INVESTMENT CRITERIA OF VENTURE CAPITAL COMPANIES

This paper reviews research literature pertinent to he criteria venture capital companies use when deciding whether or not to inves t in a particular business deal. Development of literatures in the field is discusse d at length and taxonomized into three stages: (1) exploratory research stage, (2) validation research stage, and (3) advanced research stage. In the exploratory stage, res archers focus on indicating investment criteria and identifying the entire inve stment process within an American setting. In validation stage, researchers seek appl icability and implications of the criteria to investors’ performance and strategy within and o utside the U.S. In advanced stage, researchers employ advanced statistical tools to si mulate and create multi-dimensional models of evaluation criteria and the investment pr ocess. Two theoretical frameworks regarding competitive ad vantage, namely industrial organization and the resource-based views, are empl oyed to systematically integrate existing evaluation criteria into one model. The in dustrial organization framework encompasses criteria outside an investee context, w hile the resource-based view considers internal characteristics of entrepreneurs and their firms. * DBA Candidate, IGSM, University of Australia ! "#$ " % & ' ()*#ก +% * & ' ( 58 Subject significance and knowledge gap Drawing from the works of Hoffman (1972), Wells (19 74), Poindexter (1976), Dorsey (1977), and Timmons & Gumpert (1982), Tyebje & Bruno (1984) modeled five salient steps which venture capital companies follo w during the investment process: deal origination, deal screening, deal evaluation, deal structuring, and post-investment activities. This paper focuses on the third step, in which vent ure capitalists assess the potential risk and return of a specific business de al. Intuitively, venture capital firms will pursue final investment agreements with entrep reneurs if the expected returns are greater than the risks. Empirically, the venture c apital industry shows an economic efficiency because its higher risks are compensated by higher returns (Poindexter 1976, Charles River Associates 1976). It is the central concern of this paper to explore which criteria venture capital investors use to measure s ch risks and returns during their decision-making. The findings would enable entrepreneurs to become m ore aware of investor expectations, knowledge entrepreneurs can use to pr oduce more effective business proposals and thus increase the chance of finalizin g deals. As Hall and Hofer (1993) put it, “Blindly sending business plans with a generic cover letter was not a successful approach in the proposals studies. ” These findings would be useful to venture capitalists as a checklist to review their own operations. Pol icy makers, such as the government, could use the findings to become more aware of how investors and investees interact, knowledge that could be applied to creating more ef fective national policies that promote the venture capital industry as a whole. Given that there are already a considerable number of previous studies along this line, why is more research is necessary? This paper dd esses three major gaps in knowledge. First, after extensive research to uncover a single study that covers all possible criteria, it is clear that no such single study exi sts. More recent works have added new variables while leaving previous criteria behind. F or example, Tyebjee and Bruno (1981 and 1984) added more extensive criteria to Poindext er’s 1976 study. MacMillan and his colleagues (1985), though following up to Tyebjee a nd Bruno’s 1981 work, excluded certain criteria after the preliminary telephone su rvey.