Should you bet on the jockey or the Horse

8/18/2019 Should you bet on the jockey or the Horse

1/41

THE JOURNAL OF FINANCE • VOL. LXIV, NO. 1 • FEBRUARY 2009

Should Investors Bet on the Jockey or the Horse?

Evidence from the Evolution of Firms from EarlyBusiness Plans to Public Companies

STEVEN N. KAPLAN, BERK A. SENSOY, and PER STRÖMBERG∗

ABSTRACT

We study how firm characteristics evolve from early business plan to initial public of-

fering (IPO) to public company for 50 venture capital (VC)-financed companies. Firm

business lines remain remarkably stable while management turnover is substantial.

Management turnover is positively related to alienable asset formation. We obtainsimilar results using all 2004 IPOs, suggesting that our main results are not specific

to VC-backed firms or the time period. The results suggest that, at the margin, in-

vestors in start-ups should place more weight on the business (“the horse”) than on

the management team (“the jockey”). The results also inform theories of the firm.

SINCE COASE (1937), ECONOMISTS HAVE ATTEMPTED TO UNDERSTAND why firms existand what constitutes firms.1 Despite the long history of theory and empiricalwork, there is little systematic or noncase evidence concerning what constitutes

a firm when it is very young and how a young firm evolves to a mature company.In this paper, we provide such evidence by studying 50 venture capital (VC)-financed firms from early business plan to initial public offering (IPO) to publiccompany (3 years after the IPO). We explore financial performance, line of business, point(s) of differentiation, nonhuman capital assets, growth strategy,

∗Kaplan is with the University of Chicago Graduate School of Business and the National Bu-

reau of Economic Research, Sensoy is with the University of Southern California, and Str ömberg

is with the Swedish Institute for Financial Research. This research has been supported by the

Kauffman Foundation, the Lynde and Harry Bradley Foundation, the Olin Foundation through

grants to the Center for the Study of the Economy and the State, and by the Center for Research

in Security Prices. We thank the venture capital partnerships for providing data, and Sol Gargerand Nick Kramvis for excellent research assistance. We also thank Andres Almazan, Ulf Axelson,

George Baker, Ola Bengtsson, Effi Benmelech, Patrick Bolton, Connie Capone, Bruno Cassiman,

Zsuzsanna Fluck, John Graham, Oliver Hart, Cam Harvey, Thomas Hellmann, Bengt Holmström,

Mark Koulegeorge, Augustin Landier, Josh Lerner, Andrew Metrick, John Oxaal, Jeremy Stein,

Toby Stuart, Krishnamurthy Subramanian, Lucy White, Luigi Zingales, two anonymous referees,

and seminar participants at BI, the Center for Economic Policy Research Summer Symposium at

Gerzensee, Columbia, Cornell, Federal Reserve Bank of New York, Harvard, Hebrew University,

Kellogg, Mannheim, Michigan, NBER Corporate Finance Group, NBER Entrepreneurship Group,

RICAFE Conference in Turin, SIFR, Stockholm School of Economics, Tel Aviv University, Tilburg

University, The Tuck School (at Dartmouth), University of Chicago, University of Vienna, and

University of Wisconsin for helpful comments.1

Both Holmström and Roberts (1998) and Gibbons (2005) describe and summarize some of thiswork.

75


2/41

76 The Journal of Finance R

top management, and ownership structure at each point in time and considerhow these characteristics evolve over time. We repeat a subset of these analyseswith a sample of all IPOs in 2004.

This paper has three main goals. First, we provide a systematic description

of the early life and evolution of an important sample of firms. In so doing, weprovide information on firms before the post-IPO period studied in Fama andFrench (2004).

Our second goal is to address an ongoing debate among venture capitalists(VCs) concerning the relative importance of a young company’s business ideaand management team to the company’s success. While VCs try to invest in com-panies with both strong businesses and strong management (see Kaplan andStrömberg (2004)), different VCs claim to weigh one or the other more heavilyat the margin. Some VCs believe that the company ’s business and market arethe most important determinants of success while others believe the key deter-

minant is the company’s management. Our sample of successful VC-financedcompanies is particularly appropriate to shed light on this debate. This debateis often characterized as whether one should bet on the jockey (management) orthe horse (the business/market). Quindlen (2000), Gompers and Lerner (2001),and Metrick (2007) discuss these two views.

According to Gompers and Lerner (2001), Tom Perkins of Kleiner Perkins (aprominent VC) looked at a company’s technological position and asked whetherthe technology was superior to alternatives and proprietary. Don Valentine of Sequoia (a prominent VC) assessed the market for the product or service andconsidered whether the market was large and growing. For example, many VCs

declined to invest in Cisco because the team was considered weak. Valentineinvested in Cisco anyway because he saw a huge market.

Alternatively, Arthur Rock, a prominent VC and early investor in Apple Com-puters, emphasized the quality, integrity, and commitment of management. Ac-cording to Rock, a great management team can find a good opportunity even if they have to make a huge leap from the market they currently occupy. In theirVenture Capital Handbook, Gladstone and Gladstone (2002) also take this per-spective, quoting an old saying: “ You can have a good idea and poor managementand lose every time. You can have a poor idea and good management and winevery time” (pp. 91–92).

