'Venture Capital for the Future - Implications of
Founding Visions in the Venture Capital Setting'
Ph.D. Dissertation by
Miriam Garvi, Jönköping International Business School
Chapter One: The Theme of this Research (pp. 3-22)
First Scene: The Assignment
The
play opens in a large office. The walls are white; there is a huge
window at one end letting in bright sunlight. A couple of bookcases are
surprisingly empty. Two young women are sitting at their desks at the
window, glancing through their calendars. There is a soft knock on the
door; RAT-A-TAT. The two women turn around as a middle-aged man enters
the room, greets them and takes a seat in the empty chair by the door...
THE
PROFESSOR: … So, welcome both of you to our Business School. I think it
would be good for you to start with a research project. We try to get
our Ph.D. Students enrolled in a project as soon as possible. It’s like
a form of research apprenticeship. (The two women are listening
intently, nodding). Now I’m not really sure what your research
interests are. (Turning to one of the women) I understand you’re into
marketing?
FIRST WOMAN: Yes. Well, I haven’t really decided yet. Marketing or
management, I have a background in both.
THE
PROFESSOR: Anyway, I’ve had a project in mind for some time now. I was
thinking that maybe one of you would like to be involved! You see, I
know a guy who teamed up with other successful business founders to
launch a regional venture capital firm. There is a lot of innovation
happening in that Region. And now a group of quite prominent people in
our Region has taken a similar initiative. There may just be a
different business logic here that could be worth exploring. (Pausing,
then addressing both women) What do you think? Does it sound
interesting?
FIRST WOMAN (In a hesitant voice): Eh… I don’t know. It doesn’t really
sound like my area…
THE PROFESSOR (Addressing the second woman): And how about you?
THE
RESEARCH APPRENTICE (eagerly): I think it sounds exciting! I’d like to
be involved! I don’t have that much to do at the moment, either,
besides taking a few classes.
THE PROFESSOR: Good. Maybe you
could start then by writing down a couple of pages on venture capital
and how you would picture this project. I think we can find some
funding for it here at the Business School. Then we can have a meeting
and discuss how to get the project started. (Takes his leave and exits
the room).
(The first woman leaves the room.)
THE RESEARCH
APPRENTICE (Addressing the audience): What did I just get myself into?
What is venture capital, anyway? Well, he’s this great professor, if he
thinks it’s important then it must be! (Distressed) What am I going to
write about? What did he say the project should focus on? I’d better
get down to the library right away; there must be some literature that
can give me a clearer idea of what I’ve got myself into…
The emergence of a research theme
Research
may start with the most naïve of questions, the one you would not
venture to pose in academic circles for fear of publicly exposing your
ignorance. For me, it started with a question that was immediately
quelled by my eagerness to get started; “What is venture capital?” My
feelings of inadequacy in being unfamiliar with the term sparked a
search that might never have come about had I been dished out an
answer.
From this confessional tale (cf. Van Maanen 1988) it might
seem as though this dissertation was a product of happenstance. I
assure you, it is not. Just as there are various ways of conducting
research, there are various ways in which a research theme will come
about. Seeing research as a process of life development, Judi Marshall
contends that “...people study topics that are relevant to them. (…)
This personal involvement is not a burden, a source of unwanted bias;
rather it provides the energy for research and heightens my
potential as a sense-maker.” (1992:281). Somewhere along the line,
something triggers one’s commitment that finds its strength in one’s
personal mosaic of background, personality, and aspirations,
influencing what phenomena to study and what questions to explore. In
an interview commenting her book ‘Men and Women of the Corporation’,
Rosabeth Moss Kanter explains how as a researcher she would not “…want
to do anything that doesn’t make a contribution to improving the
world.” (in Puffer 2004:97-98). My motivation for finding a way through
the quagmire has very much been the desire of making a contribution to
more than my own awareness and understanding. This original seed has
been a continuous source of motivation that has helped me overcome the
frustrations and discouragements that are so intrinsically linked with
any research process (see Eisner & Powell 2002).
As a
freshly-enrolled Ph.D. Candidate I had no particular preference as to
what kind of business activities I wanted to study. But, in the back of
my mind, there were questions calling for investigation, questions that
would surface from time to time prompting for answers. As a young
child, I moved with my family to the African continent because my
parents were carrying a vision of what they wanted to do with their
lives. And so the realisation of that vision – involving the move to
three different countries, with new languages to learn and new cultures
to explore – was a notable part of my childhood. Enrolling as a student
at the Gothenburg School of Economics and Commercial Law, I was taught
the golden maxim of profit-maximisation. But this did not fit with the
harsh realities of sustenance and survival I had left behind in Africa.
Nor did the fact that some people do not choose to walk the mainstream
way seem worthy of much theoretical consideration.
