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How Corporate Venture Capital Investing Increases Innovation
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Wharton Researcher Finds Advantages for Experienced Entrepreneurs.
What makes an entrepreneur?
The conventional view suggests that an entrepreneur is a big thinker — a
visionary, to employ an overworked term — who's willing to
take hefty risks to realize a dream. Call it the brains-and-bravado
model.
David Hsu, a Wharton professor of management, doesn't discount the importance of brains or bravado in starting new firms. But in a recent study, titled, "Experienced Entrepreneurial Founders, Social Capital and Venture Capital Funding," he finds that, when it comes to landing investments from venture capitalists, experience and contacts matter, too. By at least one measure, they appear to matter even more than brains.
Hsu surveyed 149 entrepreneurs to assess what influenced the timing and valuation of venture-capital investments in their young technology companies. His survey period covered the peak years of the so-called Internet Bubble.
He learned that experience mattered a lot: An entrepreneur who had previously founded a company was able to secure a higher valuation for his company and to raise money faster. That result held even if the entrepreneur's prior venture had failed. Entrepreneurs who had previously succeeded had an even bigger edge.
In fact, recent business history brims with examples of "serial entrepreneurs," people who seem to have a genius for getting companies founded, funded and forging ahead.
As an example of this phenomenon, Hsu cites Jim Clark, founder of Netscape, Silicon Graphics and a raft of other technology companies. Clark, who was the subject of the best-selling book, "The New New Thing," began his career as a computer scientist. Since then, he has launched firm after firm, reshaping the commercial landscape in the process. Silicon Graphics pioneered three-dimensional design software and high-end computer workstations. Netscape invented the web-browser business. Healtheon, now part of WebMD, tried to revolutionize healthcare. "[Clark's] greatest gift has been an ability to articulate groundbreaking ideas in a way that attracts both start-up capital and technical expertise," says Salon.com, an online magazine.
Despite his successes, Clark has a characteristic that, according to Hsu, can work against an entrepreneur when trying to raise money — a doctorate. It's a paradoxical finding. After all, you'd think that the expertise acquired in earning a PhD would reassure investors. Who better to bet on than an expert? But Hsu found that a company with a PhD founder was less likely to have a tie to a venture capitalist and thus more likely to see a lower valuation and a longer lag before funding.
That suggested to him that PhD founders might not be spending enough time meeting and greeting; aggressive networking, from participating in entrepreneurship clubs and conferences to attending happy hours and even playing in work-related softball leagues, is a staple of life in such high-tech hotbeds as Silicon Valley and Boston's Route 128 corridor.
The finding also suggested to Hsu that venture capitalists might be seeking out seasoned founders over scholarly ones. "What they want to see is not that you've contributed knowledge but that you've you been able to get down and dirty and found a business," he says.
Experienced founders, of course, have better networks of contacts than novices. They know not only venture capitalists but also angel investors, lawyers, accountants and other people in their field. That helps them when it's time to organize a new business and hire a management team. They have to spend less time on recruiting and fund-raising and can focus more on activities such as product development and marketing.
What's more, they're better known and that pays dividends. Someone like Jim Clark has an aura. People want to work for him, and investors want to bet on him. "Prior entrepreneurial founders are those that have typically been in the community the longest championing their venture ideas," Hsu points out in his paper. "[They] receive visibility through media and word of mouth…VC investors are more likely to be aware of and monitor the activities of these individuals."
And experienced entrepreneurs' social ties do more than just enable them to start firms faster. They appear to help them win better deals from venture capitalists.
According to Hsu's analysis, when a founder recruits his executive team himself, as opposed to relying on venture capitalist for help, his firm ends up with a higher valuation.
Why is that?
"Experienced entrepreneurial founders are likely to have established social ties to the labor and capital markets as well as to potential strategic alliance partners that would mitigate their reliance on VCs to ‘broker' these same ties," Hsu writes. "In contrast, novice entrepreneurs, with not as many established links on average, may be subject to brokerage fees in the form of lower valuations to their startups."
Put another way, an inexperienced entrepreneur has to accept a lower valuation because, in effect, he has to pay the venture capitalist to provide a raft of services. He's basically renting the venture capitalist's Rolodex. Experienced founders have big Rolodexes of their own, so they can hold out for better deals.
Hsu offers the analogy to building a house. "It's like the difference between being your own contractor and hiring someone to do it," he explains. "If you have the skills and can invest the time to do it yourself, you may save some money."
Another form of networking — forging relationships with angel investors — also appears to help entrepreneurs when they're raising money from venture capitalists. Hsu discovered that ties to venture capitalists through angels translated to a shorter time to funding, though it didn't provide any valuation boost. "Angel and VC investors often operate in a complementary fashion," he explains. "Angel investors typically seek investments below a certain monetary threshold and stage of venture development, whereas VCs typically seek investments over those thresholds."
Angels can serve as scouts for venture capitalists, spotting promising ventures, providing early seed money and giving entrepreneurs time to flesh them out. Once a firm gets closer to viability, a venture capitalist can step in with an investment. "Sometimes, angels can act as referrals for entrepreneurs," recommending them to venture capitalists, Hsu adds.
For aspiring entrepreneurs, Hsu's study underscores a lesson that many folks know but few heed: Having a great product or service isn't enough. You have to be able to sell it — and yourself. That means getting out and meeting angel investors, venture capitalists, lawyers, accountants and members of the media.
And occasionally even going to happy hour. .
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