When venture capital was the new kid on the block, your average VC’s role was to spot promising early-stage businesses and inject funds to help them grow. This didn’t go much beyond writing a check and waiting to see what happened. Either a start-up would crash and burn, or the VC would cash out once it went public or was bought.
Now things have changed. Increasingly, VCs are competing for the best and brightest new businesses. One way they can distinguish themselves is by the value-add they bring in terms of mentorship, contacts, and know-how. And, when done right, this value proposition translates into cash, unlocking the company’s potential, which all goes to the benefit of the business and the VC alike.
What is Venture Capital?
Venture capital is a form of private equity finance provided to early-stage, high-potential companies. VCs aim to bring value creation and innovation to their portfolio companies and gain liquidity at a high multiple of the funds they initially invest.
Venture capital goes back a long way. Originally, VC funds would pick start-up companies involved in new technologies to help them prove their models and grow. Since then, VCs have developed strategies to leverage their expertise to boost the performance of the companies in which they invest. They do this by providing capital, mentorship and strategic guidance to start-ups, in particular in the areas of recruitment and sales.
At the seed stage, VCs select the companies they think will most benefit from their investment. Then in subsequent funding rounds, they provide further finance, help to source new investors, and incentivize management and staff. They provide connections and contacts to management, and finally, at the IPO stage, they aim to get the highest valuation when they take their investment out.
How Do You Define Value?
So, the role of venture capitalists has evolved beyond funding and into coaching. But what proof do we have that these efforts bring returns? And is there any evidence that this support adds value beyond the costs of providing it?
A leading European business school took an in-depth look at this issue using studies and regression analysis. The conclusion was that VCs did indeed create value as a result of their skill. They improved the chances of an entrepreneur succeeding and taking their company private.
VCs are skilled at identifying and nurturing unproven talent. Plus, their involvement increases the chances that a newbie entrepreneur will go on to become a serial entrepreneur and that previously unsuccessful founders will improve their prospects next time around.
The authors of the report found that they could distinguish between the VC’s role as a talent scout and that of a coach. They concluded that VCs add value by constantly monitoring their investments by their presence on the board, by structuring their investments to allow them to keep a close eye on the entrepreneur, and by controlling rights to profits and veto rights over decisions. They incentivize employees with schemes that align them with the company’s goals. They also help to professionalize companies, introduce HR and marketing policies, and bolster the executive team.
Not all founders agree that VCs add significant value, however. Research demonstrates that VCs have a higher opinion of their value-add than entrepreneurs do. And others point out that while 92% of VCs say they are value-add investors, only 61% of founders agree. In addition, there are significant variables involved in extracting the value created by VCs for an individual company beyond the capital invested, and questions about how this is quantified.
Plus, VCs need to tread carefully to ensure they don’t interfere too much with the founder’s way of doing business.
What are the Value Drivers for Venture Capital?
Let’s look at the different ways VCs have to support the startups they invest in. This may include access to capital, their network, sector know-how or operational expertise. As competition to fund promising start-ups becomes more intense, it is increasingly important for VCs to be able to identify and quantify their value-add.
Here are the ways VCs add value:
Providing More Capital When Needed
Early-stage VCs often transition to later-stage investors, providing cash in further rounds to support growth and expansion. For example, VCs like Benchmark, First Round Capital and Menlo Ventures who participated in early funding of Uber, the global ride-sharing app, saw their early investment flourish. They went on to join in future rounds that supported the company’s growth and provided resources to scale, develop products and enter new markets successfully.
Recruiting
Venture capitalists can be a huge help in talent acquisition. They do this by leveraging their networks, overseeing the hiring process and offering guidance on effective team-building.
Onboarding great early hires can significantly contribute to a company’s success. Take Airbnb for instance: Belinda Johnson, who eventually became the company’s COO, had a successful career in tech and was casting around for a new role. Having heard about the company, she was keen to join. She eventually tracked down an early VC investor, Sequoia Capital, who made the introduction. Johnson’s expertise in tech and legal matters was instrumental in Airbnb’s growth and its ability to navigate legal challenges.
Developing Strategy
Venture capitalists often collaborate with founders to refine and develop strategic plans that align with market opportunities and competitive landscapes. Through brainstorming sessions and strategic discussions, VCs can offer valuable insights and help shape the direction of the company. For example, Spotify, a music streaming platform, benefited from strategic guidance provided by venture capitalist. Investors such as Northzone and Creandum worked closely with Spotify's founders to refine their business model and leveraged them to negotiate agreements with labels. This collaboration contributed to Spotify's successful growth and market leadership in the music streaming industry.
Sales
Venture capitalists often have huge networks that can be used to introduce founders to potential customers and partners, opening the doors to new markets and boosting their growth trajectory. For example, when Slack, the popular team collaboration platform, was in its early stages, it received support from venture capital firms such as Accel Partners and Andreessen Horowitz in the form of their relationship capital. These VCs offered funding to Slack, but they also added huge value by opening the door to possible new customers and important figures in the industry.
Conclusion
Venture capital brings a whole lot more than just cash to the table.
VCs can make valuable introductions, strengthen a founder’s pitch, develop a company’s narrative and help secure further funding.
VCs can connect founders to top talent, reach potential customers and build a solid pipeline of leads. They bring years of experience and industry know-how, and can offer operational guidance, whether that be in the realm of PR, marketing or product development.
Access to venture capitalists has been made easier for entrepreneurs by the growth in popularity of VC platforms that offer introductions and portfolio support.
If you’d like to understand venture capital value-add in more depth, or become a venture capitalist yourself, check out Roundtable to find out more.
References
[1] https://fastercapital.com/content/Ultimate-FAQ-Andreessen-Horowitz--What--How--Why--When.html
[2] https://www.zapflow.com/resources/blog/how-can-vc-firms-generate-value-for-a-portfolio-company
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