The third goal of the paper is to consider how our findings can inform and beinterpreted in relation to existing theories of the firm and what new theoriesmight try to explain. These theories are related to the VC debate concerning the importance of business and management in the sense that the theoriesemphasize the difference between nonhuman and human assets. For example,the basic assumption of the Hart–Moore framework is that firms are defined bytheir nonhuman assets. According to Hart (1995), “a firm’s non-human assets,then, simply represent the glue that keeps the firm together . . . If non-humanassets do not exist, then it is not clear what keeps the firm together” (p. 57).2

2 Hart’s analysis focuses on specific investment and the importance of hold-up problems. Holm-ström (1999) comes to a similar conclusion, but argues that firm ownership of nonhuman assets


3/41

Should Investors Bet on the Jockey or the Horse? 77

Two aspects of our analysis address these theories. First, we try to identifythe “glue” that holds firms together. Second, to the extent that the theories arestatic theories (in that they assume a nonhuman asset or glue already exists),we provide evidence as to the stage of a firm at which the glue emerges or

“sticks” and how the glue evolves over a firm’s life cycle.We also relate our results to theories of the firm such as Wernerfelt (1984) and

Rajan and Zingales (2001a) that emphasize specific assets or resources criticalto the firm’s evolution and growth. A critical resource may be a person, an idea,good customer relationships, a new tool, or superior management technique.

According to these theories, a firm is a web of specific investments built arounda critical resource or resources. “ At some point, the critical resource becomesthe web of specific investment itself ” (Zingales (2000, p. 1646)). By examining firms’ resources (nonhuman and human assets) early in their lives and overtime, we shed light on the nature of critical resources and the periods in which

they are critical.The theories above (as well as others such as Hart and Moore (1994)) also have

implications for the division of rents between providers of human (founders) andnonhuman capital. Zingales (2000) and Rajan and Zingales (2001b) argue thattoday’s “new firms” differ from the traditional firms of the early 20th centuryin that specific human capital has become more important. If so, the theoriessuggest that the human capital providers will capture a greater share of therents generated by the firm than they did in the past.

Finally, our results relate to a debate among sociologists as to whether pop-ulations of firms evolve by adapting or by natural selection. According to the

adaptation view, firms respond to environmental change by adapting throughorganizational or strategic change. In contrast, the natural selection view holdsthat organizational inertia makes it difficult for firms to change. While indi-

vidual firms do not change in response to environmental change, more effi-cient organizations survive and new (efficient) firms are created. Hannan andFreeman (1984) argue that creation and replacement are more important andprevalent than adaptation.

Our results are as follows. Consistent with our sample selection strategy, thesample firms experience dramatic growth in revenue, assets, and market value(although they do not become profitable). While the firms grow dramatically,

their core businesses or business ideas appear remarkably stable. Only onefirm changes its core line of business in the sense that the company producesa different product or service or abandons its initial market segment to servea different one. Rather than changing businesses, firms typically maintain orbroaden their offerings within their initial market segments. The firms sell tosimilar customers and compete against similar competitors in the three life-cycle stages we examine. This suggests that the firms ’ business idea or line of business is fixed or elemental at an early stage in a firm’s life.

Almost uniformly, firms claim they are differentiated by a unique product,technology, or service at all three stages we examine. At the same time, however,

allows the firm to structure internal incentives and to influence external parties (e.g., suppliers)who contract with the firm.


4/41


the stated importance of expertise (which one might interpret as specific hu-man capital) declines. Roughly half of the firms stress the importance of ex-pertise at the business plan while only 16% do so by the IPO and third annualreports.

While the points of differentiation, alienable assets, customers, and competi-tors remain relatively constant, the human capital of the sample firms changesmore substantially. Only 72% of the CEOs at the IPO were CEOs at the businessplan; only 44% of the CEOs at the annual report were CEOs at the businessplan. The analogous percentages are lower for founders. Similarly, only about50% of the next four top executives at the IPO were top executives at the busi-ness plan; only about 25% at the annual report were top executives at thebusiness plan.

In our cross-sectional analysis, we find that firms with more alienable assetsat the time of the business plan have substantially more human capital turnover

over time.Next, we consider the division of rents. For their human capital assets specific

to the company, our estimates suggest that founders retain from 10.8% to 19.6%of the value created by the firm just before the IPO. These estimates are muchlower than those for the earlier time period in Baker and Gompers (1999), andraise some doubt regarding the claim in Zingales (2000) that “new” firms aremore dependent on specific human capital and, therefore, allocate a greaterfraction of the value created to founders.

To address concerns that our sample of 50 VC-backed firms might be special insome way, we repeat our analyses of line-of-business changes, top management

changes, and ownership structure for all nonfinancial start-ups firms that wentpublic in 2004—both VC and non-VC backed. We obtain qualitatively similarresults to those in our primary sample. We find that 7.5% of the firms changetheir business lines. While this is somewhat greater than the 2% for our mainsample, it is still small in an absolute sense. We find no statistical difference be-tween changes for VC-backed and non-VC backed firms. For the few companiesthat change business lines, the median date of the change is 7 years before theIPO—longer than the median time to IPO for our main sample. At the sametime and as with our primary sample, we find more substantial turnover of management. At the IPO, a founder is CEO of only 49% of the VC-backed firms

and 61% of the non-VC-backed firms.Our results inform the VC debate about the relative importance of the busi-ness (horse) and the management team (jockey). The results call into questionthe claim Quindlen (2000) attributes to Arthur Rock that “a great managementteam can find a good opportunity even if they have to make a huge leap fromthe market they currently occupy” (p. 35). The results for both of our samplesindicate that firms that go public rarely change or make a huge leap from theirinitial business idea or line of business. This suggests that it is extremely im-portant that a VC picks a good business. At the same time, firms commonlyreplace their initial managers with new ones and see their founders depart,

yet still are able to go public, suggesting that VCs are regularly able to findmanagement replacements or improvements for good businesses.


