Harvard Business Review: Peek Into the Role of a Venture Capitalist

An article we liked from the Harvard Business Review:

How Venture Capitalists Make Decisions

An inside look at an opaque process 

Summary. For decades now, venture capitalists have played a crucial role in the economy by financing high-growth start-ups. While the companies they’ve backed—Amazon, Apple, Facebook, Google, and more—are constantly in the headlines, very little is known about what VCs actually do and how they create value. To pull the curtain back, Paul Gompers of Harvard Business School, Will Gornall of the Sauder School of Business, Steven N. Kaplan of the Chicago Booth School of Business, and Ilya A. Strebulaev of Stanford Business School conducted what is perhaps the most comprehensive survey of VC firms to date. In this article, they share their findings, offering details on how VCs hunt for deals, assess and winnow down opportunities, add value to portfolio companies, structure agreements with founders, and operate their own firms. These insights into VC practices can be helpful to entrepreneurs trying to raise capital, corporate investment arms that want to emulate VCs’ success, and policy makers who seek to build entrepreneurial ecosystems in their communities.

Over the past 30 years, venture capital has been a vital source of financing for high-growth start-ups. Amazon, Apple, Facebook, Gilead Sciences, Google, Intel, Microsoft, Whole Foods, and countless other innovative companies owe their early success in part to the capital and coaching provided by VCs. Venture capital has become an essential driver of economic value. Consider that in 2015 public companies that had received VC backing accounted for 20% of the market capitalization and 44% of the research and development spending of U.S. public companies.

Despite all that, little is known about what VCs actually do and how they create value. To be sure, most of us have the broad sense that they fill a crucial market need by connecting entrepreneurs who have good ideas but no money with investors who have money but no ideas. But while the companies that VCs fund may make headlines and transform entire industries, venture capitalists themselves often prefer to remain in the background, shrouded in mystery.

To pull back the curtain, we recently surveyed the vast majority of leading VC firms. Specifically, we asked about how they source deals, select and structure investments, manage portfolio companies post-investment, organize themselves, and manage their relationships with limited partners (who provide the capital VCs invest). We received responses from almost 900 venture capitalists and followed up with several dozen interviews—making our survey of VCs the most comprehensive to date.

Our findings are useful not just for entrepreneurs hoping to raise money. They also offer insights to educators training the next generation of founders and investors; leaders of existing companies seeking to emulate the VC process; policy makers trying to build start-up ecosystems; and university officials who hope to commercialize innovations developed in their schools.

Hunting for Deals

The first task a VC faces is connecting with start-ups that are looking for funding—a process known in the industry as “generating deal flow.” Jim Breyer, the founder of Breyer Capital and the first VC investor in Facebook, believes high-quality deal flow is essential to strong returns. What’s his primary source of leads? “I’ve found that the best deals often come from my network of trusted investors, entrepreneurs, and professors,” he told us. “My peers and partners help me quickly sift through opportunities and prioritize those I should take seriously. Help from experts goes a long way in generating quantity and then narrowing down for quality.”

Breyer’s approach is a common one. According to our survey, more than 30% of deals come from leads from VCs’ former colleagues or work acquaintances. Other contacts also play a role: 20% of deals come from referrals by other investors, and 8% from referrals by existing portfolio companies. Only 10% result from cold email pitches by company management. But almost 30% are generated by...

Read the rest of this article at hbr.org...

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