Allocation of Attention to Portfolio Companies and the Performance of Venture Capital Firms

By Jaaskelainen, Mikko; Maula, Markku et al. | Entrepreneurship: Theory and Practice, March 2006 | Go to article overview

Allocation of Attention to Portfolio Companies and the Performance of Venture Capital Firms


Jaaskelainen, Mikko, Maula, Markku, Seppa, Tuukka, Entrepreneurship: Theory and Practice


This article proposes that the attention allocated by venture capitalists to portfolio companies impacts their performance. The article develops arguments for optimal portfolio size and for the moderating roles of syndication frequency and role. The hypotheses receive support from analyses employing longitudinal data of the leading U.S. venture capital firms. Our results indicate the value of venture capitalist involvement and give guidance for its optimal allocation and syndication,

Introduction

Prior research has identified that venture capitalists commonly participate actively in the monitoring and management of their portfolio companies (Sahlman, 1990). According to Gorman and Sahlman (1989), venture capitalists typically spend 60% of their time managing their investments, while the balance is spent on screening new investments and on administration. Active management of investments is widely regarded as a defining characteristic of venture capitalists (Ehrlich, Denoble, Moore, & Weaver, 1994; Fried & Hisrich, 1995; Hellmann & Puff, 2002; Lerner, 1995; Sapienza, Manigart, & Vermier, 1996), although the level of involvement varies according to the chosen investment strategy, stage of the venture, role of the venture capitalist in a syndicate, level of innovation of the venture, and experience of the venture capitalist (Elango, Fried, Hisrich, & Polonchek, 1995; Macmillan, Kulow, & Khoylian, 1989; Sapienza, Amason, & Manigart, 1994).

The motivation of venture capitalists is to maximize the performance of their investments by providing value-added support and by controlling and monitoring the development of the companies (Gorman & Sahlman, 1989; Lerner, 1995; Macmillan et al., 1989; Rosenstein, Bruno, Bygrave, & Taylor, 1993; Sahlman, 1990; Sapienza, 1992; Sapienza & Gupta, 1994; Sapienza et al., 1996). While the earlier research has been able to validate the value added by a venture capitalists' involvement in a venture (Busenitz, Moesel, & Fiet, 1997; Higashide & Birley, 2000; Macmillan et al.; Rosenstein et al., 1993; Sapienza, 1992; Sapienza et al.), the limitations that they face in these tasks have received less attention. Although the scarcity of their time has been widely acknowledged in the earlier research on venture capitalist involvement (e.g., Gifford, 1997), the empirical analysis concerning this issue is scarce (Lerner, 1995) and is mainly based on anecdotal evidence (Gorman & Sahlman, 1989; Macmillan et al.; Sapienza et al.). The challenge is that the performance of an individual portfolio firm does not directly translate to the whole portfolio's performance. A venture capitalist seeks to allocate the optimal amount of attention to an individual venture in order to maximize the performance over all portfolio companies. Thus, although there is evidence for value added by venture capitalists, the link between their level of involvement and the performance of the portfolio has not been established.

We set out to examine how venture capitalist involvement in portfolio firms is related to the performance of the venture capital (VC) firm. We explore the limitations of venture capitalists' involvement considering the nature of informational and interpersonal aspects of their assistance and governance. The key proposition of the article is that the way a VC firm allocates attention to portfolio companies affects the performance of those companies and thus, the overall performance of the VC firm. We divide our argumentation in two parts. The first part addresses the effects of attention allocated to individual portfolio companies, and the second part discusses the effects of that attention on the portfolio level. Furthermore, we argue that cooperation through syndicated coinvestments with other venture capitalists and through sharing the workload effectively alleviates the constraints on providing attention. Our analysis of the data set on the 94 leading VC firms in the United States provides support for our arguments. …

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