My senior year
at university involved writing a master’s thesis together with a fellow
student. Finding a research topic was a dilemma until our
supervisor-to-be planted the idea of looking into telework among
Scandinavians abroad. Location theories that we came across in economic
geography about why people moved from one place to another and what
determined their choices emphasised the maximisation of the
individual’s own utility (cf. Etzioni 1988). But this did not reflect
the complexity of motives revealed in our investigation. Interviewing
sixty Scandinavians who had moved to the Mediterranean Sun Belt, we
found a commonality in that they had (re-)arranged their work lives so
as to improve their quality of life (Garvi & Kullenberg 2000).
Behind the move from Scandinavia to Italy, France or Spain lay a vision
of what these people desired in life and wanted to accomplish (cf.
Senge 1990/2006). What the vision was about was as diverse as the
people we encountered.
Arriving in Jönköping, the very first
research work I undertook as a Ph.D. Candidate was a small-scale
project together with a colleague. Intrigued by young people’s rising
ambitions to create new companies and their visions of growth, we
interviewed ten entrepreneurs at the Business Incubator connected to
Jönköping International Business School (JIBS). What we found was a
mixture of visions of grandeur and quality of life, sometimes combined
with unrealistic implementation – what Barbara Bird and Candida Brush
(2003) would call ‘naïve entrepreneuring’. Clearly, having grand
visions was one thing – putting them into practice quite another. And
here we saw that the ability to realise a vision and involve other
people in this process varied greatly among the individuals we met.
As
I embarked on the research project that was to become the bulk of this
dissertation, I realised that the effectiveness of a model depends on
what one wants to achieve. It made little sense for me to try to
understand what the people I encountered were looking to accomplish,
unless I tried to grasp what it was that they wanted to do – unless I
included their motives and visions. And so my encounters with people in
the venture capital setting were guided by the desire to understand
what it was that they intended to accomplish.
What transpires in the
sketch of my research journey is the room for volition, for the
opportunity to make choices and decisions. Two people – in identical or
similar circumstances – can have entirely different visions of what
they want to accomplish depending on differing perceptions of reality
and dispositions. I thus see a vision as reflecting the intended
purpose of what we want to achieve, which may or may not coincide with
how things actually are. It holds the rationale for what others may see
as straggly but that to you makes perfect sense. And therein lies its
beauty; a vision can entail a strong commitment to a cause, sparking
the will towards new accomplishments (see Levin 2000).
Let us
start this journey, therefore, as I started mine – with impatient
curiosity as to what people might envision when they embark on
something new. Imagine, for a second, that you had the opportunity to
talk with Karl-Oskar and Kristina only moments before they set out on
their voyage to America, in the hope of a new future. What did they –
and their fellow boat passengers – envisage as they took that bold step
to change their lives? Did they share the same dream, the same
ambitions? Or were they simply united in their escape from misery and
their hopes for something better? Though the literary world of Vilhelm
Moberg bears little resemblance to the realm of venture capital, these
questions that help us make sense of human initiative still linger
through time and space.
In the wake of venture capital
Is
access to capital what makes the subtle difference between success and
failure? The ‘power of money’, ‘money talks’, ‘cash is king’ – various
idioms reflect the view that the access to financial resources is a
powerful facilitator. Adding the epithet of ‘venture’ directs one’s
thoughts towards a specific kind of capital that involves chance, risk,
or danger (Longman 1984). As I turned my attention toward the on-going
debate on venture capital, I became concerned with what it would mean
for the founder of a business, who had started his or her enterprise
with a notion of who and what it was for, to become affiliated with a
partner taking an ownership stake in the business.
Let me put these
reflections in their proper context by dwelling briefly on the
background surrounding the early stages of my research. In late 1999,
Sweden and much of the industrialised world was living the ‘IT bubble’.
As the valuations of stock in computer technology companies – and in
particular anything related to the Internet and e-commerce – reached
astonishing levels and reports flowed in of individuals turning
millionaires almost overnight, there seemed to be no shortage of money.
For many of the young entrepreneurs at the business incubator connected
to JIBS, any business idea in e-commerce was expected to bring on a
flow of venture capital, taking the new venture on an exciting ride to
the heart of the capital’s booming IT district. My impression at the
time was that venture capital was almost everyone’s desire, as a magic
wand for what many people seemed to be dreaming of – namely fame and
fortune.
Many of the dreams and ambitions encountered in 1999-2000
appear naïve and unrealistic with hindsight. But they echoed also in
the media, such as in this article raising the challenge; “If you want
to get rich, be an engineer!” and providing the recipe for making new
millionaires:
How do you become rich? Well, you get yourself a
proper education. Preferably within an area that is somehow related to
information technology. Then you continue with research or at least
developing some kind of speciality within that area. After that, you
found a company around your speciality together with a few research
colleagues and many venture capitalists. A few years later, you sell it
all for a couple of billion kronor.
Though the article was written
on an ironic note, the marvel at a new era where wealth was suddenly
within the reach of anyone who was brave enough to set up his or her
own venture was tangible.
