University of Amsterdam
MSc. in Business Administration – Strategy Track
18th of August, 2017 mm
Venture Capitalists Attitude to
Entrepreneurial Failure
Author: Regina Laura Lipták Student Number: 11386460
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Statement of originality
This document is written by Regina Laura Lipták who declares to take
full responsibility for the contents of this document.
I declare that the text and the work presented in this document is
original and that no sources other than those mentioned in the text and
its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents
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Table of Content
I. Introduction ... 6
II. Theoretical Background ... 7
1 The Investment Decision-Making Process of Venture Capitalists ... 7
1.1 Stages of the Investment Decision-Making Process ... 7
1.2 The Venture Capitalists’ Investment Criteria ... 9
1.3 VC Firm Specific Criteria ... 12
2 Research question ... 13
2.1 Previous Entrepreneurial Experience ... 13
2.2 The Outcome of the Previous Experience ... 15
III. Hypothesis Development... 16
1 Relationship Between Experience and Investment Size ... 17
2 Relationship Between O utcome and Investment Size ... 18
3 Modifying Effect of Different Types of Experience ... 19
IV. Data and Methodology ... 20
1 The Data Source ... 20
2 Data Collection ... 20 3 Sample ... 20 4 Variables ... 20 5 Methodology... 20 V. Empirical results ... 20 1 Descriptive Statistics ... 21
2 Results of the Hypothesis Testing ... 22
2.1 Results of Model (1) and Model (2) ... 22
2.2 Results of Model (3) ... 23
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2.4 Summary of the Results... 27
VI. Conclusion and discussion ... 28
1 Findings and Contributions ... 28
2 Limitation of the research... 30
VII. References ... 31
VIII.Appendix ... 33
List of Tables
Table 1: The summary of Model (1) and Model (2) ... 22Table 2: Coefficients of Model (1) and Model (2) ... 23
Table 3: Summary of Model (3) ... 24
Table 4: Interaction Variables ... 25
Table 5: Conditional effect of X on Y ... 25
Table 6: The results of the interactions in Model (4) ... 26
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ABSTRACT
This paper examines the venture capitalists (VC) attitude to the length, type and the outcome of the entrepeneurs’ previous experience with the support of a dataset about 69 founders and their prior experience. This study found support for the assumption that venture capitalists do not take into account only the presence or the length of the experience, but valuate the outcome (failed or succeeded), as well. The most important finding of this study that venture capitalis ts appreciate to have successful founding experience in terms of valuation, but do not punish a failed experience. It can be conluded that having an unsuccessful experience in the past does not count as a black mark and does not influence the future funding opporuntities of an entrepreneur.
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I.
Introduction
This research aims to provide meaningful insights on the venture capitalists’ attitude to serial entrepreneurs with successful and failed previous experience. I examine whether an unsuccessful venture in the entrepreneurs’ portfolio counts as a “black mark” or as a sign of being experienced.
The fact that the entrepreneurs themselves are one of the main criteria in case of venture investment is proved in the entrepreneurial literature (Macmillan et al., 1985; Fried and Hisrich, 1994; Vinig and de Haan, 2005; Petty and Gruber, 2011) . The quality of the entrepreneur is often measured by her/his human and social capital (Carter et al., 2003; Hsu, 2007). Even though the relationship between prior experience and new venture performance is academically not always clear (Sandberg and Hofer, 1987; Stuart and Abetti, 1990; Cooper et al., 1994; Kakati, 2003; Gompers et al., 2010; Toft-Kehler et al., 2014), venture capital investors prefer entrepreneurs with track record (Stuart et al., 1999; Hsu, 2004; Zhang, 2011). The academic researches show mixed views on the importance of the outcome of previous experience (Gompers et al., 2010; Paik, 2014), but it fails to provide qualitative results on the opinion of venture capitalist on the topic. This gap in the entrepreneurial literature leads to the following research question: how does a previously succeeded or failed entrepreneurial experience
influence the venture capitalists’ view on the entrepreneur’s new venture?
To answer the question, I collected the data of 69 early stage VC investments, in every case the founder of the new venture has a clear track record. I examine how the previous experience of the entrepreneurs influences the attitude – the investment size – of the venture capitalists. The next two chapters review the related literature and develop the hypothesises. Chapter 4 describes the collected data, chapter 5 demonstrates the empirical results and chapter 6 discusses the significance of the findings.
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Theoretical Background
As Stuart et al. stated, “…because the quality of young companies often cannot be observed directly, evaluators must appraise the company based on observable attributes that are thought to co-vary with its underlying but unknown quality.” (Stuart et al., 1999: p.317).
One of the factors that complicates to evaluate a venture is information asymmetry. Informat io n asymmetries can arise when the venture capitalists and the entrepreneur have differe nt information (e.g. about the entrepreneurial skills, experience) or different interests (e.g. in effort) (Bosse and Phillips, 2016). The occurrent opportunistic behaviour of the entrepreneur and the variety of their ability to identify and exploit opportunities mean a higher risk for the investors (Shane and Cable, 2002).
