Value-Added Activities in Venture Capital and the Effects of Stage- An Empirical Study

Value-Added Activities in Venture Capital and the Effects of Stage: An Empirical Study

Bachelor Thesis B.Sc. International Business

Copenhagen Business School

May 2013

Written by

Martin Franqois Lucas Collignon Paul Joachim Brejnholt Satchwell

Anders Philip Skovsgaard Valentin

Supervised by

Evis Sinani, Associate Professor, PhD Department of International Economics and Management

Character count: 167,327 | 73.5 standard pages

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Acknowledgments:

Special thanks to:

Ted Zoller Director of the Centre for Entrepreneurial Studies at the University of North Carolina at Chapel Hill, Senior Fellow at the Ewing Marion Kauffman Foundation

Mai-Britt Zocca Senior Program Manager at Copenhagen Bio Science Park Program Director of EL2 Knowledge Lab CEO & Founder of OncoNOx ApS

Jesper Knudsen Senior Business Consultant & Partner at Accelerace

Jesper Roested Investment Director at VF Venture

Frank Knudsen Investment Director at SEED Capital

Magnus Corfitzen Investment Director at Sunstone Capital

Christian Wylonis Venture Capital Associate at Creandum

Rasmus Toft-Kehler PhD Student at the Copenhagen Business School Co-founder and CEO at Synercure ApS

Anders Hoffmann Deputy Director General at Danish Business Authority

Nicolai Hjer Nielsen Serial entrepreneur Business angel External Associate Professor at the Copenhagen Business School

Kristoffer Boye Astrup Chief Consultant at Ministry for Business and Growth Denmark

Terttu Luukkonen Chief Research Scientist, Research Institute of Finnish Economy

Furthermore we are grateful for the contributions of:

Leonora Bech, Fabio Bertoni, Joel Eriksson Enquist, Peter Thorlund Haahr, Martin Hauge, Gregers Kronborg, Lars Nordal Jensen, Kristine Leary, Anne Birgitte Lundholt, Simone Louise Petersen, Tine Thygesen, Peter Torstensen, as well as founders, CEOs, and entrepreneurs who took the time to respond to our survey.

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EXECUTIVE SUMMARY

This thesis explores how Venture Capital funds value-added activities differ between stage and if

the Venture Capital funds specialize accordingly.

Departing from the value-add perspective of Venture Capital, in which funds transfer knowledge

through the relationships with their portfolio companies, this empirical study surveys 275

portfolio companies from Danish-based Venture Capital funds operating within ICT or Life

Science. The survey consists of 28 questions on the perceived contribution of the VC funds in

various value-added activities, as well as a maximum of 37 questions on the characteristics of the

firm, the founders, the deal, and the level of interaction with the fund.

With 69 usable responses, the effect of the stage on the portfolio companies perceptions is

analysed through a factor analysis which constructs eight factors from the 28 questions on

perceived value-add to be used as dependent variables in an ordinary least-squares regression.

We construct two models using backward selection: First a model including independent

variables for company stage, industry, age, founder experience, prior funding, the size of

investment, and a factor for the degree of interaction between the firm and the fund. Thereafter,

we construct an identical model which additionally includes nine dummy variables for the

individual funds in our sample which assesses the specialization of funds by modelling whether

the effect of stage from model one is removed by the funds.

We find that the perceived importance of value-added activities differs across portfolio company

stages for factors of strategy, market position, and credibility, while we find no difference across

stages for factors of technology, professionalization, finance, internationalization, or exit

orientation. We also find that Venture Capital funds specialize in stage with respect to value-

added activities within strategy, market position, and credibility. Finally, we find that increasing

the amount of interaction between the Venture Capital fund and its portfolio company results in

a higher perceived contribution of the fund, all else equal.

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Table of Contents

1. Introduction............................................................................................................................................. 5

2. Literature Review .................................................................................................................................... 7

2.1 Perspectives on Venture Capital: Financial Intermediary versus Value-Add .......................... 8

2.1.1 Financial Intermediary Perspective ........................................................................................ 8

2.1.2 Value-Added Perspective ......................................................................................................... 9

2.2 Knowledge Transfer and Value-Add from the Venture Capital Fund ................................... 10

2.3 Fund Level Determinants of Value-Added Activities .............................................................. 11

2.4 Specializations of Venture Capital Funds ................................................................................... 12

2.5 Effects of Stage Specialization ..................................................................................................... 13

2.6 Specific Value-Added Activities and Hypothesis Formation .................................................. 16

2.6.1 Strategic Value-Add ................................................................................................................ 17

2.6.2 Financial Value-Add ............................................................................................................... 18

2.6.3 Credibility Value-Add ............................................................................................................. 19

2.6.4 Professionalization Value-Add .............................................................................................. 20

2.6.5 Marketing Value-Add ............................................................................................................. 21

2.6.6 Technological Value-Add ...................................................................................................... 22

2.6.7 Internationalization Value-add .............................................................................................. 23

2.6.8 Exit Orientation Value-Add .................................................................................................. 24

2.6.9 Fund Stage Specialization ...................................................................................................... 25

3. Methodology ......................................................................................................................................... 26

3.1 Sample Selection ............................................................................................................................. 26

3.1.1 Geography ................................................................................................................................ 27

3.1.2 Institution Type ....................................................................................................................... 27

3.1.3 Industry ..................................................................................................................................... 28

3.1.4 Sampling Error ........................................................................................................................ 29

3.2 Survey Construction ....................................................................................................................... 30

3.2.1 Value-Added Activities ........................................................................................................... 31

3.2.3 Survey Errors ........................................................................................................................... 36

3.3 Data Collection ............................................................................................................................... 37

3.3.1 Format of Survey and Email ................................................................................................. 37

3.3.2 Obtaining Contact information ............................................................................................ 37

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3.3.3 Data Collection Errors ........................................................................................................... 39

3.4 Data Correction .............................................................................................................................. 39

3.5 Methods for Data Analysis ........................................................................................................... 41

3.5.1 Variable Construction and Data Treatment ........................................................................ 41

3.5.2 Analysis Methods for Factor Analysis ................................................................................. 43

3.5.3 Analysis Methods for OLS Regression ................................................................................ 45

3.5.4 Including Fund Dummies ...................................................................................................... 47

3.5.5 Analysis Errors ........................................................................................................................ 47

4. Results .................................................................................................................................................... 49

4.1 Factor Analysis................................................................................................................................ 49

4.1.1 Factor Analysis of Dependent Variables ............................................................................. 49

4.1.2 Factor Analysis of Interaction Term .................................................................................... 52

4.2 Regression Analysis ........................................................................................................................ 52

4.2.1 Descriptive Statistics .............................................................................................................. 52

4.2.2 Model I: Factors Regressed on Stage .................................................................................. 57