5/41


It is important to note that the results do not imply that good managementis not important. The large equity incentives VCs provide to new managementsuggest that good management is valuable. However, the results suggest thatpoor or inappropriate management is much more likely to be remedied by new

management than a poor or inappropriate business idea is to be remedied by anew idea. Our results and their interpretation are also consistent with a quoteattributed to Warren Buffett: “When a management team with a reputationfor brilliance tackles a business with a reputation for bad economics, it is thereputation of the business that remains intact” (http://en.wikiquote.org/wiki/ Warren Buffett).

We also believe that our results inform theories of the firm. The theories of Hart–Moore–Holmström assume that a firm must be organized around nonhu-man capital assets. We find that nonhuman capital assets form very early ina firm’s life. Identifiable lines of business and important physical, patent, and

intellectual property (IP) assets are created in these firms by the time of theearly business plan, are relatively stable, and do not change or disappear asspecific human capital assets turn over. These can be interpreted as the “glue”discussed by Hart (1995).

This should not be interpreted as saying that specific human capital is un-necessary or unimportant. Obviously, a specific person has to have the initialidea and start the firm. In contrast to nonhuman assets, however, our resultsindicate that it is possible and not unusual to replace the initial human assets(founders) and find other people to run the firm. This also is consistent with the

view that the human capital of VCs is important; the VCs play an important

role in finding those replacements (Hellmann and Puri (2002)).The early emergence and stability of nonhuman assets are consistent with

those assets being the critical resources described in the critical resource the-ories.3 The instability of the human assets suggests that to the extent that theinitial critical resource is a specific person or founder, the “web of specific in-

vestments” (Zingales, 2000) that forms around the founder itself becomes thecritical resource relatively early in a firm’s life.

The cross-sectional analysis provides further support to these interpretationsof the Hart–Moore–Holmström and critical resource theories. Firms with morealienable assets at the business plan have substantially more human capital

turnover over time. This suggests that specific human capital is less criticalafter alienable assets have formed.4

Finally, our results on the stability of firm business lines are supportive of Hannan and Freeman (1984), who argue that creation and replacement (ornatural selection) are more prevalent than adaptation.

3 The stability of nonhuman assets is consistent with Lemmon, Roberts, and Zender (2008), whofind that firms’ capital structures are “remarkably stable over time.” To the extent that a firm’sassets remain stable over time, one might expect the way those assets are financed to remain stableas well.

4 Our results also are consistent with Aghion, Dewatripont, and Stein (2005). Their model studiesthe tradeoffs between academic and private sector research. Based on control right considerations,

they predict that once an idea becomes the property of a private firm (rather than an academicinstitution), it will be developed along relatively narrow lines.


6/41


We view this study and methodology as an empirical step in studying thenature and evolution of firms. While we believe that the results are novel andinform the jockey/horse debate as well as theories of the firm, we acknowledgethat the samples may be special in that all the firms eventually go public. We

do not believe this affects our primary conclusions and inferences. We discussthe strengths and weaknesses of our sample in Section I.B. below.

Our work is related to the papers that emerged from the Stanford Project onEmerging Companies (Baron and Hannan (2002), Baron, Hannann, and Burton(1999, 2001), Beckman and Burton (2005), Hannan et al. (2000), Hellmann andPuri (2000, 2002)). As we do, they study a panel of young firms —in their case,high-tech firms in Silicon Valley—but they ask a different set of questions.Baron and Hannan (2002) summarize the findings of their papers as showing that initial employment models are important and tend to persist. When theyare changed, employee turnover increases and performance declines. Beckman

and Burton (2005) study the evolution of top management teams. The humancapital characteristics of the founding teams of their companies do not predict

venture capital financing or going public. This is suggestive that the businessidea and nonhuman capital assets are relatively more important to success.

Our research is also related to Bhide (2000), who studies 100 companies from Inc. Magazine’ s list of 500 fastest growing companies in 1989. Bhide finds thatmany of those companies are founded by people who replicated or modified anidea encountered in their previous employment, but did relatively little formalplanning before starting the business. Partly as a result, these companies adjusttheir initial concepts, sometimes changing and sometimes broadening them.

Our work is complementary in that it appears that Bhide’s focus is more on theformation stage in which the entrepreneur is the critical resource, rather thanthe growth stages that we study after the firm has been formed.

The paper proceeds as follows. Section I describes our samples. Section IIdescribes the initial financial characteristics, business idea, point(s) of differ-entiation, assets and technology, growth strategy, customers, competitors, man-agement, ownership structure, and board of directors of the sample firms andtheir evolution. Section III presents our cross-sectional estimates. Section IV presents the results for the 2004 IPO sample. Section V summarizes and dis-cusses our results.

I. Sample

The main sample consists of 50 firms that went public in an IPO and forwhich we obtain an early business plan or business description at the timeof a VC financing. We obtain 30 companies from the sample of VC-financedcompanies in Kaplan and Strömberg (2003). We obtain 20 more companies byasking several VCs for business plans of firms they had financed that hadsubsequently gone public.

For all sample companies, we have copies of the business plans and/or the

VC investment memos that describe the company at the time of VC fund-ing. (We do not find meaningful differences in the two types of documents.


7/41


Accordingly, in what follows, we drop the distinction and collectively refer tothem as business plans.) From these documents, we identify the early (andoften initial) characteristics of these firms. We also search for company andindustry descriptions from 1990 onward in Thomson’s Corporate Technology

Information Services and its predecessor, CorpTech Directory of TechnologyCompanies. We refer to these as the CorpTech Directories. For all sample com-panies, we obtain detailed company descriptions at the time of their IPOsfrom S-1 registration statements or 424(b)(4) prospectuses filed with the SEC.When available, we collect the company’s annual report that is closest to 36months after the IPO—a period roughly equal to the time from the busi-ness plan to the IPO. We obtain annual report descriptions from SEC form10-K filings. In the case of one Canadian company, we collect an “annualinformation form” on form 40-F. Ownership data are not provided for thisfirm.