“Never before have so many been willing to
invest so much in new and unlisted companies” trumpeted a headline in
the business magazine Veckans Affärer in the summer of 2000. Announcing
that more than 50% of the total risk capital amounting to 170 billion
SEK was available for new investments, venture capital was now a global
phenomenon with capital flowing in from oversees at an astonishing
pace. “The phenomenon is global. In the U.S., with an estimate of two
thirds of all the risk capital world-wide, as much funds have been
pumped in during the last two years as in the preceding
twenty.”
I
was one of the many people who read reportages such as the one above
with increasing attention, as I followed two groups of individuals who
had recently involved themselves with the provision of venture capital.
Stories of successful investments proliferated. One case which received
its fair amount of publicity was the acquisition in May 2000 of
Altitun, a laser technology company, by the American corporation ADC
Telecommunications. The deal was reportedly worth 8 billion SEK. The
company had only existed for three years, and with equity shares worth
well over 500 million SEK each for its founders, the press had a field
day. In the climate surrounding the millennium, ‘growth’ was the buzz
word. However, it was not gradual, long-term growth that was confirmed
through such stories as Altitun, but the astonishing pace at which
financial value could be created. At the annual event organised by the
Swedish Venture Capital Association (SVCA) in March 2001, the Altitun
story was the highlight of the programme. Listening to the co-founder
and CEO of the company as well as one of the venture capitalists having
made the ‘lucky’ investment, I wondered at how an ever-accelerating
growth pace was the management fashion. Rapid growth meant rapid
changes, such as the arrival of new employees or new contracts. But
rapid growth could also prove challenging when an acquired entity was
to be incorporated into an existing organisation in order to expand its
resource base. The potential challenges of this fashion were not,
however, the topic of the day.
Meanwhile, in my fieldwork I was
encountering several people who were questioning the sustainability of
an idea when profitability was not part of the equation. A brochure
distributed in 2000 by Connect Sweden, a network organisation for
entrepreneurs, subtitled ‘How You as a growth entrepreneur handle
investors’, gave the following cautionary advice: “Perhaps you should
decline when an investor offers 10 million kronor for 30 per cent, and
instead accept the offer of another who is willing to venture merely 5
million kronor, but who will be building value in the company in a much
better way.” (2000:20). In another report published by Connect Sweden
in the following year, nine IT entrepreneurs having received venture
capital in 1999-2000 were interviewed by students Niclas Qvist and
Henrik Saläng. They found that the financiers in question – venture
capitalists and business angels alike – focused on rapid increases in
investment value through short-term measures. For lack of a long-term
or at least a medium-term perspective, these actors could hardly be
reconciled with the image of investors who were patient enough to await
the due course of development of a fledgling venture. The lack of
experience of these venture capitalists – some of which were only just
starting out – was also brought to attention. “The thought that these
venture capital firms and business angels who made their investments in
the good times didn’t really have control of their own operations is
just as fascinating as it is scary.” (Qvist & Saläng 2001:39).
The
moral of these stories was for entrepreneurs to choose their investors
with care.
By 2001, rapid growth had become risky business. In the
spring of 2000, several e-commerce ventures filed for bankruptcy. By
February 2003, Altitun’s assets had been auctioned off, marking the end
of an existence of little more than five years. The fact that many of
these ventures were backed by well-known industrial or financial
profiles fuelled concerns that risk capital, or venture capital, was
perhaps not as serious nor as competent as it had been depicted to be.
When the value of IT stock plummeted, it seemed that risk capital lost
some of its favour with the media. In the search for explanations,
investors behind those ventures that had failed were not exempt from
blame, raising the question of whether they should, in fact, have
‘known better’. Amidst accusations of incompetence and poor judgement,
venture capital now appeared to be a problem.
In February 2004, the
Swedish Agency for Economic and Regional Growth (Nutek) published a
report with the following observation by Per Åhlström, a publicist and
consultant:
Venture capital companies often assert that there is
no shortage of risk capital, there is only a lack of capable
entrepreneurs with good ideas. That’s just another way of saying that
they have a hard time finding investment objects that correspond with
their requirements. But many entrepreneurs are for their part not
particularly pleased with their affiliation with venture capitalists.
They’re afraid of losing control of their business, they feel (often
rightly so) that the venture capitalists’ conditions are unreasonable
or that their offers are unacceptable. Many business owners bear
witness to the fact that most venture capitalists demand unreasonably
rapid growth and the possibility to exit after too short a time, often
only a couple of years. (Åhlström 2004:57).
The image conveyed here
was not that of a harmonious partnership where venture capitalists were
welcomed as ‘knights in shining armour’ and entrepreneurs were valued
for their creative ingenuity. Instead, it highlighted conflicting,
possibly irreconcilable, perspectives between two parties with little
reason to trust one another. In this context, venture capital emerged
as intriguing, triggering my purpose of elaborating the
phenomenon.
