Unreliable evidence: why investors misjudge the technological expertise of founders of high technology ventures

We report the reflections of five venture capitalists and five business angels drawn from US, the UK, and Israel on their evaluation criteria for early stage high tech investments and their interpretations of selected prior research related to evaluation of founder’s human capital. We found that these early stage high tech investors tended to focus on harvest potential and miss factors that predict early survival and growth. The interviews confirmed a gap between in use and espoused criteria, and extensive use of gut feeling in decision-making. We offer criteria that investors could consider to improve their funding decision processes. INTRODUCTION The subject of this paper is evaluation criteria of investors in early stage high tech ventures, with special emphasis on evaluation of the founder’s human capital . We report on interviews with ten investors in early stage high tech ventures, five venture capitalists and five business angels drawn from three countries where this form of funding is relatively highly developed: the US, Israel and the UK (Bygrave, 2005). In this paper, we try to complete a research cycle that, too often, remains incomplete. Research in social science is often portrayed as a two stage process, beginning in exploratory mode, often using case study methodology to induce theory, which is then tested statistically using large scale confirmatory techniques (Eisenhardt, 1989). In the first stage, the researcher typically interacts directly with individuals in the field, while in the second stage, interaction is more indirect, for example through postal surveys or secondary data, and relies on the quality of interpretation in the first stage to direct interpretations in the second stage. Less common but, we assert, especially valuable if the research is to have value to practitioners, is a third stage: that of direct interaction with individuals that are the subject of the study to gain their reflections on the research findings and achieve a resolution of the “insider’s view” and the “outsider’s” view (Morey and Luthans, 1984, p.28). This paper reports the results of a “third stage” in research on investment in young high-tech ventures. The capabilities and the attitudes of founding entrepreneurs are critical factors in the performance of new ventures (Hart, Stevenson, and Dial, 1995, p. 92; Greene, Brush and Hart, 1999), but also in investors’ decisions (MacMillan, Siegel and Subbaranasimha, 1985; Muzyka, Birley and Leleux, 1996 ; Zacharakis and Dean, 2005). Although some argue that venture capitalists seek good industries over good people (Zider, 1998), researchers have found that for many venture capitalists (VCs), the quality of the entrepreneur ultimately determines the funding decisions: they back the ‘jockey’ rather than the ‘horse ’ (MacMillan et al. 1985; Muzyka et al. 1996). However, judging the quality of the entrepreneur is difficult for VCs (Kozmetsky, Gill, and Smilor 1985; Smart 1999). The veteran venture capitalist Arthur Rock is quoted as saying “nearly every mistake I’ve made has been in picking the wrong 441 VENTURE CAPITAL, CREATION AND DEVELOPMENT