
3.5.1. Risk or Uncertainty
3.5.2. Risk Assessment
3.5.3. Risk Tolerance
3.5.4. Risk Experience and Stage
3.5.5. Identifying Risks
3.5.6. Venture Capital Experiences
3.6. TECHNOLOGY AND VENTURE CAPITAL
4. VENTURE CAPITALISTS AND SEED INVESTING
4.1. THE VENTURE CAPITAL ORGANIZATION
4.1.1. Structure
4.1.2. Technical Data
4.1.3. Management
4.2. SEED STAGE CAPITAL
4.2.1. Different Views
4.2.2. Defining Seed Capital
4.3. SEED INVESTMENT DIFFICULTIES
4.3.1. Risk
4.3.2. Lack of Information
4.3.3. Recruiting
4.3.4. Investment/Cost Ratio
4.3.5. Goal Incongruence
4.3.6. Bargaining Power
4.4. SEED INVESTMENT ENVIRONMENT
4.4.1. Society View of Entrepreneurial Activity
4.4.2. History of Venture Capital
4.4.3. General Market Conditions
4.4.4. Access to Soft Funding
4.5. SEED INVESTMENT STRATEGIES
4.5.1. Ownership
4.5.2. Syndication
4.5.3. Return on Investment
4.5.4. Staging of Capital
4.5.5. Investment Horizon
4.5.6. Investment Focus
5. ANALYSIS
5.1. SEED INVESTMENT DIFFICULTIES
5.1.1. Risk
5.1.2. Investment Inefficiency
5.1.3. Goal Divergences
5.1.4. Bargaining Power
5.2. SEED INVESTMENT ENVIRONMENT
5.2.1. Deal Flow
5.2.2. Investment Climate
5.2.3. Soft Financing
5.3. VENTURE CAPITALISTS AND SEED INVESTING
5.3.1. Venture Capitalists Role
5.3.2. Pre-Investment Activities
5.3.3. Post-Investment Activities
6. CONCLUSION
6.1. SEED STAGE INVESTING – DIFFICULT IN ITS NATURE
6.2. NEED OF SOFT FINANCING
7. BIBLIOGRAPHY
7.1. LITERATURE
7.1.1. Articles
7.1.2. Books
7.1.3. Newspaper Articles
7.2. ELECTRONICAL SOURCES
7.3. OTHER SOURCES
7.4. INTERVIEWS
7.4.1. Face-to Face Interviews
7.4.2. Telephone Interview
7.4.3. Email Questionnaires
7.4.4. PVA-MV AG Contact
8. APPENDIX
8.1. QUESTIONNAIRE

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