4.2.3 Model II: Factors Regressed on Stage and Characteristics .............................................. 57

4.2.4 Model III: Factors Regressed on Stage, Characteristics, and Interaction ....................... 59

4.2.5 Model IV Backward Selection of Model of Stage on Value-Added Activities ........... 61

4.2.6 Model V Controlling for Individual Funds ...................................................................... 64

4.3 Hypothesis Evaluation ................................................................................................................... 67

5. Discussion .............................................................................................................................................. 69

5.1 Hypotheses 1-8: Value-Added Activities and Stage .................................................................. 69

5.2 Hypothesis 9: Venture Capital Stage Specialization .................................................................. 74

6. Conclusion: ............................................................................................................................................ 76

6.1 Implications for Practitioners and Researchers ......................................................................... 77

6.2 Limitations and potential weaknesses of our research .............................................................. 78

7. Recommendations for Future Research ............................................................................................ 80

8. Bibliography........................................................................................................................................... 81

Appendix .................................................................................................................................................... 89

I. Overview of Interviews .................................................................................................................... 89

II. Number of VC Investments by Industry in Denmark .............................................................. 90

III. Sample Survey ................................................................................................................................ 91

IV. Individual KMO Scores .............................................................................................................. 100

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V. Overall Principal Component Analysis with Screeplot ............................................................ 101

VI. Principal Component Analysis of Dependent Variables ....................................................... 102

VII. Principal Component Analysis of Interaction ........................................................................ 104

VIII. Heteroskedasticity Tests .......................................................................................................... 105

IX. Theory of the Special Case of White Test ................................................................................ 108

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List of Tables

Table 1: Overview of Funds Present in Our Sample........................................................................... 28

Table 2: Distribution of VC-backed firms in sample and in responses ............................................ 40

Table 3: Factorability Tests ...................................................................................................................... 49

Table 4: Rotated Principal Component Analysis ................................................................................. 50

Table 5: Cronbach Alpha Scores ............................................................................................................ 51

Table 6: Factor Loadings Matrix............................................................................................................. 51

Table 7: Descriptive Statistics: Value-Add Importance ...................................................................... 52

Table 8: Descriptive Statistics: Independent Variables ....................................................................... 53

Table 9: Correlation Matrix (1/3) ........................................................................................................... 54

Table 10: Correlation Matrix (2/3) ......................................................................................................... 55

Table 11: Correlation Matrix (3/3) ......................................................................................................... 56

Table 12: Regression i Output ................................................................................................................ 57

Table 13: Regression ii Output ............................................................................................................... 58

Table 14 Regression iii Output ............................................................................................................... 60

Table 15: Regression iv Output .............................................................................................................. 63

Table 16: Regression v Output ............................................................................................................... 65

List of Figures

Figure 1: Outline of the Theoretical Causality of the Thesis ................................................................ 7

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1. INTRODUCTION

How, as a fund, can I deliver the most value along with my money cause my moneys as green as

someone elses?

- Josh Kopelman (2013), Partner at First Round Capital

Venture Capital is the collective term for capital provided to early-stage, high risk growth

companies. It operates in the undergrowth of the business formation forest by investing large

sums of money in companies that have unobservable track records, but have the drive to get

places, helping turn the ideas entrepreneurs of today into the companies of tomorrow.

In recent years, this question of value-add has become ever more relevant from the perspective

of both the fund and the entrepreneurs. The Venture Capital industry globally has seen only

modest returns and a declining number of funds (EVCA 2012; NVCA 2012). This directly

affects entrepreneurs, who list access to financing and bridging financing gaps as one of their

largest challenges (EVCA 2012). Venture Capital is also ever-present in the minds of national

governments and intra-governmental organizations such as the EUs, as it has a direct effect on

innovation, job creation and growth in societies (Kortum and Lerner 1998). As a consequence,

governments are pledging ever more money to innovation incubators, accelerators, direct

investments, or funds-of-funds (E&Y 2010). Despite all this focus on Venture Capital, it still

remains unclear how Venture Capital funds should overcome this challenge of adding value to

portfolio companies and harvest solid returns.

Academia research, although still a relatively young domain of research, is strongly warranted by

the contemporaneousness of this issue. Two perspectives on role of Venture Capital are

predominant: One stream investigates how funds can optimize their investments from a finance

and economics perspective, utilizing concepts such as risk-reward and portfolio diversification.

The other, based in management and entrepreneurship research focuses on the contribution of

the Venture Capital fund in the interaction with its portfolio companies (Landstrm 2007).

While the former theory might be utilized in practice, there is a clear observation of the latter

with funds moving towards a pyramidal structure, attempting to provide more assistance, and

ultimately value, to their portfolio companies (Wasserman 2005). Value-added activity is a branch

of research within Venture Capital which examines these post-investment activities of Venture

Capital funds towards their portfolio companies. It is engaged in the types of activities conducted

by the Venture Capital funds, such as assistance and knowledge transfer, as well as the

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determinants of Venture Capital funds capability of these activities, such as what knowledge

stock the Venture Capital fund holds and the mode of each individual activity. Overall, it focuses

on the Venture Capital funds ability to conduct value-added activities successfully.

In this paper, we shed light on one aspect of this. We investigate how the stage of the company

relates to the need for value-added activities in portfolio companies, and whether or not Venture

Capital funds actually act on the demands of their portfolio companies. This paper therefore

investigates the relationship between portfolio companies and Venture Capitalists with the

following research question:

How do Venture Capital funds value-added activities to their portfolio companies differ between stages, and do

the funds specialize accordingly?

In the following section this thesis will first outline the literary framework for value-added

activities within Venture Capital and construct nine hypotheses on the effect of stage on the

perceived value of various value-added activities. This will be followed by section three, which

contains the procedures used in this empirical study. This section contains the selection of our

sample of all current ICT and Life Science portfolio companies in Danish-based Venture Capital

funds, followed by an elaboration of our survey assessing entrepreneurs perception of VC funds

contribution of value-added activities. This section concludes with an overview of our collected

data and the methods used in this regard. Section four contains the results from our two analysis

methods. First we conduct a Principal Component Analysis which groups answers within

underlying factors allowing them to be used in a regression analysis. Second we model these

factors against characteristics of the company and its founders in an Ordinary Least-Squares

regression analysis to predict whether there is a significant difference between stages. Finally our

hypotheses will be evaluated based on the regression outputs. Section five discusses our results

in relation to our hypotheses and previous research, which leads to section six and the

conclusion of our research question. This will be followed by an assessment of this thesis

significance and implications for future research.

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2. LITERATURE REVIEW

This section places this thesis within the extensive literary framework on Venture Capital and

provides a foundation for generating our hypotheses in relation to our research question. We

first conduct a brief review of the two overarching perspectives on Venture Capital to highlight

the differences between the two. A section on the impact of VC funds involvement in their

ventures, which addresses the factor of interaction on value-added activities, will follow. Then,

we will consider theories behind the impact of specialization of VC funds with respect to

geography, industry, and stage of the portfolio company. This finally leads to our hypotheses

formation, where we investigate the literature base for particular value-adding activities and how

these activities relate to stage from the entrepreneurs perspective. The theoretical causality is

highlighted in figure 1 (below).