Kaplan and Strömberg (2001). identified three primary ways that investors can mitigate the conflicts raised from information asymmetries: (1) pre-investment screening; (2) structuring financial contracts; (3) post-investment monitoring and advising. During the pre-invest me nt screening process the investor can engage in information collection before deciding whether to invest.
1 The Investment Decision-Making Process of Venture Capitalists
As the focus of this study is the investment decision-making process and the criteria used by VCs, this chapter describes the steps that are taken from seeing the introduction material of a new venture the first time to closing a deal and introduces the different criteria used by venture capitalist to valuate a new venture.
1.1 Stages of the Investment Decision-Making Process
Because VCs treat information about their decision-making process as private and secondary data is barely available, Fried and Hisrich (1994) examined 18 venture capital firms during the investment process to find the common factors. They identified six different stages during the
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investment decision- making process: (1) Origination, (2) VC firm-specific screen, (3) Generic screen, (4) First-phase evaluation, (5) Second-phase evaluation and (6) Closing. In the first stage, during the origination VCs receive investment proposals through industry directories or as “cold” proposals, without any introduction. Many VCs use Firm-specific criteria which are in line with their specialization. Most of the time, these criteria are based on the stage of the financing (early or later stage companies), geographic location or industry. In the Generic screen stage VCs take into consideration the concept, the management and the possible return to decide whether the proposal can be send to the next stage. During the First-phase evaluat io n the VCs gather additional information from the entrepreneur, customers and industry experts to determine whether there is a serious interest in the deal. As the fifth stage requires significa nt time, the VC firms already determine the value or the price of the deal, before they enter to that stage. In the Second-phase evaluation VCs focus on the possible obstacles and they can be overcome. The proposals passed through the first five stages, end up in the Closing stage, when the details of the structure are finalized and legal documents negotiated.
Hall and Hofer (1993) summarized four previous studies about the steps made by venture capitalists during their decision- making process. The results are in line with the findings of Fried and Hisrich (1994). All the studies mentioned the general search for investments as the first step, which is followed by the screening process. The evaluation and due diligence were mentioned in every study, but sometimes represented separated steps and the invest me nt process always ended with deal structuring and post-investment activities, as monitor ing, advising and cashing out.
Venture capitalists established different investment criteria to speed up the screening phase. The new venture proposals must meet those requirements to pass through the next stage. As the valuation or the pricing of a deal is based on the fulfilments of those criteria, in the next chapter the venture capitalists’ investment criteria will be discussed.
9 1.2 The Venture Capitalists’ Investment Criteria
In one of the earliest studies about the investment decision making process of venture capitalists, five investment criteria were identified: (1) market attractiveness, (2) product differentiation, (3) managerial capabilities, (4) environmental threat resistance and (5) cash-out potential (Tyebjee and Bruno, 1984). According to the study of Macmillan et al. (1985), the criteria used by venture capitalists to decide on funding or not can be divided to five categories: (1) the entrepreneur’s personality; (2) the entrepreneur’s experience, (3) the characteristics of the product or service, (4) the characteristics of the market and (5) financial consideration. Fried and Hisrich, (1994) identified three categories to classify the investment criteria: (1) concept, (2) management and (3) return. Finally, Zacharakis and Meyer (2000) summarized the existing literature on VCs’ decision making criteria and stated a similar conclusion: there are four categories which can be passed or fail by a new ventures during the screening process: (1) entrepreneur/team capabilities, (2) product/service attractiveness, (3) market/competit ive conditions, and (4) potential returns if venture is successful.
In the following chapters the above-mentioned criteria are categorized as concept, financ ia l characteristics and management. To better understand the screening and valuation stages of the venture capitalists decision- making process, the most common investment criteria will be briefly described.
1.2.1 Concept
The criteria of the concept are related to the characteristics of the product and the market. In this chapter the literature about the required factors to invest will be summarized.
Product
Zacharakis and Meyer (2000) summarized eight previous studies about the venture capitalis ts’ investment criteria and found that from the product/service characteristics the most important is the attributes of the product and its proprietary. The product differentiation and the market
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acceptance were the second mostly mentioned requirements from VCs. The requirement for an existing prototype was only mention in one study from the eight.
The researchers interest in the importance of proprietary in the valuation process begin to arise in the last few years. Hoenig and Henkel (2015) examined how venture capitalists may use observable resources as signals of unobservable quality dimensions to valuate a new venture. One of the quality signals of a product can be the patent which protects the technology behind the product. According to their research, patents affect the venture capitalists’ decision making in their property rights function. However, there is no indication that they serve as technology quality signals. Block et al. (2014) made a similar study about trademarks and found a positive relationship between the presence of the trademarks and start-up valuation. However, they discovered that the number and breadth of trademark applications have inverted U-shaped relationships with the financial valuations. Both studies mentioned, the earlier the start-up’s progress is in the venture cycle, the more important the presence of the trademark or the patent is.
Market
According to the study of Zacharakis and Meyer (2000) the most important market characteristics for venture capitalists during the investment decision-making process is the existing market size and the potential market growth. Additionally, at least one of the summarized studies mentioned competitor threat, barrier to entry and the venture creates new market as an investment criterion.