For 18 firms, we do not record an annual report observation: 8 were takenover and 3 went bankrupt less than 3 years after the IPO; 7 are public, buthave not filed an annual report more than 2 years after the IPO. We retain thebusiness plan and IPO observations for all 50 firms.

We describe the sample of all 2004 IPOs in Section IV.

A. Description

Table I presents summary information for our main sample. The mediancompany is 23 months old as of the business plan, so these documents describe

the companies when they are young. As we document below, these companiesare early-stage businesses at the time of the business plan; the median companyhad no revenue in the most recently ended fiscal year at the time of the businessplan.

The median time elapsed between the business plan and the IPO in oursample is 34 months, with a further median gap of 35 months between the IPOand the annual report observations. The IPO observation is therefore quiteclose to the midpoint of the business plan and annual report observations (andwe constructed it to be so). The median total time elapsed is 68 months; theaverage is 72 months.

Of the 49 companies whose founders we are able to identify, 21 have onefounder, 17 have two cofounders, and 11 were cofounded by three or more indi- viduals.

Table I also shows that the bulk of the sample companies were founded inthe early to mid 1990s while the business plans describe the companies in themid to late 1990s. Thirty-one of the 50 IPOs took place in 1998, 1999, or 2000,at the height of the technology boom. The time frame of the sample, therefore,also corresponds to the period in which “new firms” emerged as described inZingales (2000) and Rajan and Zingales (2001b). The industry breakdown of our sample is heavily weighted toward high-technology firms: 17 in biotech, 15

in software/information technology, 3 in telecom, 5 in healthcare, 6 in retail,and 4 in other industries, of which 3 are high-tech companies.


8/41


Table I

Sample SummaryThis table reports median, average, and standard deviation of (i) the age of the firm in months as of the date of the business plan (BP), (ii) the time elapsed in months between the business plan and the

IPO, (iii) the time elapsed in months between the IPO and the annual report (AR), and (iv) the timeelapsed in months between the business plan and the annual report for 50 VC-financed companies thatsubsequently went public. The table also reports frequency distributions of the number of founders;the years sample firms were founded; and the years of their business plans, IPOs, and annual reports;the industries in which they operate; and their status as of May 31, 2006.

Months between Months between Months between Age (Months) at Business Plan IPO and Business Plan

Business Plan and IPO Annual Report and Annual Report

Median 23 34 35 68 Average 40 40 36 72 SD 51 25 3 24

Num. Obs. 50 50 32 32

Number of companies with business plan dated priorto or concurrent with first VC financing

20

Number of companies with one founder 21Number of companies with two cofounders 17Number of companies with three or more cofounders 11

Number Firms Number NumberFounded Business Plans Number IPOs Annual Reports

1975–1980 31980–1984 2

1985–1989 5 4 11990 1 11991 4 11992 3 21993 2 31994 7 1 11995 10 8 3 11996 5 11 31997 2 10 31998 6 9 5 31999 2 14 12000 12 42001 1 32002 1 102003 1 62004 4 12005 12006 1

Industry Breakdown

Biotechnology Software/IT Telecom Healthcare Retail Other

Num. firms 17 15 3 5 6 4

Status as of May 31, 2006

Active Acquired/Merged Bankrupt

Num. firms 25 18 7


9/41


Finally, Table I shows the companies’ status as of May 31, 2006: 25 are stillactive, independent companies, 18 have been acquired, and 7 have failed andgone bankrupt.

B. Sample Selection Issues

As discussed in the introduction, there are some selection issues with thissample. First, we only analyze VC-backed companies because it is from our VCcontacts that we were able to obtain the necessary data. Second, the companiesmay not be random VC-backed companies because our VC contacts may not berepresentative of all VCs. Third, a majority of the companies were funded inthe tech boom because we began to collect the original sample in the late 1990s.Fourth, we only analyze companies that go public.

We address the first three issues in Section IV by analyzing the sample of all

start-up IPOs in 2004. These include all VC-backed and non-VC-backed IPOsin 2004. These also include firms that survived, if not thrived, after the techbust of the early 2000s.

In our main sample, we analyze companies that go public because data areavailable. The 2004 IPO sample has the same selection bias. In using thesesamples, we exclude firms that fail, firms (some of which are successful) thatare acquired by other firms, and firms that survive but do not go public.

It would be interesting to study firms that fail, but it is difficult to obtaindata for such a sample. We believe it unlikely that studying failed start-upfirms would change our conclusion that investors should, on the margin, bet on

the horse rather than the jockey. However, it is (theoretically) possible that nofirms—winners or losers—change their business models, while all losers andonly half of winners change management. In that case, it would still be impor-tant to invest in a business that can succeed, but it also would be importantto have a good management team at the start.5 While we cannot discount thisscenario, we think it unlikely given the widespread belief that it is common forfirms to change their business lines. Clearly, studying failed start-ups wouldbe an interesting topic for future research.

It is similarly difficult to obtain data for firms that are acquired. That said,if there is a bias in acquired firms, we would argue that it is toward firms in

which specific human capital is relatively less important. The reason for thisis that acquirers generally retain the business, but do not always retain (andoften let go) the top management and employees of the firms they acquire (e.g.,Martin and McConnell (1991), Matsusaka (1993)). Firms that go public retainthe business, top management, and employees.

Similarly, while it would be interesting to study firms that survive but do notgo public, it also is difficult to obtain data for them. We suspect, however, thatrelatively few such firms reach significant size.