FIGURE 1: OUTLINE OF THE THEORETICAL CAUSALITY OF THE THESIS

Hypothesis Formation

Effects of Stage Specialization

Specializations of Venture Capital Funds

Fund Level Determinants of Value-Added Activities

Knowledge Transfer and Value-Add from the Venture Capital Fund

Perspectives on Venture Capital: Financial Intermediary versus Value-Added

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2.1 PERSPECTIVES ON VENTURE CAPITAL: FINANCIAL INTERMEDIARY VERSUS

VALUE-ADD

Research on Venture Capital (VC) generally takes two perspectives. One is that Venture Capital

funds (from here on referred to as VC funds) are purely financial intermediaries, reducing

information asymmetries and thereby uncertainties. The other is that VC funds also act as value-

adding investors who advise and help operate their portfolio companies, thus providing real

value enhancement (Bertoni, Croce, and Quas 2010).

2.1.1 FINANCIAL INTERMEDIARY PERSPECTIVE

The financial intermediary understanding of VC stems from the premise that VC funds operate

in markets with information asymmetries. These asymmetries create a state where there is an

excess demand of capital through credit rationing which results in profitable projects not being

funded. In these situations, VC funds act as mechanisms to reduce the information asymmetries

and resulting adverse selection problems (Amit, Brander, and Zott 1998). Additionally, the

financial intermediary perspective is concerned with principal-agent issues in which moral hazard

exist between the VC-fund and the entrepreneur from the premise that incentives are not always

aligned (Kaplan and Strmberg 2001).

In the financial intermediary understanding, the VC fund is oriented towards three methods of

overcoming uncertainties, adverse selection and moral hazard. First, a key activity is selecting

ventures correctly through a screening process which is particularly targeted high-technology

startups with an unobservable track-record, whereby information that was previously hidden is

understood and thus eliminates the effect of adverse selection (Ueda 2004). Second, the VC fund

contractually eliminate moral hazard issues by virtue of control rights e.g. in the shape of cash-

flow rights, voting rights, redemption rights (Kaplan and Strmberg 2001). These contractual

terms allow an element of control over the portfolio company, with which divergent incentives

and intentions can be mitigated. Last, VC funds engage in extensive monitoring efforts, e.g.

through reports on various key performance indicators in the portfolio ventures. This structure

frequently revolves around a staging of financing within an investment: instead of a lump sum

given to the entrepreneur, the total investment is divvied along multiple rounds, each of which is

contingent on the portfolio companys progress. This allows a VC fund to control for moral

hazard issues with respect to the entrepreneur along the lifetime of their principal-agent

relationship (Gompers 1995).

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Indeed the financial intermediary perspective contributes to a substantial part of the

understanding of Venture Capital and its raison d'tre. The following section will now focus on

the perspective of value-add.

2.1.2 VALUE-ADDED PERSPECTIVE

The value-added perspective is concerned with the VC funds efforts to improve the operations

of their portfolio firms through an active involvement in their investments which exceeds solely

monitoring efforts. The VC funds attempt to gain a competitive advantage through a costly

effort to advise and control the entrepreneurial ventures. The value-added perspective is thereby

only concerned with the post-investment activities of the Venture Capital process (for

characterization of the phases, see Tyebjee and Bruno 1984). De Bettignies and Brander (2007)

find that the existence of VC funds as purely financial intermediaries eventually discontinues

them from an entrepreneurial choice perspective, as the survival of the VC fund necessitates

value-added contributions when entrepreneur ownership is diluted in relation to bank financing.

This evaluation serves, given an availability of bank financing, as an argumentation for the

existence of value-added efforts.

From the basis of performance post-Initial Public Offering (IPO), Arthurs and Busenitz (2006)

find that VC-backed firms are better able to cope with product-related and management issues

or as they put it, VC-backed firms exhibit better dynamic capabilities. This is due to VC fund

involvement and engagement in value-added activities. This conclusion remains weak, in the

sense that it seems hard to distinguish whether involvement actually caused this ability or if it is

simply caused by superior selection efforts in the pre-investment phase. Baum and Silverman

(2004) shed light on this question of whether Venture Capital funds select ventures which are

inherently stronger performing or if they are able to build them. In their study, they find

evidence of both occurrences taking place, i.e. that the selection efforts as well as the value-add

measures result in better IPO performance of the portfolio company. The study finds significant

evidence for the effect of value-added activities, but could not conclude on the isolated effect of

value-added activities. This conclusion is in line with Frederiksen, Olofsson, and Wahlbin (1997),

who find evidence that Venture Capitalists conduct value-added activities through active

involvement. The economic development of the portfolio companies and its relationship to

value-added is unclear, with Frederiksen, Olofsson, and Wahlbin (1997) interestingly implying

that this results from VC funds dedicating their time to interacting with underperforming

portfolio companies, fittingly coined firefighting in the article.

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These studies, which find evidence for the impact of value-add, are in conflict with the

conclusions of Bertoni, Croce, and Quas (2010). Their study showed that value-add is not

significant, in the sense that it seemed to be appropriated by non-VC-backed firms in the market,

resulting in no significant differences being perceived. There thus seems to be disagreement with

respect to the effect of value-added activities on portfolio companies in VC funds.

In conclusion, it is not entirely agreed upon whether VC funds that conduct extensive value-

added activities actually exhibit better performance from a portfolio and, in extension, from a

fund perspective. In this paper, however, we intend to apply the broader, value-added

perspective rather than the financial intermediary perspective, as it seems likely that capability

building as a result of value-added activities does occur. Thus the question becomes how these

value-added activities transfer knowledge from the VC fund to the portfolio company. The

following section sheds light on this subject.

2.2 KNOWLEDGE TRANSFER AND VALUE-ADD FROM THE VENTURE CAPITAL

FUND

The premise of value-added activities is that entrepreneurial firms can learn from their investor.

This entails a level of interaction between the two parties as well as permeability of knowledge

between the VC fund and the portfolio company. The following section attempts to explain

these two mechanisms: interaction and permeability.

Interaction can be interpreted as communication between the VC fund and the portfolio

company. Studies have shown that Venture Capitalists spend 45-70% of their time assisting

their portfolio companies (Zider 1998; Gorman and Sahlman 1989). Interaction consequently

signifies a key part of what Venture Capitalists do. In that regard, Sapienza (1992) finds that the

frequency of interaction is a determinant of the perceived value-add from the VC fund, thus

lending support to the notion that interaction plays a part in transferring knowledge. However,

just as there is uncertainty regarding whether or not value-add actually increases performance,

there is also uncertainty regarding the relationship between interaction and performance.

