Factors Determining the Performance of Early Stage High-Technology Venture Capital Funds – A Review of the Academic Literature

The purpose of this literature review is to document academic research concerning factors influencing the performances of venture capital funds, as well as the venture capital fundraising decisions. Industry specialisation, large fund sizes, strong deal flow, syndication of investments, and especially, experience, all appear to be factors leading to superior investment performance, which is particularly well illustrated by the US venture capital industry. The review also concludes that venture capital fund returns to a great extent depend on an early or later stage focus, and the timing of the fundraisings. For policy makers the most significant measures, according to the findings, are to nurture a competitive local technology stock market, establish efficient legal frameworks and tax structures, and minimize labour market rigidities. Moreover, it seems like the vast majority of all venture capital returns are generated by the limited number of funds in the top quartile. Therefore, the possibility to get access to the best performing venture capital funds is probably more important than anything else in order for institutional investors to gain excess returns. In terms of geographical differences, the UK venture capital situation appears to be somewhere half way between the US and the continental Europe. First edition: 2005-07-06 Latest save date: 2006-02-24 1. EXECUTIVE SUMMARY .................................................................................................... 4 2. INTRODUCTION................................................................................................................ 7 2.1. Background .......................................................................................................................................7 2.2. Research Purpose ..............................................................................................................................8 2.3. Research Methodology......................................................................................................................9 2.4. Organisation of This Review ..........................................................................................................10 3. VENTURE CAPITAL (VC) OVERVIEW ............................................................................ 12 3.1. A Brief Description of VC..............................................................................................................12 3.2. Some Industry Data about the UK VC Market ...............................................................................13 3.3. VC Performance..............................................................................................................................14 3.3.1. VC performance and success – for whom? ....................................................................................14 3.3.2. How to evaluate VC returns............................................................................................................15 3.3.3. Academic studies of VC returns ......................................................................................................16 3.3.4. Empirical evidence for claims that US VC outperforms EU VC ...................................................17 4. VC RESEARCH STREAMS AND SCOPE FOR THIS REVIEW .............................................. 19 4.1. A Brief Overview of VC Research Streams ...................................................................................19 4.1.1. Academic research: Portfolio company level.................................................................................19 4.1.2. Academic research: VC firm level ..................................................................................................19 4.1.3. Academic research: LP level ..........................................................................................................20 4.1.4. Academic research: Market factors................................................................................................21 4.2. Scope for this Literature Review.....................................................................................................21 5. LITERATURE REVIEW OF VC PERFORMANCE FACTORS ............................................... 23 5.1. Characteristics of Portfolio Companies...........................................................................................23 5.1.1. Summary: Characteristics of portfolio companies.........................................................................24 5.2. Characteristics of VC Funds ...........................................................................................................25 5.2.1. Partnership structure.......................................................................................................................25 5.2.2. Specialisation...................................................................................................................................25 5.2.3. Continuous success and importance of brand................................................................................25 5.2.4. Fundraising......................................................................................................................................26 5.2.5. Summary: Characteristics of VC funds ..........................................................................................27 5.3. The Investment Process...................................................................................................................27 5.3.1. Deal generation ...............................................................................................................................27 5.3.2. Due diligence and valuation ...........................................................................................................28 5.3.3. Deal structuring...............................................................................................................................28 5.3.4. Syndication.......................................................................................................................................29 5.3.5. Summary: The investment process..................................................................................................31 5.4. The Management of Portfolio Companies ......................................................................................32