Handbook of Research on Venture Capital: Volume 2

Handbook of Research on Venture Capital: Volume 2

A Globalizing Industry

Handbooks in Venture Capital series

Edited by Hans Landström and Colin Mason

This Handbook charts the development of venture capital research in light of the global financial crisis, starting with an analysis of the current venture capital market and the changing nature of the business angel market. Looking at governance structures; the performance of venture capitalists in terms of investments, economic impact and human capital; geographical organization of business angels and venture capital global ‘hotspots’; this book also analyses the current state of venture capital research and offers a roadmap for the future.

Chapter 7: Venture capitalists as smart investors

Roger Sørheim

Subjects: business and management, entrepreneurship, economics and finance, corporate governance, economics of innovation, financial economics and regulation, innovation and technology, economics of innovation

Extract

The venture capital phenomenon has received escalating research interest, and the role of VCs as smart investors has been given considerable attention. In a situation in which returns are diminishing on venture capital investments, the extent to which VCs can act as smart investors is an issue of vital importance. Both in Europe and the US, returns have fallen to single-digit or even negative percentages in recent years (Ghalbouni and Rouziès, 2010). This is in sharp contrast to the situation around the turn of the millennium, when US VCs received annual returns of approximately 80 per cent. The decreasing returns correspond with a steep fall in the number of exits completed and longer times between investment and exit (Ghalbouni and Rouziès, 2010). A number of studies suggest that institutional venture capitalists (VCs) play roles above and beyond those of traditional financial intermediaries. VCs spend substantial time and effort supporting their investments, and they act as smart investors in order to enhance the overall performance of their portfolio firms (De Clercq et al., 2006). Gorman and Sahlman (1989) found that most VCs spend more than half of their time actively involved with the companies in their portfolios. In the post-investment phase, VCs involve themselves in two main activities: monitoring and value-adding activities (De Clercq et al., 2006). VCs often are more involved than other investors in monitoring their investments. There are several reasons for this. First, investments in entrepreneurial ventures are illiquid and cannot be sold immediately. Further, the uncertainty associated with entrepreneurial ventures is high, and the VC must spend time determining the venture’s current status and future prospects. The use of the term ‘value-adding activities’ implies that the VC conducts activities that add value to the investments.

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