Bottazzi, Da Rin, and Hellmann (2008) find that when controlling for reverse causality, i.e. VC

funds may interact more with companies that perform well or poorly, which is similar to the

proposition of Frederiksen, Olofsson, and Wahlbin (1997), the level of interaction is not a

significant determinant of portfolio company performance. However, they do find that value-

added activities themselves are significant and positive. Activism in the broad sense on the part

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of VC funds thus helps guide the portfolio company towards success, but the study did not find

that interaction, as a measure of communication, significantly contributed to the success of the

portfolio companies. This lends to this thesis framework by forming a distinction between

interaction and value-added activities.

The second mechanism of knowledge transfer is the permeability of knowledge. This aspect of

knowledge transfer is arguably governed by the nature of the relationship between the VC fund

and the portfolio company. In this regard, Berglund, Hellstrm, and Sjlander (2007) suggest

that merely through a VC funds presence in the processes of the entrepreneurial firm, VC funds

can contribute to the entrepreneurs learning capacity, thus representing a form of indirect

knowledge transfer under the right circumstances. More directly though, the high degrees of

knowledge sharing, relationship-specific investments, goal congruence, and the level of trust

between the two actors have been proposed as conducive to the quality of value-added activities

(De Clercq and Sapienza 2001). This capacity to establish a solid relationship for permeability of

knowledge further instigates better perceived performance (De Clercq and Sapienza 2006).

Relationships and the corresponding permeability of knowledge thereby constitute a mechanism

through which value-add is transferred, potentially increasing the performance of the portfolio

companies and consequently the VC funds. This highlights the idea that the value-added

perspective is of a softer nature than the financial intermediary perspective. The complexity of

permeability of knowledge lends to this thesis omitting it as a further area of interest. While

explanatory, it is still in a propositional stage of research and will therefore be disregarded for the

remainder of this thesis. We assume value-added activities are only transferred through

interaction when active efforts exist, thus taking the degree of permeability for granted.

2.3 FUND LEVEL DETERMINANTS OF VALUE-ADDED ACTIVITIES

We have given a review of the dichotomous research orientations with respect to Venture

Capital, i.e. the financial intermediary vs. value-added perspective. Given this thesis focus on

value-added activities, we highlighted the mechanisms through which knowledge is transferred

between the VC fund and the portfolio company. In the following section we emphasize how

value-added activities are related to VC fund level strategies, focusing on VC fund specialization

as a method to enhance value-add to portfolio companies, beginning with the concept of limited

attention.

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Given that interaction is the mechanism through which knowledge is transferred, there is a cost

associated with value-added activities. This presents itself through a time-resource constraint in

VC funds, implying an allocation of the VC funds efforts between portfolio companies

(Fulghieri and Sevilir 2009; Gifford 1997). The Venture Capitalist in effect experiences a

tradeoff between dedicated efforts to a few ventures and a low involvement in many ventures,

risking by analogy scraping butter over too much bread. Portfolio size thereby becomes a determinant

of the level of value-added activities given a set time resource. Nevertheless, portfolio size is not

the only determinant given such a time constraint. Funds can also specialize in a particular type

of firm to have the highest possible degree of adaptation to portfolio company needs, thereby

making their value-added activities more constructive. The foundation of specialization is that

VC funds are able to accumulate knowledge that can be transferred to the portfolio companies.

Highlighting this concept, Yang, Narayanan, and Zahra (2009) conclude from an organizational

learning perspective that the Venture Capitalist learns from a diversity of experiences, which

contribute to an overall understanding of a concept, as well as intensity of the experiences that

contribute to an in-depth expertise. This implies that under time and learning constraints a trade-

off ultimately exists between specialized and diversified learning from the VC funds point of

view, where the in-depth expertise represents a specialized accumulated knowledge (Yang,

Narayanan, and Zahra 2009).

To obtain and accumulate this type of knowledge, VC funds can specialize in particular types of

ventures, thus incurring a higher intensity of experiences and becoming experts in that field. This

specialization results in a more particular type of expertise, reducing uncertainties associated with

working with portfolio companies. Such a specialization can occur along multiple dimensions,

namely geography, industry, and stage, which will be reviewed in the following section. As stage

is the primary focus of this paper, the former two will be evaluated briefly, while the latter will be

given a more extensive literary review.

2.4 SPECIALIZATIONS OF VENTURE CAPITAL FUNDS

We have thus far established that the amount of attention paid to a specific portfolio company,

along with the expertise behind the attention, are determinants of value-added activities and that

this accumulation of knowledge can be obtained through specialization. The question then

becomes what implications specialization carries, which will be investigated here.

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Gompers, Kovner, and Lerner (2009) investigate the relationship between organizational

structure with respect to industry specialization and the success of the VC funds investments,

and whether this specialization results in improved or worsened performance. They find

conclusive evidence that specialization is associated with a higher probability of IPO exit, a

desired outcome of VC investments. Patzelt, Zu Knyphausen-Aufse, and Arnoldt (2006)

moderate this conclusion by stating that diversification within an industry also effectively reflects

a risk diversification because the within-industry risk profiles of portfolio companies can be

substantially different. It has to be kept in mind that the sample used was biotechnology firms

which encompass highly different risk profiles depending on their technological basis, thus

making inference to other industries less given.

The matter of specialization versus diversification is extensively researched by Knill (2009).

Knills (2009) premise is that the choice between specialization and diversification is determined

by the nature of the VC funds limits with respect to time and expertise. Through an

investigation across industry, geography, and stage, the author finds that diversification is

significantly and positively related to the growth of the VC fund over time, with stage

representing the second strongest predictor. The analysis also concludes that the entrepreneurial

outcome, measured in the study by time to exit via IPO, is negatively related to diversification of

industry and stage, with industry having the most negative impact. In addition to conclusions

that span geography, industry, and stage specialization, the study highlights a divergence between

the VC fund and its portfolio company in their determinants of success. Knill (2009) thereby

validates that stage specialization results in better performing firms because of increased levels of

competency transfer. It also highlights that different interests exist in the relationship between

VC fund and portfolio companies when it comes to stage specialization, lending to the necessity

of research on the interaction between stage specialization and the portfolio firm perspectives.

Thus, it serves as a fitting outset for a characterization of how stage specialization is viewed in

the literature. The following section will attempt to shed light on this factor of VC fund strategy.