1.2.2 Financial characteristics
Venture capital firms are return-driven, as their primary objective is to deliver high returns to the outside investors (limited partners) whose funds they manage (Mason and Stark, 2004). Compared to the institutional investors’ portfolio, VC portfolios are likely to be relative ly undiversified. Moreover, VCs developed their specific skills in identifying, investing in and
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monitoring new and/or radically changing firms (Wright and Robbie, 1998). All the mentioned factors – way of operation, being undiversified, having specific skills – increase the expected return from an investment.
To determine the expected return, venture capitalists use different measurements. According to the study of Mason and Stark (2004) the aspects that VCs take into account are the (1) the financial structure of the business (e.g. costs and pricing, revenue streams and financ ia l projections), (2) the value of the equity/worth of business, and (3) the likely rate of return and exit route possibilities. The findings of Zacharakis and Meyer (2000) show that the most common criteria used by VCs is the return on revenue, which followed by the liquidity and cash-out methods. Other financial characteristics which were mentioned by the examined VCs are the expected risk, percentage of equity, investor provisions and size of the investment need.
1.2.3 Management
The Team
The definition of entrepreneurial teams has been a debate for a long time. Vanaelst et al. (2006) summarized in their study the evolution of the definition. The basic concept, as entrepreneur ia l team means two or more individuals who jointly establish a firm in which they have a financ ia l interest, was broaden to cover those individuals who have direct influence on strategic choices. The definition was later completed with an equity stake condition. Vanaelst et al. (2006) stated that concept “team” is evolving and changing over the lifetime of a new venture.
Muzyka et al. (1996) examined the trade-offs in investment decisions and found that all five management team criteria which were questioned by them were ranked among the first seven most important criteria. Their overall conclusion was that the interviewed VC would prefer to invest in a new venture with a good management team and a reasonable financial and product-market characteristic, even if the opportunity does not meet the overall fund and deal requirements. As Bygrave, William D., (1997) summarized his work, VCs would rather invest “in a grade A team with a grade B idea than in a grade B team with a grade A idea”
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Hoenig and Henkel (2015) examined what makes a team “grade A” and they found the team experience as the most important quality signal to help attracting financing. In their literat ure summary, team experience was measured based on management skills and history, leadership potential, industry-related competence and familiarity with the target market.
The Entrepreneur
Venture capitalists pronouncedly consider the entrepreneur itself as an investment criteria. According to MacMillian’s findings “it is the quality of the entrepreneur that ultima te ly determines the funding decision.” (Macmillan et al., 1985 p.8). Fried and Hisrich found that the VC firms interviewed all members of the management team and contacted the entrepreneur's former business associates in almost every case (Fried and Hisrich, 1994). Vinig and de Haan proved in their study that the VC investors - in the USA and in Europe as well - considered the entrepreneur as the most important attribute (Vinig and de Haan, 2005). Petty and Gruber found evidence – based on 11 years of archival data of VC firms – that the entrepreneur by him/herse l f can be a reason to reject a company, for example in the case of lack of management skills or bad reputation (Petty and Gruber, 2011). Based on the literature, the quality of the entrepreneur plays an important role in the decision-making process of venture capitalists.
1.3 VC Firm Specific Criteria
The list of investment criteria can vary by venture capital firms. Hall and Hofer, (1993) summarized previous studies about VCs’ investment criteria and found that the most important requirements which do not belong to the concept, management or financial consideratio n groups of criteria is the stage of the new venture’s development, size of the required investme nt, the VCs’ familiarity with technology, product and/or market, geographic location of the VCs and the new venture, and the involvement of other investors. All these criteria can influence the
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decision-making process of the venture capitalists, even if they do not determine the quality of a new venture.
The venture capital firms are most of the time specialized or focusing on one segment of the new ventures. Their focus can differ by the age of the new venture (e.g. early or later stage VCs), location (e.g. international or national VCs) or sometimes VCs have their own criteria (e.g. social investors).
Some of the VCs started to use an other type of criteria to evaluate new ventures which does not fit to the concept, management, financial consideration group of criteria. The social or responsible investments show a significant growth in the last decade. The impact investors as a type of social impact investors take into account non-financial criteria, as well. It means these venture capital firms invest in companies, organizations and funds with the intention to generate social and environmental impact alongside a financial return (Scholtens, 2014)
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Research question
In the previous chapters the most important criteria used by venture capitalist to evaluate new ventures were briefly described. The criteria can be categorized as concept, manageme nt, financial considerations and VC firm specific factors. As many of the mentioned literat ure stated, the entrepreneur or the founder of a new venture is a crucial criterion for the investors. In this chapter the reasons behind the importance of the founder will be introduced, which will lead to the research question of this study.
2.1 Previous Entrepreneurial Experience
2.1.1 Relationship between experience and future performance
The entrepreneurial literature distinguishes three different types of capital that an entrepreneur can have: financial, human and social. Carter et al. (2003) state that the human capital of the entrepreneur tends to be the most important signal of quality, as the human capital consists of achieved attributes that lead to increased levels of productivity. Hsu, (2007) stated that the
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human and the social capital cannot be completely separated from each other, since taking part in education, trainings or gaining founding or working experience leads to higher human and social capital at the same time.