We mention one last selection issue. The industries of the 50 sample firms arerepresentative of the industries that VCs invest in. However, investments in

5 We thank John Graham for suggesting this possibility.


10/41


11/41


Table II

Financials and Employees

This table reports median, average, and standard deviation of revenue, number of employees,assets, earnings before interest and taxes (EBIT), and market capitalization at the business plan

(BP), IPO, and annual report (AR). Revenue, assets, and EBIT are reported as of the end of theprior fiscal year. We report statistics broken out by all sample firms, biotechnology firms, andnon-biotechnology firms.

All Firms Biotechnology Firms Non-Biotechnology Firms

BP IPO AR BP IPO AR BP IPO AR

Revenue ($M)Median 0 7.3 69.1 0 2.9 20.7 0.6 12.9 126.8 Average 5.5 42.3 252.7 0.7 4.9 30.1 8.2 61.6 374.5 SD 13.5 153.4 516.1 1.6 5.3 14.8 16.2 186.8 606.1Num. obs. 48 50 32 17 17 11 31 33 21

Number of EmployeesMedian 22 129 432 10 71 134 31 212 625 Average 91 362 1,669 17 87 195 134 504 2,441 SD 199 671 2,721 13 67 141 242 791 3,106Num. obs. 43 50 32 16 17 11 27 33 21

Assets ($M)Median 2.5 19.7 121.1 1.8 18.5 91.7 2.7 22.1 173.0 Average 5.8 44.7 357.3 3.3 23.7 96.7 6.6 55.6 493.8 SD 10.7 69.0 738.6 3.9 18.3 64.5 12.1 82.2 886.9Num. obs. 36 50 32 9 17 11 27 33 21

EBIT ($M)Median −0.8 −6.6 −26.1 −1.4 −10.3 −32.8 −0.8 −5.1 −24.8 Average −1.5 −7.5 −51.8 −1.9 −11.7 −30.4 −1.4 −5.3 −63.1 SD 2.5 13.5 104.6 2.0 7.5 18.1 2.6 15.4 128.1Num. obs. 37 50 32 8 17 11 29 33 21% positive 19% 20% 19% 13% 6% 0% 21% 27% 29%

Market Capitalization ($M)Median 18.6 233.4 225.4 14.1 254.9 265.8 18.7 232.4 222.5 Average 28.8 690.1 590.7 16.2 388.3 257.6 32.9 845.5 773.9 SD 32.5 1, 901.3 1, 527.2 11.9 368.2 216.2 36.0 2, 322.5 1, 886.4Num. obs. 41 50 31 10 17 11 31 33 20

and low stock prices during the last quarter of the year covered by the annualreport times the shares outstanding as of the report.

The median market capitalization increases sharply from $18.6 million at thebusiness plan to $233.4 million at the IPO, and then declines to $225.4 millionat the annual report. The market capitalization figures indicate a roughly ten-fold increase in value from business plan to IPO, a period of roughly 3 years.These companies, despite their negative profits, are highly valued (consistentwith generally high valuations in the booming IPO market of the late 1990s).

The decline in the market capitalization after the IPO is consistent with (andlikely driven by) the technology bust of 2000 to 2002.


12/41


B. Business

Table III presents a description of each company’s business. For each com-pany, we then determine if the description of the business changes from one

point in time to the next. To obtain the business description and changes inthe business, we examine the relevant document (business plan, S-1, annualreport) for each stage for information summarizing the company’s business. Inthe S-1 and annual report, this information is usually near the start of thedocument and then repeated with additional details in the section titled “Busi-ness.” The business plans are more free-form, but there is often an executivesummary at the beginning that contains the key information. The informationalways includes the company’s main or intended product(s). It also describes, if applicable, the company’s key technologies that contribute to the developmentof the product(s). It usually, but not always, describes the customer base, eitherto whom the company is already selling or to whom the company’s productsare targeted. For example, the customer base may be consumers or Fortune500 companies or small businesses. It sometimes mentions key customers thattend to be large, well-known companies. We supplement the information in thedocuments by searching Lexis Nexis, Venture Source, Google, and the compa-nies’ web sites—both current and historical.

We categorize changes in two ways. First, we consider whether firms changetheir line of business or business idea. The line of business changes if the firmmarkedly changes the products or services it offers, or sells to a completelydifferent set of customers.

Second, we consider whether firms broaden (doing the same things as before,but adding others), narrow (doing some of the same things, but dropping others),or maintain their initial line of business. If Apple Computer were in the sample,we would classify it as having the same line of business it had when it started—personal computers sold to the same customers—but with a line of business thathad broadened.

These comparisons have a subjective component to them. We report the in-dividual descriptions in Table III to give the reader a sense of the type andmagnitude of these changes. The descriptions have been shortened to protectthe anonymity of the companies and the VCs as well as to shorten the length of the table. The descriptions in the business plans and other documents are al-

ways at least a paragraph and usually much longer. We base our measurementsand conclusions on the more detailed descriptions to which we have access.More detailed descriptions are omitted to conserve space, but are available onrequest.

Our analysis of firm business lines is at a finer level of detail than wouldhave resulted had we classified firms into NAICS or SIC categories at eachpoint in time and then asked how those classifications differed over time. Forexample, at the six-digit (finest) NAICS code level, a firm engaged in “Disk anddiskette conversion services” receives the same code (518210) as one engagedin “Computer time rental,” while we would not consider those the same lines of

business.