2.5 EFFECTS OF STAGE SPECIALIZATION

The premise for stage specialization is arguably best characterized through life-cycle theory. The

concept of firm development through stages stems from an extensive body of literature

commonly termed life-cycle growth models, in which a firms development consists of a

sequence of challenges that have to be overcome to transition to the following stage (see Phelps,

Adams, and Bessant 2007 for an exhaustive review of literature on life-cycle theories). These

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various stages characterizations help define and frame firm development, but seem to lack a

stringent definition (Hanks et al. 1994). What furthermore complicates the understanding of

stages with respect to VC funds and their relationship to the portfolio companies is that stage as

a concept can be defined as one thing from the perspective of the VC fund, and another from

that of the portfolio company. Either way, the underlying concept behind firm stages, i.e. that

entrepreneurial ventures undergo a sequential development with corresponding changing nature

of challenges, seems to be commonly accepted and connected with the sequencing of finance in

the Venture Capital industry (e.g. Smith, Smith, and Bliss 2011; De Clercq et al. 2006; Sahlman

1990; Ruhnka and Young 1987).

Given that entrepreneurial ventures undergo a transformation as they develop, particularly with

respect to challenges and needs, this lends to a foundation for stage specialization of the VC

fund from the premise of portfolio companies need for specific knowledge requirements and

assistance in building expertise. This would explain why stage specialization is observed to be

relatively common in VC funds. (Gejadze, Giot, and Schwienbacher 2012; Bartkus and Hassan

2009). Norton and Tenenbaum (1993) further add to the concept of stage specialization through

an investigation of how systematic and unsystematic risk apply to Venture Capital, more

specifically how specialization and information sharing act as risk control measures. They find

that VC funds tend to specialize in particular stages. Furthermore, VC funds that are involved in

early stages focus on particular industries because of the necessity of specialized industry

knowledge.

It is thereby possible to distinguish between VC funds that specialize and VC funds that do not.

Schwienbacher (2012) depicts these options from an entrepreneurs point of view, where he

deduces that when faced with a choice between a specialized versus a generalist VC fund, the

entrepreneur faces a tradeoff. A specialist fund has a higher potential for value-add due to

cumulated expertise, but lacks the ability or incentive to carry the venture across stages. Contrary

to the specialist fund, the generalist fund has the ability to carry the portfolio company through

multiple phases, but potentially lacks the specialized knowledge to guarantee a high value-add,

often resulting in lower growth. Schwienbacher (2012) concludes that the potentially higher

growth path for the startup matters more than the risk of premature startup liquidation

stemming from a lack of ability to obtain follow-up financing. This proposition is supported by

G. Smiths (1999) results regarding the selection criteria of entrepreneurs with respect to VC

funds, where the stage specialization ranks in the upper quartile. Schwienbachers (2012)

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theoretical proposition is also in line with Clercq and Dimov (2006), who find stage

specialization to be negatively associated with startup failure rates, thereby supporting

Schwienbachers (2012) proposed notion that the value of specialized expertise outweighs pre-

mature cessation. This indicates that there is evidence of benefits to both entrepreneurs and VC

funds when it comes to the accumulation of stage-specific knowledge.

However, the evidence for stage specialization is not conclusive. Several studies find that it is

stage diversification which increases fund performance, rather than stage specialization. Bartkus

& Hassans (2009) empirical study finds a positive and significant relationship between stage

diversification and VC fund performance with respect to successful exits. In relation to

Schwienbacher (2012)s proposition regarding the upside of the generalist fund, Bartkus &

Hassans (2009) dependent variable, exit success, could exhibit a positive relation to stage

diversification because funds that span stages are better able to guarantee follow-up financing.

Bartkus & Hassans (2009) conclusions are somewhat supported by Cumming, Fleming, and

Schwienbachers (2009) study of style drift in Private Equity, i.e. deviations in stated stage focus

by a Private Equity fund, keeping in mind that their stage definition is wider than that of other

studies.

Within the literature of stage specialization, researchers have found that there is a tendency to

move towards later stage specialization, for example De Clercq et al. (2001) study of the Finnish

Venture Capital funds. They also found, given a higher mean stage of investment, a tendency for

diversification across stages, geography, and companies. This lends an interesting aspect to the

concept of risk diversification from the resource-based view of specialization: the trend observed

by De Clerq et al (2001) does not seem to stem from intent to specialize, but rather from a

profit-oriented risk diversification. Justifications for this strategic move can be found in empirical

evidence from Gompers, Kovner, & Lerner (2009) who find that funds focusing on later-stage

investments exhibit higher exit success rates. This in turn may cause a shift towards the later

stages. Another perspective in this regard is that the late-stage orientation is caused by a

disproportional growth in assets under management in monetary terms, which given a lack of

growth in the funds human capital resources implies a higher investment size in order to have a

sufficient degree of interaction with the portfolio company (Bygrave and Timmons 1992 through

Elango et al. 1995).

Either way, this shift towards the later stages is a trend that carries implications for the structure

of Venture Capital markets, because the VC funds in later stages are dependent on a flow of high

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quality ventures that have received prior funding. This shift has led to the much debated concept

of the funding- or equity gap in various markets (e.g. Cressy 2012; Murray 1999), followed by

governmental interventions in the market to avoid financial starvation of entrepreneurial

ventures ( e.g. Da Rin, Nicodano, and Sembenelli 2006).

This concludes our review of literature that sets the stage for our hypothesis formation. We find

a relevant conjunction between stage specialization of VC funds and their value-added activities

and that an investigation is appropriate and serves to contribute to existing literature. We

emphasize that our understanding of the gap in the literature, with respect to the

characterizations of stage specialization and value-add activities and the interactions between

them, is shared with De Clercq and Manigart (2007). Furthermore, we believe the entrepreneurial

perspective on this matter lends to interesting insights that add to the understanding of value-

added activities and Venture Capital in general.

2.6 SPECIFIC VALUE-ADDED ACTIVITIES AND HYPOTHESIS FORMATION

In the previous sections we have attempted to investigate the interactions between VC funds and

their strategies with respect to portfolio companies. The following section represents a review on

how value-add is perceived in the literature and how it interacts with stage. This section serves,

based on the previous sections, to theoretically outline this thesis hypotheses.

Large and Muegge (2008) provide an extensive review on the literature on non-financial value-

added activities, in which we also took a preliminary outset. It is important to note that

singularizing a specific area of focus from articles investigating several dimensions of value-add

would involve omitting other investigated variables. This would impoverish the value of the

previous research. Therefore, several studies in the following section span multiple sub-sections

of value-added components to avoid omitting relevant observations. Furthermore, we utilize the

distinction between types of value-added provided by Luukkonen, Deschryvere, and Bertoni

(2013). This distinction between types of value-add relatively closely resembles the classifications

used in Large and Muegge (2008) with respect to horizontal levels (e.g. executive, marketing &

sales), whereas the applied distinction excludes the differentiation on the vertical level (e.g.

legitimization, mandating, strategizing). The vertical dimension is instead applied as singularized

types of value-added activities.

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2.6.1 STRATEGIC VALUE-ADD

The literature does not seem to agree on the definition of strategic contributions. Due to its

loosely defined nature, it is frequently a topic of interest whether in the form of a distinct focus

or in the shape of a more precisely defined variable that essentially is a subset of strategy.