A wide range of studies examined the connection between the different forms of human or social capital and new venture performance. The relationship between past working experience and new venture performance is a widely-researched question. Most of the studies examined the connection between founding, management and/or industry related experience and the performance of the new venture. In one of their papers, Stuart and Abetti, (1990) found that the entrepreneurial experience, such as the number of previous new venture involvements and the level of the management role played in such ventures was the most significant factor in the case of new venture performance. The experience and the contacts, which were developed in a similar business had positive significant effect on both marginal survival and growth of new ventures (Cooper et al., 1994). Toft-Kehler et al., (2014) found that entrepreneurial experience contributes to new venture success and that entrepreneurship can be learned by practice. As a contrast, Sandberg and Hofer, (1987) founding shows that the biographical characterist ics of the entrepreneur has little impact on new venture performance. According to the study of Stuart and Abetti, (1990) other experience (age, years of business, management, and technica l experience) were not significant and advanced education beyond the bachelor's degree was negatively related to performance. The prior managerial experience (e.g. supervising managers or managing a business) did not influenced the performance of new ventures (Cooper et al., 1994). Kakati's, (2003) regression analysis on success criteria of new ventures found that relevant track record was not significant. Familiarity with the target market was significant only at 10% significance level. Despite the wide range of literature, academic studies failed to have a clear agreement on the relatedness between human and social capital of a founder and the survival, profit, growth of the new venture.
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2.1.2 Venture Capitalists Attitude to Experience
Even though there is a lack of proved relatedness between experience and performance the venture capital investors prefer entrepreneurs with existing track record. With respect to Stuart “venture capitalists have traditionally heavily weighted the previous experience, especially entrepreneurial experience, of the lead entrepreneur in their evaluation of the attractiveness of new ventures.” (Stuart and Abetti, 1990: p1.). Zhang, (2011) empirically showed that serial entrepreneurs with venture-backed founding experience raise more quickly and higher amount of investments from VCs in the first round than novice entrepreneurs. Hsu, (2004) found that prior founding experience of a startup and the entrepreneur not only reduces the time of venture capital funding but it is associated with higher valuation because of their human and social capital.
2.2 The Outcome of the Previous Experience
2.2.1 Relationship Between Outcome and Future Performance
Besides the type of the acquired human and social capital of the founder, the entrepreneur ia l literature has already proved that the outcome of the previous experience influences the future performance of the entrepreneur.
Gompers et al. found that new ventures of entrepreneurs with successful track record perform better than novice entrepreneurs or entrepreneurs with failed track record (Gompers et al., 2010). According to the study of Paik, the new ventures of entrepreneurs with track record perform better than novice entrepreneurs, regardless of whether their previous funding experience was successful or failed (Paik, 2014). In the academic field, there is no agreement on the effect of failed experience on new venture performance. The complexity of the question is further modulated by studies about learning from failure in the field of entrepreneurs hip. Several studies proved the significant effect of failure on entrepreneurial learning (Cope, 2011; Thornhill and Amit, 2003).
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2.2.2 Venture Capitalist Attitude to the Outcome
In the previous chapter, it is showed that despite of the mixed results of the connection between experience and new venture performance, venture capitalists prefer entrepreneurs with track record. In case of the connection between the outcome of an experience and new venture performance the entrepreneurial literature provides similar mixed results, which lead to the research question of this study: how does a previously succeeded or failed entrepreneurial
experience influence the venture capitalists’ view on the entrepreneur’s new venture?
This topic in the entrepreneurial literature is surprisingly under-researched. According to the knowledge of the writer, until now only two main articles can be found on this topic. Cope et al., (2004) concluded after several interviews with venture capitalists, that previous founding experience is an important factor regardless whether it was a failure or a success. Hsu, (2004) found that entrepreneurs’ involvement in financially successful new venture increase the likelihood of VC financing and results in higher valuation. The research of Cope et al., (2004) provided insights on the venture capitalists attitude to failure, but only based on qualitat ive observations. Hsu used a qualitative approach, but took into account only the internal return rate of the investment in the founder’s venture. The aim of the paper to use a quantitative
method to further investigate the view of the venture capitalists on the outcome of a previous
venture.
III.
Hypothesis Development
As Zhang, (2011) stated in his research, the older a company or later the investment stage is, the less the experience of the entrepreneur matters. Therefore, to be able to clearly examine the effect of experience on the venture capitalists’ judgement and to distinguish this effect from others which arise with time, this study focuses on investments in early stage ventures. According to the study of Heughebaert and Manigart, (2012) the valuation of a new venture by VCs depends on the characteristics of the new venture and the bargaining power of the VC and
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the entrepreneur. The final value of an entrepreneurial firms is always determined by the investment size and the equity stake received by the VC. As Manigart et al. (2000) stated during the calculation of the investment size, first of all the accounting information, market factors and prediction are taken into account. However, most of the time - because of the early stage of the investment – the information is uncertain and the VCs pay rather attention on the the invest me nt criteria, such as the track record of the entrepreneur. To be able measure the importance of entrepreneurial experience, in this study the investment size is used as a measurement of the VCs’ attitude to a new venture.
