RESEARCH: Recent research emphasises the positive effects of venture capital. Professor Sophie Manigart, of Vlerick Leuven Gent Management School, explains and shows why getting funded by a VC investor is great – but targeting the right investor is even more important.
Few events are more exciting in the life of a young entrepreneurial company than being able to raise venture capital. Venture capital investors are highly selective; hence getting an investment from them is considered as a quality mark for early ventures. Research has, for example, shown that companies that receive venture capital are able to attract more and higher quality employees, are more legitimate and are hence able to negotiate with more powerful partners, customers or suppliers. Their corporate governance is strengthened with a small but focused board that helps in strategic decision making.
A new pan-European research project, the VICO project, has investigated how European venture capital-backed companies develop, compared to their non-venture capital backed peers. Receiving venture capital has a positive effect on entrepreneurial companies beyond the mere effect of venture capital investors selecting the best deals. Capital expenditures, investments in R&D and productivity are higher in venture capital backed companies, and as a result they grow stronger compared to their peers. Interestingly, venture capital backed companies are more resilient in the current crisis: while non-venture capital backed companies reduce their number of employees following drops in sales, venture capital backed companies are currently still able to slightly grow in sales and in employees. Interestingly, portfolio firms have higher chances of success if they attract venture capital later on, when their products are already developed.
But not all venture capital is the same – especially not in Europe – and not all venture capital investors have the same beneficial impact on their portfolio companies. One important dimension in which venture capital companies are different is whose money they invest. Independent venture capital companies raise funds from unrelated limited partners, corporate and bank-related venture capital companies invest money from their parents (an industrial corporate such as Siemens or a financial institution), and public venture capital companies invest government or university funds. The VICO project therefore further investigated how venture capital heterogeneity impacts their portfolio companies, beyond the effect of merely selecting the best companies. These are the main results:
- Independent VC firms exerted an unequivocally positive impact, greater than that documented in previous studies, on the productivity and sales growth of portfolio companies.
- The effect of corporate VC investments on productivity, instead, is negligible.
- Governmental VCs appeared to have a positive impact on the growth of the early stage firms, while the impact was negligible for the more mature ones. University VCs, by contrast, have a negligible impact on the development of their portfolio companies, regardless of the age of the portfolio firm.
Another dimension relates to their experience: some venture capital firms have existed for decades, while others are new kids on the block. The VICO results strongly show that experienced VC investors have disproportionally positive effects on employment generation and asset accumulation in their portfolio companies. Further, starting with experienced VC investors will strongly increase the chances of getting a second investment round with other prestigious investors and of getting higher amounts of money later on.
Finally, getting funded by a domestic or a cross-border investor also has different implications for portfolio companies. Ventures backed solely by cross-border venture capital investors grow initially at a lower rate than companies backed solely by domestic venture capital investors, but the former catch up later, albeit only partially. Companies backed by a syndicate of domestic and cross-border VC investors experienced more vibrant growth than other VC-backed companies, both in the short and the long term. Alternatively, companies initially backed solely by domestic VC firms, which later added an international VC firm to the syndicate, performed equally well as those having international VC firms on board since the first investment round.
While raising venture capital is exciting to any entrepreneur, the VICO results suggest that getting money from the right investor may be more important to support growth and success. The best performing firms are backed by a syndicate of experienced independent venture capital investors, with a mix of domestic and cross-border investors. Hence approaching the right investor is key.
Read more about the VICO project
The Master in Financial Management at Vlerick