Strategic value-add from the VC fund to the entrepreneurial firm is typically understood as the

VC fund guiding the entrepreneur in the right direction, primarily done through board

representation (Fried, Bruton, and Hisrich 1998). Strategy is furthermore composed of an

internal process and is related to context of the entrepreneurial firm. Wijbenga et al. (2003)

propose that this context is best understood by the inclusion of an assessment of the degree of

fit with regards to strategic involvement, the premise being a distinction between agency,

entrepreneurial, positioning, and resource fit. This definition would capture in more detail the

mechanisms which drive strategic importance.

More studies have instead taken strategy as isolated from environmental concerns, i.e. from a

more general perspective. Sapienza, Manigart, and Vermeir (1996) find that VC funds perceive

the strategic role as being their most important contribution regardless of stage and that this type

of involvement potentially increases firm performance, in line with the conclusions of previous

studies (e.g. Ehrlich et al. 1994). This conclusion implies that entrepreneurial firms need strategic

contributions. Macmillan, Kulow, and Khoylian (1988) also reach this conclusion, asking

Venture Capitalists for the importance of their activities. Aside from the strategic role being the

most important, their study also finds that strategic importance exhibits little variance across

stages. Furthermore, Gabrielsson and Huse (2002), in a dyadic perception-based study, find the

development of business concepts/strategies to have a middle-of-the-pack importance level,

although being recognized as the boards main task. The conflicting results are possibly due to

the different contexts of the studies and the various value-added components which were

studied.

Regardless of the various definitions, strategic value-add overall seems to be an important type

of value-added activity, as it contributes to the ability of the portfolio company to orient itself in

its environment. Pratch (2005) highlights that strategic value-add mainly lies in providing critical

thinking, first and foremost defining the company with respect to its value proposition and

business model. This defining orientation, Pratch (2005) argues, is effectively a continuous

reevaluation of the entrepreneurial firm as it transitions through its life cycle. This implies that

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strategic value-add is an important feature of the fund-firm relationship at all stages of

development.

From the above review, we hypothesize that strategic value-add has a substantial value-add effect,

irrespective of the company stage because it is an iterative and continuous process.

Thus:

H1: There is no significant effect of stage on strategic value-add

2.6.2 FINANCIAL VALUE-ADD

Financial value-add is primarily concerned with the VC funds ability to actively contribute to

raising additional capital for the portfolio firm. This additional capital can stem either from the

VC fund themselves in the form of staged follow-on finance, from non-equity sources e.g.

through banks, or from attracting third-party VC funds.

Gomez-Mejia, Welbourne, and Balkin (1990) investigate financial value-add using a definition

that includes financial management, i.e. building financial capabilities in the portfolio company,

as well as the above-mentioned forms of capital. Based on interviews, their study finds that the

importance of financial contributions as perceived by the entrepreneur is significantly important,

both with respect to financial management and capabilities, as well as raising direct and indirect

capital. This is in line with the dyadic perception-based findings of Gabrielsson and Huse (2002)

with respect to building financial competencies and the acquisition of capital. This is also

consistent with numerous other studies (Maula, Autio, and Murray 2005; Ehrlich et al. 1994;

Gorman and Sahlman 1989; Macmillan, Kulow, and Khoylian 1988). The only inconsistency in

the literature to the authors knowledge is Sapienza (1992, pt. through Large and Muegge 2008)

which finds that from dyadic perspectives, the role of financier is only moderately important.

This inconsistency can stem from a multitude of causes, examples being the context of questions

asked, the definition of the financial value-add which remains unspecified in the article, or the

sample. Nevertheless, there still seems to be a relatively high degree of agreement in the literature

with respect to the significance of financial value-add. Given the premise that a firms survival is

dependent on continuous financial resources to develop and expand the business, and that a

startup firm intends to progress through all of its life-cycle stages, it can be argued that the

startup has needs for external financial contributions regardless of stage (Smith, Smith, and Bliss

2011).

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We thus hypothesize that given the evidence from previous literature with respect to the

importance of financial contributions and the continuous nature of this need, financial value-add

has a significant effect irrespective of stage:

H2: There is no significant effect of stage on financial value-add

2.6.3 CREDIBILITY VALUE-ADD

In addition to active efforts in competency transfers from the VC fund to the portfolio company,

the VC fund also contributes passive qualities that add value to the portfolio company. Of these

passive elements, reputation or in effect credibility is particularly important.

Startups are characterized by high degrees of uncertainty and unobservable track records.

However, if the startup is affiliated with a third party that exhibits high degrees of observable

credibility, part of this reputational benefit will effectively spill over to the startup. This lends to a

lowering of the externally perceived uncertainty regarding the quality of the startup (Hochberg,

Ljungqvist, and Lu 2007). This affiliation with a VC fund with a high prominence increases the

likelihood that the VC is associated with other prominent investors and thus improves deal-flow

(Hochberg, Ljungqvist, and Lu 2007). This in turn creates the effect that the reputation of a VC

fund becomes a desirable quality from the entrepreneurs perspective. Therefore, as Hsu (2004)

argues, a market effectively arises where startup firms pay for affiliation with high-reputation

VC funds by accepting lower valuations, of which he also finds empirical support.

Furthermore, Stuart, Hoang, and Hybels (1999) investigate this type of endorsement in relation

to performance at the IPO stage. They find that, for the portfolio company, the prominence of

an affiliated VC fund facilitates the association of other prominent partners, and has a

significantly positive effect on the IPO. This conclusion is in line with the findings of Megginson

and Weiss (1991), Dolvin (2005) and Nahata (2008) with respect to various normative IPO

metrics, such as reduced underpricing at IPO, lowered underwriter costs, and issuance costs.

In conclusion, there is evidence for the importance of credibility, warranting its investigation. We

theorize that the effect of this value-add applies equally to through the various stages of the

startups development i.e. pre-seed through expansion, but also in terms of exit. Thus we

hypothesize:

H3: There is no significant effect of stage on credibility value-add

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2.6.4 PROFESSIONALIZATION VALUE-ADD

Professionalization is a commonly studied topic within the value-added perspective.

Professionalizing the portfolio companies is primarily pursued because a) total dependency on

the entrepreneur for management of the portfolio company is risky and inherently

counterproductive and b) it makes the firm easier to finance, both for the VC fund and in

follow-up rounds (Zingales 2000). Active efforts on part of the VC fund towards

professionalizing the portfolio company thus constitute a value-add activity through efforts such

as corporate governance, HR policies, board, management, and advisor setup. With respect to

corporate governance, Hochberg (2011) conducted a normative study of venture-backed versus

non-venture backed firms in the post-IPO phase. The study finds that VC-backed firms have

better governance in the post-IPO phase when measured as cost control management, market

reactions to shareholder rights agreements, and lastly a string of board, audit and chairman

metrics.