13/41


T a b l e I I I

L i n e s

o f B u s i n e s s

S t a t e d b u s i n e s s a t t h e b u s i n e s s p l a n ,

I P O , a n d a n n u a l r e p o r t f o r c o m p a n i e s w h o s e l i n e s o f b u s i n e s s s t a y s

a b o u t t h e s a m e o v e r t i m e ( P a n e l A ) , c o m p a n i e s

w h o

s e l i n e o f b u s i n e s s b r o a d e n s / n a r r o w

s b e t w e e n t h e b u s i n e s s p l a n a n d I P O b u t n o t b e t w e e n t h e I P O a n d t h

e a n n u a l r e p o r t ( P a n e l B ) , c o m p a n i e s w h o s e l i n e

o f b

u s i n e s s b r o a d e n s / n a r r o w s b e t w e e n

t h e I P O a n d a n n u a l r e p o r t b u t n o t b e t w e e n t h e b u s i n e s s p l a n a n d I

P O ( P a n e l C ) , c o m p a n i e s w h o s e l i n

e o f b u s i n e s s

b r o a d e n s / n a r r o w s b e t w e e n b o t h t h e b u s i n e s s p l a n a n d I P O a n d t h e I P O a n

d a n n u a l r e p o r t ( P a n e l D ) , a n d c o m

p a n i e s w h o s e l i n e o f b u s i n e s s c h a n g e s ( P a n e l E ) .

T h e

t a b l e a l s o r e p o r t s t h e p e r c e n t a g e o

f c o m p a n i e s w h o s e s t a t e d l i n e s o f b u s i n e s s c h a n g e , b r o a d e n , n a r r o w , o r s t a y t h e s a m e o v e r t h o s e p e r i o d s ( P a n e l F ) .

P a n e l A : C o m p a n i e s W h o s e L i n e o f

B u s i n e s s S t a y s A b o u t t h e S a m e o v e r T i m e

C o m

p a n y

B u s i n e s s P l a n

I P O

A n n u a l R e p o r t

1

• D e v e l o p m e n t o f a n a l g e s i c s



2

• C h e m i c a l a n a l y s i s i n s t r u

m e n t a t i o n a n d

r e s e a r c h s e r v i c e s

• C o n t r a c t r e s e a r c h a n d d e v e l o p m e n t

s e r v i c e s

• C o n t r a c t r e s e a r c h a n d d e v e l o p m

e n t

s e r v i c e s

3

• S p e c i a l t y s u p e r m a r k e t s

• S p e c i a l t y s

u p e r m a r k e t s

• S p e c i a l t y s u p e r m a r k e t s

4

• C u s t o m e r i n f o r m a t i o n m a n a g e m e n t

s o f t w a r e

• E n t e r p r i s e

r e l a t i o n s h i p m a n a g e m e n t

s o f t w a r e

• E n t e r p r i s e c u s t o m e r r e l a t i o n s h

i p

m a n a g e m e n t s o f t w a r e

5

• N o n i n v a s i v e c a r d i a c s u r g

e r y

• N o n i n v a s i v e c a r d i a c s u r g e r y

• N o n i n v a s i v e c a r d i a c s u r g e r y

6

• P r o d u c t i o n o f n a n o c r y s t a

l l i n e m a t e r i a l s

• D e v e l o p m e n t a n d m a r k e t i n g o f

n a n o c r y s t a l l i n e m a t e r i a l s

• E n g i n e e r i n g a n d m a n u f a c t u r i n

g o f

n a n o c r y s t a l l i n e m a t e r i a l s

7

• T e l e c o m s e r v i c e p r o v i d e r

• T e l e c o m s e

r v i c e p r o v i d e r

• T e l e c o m s e r v i c e p r o v i d e r

8

• S u p e r s t o r e s p e c i a l t y r e t a

i l e r

• F u l l - l i n e s p e c i a l t y r e t a i l e r

• F u l l - l i n e s p e c i a l t y r e t a i l e r

9

• O f f i c e s u p p l y s t o r e s



1 0

• L i v e - v i r u s v a c c i n e s

• L i v e - v i r u s

v a c c i n e s

• D i s e a s e p r e v e n t i o n t h r o u g h l i v e - v i r u s

v a c c i n e t e c h n o l o g y

1 1

• D i g i t a l p r e p r e s s e q u i p m e

n t

• D i g i t a l p r e

p r e s s e q u i p m e n t

• D i g i t a l p r e p r e s s e q u i p m e n t

1 2

• M a p s a n d m a p p i n g - r e l a t e d p r o d u c t s ,

s e r v i c e s , a n d t e c h n o l o g y

• M a p p i n g p

r o d u c t s a n d s e r v i c e s

1 3

• T h e r a p e u t i c p r o d u c t s f o r

c a n c e r a n d

i n f e c t i o u s d i s e a s e s

• T h e r a p e u t

i c p r o d u c t s f o r c a n c e r a n d

i n f e c t i o u s d i s e a s e s

1 4

• S m a l l b u s i n e s s e q u i p m e n

t l e a s i n g

• S m a l l b u s i n e s s e q u i p m e n t l e a s i n g

1 5

• S p e c i a l t y r e t a i l e r

• S p e c i a l t y r

e t a i l e r

1 6

• S a l e s a n d m a r k e t i n g a u t o m a t i o n s o f t w a r e

• S a l e s , m a r

k e t i n g , a n d c u s t o m e r s u p p o r t

1 7

• C a t e g o r y - d o m i n a n t s p e c i

a l t y r e t a i l e r

• S p e c i a l t y r

e t a i l e r

1 8

• S u s t a i n e d - r e l e a s e d r u g d

e l i v e r y s y s t e m s

• S u s t a i n e d - r e l e a s e d r u g d e l i v e r y s y s t e m s

( c o n t i n u e d )


14/41


T a b l e

I I I — C o n t i n u e d

P a n e l B : C o m

p a n i e s W h o s e L i n e o f B u s i n e s s B r o a d e n s / N a r r o w s ( B / N ) b e t w e e n t h e B u s i n e s s P l a n a n d I P O