The influence of venture capital
Venture
capitalists have been credited with the development of dynamic regions
such as Route 128 in Boston and Silicon Valley in California, and with
the emergence of new industries such as computers and biotechnology
(Bygrave & Timmons 1992; Hambrecht 1984). It is not uncommon to
view venture capital as a vital and necessary element for a dynamic
socio-economic landscape, one which is characterised by growth and
renewal (cf. Braunerhjelm 1999). In 2001, Paul Gompers and Josh Lerner
concluded; “No matter how we look at the numbers, venture capital
clearly serves as an important source for economic development, wealth
and job creation, and innovation.” (:83). Venture capital can create a
much-needed space for ideas and initiatives to flourish where the road
towards fruition is far from straightforward.
Fuelled by national
statistics (such as quarterly reports on venture capital published by
Nutek in Sweden), one debate on the venture capital phenomenon focuses
on the availability of funds for investment in unlisted companies, and
in particular of funds directed towards the earlier life stages of a
venture. Implicit here is the long-held tenet that securing venture
capital is a key to the success of a new venture (cf. Waluszewski
&
Wedin 2005). However, the role of venture capital in the emergence of
investment ‘bubbles’ (e.g. Sahlman & Stevenson 1987) is an
indicator of the fact that venture capital in itself is no guarantee to
success. As Vance Fried and Robert Hisrich so poignantly observe, “The
VC can be either a constructive force, an impotent one, or even a
destructive force in the company.” (1995:102).
Venture
capitalists as valuable partners for fledglings
Venture
capitalists are typically associated with the development of firms in
need of capital in order to launch a project, grow, expand, or venture
into new lines of business. This provides the basis for a business
model that relies on the growth of invested capital that can spring
from such a development process (enabling the ‘recycling’ of funds into
new affiliates, e.g. Braunerhjelm 1999; Isaksson 2006; Zider 1998).
Venture capitalists are also associated with ‘more than just money’,
accounting for the venture epithet (see Bygrave & Timmons
1992). In
this context, it is common to refer to active investing (e.g. Hellmann
& Puri 2000), signalling that venture capital brings an
involvement
beyond the passive holding of an investment – though the level of
involvement may vary depending on the ‘choice’ of the venture
capitalist in question (see Elango, Fried, Hisrich & Polonchek
1995) and on the particulars of the investment situation (see
Fredriksen 2003).
In a world of unpredictability, the venture
capitalist is often applauded for displaying a more patient outlook
than the average investor, simply because the venture capitalist, just
as the business founder, will reap the benefits of the investment only
after a particular outcome is successfully reached (cf. Bygrave
&
Timmons 1992). One can readily envisage how this investment in money
and in time may be a valuable recourse for business founders,
entrepreneurs, and innovators in need of resources in order for their
product or service to reach its market, where other avenues of
financing such as bank loans are inaccessible (e.g. Wasserman 1988). In
particular, their networks can be valuable resources for any founder or
entrepreneur in need of financial, commercial or technology-based
contacts to bring the venture to life (e.g. Rickne 2000; Powell et al.
2002), and their knowledge and experience of business development
(Sapienza & De Clercq 2000) may serve to check those risks
which
are easily disregarded by a founder blinded by an enthusiastic belief
in his or her idea (e.g. Amit, Glosten & Muller 1990; Gompers
&
Lerner 2001). In many cases, the endorsement by a high profile venture
capitalist will boost the reputation of a start-up, by giving
credibility to an actor with no track-record (e.g. Hsu 2004). Some will
conclude that venture capitalists are ‘serious and responsible
partners’, becoming actively involved with an affiliate in those
situations and circumstances where this is called for, such as in the
face of a public offering or a crisis; leaving considerable leeway as
to the daily operations of the company (see Fredriksen 2003). It is
therefore not surprising that venture capitalists are generally held in
high esteem as vital elements of an innovation system (Eliasson
&
Eliasson 1996) and as ‘intelligent financiers’ who specialise in a
particular kind of knowledge (cf. Amit, Brander & Zott 1998;
Cable
& Shane 1997; Sapienza & De Clercq 2000).
Implications
of venture capital affiliation
Venture
capitalists are known to influence a number of issues which have a
bearing on the strategic orientation of their affiliates (see Hellmann
& Puri 2000; Hsu 2006; Rosenstein 1988; Sweeting 1991). Control
is
ensured through concentrated equity positions and various governance
mechanisms which provide ownership and economic rights (see Sahlman
1990; Jain & Kini 1995). The board of the affiliate is a
frequently
employed arena for interaction (Rosenstein 1988; Rosenstein, Bruno,
Bygrave & Taylor 1993; Gabrielsson & Huse 2002;
Gabrielsson
2003), where venture capitalists act out strategic (i.e. acting as a
financier, business consultant, and sounding board), interpersonal
(i.e. acting as friend/confidant and coach/mentor), and operational
(i.e. being a source of industry and professional contacts, and a
managerial recruiter) roles (Sapienza, Amason & Manigart 1994).
The
venture capitalist enjoys an influential position in a broad array of
matters which will shape the development of a venture.