1 Relationship Between Experience and Investment Size
The positive relationship between the entrepreneurs’ previous founding experience and a higher amount of VC investment in their new venture is already academically proved (Hsu, 2004; Stuart and Abetti, 1990; Zhang, 2011). As Hsu (2004) stated, the more activities (training, working, education, founding experience) the entrepreneurs take part, the more experience – social and human capital – they can collect. Stuart and Abetti (1990) in their study used the time spent in different fields (e.g. being a technical expert, a manager or a CEO of a company) as the measurement of experience and assumed that the longer the entrepreneurs fulfil a position, the more experience they can acquire. This study uses the time spent in the examined venture by the entrepreneurs to capture the experience they collected. Although, the relations hip between experience – having it or not – and the investment size was already examined in several studies, the years that the founders spent in their previous venture has not been used as a predictor for investment size until now. Therefore, the first hypothesis of this research is the following:
H1: The more time the entrepreneurs spent in their previous venture, the higher investment size they receive during the funding of their new venture.
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2 Relationship Between Outcome and Investment Size
This study assumes that the relationship between the experience of the entrepreneurs and the future investment size can be influenced by different factors. First factor which is taken into account is the outcome (failed or succeeded) of the examined experience. A previous experience is considered as failed, if the status of the examined venture (founding experience) was ‘closed’ in the database or, when the founder left the company within 3 years. As the average early stage investment of the venture capitalist from entering to the exiting last 3 years (Schwienbac her, 2009) and during this period VCs need a reliable entrepreneur. A venture was categorized as successful if it was still active after the founder left, was acquired or went public.
The question is whether the influence of the experience on the investment size depends on the outcome. According to the study of Cope et al. (2004) venture capitalists attitude to a failed experience varies by firm. However, they valuate the overall experience positively. As the mentioned study was based on interviews with VCs, there is a lack of empirical evidence for the results. Therefore, this study examines the indirect effect of a successful or an unsuccess ful track record on the investment size in the entrepreneurs’ new venture though the experience of the founder. The first part of the second hypothesis is the following:
H2a: The outcome of the entrepreneurs’ previous experience modifies the venture capitalists’ judgment on the entrepreneurs’ previous experience and therefore influences the investment size.
Hsu, (2004) found that entrepreneurs’ involvement in financially successful new venture increases the likelihood of VC financing and results in higher valuation. Hsu (2004) took into account only the effect of successful previous experience, which creates a gap in the literat ure about the effect of failed experience on the investment size. Therefore, to examine the direct effect of a failed experience, the second part of the second hypothesis is the following:
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H2b: Having an unsuccessful founding experience effects the investment size in the entrepreneurs’ new venture on a negative way.
The theoretical framework for Hypothesis 2a and 2b can be found on Picture 1, where X represent the experience, Y the investment size and M, the one which modifies the relations hip is the outcome of the experience.
Figure 1: Conceptual model for hypothesis 2a and 2b- Source: (Hayes, 2012)
3 Modifying Effect of Different Types of Experience
As there is wide range of experience or human capital, which can be acquired by entrepreneurs during their careers, this study aims to examine their modifying effects of the differe nt experience on each other.
Hsu (2007) stated that acquiring more human capital for example through having non-found ing experience positively influences the investment size. Therefore, this study uses the findings of Hsu (2007) and takes into account the modifying effect of having non-founding working experience as an entrepreneur. The last hypothesis is the following:
H3a: Having non-founding experience as an entrepreneur positively modifies the venture capitalists’ opinion on the outcome of the founders’ previous experience, which results in a higher investment size.
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Zhang (2011) found in his study when he examined the difference between serial and experienced entrepreneurs, that serial entrepreneurs raise higher amount of money in their new ventures than entrepreneurs with only one founding experience. Therefore, this study examines whether being a serial entrepreneur can positively influence the effect of the outcome on the investment size. The first part of the third hypothesis is the following:
H3b: Being a serial entrepreneur positively modifies the venture capitalists’ opinion on the outcome of the founders’ previous experience, which results in a higher investment size.
The theoretical framework for Hypothesis 3a and 3b can be found on Figure 2, where X represent the experience, Y the investment size, M is the outcome of the experience and in case of H3a the W is represents being a serial entrepreneur and in case of H3b W is represents having non-founding experience.
Figure 2: The theoretical framework of hypothesis 3a and 3b - Source: (Hayes, 2012)
IV.
Data and Methodology
V.
Empirical results
This section presents the several regression analyses and examine whether they support or reject the hypothesises (H1, H2, H3a and H3b) of this paper. To test the hypothesises the statistic
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program, called SPSS was used. In this chapter the results of 5 different model can be found. Model (1) contains only the dependent variable (VC_Investment_Size) and the control variables (Physical_Product, Location_Europe and Series_A). In Model (2) the independent variable (Time_Spent_in_PV) was added to Model (1). In Model (3) the moderating effect of the
Failed_Experience on the independent variable was examined. Model (5) measures the
modifying power of the situation when the entrepreneur has other working experience and Model (6) the situation when the entrepreneur not only an experienced, but a serial entrepreneur.