B u t N o t b e t w e e n t h

e I P O a n d t h e A n n u a l R e p o r t

C o m

p a n y


I P O


1 9

• W e b - b a s e d e n t e r p r i s e a p p l i c a t i o n

s o f t w a r e

( N ) L i v e b u s i n e s s c o l l a b o r a t i o n s o f t w a r e a n d s e r v i c e s

• A p p l i c a t i o n s o f t w a r e a n d s e r v i c e s f o r

r e a l t i m e e n t e r p r i s e c o l l a b o r a t i o n

2 0

• E x p e r i m e n t a t i o n p l a t f o r m f o

r a w i d e

r a n g e o f b i o l o g i c a l a n a l y s e s

( N ) T o o l s f o r l a r g e - s c a l e a n a l y s i s o f g e n e t i c v a r i a t i o n a n d

f u n c t i o n

• T o o l s f o r l a r g e - s c a l e a n a l y s i s

o f g e n e t i c

v a r i a t i o n a n d f u n c t i o n

2 1

• I m p l a n t a b l e h e a r i n g d e v i c e s

( B ) I m p l a n t a b l e a n d s e m i - i m p l a n t a b l e h e a r i n g d e v i c e s

• I m p l a n t a b l e a n d s e m i i m p l a n t a b l e

h e a r i n g d e v i c e s

2 2

• D r u g s c r e e n i n g a n d d i s c o v e r

y

( B ) D r u g c a n d i d a t e d

e v e l o p m e n t

• D r u g c a n d i d a t e d e v e l o p m e n t

2 3

• D r u g t a r g e t d i s c o v e r y

( B ) D r u g t a r g e t d i s c o

v e r y a n d s m a l l m o l e c u l e d r u g

d e v e l o p m e n t

• S m a l l m o l e c u l e d r u g d i s c o v e r

y a n d

d e v e l o p m e n t

2 4

• P r o d u c t s a n d s e r v i c e s t o a c c e l e r a t e d r u g

d i s c o v e r y

( B ) C r e a t i n g d r u g c a n d i d a t e s t h r o u g h i n n o v a t i o n s i n

c h e m i s t r y

• C r e a t i n g s m a l l m o l e c u l e d r u g

s t h r o u g h

t h e i n t e g r a t i o n o f c h e m i s t r y , b i o l o g y , a n d

i n f o r m a t i c s

2 5

• I n t e r n e t c o m m u n i c a t i o n s e r v i c e s

( B ) I n t e r n e t s y s t e m a

n d n e t w o r k m a n a g e m e n t

• I n t e r n e t i n f r a s t r u c t u r e o u t s o u r c i n g

2 6

• P r o d u c t s f o r t h e t r e a t m e n t o

f a b n o r m a l

u t e r i n e b l e e d i n g

( B ) S u r g i c a l s y s t e m s

f o r t h e d i a g n o s i s a n d t r e a t m e n t o f

g y n e c o l o g i c a l d i s o r d e r s

2 7

• I n t e r n e t - b a s e d m i c r o p a y m e n

t s s y s t e m

a n d i n c e n t i v e c u r r e n c y

( B ) I n t e r n e t - b a s e d d i

r e c t m a r k e t i n g a n d a d v e r t i s i n g

s e r v i c e s c o m b i n e d w i t h p r o g r a m s t h a t r e w a r d

c o n s u m e r s w i t h c

a s h

2 8

• T r e a t m e n t f o r p s y c h o t i c m a j o r d e p r e s s i o n

( B ) D r u g d e v e l o p m e n

t f o r s e v e r e p s y c h i a t r i c a n d

n e u r o l o g i c a l d i s e a s e s

2 9

• D i s c o v e r y a n d d e v e l o p m e n t o f d r u g s f o r

m e m o r y - r e l a t e d d i s o r d e r s

( B ) D e v e l o p m e n t o f d

r u g s f o r a b r o a d r a n g e o f c e n t r a l

n e r v o u s s y s t e m d

i s o r d e r s

3 0

• D e v e l o p m e n t o f t r e a t m e n t s f o r

p u l m o n a r y i n f l a m m a t o r y d i s e a s e s

( B ) D i s c o v e r y a n d d e v e l o p m e n t o f t r e a t m e n t s f o r a l l e r g i e

s ,

i n f e c t i o u s d i s e a s e s , a n d c h r o n i c i n f l a m m a t o r y d i s e a s

e s

3 1

• I n t e r n e t m a r k e t i n g s o f t w a r e

( B ) I n t e r n e t m a r k e t i n g a n d d a t a a g g r e g a t i o n s o f t w a r e

3 2

• E - c o m m e r c e s o l u t i o n s

( B ) E - c o m m e r c e a n d d i r e c t m a r k e t i n g s e r v i c e s

3 3

• W i r e l e s s d a t a c o m m u n i c a t i o n s

( N ) W i r e l e s s c o m m u n

i c a t i o n a n d i n f o r m a t i o n s y s t e m s f o r

h e a l t h i n f o r m a t i o n

3 4

• C o m b i n a t o r i a l c h e m i s t r y

( N ) C o m p u t a t i o n a l d r u g d i s c o v e r y

3 5

• S o f t w a r e a n d s e r v i c e s t o i n d u s t r i e s

t r a n s f o r m e d b y h u m a n g e n o

m e r e s e a r c h

( N ) S o f t w a r e p r o d u c t

s a n d s e r v i c e s t o a c c e l e r a t e d r u g

d i s c o v e r y a n d d e v e l o p m e n t

( c o n t i n u e d )


15/41


T a b l e


P a n e l C : C o m p a n i e s

W h o s e L i n e o f B u s i n e s s B r o a d e n s / N a r r o w s ( B / N ) b e t w e e n I P O a n d A n n u a l R e p o r t B u t N o t b e t w e e n