Informal
involvement is a notable ingredient of a venture capital process (see
Tyebjee & Bruno 1984), where the interpersonal role of venture
capitalists in providing e.g. moral support becomes particularly
visible (see Fried & Hisrich 1995). Interactions with
‘professional
venture capitalists’ who bring their own ideas about what is
strategically relevant or desirable shape the venture even before a
formal relationship has been established (Willquist 2001). Elements of
social exchange, such as perceived fairness (e.g. Sapienza &
Korsgaard 1996), communication and commitment play in on the
development of the venture, as aspects conducive to a climate of trust
and cooperation (see De Clercq & Fried 2005; cf. Harrison
&
Dibben 1997). This is particularly delicate considering the dual role
of an ‘insider’ (e.g. as a strategic resource) and an outsider (as an
external owner looking to protect its own interests which may or may
not coincide with those of the affiliate) that is taken on by the
venture capitalist in its relationship with the affiliate (Fredriksen
1997). Furthermore, as illustrated by a recent article entitled the
‘Entrepreneur’s Guide to the Venture Capital Galaxy’, such a
relationship involves dynamic roles as it progresses through various
phases (De Clercq, Fried, Lehtonen & Sapienza 2006).
From the
receiving end, venture capital involves relinquishing control over a
number of issues which serve to define the identity of what is created.
In particular, it may engender a deeper conflict as to the vision for
one’s business, in terms of what people want and what they seek to
achieve. The process that is initiated and intensified with venture
capital affiliation often leads to the departure of a founder, by own
accord or by replacement (see Hellmann & Puri 2002).
Fundamental
differences with respect to divergent motives and time perspectives
(Florida & Kenney 1988) and the kind of innovation that is
fostered
(Perry 1988) may lead to costs in terms of the loss of motivation and
creative ability which seem as detrimental to the development of a new
venture as the financial costs incurred by a conflict (cf. Higashide
& Birley 2002). When such a partnership compromises with core
ideas
and fundamental values, this inevitably raises concerns as to how
rewarding or fulfilling venture capital affiliation may be on the human
as well as the strategic level.
The multiple dimensions that are
affected by venture capital investment imply that venture capital is a
complex matter in both strategic and human terms. This brings
the
question of who is providing the venture capital to the forefront.
Sanford Ehrlich and his colleagues conclude:
…an overzealous founder
may find that the long-term costs far exceed the short-term benefits if
there is a mismatch in expectations between the relevant parties. Who
the entrepreneur gets his/her money from is just as important as the
amount of capital obtained initially. (Ehrlich, Noble, Moore &
Weaver 1994:145).
Research that focuses on the individuals behind
venture capital provision can thus contribute to a better a priori
understanding of the implications of venture capital affiliation, both
in strategic and in human terms.
Inconsistencies
of a phenomenon
The
influence of the venture capital phenomenon is reflected in research,
where venture capital has emerged as an academic field of enquiry since
the 1980’s, gaining ground in the 1990’s and attracting growing
interest from various disciplines (see Fried & Hisrich 1988;
Barry
1994). As Vance Fried and Robert Hisrich note, “Given the importance of
venture capital financing to economic development as well as venture
creation, it is not surprising that venture capital has emerged as a
topic of more interest and research effort.” (1988:15). In this sense,
the emergence of venture capital as a field for research is associated
with the recognition of its importance for economic development and
venture creation (see Gorman & Sahlman 1989). In the editorial
of
the first issue of Venture Capital, a specialised journal in the field,
Colin Mason and Richard Harrison refer to ‘a broad consensus of
opinion’ recognising the importance of entrepreneurial activity for
economic development and the role of venture capital in shaping the
socio-economic landscape; “…there is now growing appreciation of the
key role of venture capital in innovation, job creation, economic
growth and industrial renewal in a wide range of geographical
contexts.” (1999:1).
The debate that surrounded venture capital in
1999-2001 contrasted the view of venture capital as an ideal solution
for business development with that of the venture capitalist as an
irresponsible speculator of other people’s money. And although the
heterogeneity of those providing venture capital was increasingly
acknowledged, venture capitalists typically came across in the research
literature as a homogeneous group of actors with similar goals and
motivations. Such inconsistencies set the scene for further
investigation.
Tensions
between venture and capital
One
inconsistency of the venture capital phenomenon concerns the tension
between venture and capital, between venture capital as an instrument
for business development and venture capital as an instrument for
capital gains. As Rosenstein and his colleagues summarise the debate:
“At one end of the spectrum, venture capitalists incubate start-ups and
nurture hatchlings, while at the other extreme, so-called “vulture”
capitalists feed on fledgling companies.” (1993:99). In a sense, this
becomes a question of whether and to what extent venture capital is
beneficial for other implicated parties than the capital owners.
Evidence on resource misallocation (Amit et al. 1990; Florida &
Kenney 1988), investment bubbles (see Sahlman & Stevenson 1987)
or
precipitated initial public offerings (Florida & Kenney 1988;
cf.
Gompers 1996) point towards ‘vulture’ capitalism. In the context of
high-tech firms, recent evidence has suggested that the influence of
venture capitalists on the affairs of the affiliate is mainly limited
to a financial perspective (see Eliasson & Eliasson 1996;
Rickne
2000), which may also be indicative of the dominance of capital over
its venture epithet.