Meanwhile, Sapienza (1992, pt. through Large and Muegge 2008) investigates recruitment of

management, and finds it to rank relatively low in importance. This finding is in line with

Gabrielsson and Huse (2002), who find professionalization to rank moderate and recruitment

low in importance, respectively, furthermore coinciding with the observations of CEOs in

Gomez-Mejia, Welbourne, and Balkins (1990) dyadic study.

From a human capital perspective, Hellmann and Puri (2002) investigate how VC funds

professionalize their portfolio company from the firm perspective. Specifically, they investigate

how VC funds build the internal organization, such as HR policies and the recruiting of

management, along with an investigation of CEO turnover. Hellmann and Puri (2002) find that

VC-backed firms professionalize along these dimensions faster, but also that the importance of

the VC funds involvement is higher in the earlier stages of the firms development. This lends to

the concept that professionalization is one of the first things VC funds engage in once an

investment has been made.

Even if there is not conclusive agreement as to the importance of professionalization measures,

there is evidence in the literature that suggests that professionalization is more prominent in the

early stages of portfolio companies.

In conclusion, based on the literature we hypothesize that professionalization, and thereby the

construction of professional processes and of human capital, will be more prevalent in the earlier

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stages. Thereby the professionalization value-added activities effect from the firm perspective

will be higher the earlier the stage:

H4: There is a negative effect of stage on professionalization value-add

2.6.5 MARKETING VALUE-ADD

A significant part of the new ventures development is associated with the development of a

defendable market position, i.e. the commercialization of the ventures core business concept.

Building a solid market position represents an opportunity for the new venture to establish a

revenue base and generate profits to fund future growth. Stre (2003)s case study on informal

Venture Capital in Norway lends to the proposition that an important aspect of VC fund efforts

is to develop a market orientation. However, this concept of market orientation can be carried

out from a strategic rather than hands-on marketing base. This distinction is important because

the understanding of marketing in the literature exhibits overlaps between the strategic and the

operational side of marketing. Maula, Autio, and Murray (2005) apply a distinction between

social capital-derived marketing, similar to an operational understanding, and a knowledge-based

marketing, more congruent with a strategic understanding. In the study, they find that the two

components measure comparably in relation to each other and that they exhibit moderate

importance. However, that is not always the case. While the distinction is congruent with

Macmillan, Kulow, and Khoylian (1988), they find that VC fund investment managers in the

studys sample intended to be more engaged in marketing due to its importance in creating

growth, but that the level of actual involvement with marketing was low, in line with other

studies (Gabrielsson and Huse 2002, Ehrlich et al. 1994). Macmillan, Kulow, and Khoylian (1988)

explain this conflict of importance versus intent through the relative costs associated with them:

operational marketing efforts are more costly than strategic marketing efforts, with the VC fund

investment manage thus preferring to engage in marketing at the strategic level. Meanwhile,

Hellman and Puri (2000) study the time-to-market for venture-backed and non-venture-backed

companies, and find evidence that VC fund involvement results in significantly faster time-to-

market, implying a value-added activity in the early stages. This implies that VC funds to some

extent do exert operational marketing efforts.

In that regard, operational marketing value-add represents a significant part of venture

development. Nonetheless, the cost associated with it implies that it is not something that would

be perceived as important by the portfolio company, due to the low involvement of the VC fund

in this matter. However, we argue that as the marketing efforts move towards a more strategic

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nature with stage development, so does the VC fund investment managers involvement in the

effort, implying that the value-added effect should grow as the firm moves along its lifecycle.

In conclusion, we hypothesize that the effect of marketing value-add efforts will increase the

later the portfolio company stage, due to a transition from an operational marketing focus to a

strategic marketing focus. Thus:

H5: There is a positive effect of stage on marketing value-add

2.6.6 TECHNOLOGICAL VALUE-ADD

A commonly applied basis for innovation is the establishment and protection of new technology.

Innovative solutions are a frequently associated with startups and Venture Capital, and a series of

studies find Venture Capital to spur innovation in portfolio companies (e.g. Kortum and Lerner

1998; Popov and Roosenboom 2009). In line with these conclusions, Bertoni and Tykvov (2012)

find that VC funds actively promote their portfolio firms effort towards patenting, and by that

proxy spur innovation.

Meanwhile, this connection between innovation and Venture Capital is found to only weakly

exist in Engel and Keilbachs (2007) study of German startups. They explain this by the intensity

of innovation happening prior to VC investment, wherein a technological position is an ex-ante

condition for investment. This conclusion is supported by Caselli, Gatti, and Perrini (2009) who

find that VC funds do not significantly promote innovation, but rather the pursuit of greater

sales. It is thus important to recognize that VC funds contribution to innovation on a broad

level might be visible due to VC funds picking innovative firms ex-ante, while not focusing on it

ex-post, thereby lending to a conclusion that VC-backed firms are more innovative. This

coincides with the findings of Gabrielsson and Huse (2002), Ehrlich et al. (1994), and Macmillan,

Kulow, and Khoylian (1988) stating that building technical competence is perceived as being

relatively unimportant from both the VC funds and entrepreneurs perspectives.

VC funds furthermore add value to portfolio companies by leveraging their networks to establish

strategic alliances that foster inter-firm technological and R&D partnerships (Lindsey 2008). This

constitutes a value-added activity that exists outside of traditional mechanisms of transferring

value-add, in that it is external in nature. However, we do not perceive it as a significant category

of value-added activities, thus not particularly moderating the otherwise low importance

evidenced in the literature.

Due to the low importance associated with technological value-added activities, along with the

general perception in the literature that VC funds generally select innovative companies rather

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than building them, we hypothesize that the effect of technological value-added activities will be

more prominent in the earlier stages.

H6: There is a negative effect of stage on technological value-add

2.6.7 INTERNATIONALIZATION VALUE-ADD

Internationalization value-add represents the VC funds efforts to enhance the international

aspects of the portfolio company. It represents the knowledge, abilities, and resources of the VC

fund that are international in nature, which are transferred to the portfolio company. High-tech

startups aim to internationalize because it represents an ability to scale up, leveraging costs

already incurred, thus increasing profitability (Qian and Li 2003). Smolarski and Kut (2011) also

find internationalization to be associated with the VC fund post-investment phase behavior with

their investments and to be positively associated with performance. They conclude that

syndication and monitoring both positively influence internationalization and performance when

taken as separate effects, but that they moderate each other. This lends to the idea that VCs can

influence the internationalization of their portfolio firms, and that it is in the firms interest.