1 Descriptive Statistics
The sample contains 69 self-collected deals and there is only 8 missing data point, which represents less than 5% of the whole dataset. The normal distribution of the dependent and independent variables was tested. The dependent variable (VC_Investment_Size) shows normal distribution only after removing two outliers from the sample.
The correlation matrix provided by SPSS can be found in Table 1. Based on the Pearson correlation coefficients there are three statistically significant predictor variables in terms of investment size. Two out of the three are control variables: the product type (Physical_Product r=0.286), the investment type (Series_A r =0.395). The third one is the strongest predictor which correlate with the investment size, based on the Pearson coefficients, is the independent variable (Time_Spent_in_PV, r =0.506). Beside the correlation between dependent variable and the mentioned variables, a statistically significant relationship was detected between the independent variable, Time Spent in PV and the moderator variable, Failed_Experience. The correlation matrix can be found in Appendix 1., the mean and the standard deviation of the variables with the variable description can be found in Appendix 2.
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2 Results of the Hypothesis Testing
2.1 Results of Model (1) and Model (2)
First, the relationship between the independent variable (Time_Spent_in_PV) and the dependent variable (VC_Investment_Size) was examined with a hierarchical regression analysis. The hierarchical multiple regression contains three control variables, as well: Series_A,
Location_Europe, Physical_Product. As a first step, only the dependent variable and the contro l
variables were entered to be able to later observe the independent effect of Time_Spent_in_PV on the VC_Invesment_Size. The model summary results can be seen in Table 2. Model (1), which contains only the dependent and the control variables, is significa nt at level of 1% and explains 24.2% of the variation in VC_Investment_Size, which means most of the variance in the dependent variable is explained by other factors. In Model (2), due to the independent variable which is controlled by Physical_Product, Series_A, Location_Europe variables, the 49.9% of the total variance is explained. It means that entering the Time_Spent_in_PV increased the explained variance by 25.7%, which is a statistically significant change. Model (2) is also significant at the level of 1%. As the difference between R and R² decreased in Model (2) compared to Model (1), it can be assumed that the increased variable number is not the only cause of the development of R².
Summary of Mode (1) and Model (2)
R R² Change in R F
Model (1) 0.492 0.242 0.242 6.479***
Model (2) 0.670 0.449 0.257*** 11.799*** Statistical significance: *p <0.1; **p <0.05; ***p <0.01
Table 1: The summary of Model (1) and Model (2)
In Model (1) two control variables show statistically significant influence on the dependent variable: Physical_Product and Series_A. In Model (2) three out of four predictor variables
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were statistically significant. Although, three variables are significant, the independent variable has the highest Beta value (β = .465, p <0.000), which means Time_Spent_in_PV has the most predictive power on VC_Investment_Size. Model (2) provides support to the first hypothesis (H1). The interpretation of the results is, if the entrepreneurs spend one year more in their previous venture, the investment size in the new venture will be higher with 0.933 million US$ ceteris paribus.
Coefficients of Model (1) and Model (2)
Model (1) SE β t Physical Product .111 .283 2.527* Series A .113 .376 3.367 ** Location Europe .115 -.146 -1.305 Model (2) SE β t Physical Product .097 .256 2.617* Series A .101 .313 3.189** Location Europe .100 -.140 -1.428 Time Spent in PV .102 .465 4.729*** Statistical significance: *p <0.1; **p <0.05; ***p <0.01
Table 2: Coefficients of Model (1) and Model (2)
2.2 Results of Model (3)
In this case the relationship between the independent variable, Time_Spent_in_PV and the dependent variable, VC_Investment_Size was examined, as well. However, the moderating effect of the outcome of the previous venture was taken into account. In Model (3) a moderating variable, Failed_Experience was added to Model (2). Table 3 shows the summary of Model (3). By adding a moderator variable (Failed_Experience) to Model (2) the final model can explain 50.8% of the variance in VC_Investment_Size. This means an additional 4.12% change in R², which is significant at the level of 5%. Model (3) is statistically significant at the level of 1%.
24 Model Summary R² F Df1 Df2 P Model (3) .508 9.654 6.000 56.000 0.000 R²-Change F Df1 Df2 P Interaction Effect .0412 4.694 1.000 56.000 0.035 Statistical significance: *p <0.1; **p <0.05; ***p <0.01
Table 3: Summary of Model (3)
The conditional effect of Failed_Experience on the VC_Investment_Size when the average
VC_Investment_Size is taken into account is -0.042. It means that in case of an average
investment size, the difference between entrepreneurs with successful and failed experience is 41 800 US$. However, this result is statistically not significant.
The conditional effect of Time_Spent_in_PV on the VC_Investment_Size when the entrepreneurs have fully successful track records equals to 0.677. It means that if an entrepreneur with a successful track record spends one more year in the previous venture than the other entrepreneur with similar successful track record, the first one receives ceteris paribus 677 000 US$ more.