Literature on informal venture capital
suggests that private investors tend to be more highly motivated by the
development of the firm as a reward in itself than formal actors
(Osnabrugge 1998 in Sapienza & De Clercq 2000) – also referred
to
as ‘psychic income’. On the other hand, there is research that suggests
that the overall goal of a (formal) venture capital firm may differ,
depending on whether the capital owners are investors who seek direct
monetary returns on investment, or corporate owners who have other
strategic goals for instance (Elango et al. 1995). The latter may be
looking to venture capitalist investments as a way of obtaining a
window on new technology (cf. Maula 2001). In his case study, Lee Tom
Perry (1988) differentiates between three different types of venture
capitalists, viz. those who ultimately seek high financial returns,
those who are looking to build a company for IPO and those who are
driven by the development of new technology. Analogically, he finds
that different kinds of entrepreneurs are driven by different motives,
and that it is desirable to obtain compatible matches between the
objectives of the venture capitalist and those of the entrepreneur.
Though the three ideal-type matches suggested by the study may very
well need further refinement, Perry highlights that venture capitalists
may pursue different ends, leading to differences in behaviour and
affecting the relationship with the affiliate on a variety of
levels.
Reviewing the emergence and evolution of venture
capital in the U.S., Bygrave and Timmons (1992) contrast a ‘classic’
form of venture capital, which earned its name as patient and
risk-taking, with a ‘merchant’ form. Entitled ‘Venture Capital at the
Crossroads’, their book raised the concern that ‘classic’ venture
development with a focus on early-stage ventures and active involvement
was giving way to a form of venture capital which had more in common
with investment banking, with financial skills being applied to create
capital gains with minimal risks through investments in later, more
mature stages. The discussion by Bygrave and Timmons brought attention
to whether the primordial focus of venture capital was shifting from
the fostering of new firms to the management of investor funds,
revealing inherent tensions that may lead to maximising capital gains
in the short-term at the expense of the well-fare of a company in the
longer-term. Bygrave and Timmons’ concerns appear all the more
important as they give rise to questions that relate to ‘Who are we
here for?’, or to use the terminology of Peter Blau and Richard Scott
(1962), to the ‘prime beneficiary’ of venture capital. The contrast
between classic and merchant venture capital, between the image of
incubating and nurturing new ventures and that of financial trading,
opens up for critical reflections as to the intended beneficiary(-ies)
of venture capital.
Venture capital affiliation gives access to a
resource pool in terms of e.g. financial, human and social capital. A
relevant question is, of course, whether the application of this
resource pool is actually beneficial for the venture. Much of the
debate on venture capital has been dominated by the issue of
value-added (see Mason & Harrison 1999; Manigart &
Sapienza
2000) and the circumstances that may cause venture capitalists to add
more value (see Willquist 2003). Even so, the value creation effect –
i.e. the link between added value in terms of management competence and
performance – has yet to be explained (e.g. Barry 1994; Braunerhjelm
1999; Olofsson 1996). However, the complexity of venture capital
provision in terms of different approaches to and involvement in the
relationship with affiliates makes it difficult to reach any conclusive
answer on the matter (Mason & Harrison 1999). And this leads us
to
the need for incorporating heterogeneity into research designs in the
venture capital domain, as a way of problematising issues of intended
beneficiary, intended purpose, and of critically reflecting on various
implications that are entailed as venture capitalists position
themselves somewhere along e.g. classic-merchant or nurturer-vulture
spectra.
Heterogeneity
lost in abstraction
Venture
capital research tends to convey the idea of a homogenous population of
firms, offering little variation on the actor level. It is dominated by
studies on the aggregate level, consistent with the aim of providing
policy-makers with insights into how best to focus their efforts and
initiatives in order to stimulate the provision and efficiency of
venture capital (see Callahan & Muegge 2003). From a financial
perspective, the venture capitalist is viewed as an intermediary
between institutional pools of financing and private equity with high
growth prospects (e.g. Gompers & Lerner 1999). This brings
attention to the potential macroeconomic benefits resulting from a
financial intermediary selecting, monitoring and adding value to the
most promising ventures (see Manigart & Sapienza 2000). In most
studies, the venture capitalist has become synonymous with the limited
partnership organisation. As organised pools of institutional money,
limited partnerships are powerful actors on the venture capital arena,
spreading across national borders. This organisational form for venture
capital provision emerged in the U.S. in the eighties as large pools of
capital from pension funds were made available for investment,
following the 1979 amendment to the ‘prudent man rule’. It came to
outrival an earlier form, the small business investment company (SBIC)
that proliferated in the sixties (see Bygrave & Timmons 1992;
Gompers & Lerner 1996).
