Greg Bell and his colleagues at the University of Dallas recently completed a study on how a VC decides how much to invest in a particular deal. Based on his findings Greg emailed me and asked, “So essentially, we would like to know whether VCs view confidence in a new venture separately than confidence in the entrepreneur? Do they view one as more important than the other?”
Before I give my opinion (based on nothing by my experience) I thought I would share Greg’s findings:
Our study focused on determining what characteristics or factors are important to VCs during the deal structuring stage of the VC decision-making process. Up to this point, research has segmented the VC management process into eight stages: 1) generating a deal flow, 2) proposal screening, 3) proposal assessment, 4) project evaluation, 5) due diligence, 6) deal structuring, 7) venture operations, and cashing out. By concentrating on stage six, which follows the stage five “invest or not invest” decision, we set out to examine how VCs determine how much funding to deliver, in how many stages to deliver the funding, and how much personal involvement and control are warranted in the Venture Capital - Entrepreneur relationship. Our study is based on a survey of venture managers in 95 venture capital firms identified in the 2003 Texas Venture Capital Directory.
Our results confirmed our assumptions that VCs who have high initial confidence in an entrepreneur contribute greater levels of venture financing. However, we were surprised to find that VCs with high initial confidence in the potential success of a venture itself actually contributed lower levels of venture financing. We considered with greater levels of confidence in the venture, there is less need for high levels of financing. An alternative interpretation of these findings could be that as the levels of confidence in the venture rise, the level of risk and possible return are reduced. Given multiple investment opportunities, the VC’s in our sample may choose to invest more money in ventures with the possibility of higher returns. Thus, less money is available to the “safer” investments.
Finally, our results indicate that VC control over the entrepreneur and venture (such as ability to change the management structure, change compensation structure, and adjust ownership structure) is not related to the initial financing level, nor is VC control related to the extent of financial structure.
If I had a dollar for every time I’ve heard a VC say, “We invest in the team, not the company.” Fred Wilson explains, “No business is so good that the wrong people can’t mess it up. And no business is so bad that the right people can’t fix it. If you think about what a business is, it’s a collection of people who have been organized in attempt to profit from offering a product or service to the marketplace. So if you don’t get the people part of the equation right, everything else is really immaterial.”
I think Greg’s findings are dead right. The truth is that most VCs, especially early stage, realize that the idea that an entrepreneur leads with (i.e. the one they fund) will likely be very different in the future. Very few early stage business plans weather reality intact, but a great team can mold a flawed plan into something great. So you can imagine, most experienced VCs realize that the right team can make all of the difference in the world. As I have explained previously, a great idea without a team who can execute is worth $20.
Greg’s final results that VCs rarely decide to invest in a team they don’t like even if they liked the idea and could easily change the management structure in the future. What I find most ironic is that while VCs are more interested in the quality of the entrepreneur vs. the quality of the idea they fire the founder/CEO/entrepreneur within 12 months almost half of the time.
So to answer Greg’s questions directly: Yes and Yes!