With the coefficient of the interaction (Int_1) the question: how much the effect of the
Time_Spent_in_PV on VC_Investment_Size is different between failed or fully successful
entrepreneur, can be answered. The interaction is statistically significant at the level of 5%, which means that the effect of the duration of the examined experience on the investment size in the new venture depends on the track record of the entrepreneur. The interpretation of the interaction is the following: if the entrepreneur spends one more year in the previous venture, the difference in investment size between failed and successful entrepreneur s ceteris paribus decreases by 740 000 US$. This result provides a support for H2a, because the outcome of the previous experience influences the investment size by modifying the judgment on the previous experience.
25 Interaction Variable Variables Coeff SE t Failed_Experience -.042 .143 -.144 Time_Spent_in_PV .677 .144 2.609*** Int_1 -.740 .169 -2.167** Statistical significance: *p <0.1; **p <0.05; ***p <0.01
Table 4: Interaction Variables
The moderating effect of the outcome of the experience is significant only in case of having fully successful track record (P < 0.000) and it is not significant for those entrepreneurs who has a failed experience (P < 0.841). It means that spending more time in the previous venture statistically increases the investment size in the new venture, only if the experience was successful. Spending more time in the previous venture and having failed experience decrease the investment size in the new venture, but the results are statistically not significant. With these results H2b can be rejected, because having an unsuccessful experience does not influe nce negatively the investment size.
Conditional effect of X on Y at values of the moderator:
Failed Experience Effect se t p
No 0.677 0.125 5.426 0.000***
Yes -0.0633 0.313 -0.202 0.841
Statistical significance: *p <0.1; **p <0.05; ***p <0.01
Table 5: Conditional effect of X on Y
As a summary, the results show that the effect of the duration of the experience on the VC investment in the new venture depends on the outcome of the experience (failed or succeeded). The relationship between the time spent in previous venture and the VC investment size is only significant when the entrepreneur has a fully successful track record and the relationship is positive in this case. Although, the same effect is not significant in case of the failed
26
entrepreneurs, the direction of the effect can be determined and shows an opposite effect, a negative one as the successful track record.
2.3 The results of Model (4) and Model (5)
In Model (4) and Model (5) the question was examined whether a newly entered variable (Working_Experience or Serial_Entrepreneur) can modify the effect a failed or succeeded track record on the relationship between the duration of the experience and the new VC invest me nt size.
The results of Model (4) can be found in Table 6 below. Int_2 represents the interaction between the Working_Experience and the Time_Spent_in_PV, Int_3 the interaction between
Failed_Experience and Working_Experience and Int_4 the interaction among
Working_Experience, Failed_Experience and Time_Spent_in_PV. As none of the P-value of
the interactions can be considered as the sign of statistical significance, there is no evidence for the presence of the moderated mediation effect. Further conclusions cannot be made about the relationship between the variables and the modifying effect of the working experience. As the results are statistically not significant, the first part of the third hypothesis (H3a) must be rejected.
Interaction Variable of Model (4)
Variables Coeff SE t p
Int_2 -.375 .263 -.189 .159
Int_3 -.556 .637 -1.428 .387
Int_4 .320 .708 -.873 .653 Statistical significance: *p <0.1; **p <0.05; ***p <0.01
Table 6: The results of the interactions in Model (4)
Model (5) is a modified version of Model (4), where the moderated mediation effect of the Serial_Entrepreneur was examined. The question whether being a serial entrepreneur influe nces
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the effect of having failed or successful track record on the relationship between the duration of the experience and the new VC investment size. Int_2 represents the interaction between the
Serial_Entrepreneur and the Time_Spent_in_PV, Int_3 the interaction between
Failed_Experience and Serial_Entrepreneur and Int_4 the interaction among
Serial_Entrepreneur, Failed_Experience and Time_Spent_in_PV. As none of the P-values of
the interactions show the sign of a statistically significant result, the question cannot be further examined and the second part of the third hypothesis (H3b) must be rejected.
Interaction Variable of Model (5)
Variables Coeff SE T p
Int_2 .252 .253 .994 .325
Int_3 -.955 .850 -1.124 .266
Int_4 -1.328 .918 -1.445 .155 Statistical significance: *p <0.1; **p <0.05; ***p <0.01
Table 7: The results of the interactions in Model (5)
As a summary, based on the results of Model (4) and Model (5) no modifying effect could have been detected in case of the relevant working experience beside the founding experience or of being not only an experienced, but repeated entrepreneur. As the sample size is considered as small, examining the question of this chapter on a bigger sample, maybe could provide better insights for H3a and H3b.
2.4 Summary of the Results
Hypothesis one and two is supported, 3a and 3b is rejected. The interpretation of the results and the answers for the research questions can be found in the next chapter.
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VI.
Conclusion and discussion
1 Findings and Contributions
This paper examines how the entrepreneurs’ experience – the length, the outcome and the type of the experience – influences the venture capital investment size in an early stage venture investment. To be able to answer the research question the data of 69 VC investment and the background of the entrepreneurs who received the investment were collected. Testing the hypothesises with the PROCESS model resulted in three rejected (H2b, H3a and H3b) and two supported (H1, H2a) hypothesises. The interpretation of the results and the final contribution to the literature can be found in this chapter.