It is common to distinguish between a
formal and an informal segment of the capital market (e.g. Braunerhjelm
1999; Isaksson 2006; Karaömerlioglu & Jacobsson 2000; Wright
&
Robbie 1999), where venture capital firms and private financiers or
business angels complement each other in the financing of small
businesses (see Harrison & Mason 2000). This is mirrored in the
literature on venture capital by two streams of research which emerged
as the role of informal investors in financing early-stage ventures
gained recognition (see Wetzel 1983). The increasing tendency
of
private investors to operate in syndicates, alliances and networks is,
however, blurring the boundary between formal and informal (see Mason
& Harrison 1999).
Despite an increasing body of research on
venture capital, incorporating heterogeneity into research designs is
challenging. In the formal stream of venture capital research, one
particular form of venture capital is emphasised, whilst other remain
in the shadows. As Christopher Barry contends, “There are various types
of venture capital organizations. This paper and most of the literature
tends to stress the limited partnership form, but there are others.”
(1994:12). In the mid eighties, Jeffrey Timmons and William Bygrave
noted the discrepancy between a homogeneous view of the venture capital
‘industry’ and the empirical diversity in terms of strategy and
organisation among venture capital actors.
The venture capital
industry is generally perceived as an agglomeration of homogeneous
firms, whereas, in fact, they are quite heterogeneous. Differing
objectives, strategies, resources, locations, associations, and
organizational forms result in a great deal of variety within the
venture-capital industry. This diversity needs to be understood and
incorporated into well-focused research designs if studies of the
venture-capital industry are to be most productive. (1986:163)
A
few years earlier, a seminal paper by Tyzoon Tyebjee and Albert Bruno
(1984) structuring the venture capitalist investment activity into a
sequential model had cautioned against the design of models that would
be too rigid to reflect the heterogeneity of venture capital practices.
In the same vein, Fried and Hisrich noted a few years later that
research tended to look for similarities among actors, omitting
differences that might prove particularly interesting to explore:
“…research designs have generally ignored differences between venture
capital firms and also between investees.” (1988:22).
Such
observations give rise to concerns that potentially important
dimensions are lost in abstraction. Turning to literature on small
business finance in general, the poor reflection of heterogeneity in
research designs appears to be part of a wider problem. As Hans
Landström concludes:
In many cases, researchers have considered the
actors of both the supply and the demand sides as homogenous; the
venture capitalists have been considered as a homogeneous group of
financiers, the group ‘small firms’ has been considered to be
homogeneous, etc. The increase in knowledge indicates that this is not
the case – both the supply and the demand side consist of many
different actors… (2003:18).
Reflecting on heterogeneity in the domain of entrepreneurship studies,
Per Davidsson writes that:
…I
firmly believe that a theory or a research design that assumes that
economic aggregates (such as an industry, or demand) are made up of the
sum of identical micro-level entities, is unlikely to be a fruitful
starting point for understanding or researching the entrepreneurship
phenomenon. For example, individuals are heterogeneous with respect to
experience, skills and cognitive capacity… and also have heterogeneous
motivations… (…) Importantly, they will also have different views on
what constitutes a successful or acceptable outcome… (2004:22).
Davidsson’s
reflections remind us that business activities are carried out by
individuals, and challenge us to go beyond sums of ‘identical
micro-level entities’, as we move closer to the realities of the human
actors. Identifying two distinct logics of ‘empire builder’ and
‘temporary partner’ amongst Swedish providers of venture/risk capital,
Christer Olofsson argues that in order to distinguish between them, a
perspective that moves beyond ‘external signs’ of venture capital
practices is called for.
… it is important to distinguish between
various kinds of venture capital firms. For instance, external signs
such as majority or minority ownership are not decisive in determining
whether an investor should be considered to be a temporary partner or
an empire builder. But ... it is only after an investor has made a
number of investments that it is possible give an opinion on the nature
of the business with some degree of certainty. (1986:6).
In
many ways, venture capital research has pursued a common avenue, where
empirical studies with weak theoretical connections which have served
to map out the phenomenon have been coupled with the testing of
hypotheses derived from financial theory (with a particular preference
for agency theory; see Arthurs & Busenitz 2003). Highlighting
the
paucity of theoretical perspectives, Fried and Hisrich suggested that
venture capital research would benefit from concepts from other fields
that would reflect the wider realms of influence on an affiliate:
…financial
theory should not be the only theoretical basis for research. Venture
capital plays an active role in the strategy, marketing, management and
legal structure of the entrepreneurial firm. It is likely that concepts
from all of these disciplines are relevant to the study of venture
capital. (1988:26).
A decade later, this call was echoed in
literature reviews by Mike Wright and Ken Robbie (1998), as well as
Mason and Harrison (1999). Tensions between theoretical models, on the
one hand, and empirical evidence, on the other, challenges research to
focus on other aspects of the venture capital phenomenon that have
hitherto remained in the dark. Since, theoretical perspectives from
other domains (such as procedural justice, stewardship theory, social
capital theory) have been applied in order to broaden horizons, making
this field of research a ‘later adopter’ of lenses that are already in
use in other domains of social studies. It is perhaps intriguing that
venture capital research has hitherto taken a bystander role in
promoting more innovative approaches, rather than actively
incorporating a venturing element that is so strongly associated with
the empirical phenomena of study. In the words of Barry, “Realistic
treatments of the issues faced in venture capital research will require
innovative approaches.” (1994:14). The challenge of incorporating
heterogeneity into research on the venture capital phenomenon is still
there for the taking, affecting the choice of methodology, the kind of
venture capital firms that are the focus of study, and the role of
theory.
