Impact of VCs' Own Attributes on their Investment Decision-Making

During the analysis phase of my dissertation research, I discovered that the quality (depth & richness) of responses from the 16 Canadian VCs I interviewed varied considerably by experience. I included number of years working as a VC (ranging from 1 to 26), as well the number of firms worked for and the number and value of deals completed. Why is experience important? Because VCs develop more comprehensive thinking models for investment evaluation as they learn. However, some research has indicated progressively more experience is not always better as longer time in the role can cause some VCs to become trapped in their thinking models. Thus, an inverted U-shaped relationship between experience and decision-making effectiveness has been contemplated, with 14 years being the ‘optimal’ amount. This is one reason why my research about the contribution and value that professionally-qualified financial managers can bring to entrepreneurial ventures is important: it can offer new factors and information that VCs can use to expand their approach to evaluating management capabilities – an investment decision construct which seems to be weak.

One measure of VC experience was identified by Dimov (2007) as the VC-firm’s “finance capacity”. This is a reflection of the collective experience of VC investment managers’ experience in financial roles (primarily non-VC) which is thought to represent their capability to understand the requirements for an investee to be successful. An interesting finding of Dimov’s study was that VC-firms with greater finance capacity tend to select fewer early-stage investments (which are the riskiest due to higher levels of uncertainty). It is unclear whether VCs actually measure risk, but they are certainly aware of it as a result of their due diligence and attempt to control it through deal structure features and post-investment monitoring and coaching.

Perhaps a significant finding of prior research is that VCs’ experience influences their management team assessments. For example, novice VCs tend to focus on verifiable qualifications of individual team members while experienced VCs attempt to make intuitive judgments about team cohesion. It seems more experienced VCs attribute more weight to the forest than the trees when evaluating management teams. Based on these findings, researchers had two recommendations for VC-firms: use novice VCs for deal screening and more experienced VCs for in-depth evaluation; and, the more experienced VCs could be coaching their less-experienced counterparts.

As the VC industry is over seven decades old, its initial homogeneity has given way to specialization. VC-firms now differentiate themselves along multiple dimensions including venture stage priorities for investment, deal sizes & structure, staff utilization orientations (time & services provided to investees), and sources of capital (e.g. institutional vs. high-net worth individuals). Capital seekers should make themselves aware of these distinctions to focus their efforts effectively and efficiently. But in addition to these objective differentiators, both capital providers & seekers should be interested in their cognitive ‘fit’. The journey ahead will be fraught with challenges and consequent stresses and tensions. With similar approaches to thinking and problem-solving at the cognitive level, disruptive conflict can be avoided and better partnering achieved.