First, the effect of the founding experience on the investment size was examined. In this case the experience was measured by the years that the founders spent in the examined previous venture. As several studied stated during a longer time of experience, more human and social capital can be acquired and venture capitalists prefer entrepreneurs with more experience. The study found support to the fact that VCs appreciate having longer experience with a higher investment size. As, in this case the time was taken into account when the founder left the company and more years they spent in their venture the higher amount of investment they received, I assume that beside the higher human and social capital, VCs are looking for reliable entrepreneurs who can run the company at least during the investment time.
Second, the effect of having an unsuccessful track record was examined. Being unsuccess ful means that the company was closed or the entrepreneur left the venture sooner than 3 years after the founding. The first question was whether the outcome influences the investment size through the judgment of the experience. The results showed if the entrepreneurs spend one more year in their previous venture, the difference in investment size can be detected between failed and successful entrepreneurs. It provides support for the assumption that VCs look into the
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outcome of the previous experience and not only the experience itse lf matters during the valuation of a new venture. Furthermore, this study assumed that having a failed experience
will negatively influence the investment size. However, based on the results the conclusion is that only the successful experience had a positive and significant effect on the investment size . Having a failed experience did not influenced significantly the investment size. It does not
provide support for the assumption that VCs have a negative attitude to failed entrepreneurs. An explanation for the result can be that venture capitalists examine the reasons
of the failure and take into account the circumstances and do not make the entrepreneurs themselves responsible for the failure.
Finally, this study examined whether the effect of the outcome on the investment size through the experience can be influenced by other factors. This study assumed that having non-found ing working experience or being a serial entrepreneur positively modifies the effect of the founding experience and provides further reason for a higher investment. However, in this case no such an influenced could have been detected.
This study can contribute to the literature about entrepreneurial experience. The effect of the experience on the investment size and the attitude of the venture capitalist to it were already examined by several papers. The results of this study can provide a support for the general findings about entrepreneurial experience, as it showed that experience does matter for the venture capitalists in terms of investment. However, the effect of the outcome of the previous experience is an under-researched field of the entrepreneurial experience. Therefore, the results of this study can fill up several holes in the literature. First, now it is empirically justified that the success or a failure influences the investment size through the judgement of the experience and not directly by itself. Second, now it is empirically proved that venture capitalists appreciate to have a fully successful track record in terms of investment size, but do not punish the
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entrepreneurs with a failed experience. The fact that having an unsuccessful venture does not mean a black mark on the entrepreneur is concluded.
2 Limitation of the research
The field of venture valuation and the judgment of the entrepreneurial experience is a wide and complex topic. In terms of new venture valuation there is high uncertainty about several factors, sometimes the market does not exist yet or the VC is familiar with the entrepreneur. Therefore, the valuation methods and the emphasises used during the process are differ by firms. Studies have already shown that the valuation method differs not only by continent but by countries, as well. Although this paper provides a great overview on the VCs general attitude to entrepreneurial experience, with a sample which contains more detailed location of the venture and the venture capital firms could give a more specific understanding. I assume – in line with the entrepreneurial literature - that being a serial entrepreneur or having a non-found ing working experience effects the investment size, and modifies the effect of the outcome. However, because of the limited sample size it could have not been detected in this study. Therefore my suggestion for a future research is that to examine similar hypothesises on a bigger sample with an extension of information about the exact location of the venture capital firm.
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IX.
Appendix
Appendix 1: Correlation Matrix
Correlation Matrix Variable 1 2 3 4 5 6 7 8 1 Physical Product 1 2 Series A .40 1 3 Location Europe .083 -.001 1 4 Working Experience -.230 -0.047 -.119 1 5 Repeated Entrep. -.099 .116 .011 -.070 1 6 Time Spent in PV .054 .106 -.016 -.046 -.064 1 7 Failed Experience -.079 -.106 -.055 -.131 .084 -.527** 1 8 VC Investment Size .286* .395** -.123 -.039 .054 .506** -.178 1
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* Correlation is significant at the 0.05 level (2-tailed) ** Correlation is significant at the 0.01 level (2-tailed)
Appendix 2: Summary Statistics and Variable Definition
VARIABLE DEFINITION MEAN S.D.
Dependent Variable
Venture Capital Investment Size
The amount of the invested money by the venture
capital firm in the new venture of the founder 4.18 5.62
Independent Variables: Measurement of the Background of the Founder
Working Experience Dummy = 1, if the founder has working
experience beside the founding experience 0.68 0.47
Repeated Entrepreneur Dummy = 1, if the founder has more than 2
founded company in the database 0.45 0.50
Time Spent in Previous Venture
The time during the founder was active in his/her
previous venture, measured in years 4.14 2.91
Failed Experience Dummy = 1, if any of the founder’s previous
experience was unsuccessful 0.41 0.49
Control Variables
Physical Product Dummy = 1, if the product requires
manufacturing facilities 0.06 0.23
Series A
Dummy = 1, if the type of the investment was categorized as series A round and not as a seed investment
0.42 0.49