Addressing the ‘mystery’ of
venture capital
Reflecting
on inconsistencies of the venture capital phenomenon brings back
questions of who and of why, of individual venture capital providers
and their motivations for doing what they do. In a report that gives a
face to several Swedish industrial corporations by narrating the story
of its founders, Anders Johnson reflects on the apparent anonymity of
Swedish business founders in the economic history literature. Though
focusing on entrepreneurs rather than venture capitalists, an analogy
may be drawn to ‘The mystery of venture capital’ as a phenomenon that
is seldom given a face in the research literature. Venture capital is
conveyed as an increasingly institutionalised industry, a global force
that shapes the economic landscape (see Avnimelech, Kenney &
Teubal
2003). In this sense, capital flows gain more attention than the
individuals behind the particular initiatives, who are left lurking
anonymously in the background. Despite a by now impressive body of
research on venture capital, we know little about the motivations of
those individuals who are behind and/or involved in particular venture
capital initiatives. Venture capital narratives tend to be lost in
abstraction as we move into the realm of academic research. As Noam
Wasserman shows in his dissertation, the venture capitalist can be seen
as an entrepreneur, opening up for interesting research questions as to
what happens within the venture capital company itself and between
those who are providing the service: “...past studies have treated VC
firms as black boxes, neglecting to explore the organizational
characteristics within the VC firms that might have important
implications for VCs’ roles as financiers.” (2002:20).
As one
effort to provide insight into the investor’s perspective, Gerald
Benjamin and Joel Margulis (2000) establish a typology of business
angels based on their differing interests and motivations for what they
are doing. They quote American business angel Norman Brodsky explaining
what captures his interest in the venture capital business:
For
me, there’s nothing like it – the business of seeing a business rise up
from nothing…. There’s just something unbelievably thrilling about
seeing the growth, watching the numbers go up, getting the business to
stand on its own… I can’t get enough of it. (…) …these deals offer me
the opportunity to teach other people some of the things I’ve learned
over the years and to share with them the excitement of bringing a new
business into existence. (in Benjamin & Margulis 2000:101).
An interview with another investor reveals that he finds
other rewards in his involvement:
It
seems to me people often cling to the impression that venture capital
is interested only in making money. I don’t believe that’s true at all.
I think that people who come into this kind of business perceive needs
and have values. (…) The companies that have integrity, that have a
product, that have meaning in them, are the ones that I think really
matter. (…) I think the money will flow if the service is there. Making
money is not the goal; profits and return become the score that gets
chalked up after the goal has been reached. (in Benjamin &
Margulis
2000:130).
Though relating to people in the ‘informal segment’ of
the capital market, the examples above illustrate heterogeneous
interests and motivations among its practitioners, with implications on
the strategic and human levels.
The research
purpose and its intended contribution
Against
this background, there are dimensions of venture capital which, though
increasingly recognised as potentially important for our understanding
of the phenomenon, are not typically the focus of such studies.
“Throughout the 20 years of organised research activity on the VC
phenomenon, the least attention has been placed on the identity,
motivation, and structure of the ones who make it happen.” (Seppä
&
Ratila 2002:4). Focusing on the mindsets and visions of the individuals
behind a particular venture capital initiative – i.e. its founders – is
a way of digging for rich descriptions that will help problematise and
make sense of the venture capital phenomenon. Drawing attention to the
faces and voices of venture capital can give further insights into the
implications - both in strategic and human terms - of such affiliation.
Accordingly, the purpose of this dissertation is to elaborate on
the venture capital phenomenon, by reflecting on particular venture
capital initiatives and the implications of the visions for their
founding.
This will involve a plunge into two contemporary venture
capital initiatives in Sweden, focusing on the people behind these
initiatives and their founding visions (chapters 3 to 6). It will also
involve trying to understand why venture capital has come to enjoy such
an applauded standing in business development by tracing the intended
purpose of a pioneering initiative that emerged in post-WWII U.S.A. and
that left a legacy that remains recognised today (chapter 7).
An
in-depth analysis of the venture capital phenomenon – both in terms of
particular initiatives and in terms of venture capital as originally
intended (see chapter 7) – will contribute to our view of the
phenomenon, by incorporating differences as well as similarities
between actors (also in terms of motivation) and providing a nuanced
view of a venture capitalist mindset. This will provide food for
thought for business founders or entrepreneurs who are seeking venture
capital affiliation, in terms of what may be appropriate for what they
seek to accomplish (see Elango et al. 1995). Knowledge of different
visions guiding such initiatives will also give room for reflecting on
the socio-economic landscape that is being shaped for the future, as a
‘grounded critique’ of the venture capital phenomenon.
Chapter Two
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