B u s i n e

s s P l a n a n d I P O

C o m

p a n y


I P O


3 6

• D i a g n o s t i c i m a g i n g a n d t r e a t m e n t o f

c a n c e r a n d c a r d i o v a s c u l a r d

i s e a s e

• D i a g n o s t i c i m a g i

n g a n d t r e a t m e n t o f c a n c e r ,

a r t e r i o s c l e r o s i s , a n d o t h e r d i s e a s e s

( N ) N e w d r u g s t o t r e a t c a n c e r a n d

a r t h e r o s c e l e r o s i s

3 7

• I n t e r n e t d a t a d e l i v e r y s o f t w

a r e

• I n t e r n e t d a t a d e l i v e r y s o f t w a r e

( B ) E - b u s i n e s s i n f r a s t r u c t u r e s o f t w a r e a n d

s e r v i c e s

3 8

• M i c r o f l u i d i c s

• M i c r o f l u i d i c s

( B ) N o v e l a s s a y c h e m i s t r y s o l u t i o n s f o r

d r u g

d i s c o v e r y a n d d e v e l o p m e n t

3 9

• U p s c a l e , c a s u a l e t h n i c r e s t a

u r a n t s

• U p s c a l e , c a s u a l e

t h n i c r e s t a u r a n t s

( B ) U p s c a l e , c a s u a l e t h n i c r e s t a u r a n t s , a n d c a s u a l

e t h n i c d i n e r s

4 0

• N o v e l a n t i m i c r o b i a l c o m p o u

n d s

• N e w a n t i b a c t e r i a

l a n d a n t i f u n g a l d r u g s

( N ) P r e v e n t i o n o f v e n t i l a t o r - a s s o c i a t e d p n e u m o n i a

P a n e l D : C o m p a n i e s W h o s e

L i n e o f B u s i n e s s B r o a d e n s / N a r r o w

s ( B / N ) b e t w e e n B o t h t h e B u s i n e s s P l a n a n d I P O a n d t h e I P O a n d


4 1

• W e b s i t e p r o d u c t i o n s o f t w a r e

( B ) W e b c o n t e n t m a n a g e m e n t s o f t w a r e

( B ) E n t e r p r i s e c o n t e n t m a n a g e m e n t

s o f t w a r e

4 2

• H o t e l r e s e r v a t i o n a n d c o m m i

s s i o n

c o l l e c t i o n s y s t e m

( B ) T r a n s a c t i o n

p r o c e s s i n g s e r v i c e s f o r t h e

w o r l d w i d e h

o t e l i n d u s t r y

( B ) H o t e l r e s e r v a t i o n a n d r e p r e s e n t a

t i o n

s e r v i c e s f o r t h e g l o b a l h o t e l i n d u s t r y

4 3

• M a r k e t r e s e a r c h

( B ) M a r k e t r e s e

a r c h a n d p o l l i n g

( B ) M a r k e t r e s e a r c h a n d c o n s u l t i n g

4 4

• S e m i c o n d u c t o r l a s e r d i o d e s a

n d r e l a t e d

s y s t e m s a n d s u b s y s t e m s

( B ) S e m i c o n d u c t o r o p t o e l e c t r o n i c i n t e g r a t e d

c i r c u i t s a n d

h i g h p o w e r s e m i c o n d u c t o r

l a s e r s

( B ) S e m i c o n d u c t o r c i r c u i t s a n d l a s e r s ;

f i b e r o p t i c s y s t e m s

4 5

• L o c a l s w i t c h e d t e l e c o m m u n i c

a t i o n s

s e r v i c e s

( B ) C o m p e t i t i v e

l o c a l e x c h a n g e c a r r i e r

( B ) N a t i o n a l c o m m u n i c a t i o n s p r o v i d e r

4 6

• B a s i c l o c a l t e l e p h o n e s e r v i c e s

( B ) F a c i l i t i e s - b a

s e d c o m p e t i t i v e l o c a l

e x c h a n g e c a

r r i e r

( B ) F a c i l i t i e s - b a s e d o p e r a t o r o f a f i b e

r o p t i c

c o m m u n i c a t i o n s i n f r a s t r u c t u r e

4 7

• C u s t o m e r i n t e r a c t i o n s o f t w a r e

( B ) E - b u s i n e s s i n f r a s t r u c t u r e s o f t w a r e

( B ) E n t e r p r i s e s o f t w a r e v e n d o r

4 8

• S t e r i l i z a t i o n s y s t e m s f o r m e d

i c a l

i n s t r u m e n t s

( B ) S t e r i l e p r o c e s s i n g a n d i n f e c t i o n

p r e v e n t i o n s y s t e m s

( B ) I n f e c t i o n p r e v e n t i o n a n d r e l a t e d

c o n s u m a b l e s , a c c e s s o r i e s , a n d s e r v i c e s

4 9

• D i s e a s e g e n e d i s c o v e r y

( B ) G e n e a n d d r

u g t a r g e t d i s c o v e r y ,

d a t a b a s e , a n d i n f o r m a t i o n t e c h n o l o g y

p r o d u c t s a n d s e r v i c e s

( B ) P o p u l a t i o n g e n e t i c s c o m p a n y d e v

e l o p i n g

d r u g s a n d D N A - b a s e d d i a g n o s t i c

s ( c o n t i n u e d )


16/41


T a b l e


P a n e l E : C o m p a n i e s W h

o s e L i n e o f B u s i n e s s C h a n g e s ( C )

C o m

p a n y

B u s i n e s s P

Should you bet on the jockey or the Horse

Documents

Transcript of Should you bet on the jockey or the Horse