Fernhaber and Mcdougall-Covin (2009) also investigate this concept of internationalization of

new ventures from the premise of the resource-based view. In their framework the VC funds

transfer both their international knowledge and reputation and these two factors interaction

terms. They furthermore find empirical and statistically significant positive relationships between

knowledge and reputation of the VC fund, new venture internationalization, and their interaction

effect. This implies that VC funds to some extent drive their portfolio companies abroad. One

method through which this might occur is attracting customers from international markets. In

this regard, Maula, Autio, and Murray (2005) find that internationalization efforts based on the

VC funds ability to help the portfolio firm attract foreign customers exists, but ranks relatively

low in importance. This conclusion can probably be ascribed to not all respondents having or

intending to have international operations, which nonetheless means that the average importance

will be low.

In Lockett et al.s (2008) study, they find that VC-backed firms internationalization is

significantly related to the VCs value-add contributions as measured along similar methods as

Macmillan, Kulow, and Khoylian (1988). Although not specifically measuring internationalization

value-added activities, but rather value-added activities broadly, the results imply that the effect

of the VC funds efforts still significantly influences the portfolio companies internationalization

process. Furthermore, Lockett et al. (2008) concludes that, based on the premise of resource

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availability, pre-seed and seed-stage portfolio companies have significantly higher benefits from

VC fund value-add with respect to internationalization.

We therefore hypothesize that the effect of international value-add of a VC fund will be higher

in the earlier stages due to lower resource availability:

H7: There is a negative effect of stage on internationalization value-add

2.6.8 EXIT ORIENTATION VALUE-ADD

Exit orientation value-add consists of the VC funds ability to secure an exit opportunity for their

investment, potentially generating returns to both VC fund and portfolio company owners.

These exit opportunities consist of IPOs, company buybacks, trade-sales, liquidation, secondary

sales, and reorganization, where an IPO usually is the most desirable outcome from a return and

reputational perspective (Wang and Sim 2001).

Achieving a desirable outcome is specifically strived towards from relatively early on, becoming

an integrated part of the advice that the VC fund provides to its portfolio company. Isaksson

(2006) found agreement across his sample of Swedish VC-backed firms that it was common to

head towards a desirable exit as part of the strategic orientation of the portfolio firm. However,

the intensity of exit-directed activities depends on whether or not an exit strategy is planned

from the outset of the VC fund-startup relationship, and whether the type of VC exit is planned

as well. Isaksson (2006) finds strong empirical support that exit strategy is a value-added activity

particularly for IPOs and trade-sales as exit orientations.

While both parties are interested in an exit eventually, the means to get there and the timing of

the exit is a particularly frequent type of VC fund-startup conflict (Zacharakis, Erikson, and

George 2010; DeTienne and Cardon 2010). These conflicts can moderate the effect of the VC

funds with respect to exit orientation.

By their very nature, exits still constitute a critical phase of the VC fund-startup relationship,

particularly for funds engaged in stages where such exits are likely (Petty, Bygrave, and Shulman

1994). Thus positive outcomes, in line with Wang and Sims (2001) characterization, are more

frequent for companies in later stages (Giot and Schwienbacher 2007). This indicates that exit

orientation value-add is likely to increase in importance as the portfolio company moves towards

the later stages, which in turn increases the likelihood of an exit.

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Therefore, we hypothesize that the effect of exit orientation value-add will increase the later the

stage a portfolio company is in due to the increased likelihood of exit and the prospects of

sizeable returns to the entrepreneur:

H8: There is a positive effect of stage on exit value-add

Through the distinction between eight types of value-add; strategic, financial, credibility,

professionalization, marketing, technological, international and exit orientation value-add activities, we have

established a set of hypotheses regarding the relative importance of the given value-add activity,

and its relation to the stage of the firm.

2.6.9 FUND STAGE SPECIALIZATION

Finally, referring to the previously reviewed literature on VC fund stage specialization and life-

cycle theory, we argue that funds are interested in focusing their skillsets to be able to cope with

the specific needs of their portfolio companies. We therefore theorize that when the value-added

activities effect depends on stage, including the VC funds will remove this effect. This in turn

means that, with regards to value-added activities for a given stage, that funds are specialized to a

certain degree. We therefore hypothesize:

H9: Given a significant effect of stage, the effect of individual funds removes the significance of

stage

This concludes our literature review. We have positioned this paper in the literature base by

reviewing the financial intermediary perspective in relation to the value-added perspective that

this paper applies. We furthermore highlighted how value-added activities transfer knowledge to

the portfolio companies. We then characterized the fund level determinants of knowledge

transfer, further reviewing the literature with respect to how VC fund specialization relates to

these value-added activities. We then finally conducted an extensive review of the literature

regarding specific value-added activities to create a foundation for our hypotheses formation. We

hypothesize that portfolio company stage has varying effects on each of the eight types of value-

add and that VC funds specialize within these value-added activities when they depend on the

company stage. In the following section we depict our approach to investigating hypotheses,

thus explaining the methodology we apply to establish a solid foundation for our analysis.

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3. METHODOLOGY

This thesis utilizes a survey-based research design to collect primary data measuring the portfolio

companies perceptions of the effect of value-added activities by their VC funds. This displays a

methodological congruence with previous studies on value-added activities (e.g. Maula, Autio,

and Murray 2005; Gabrielsson and Huse 2002; Ehrlich et al. 1994). We imposed a limitation of

scope in restricting our focus to VC funds with a physical presence in Denmark. This was

chosen because of the situational characteristics of a bachelor thesis.

In the section below, we will elaborate on the methods used to determine the effect of stage on

VC funds perceived contribution to their portfolio companies. First we provide a brief overview

of the selection of our sample of all current ICT and Life Science portfolio companies in

Danish-based Venture Capital funds. This will be followed by the construction of our survey on

entrepreneurs perception of VC funds contribution of value-added activities based on selected

questions from a validated survey. Thereafter we discuss how the data was collected via an

internet-based survey and corrected for use in our analysis. Following this will be an elaboration

of the principal component analysis, which groups the individual questions on perceived value-

added activities within factors. This is then followed by a characterisation of our applied

Ordinary Least-Squares regression analysis, which models these perceptions against

characteristics of the company and its founders to predict whether there is a significant

difference between seed and early-stage ventures. The final section within methodology will

elaborate on the model which, for those value-added activities which do differ between stage,

assesses the specialization of funds by re-running the model including individual fund dummy

variables and seeing whether the effect of stage is picked up by the fund dummies.

3.1 SAMPLE SELECTION

We define our population as all portfolio company investments from Danish Venture Capital

funds. To test our hypotheses of whether VC funds value-added activities depend on company

stage, we test statistics of a sample from the population. This following section will elaborate on

the selection of our sample.

The limited, dispersed, and highly private nature of the Venture Capital industry argues for the

use of professional informants as they have privileged insights and hold archetypical portrayals

of the industrys characteristics (Lee 1993). Considerable effort was used to complement our

knowledge of Danish Venture Capital funds with those of a variety of professionals. We initially

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conducted open-ended stakeholder interviews1 in the Danish Venture Capital market. This was

followed by five 45-minute semi-structured interviews with investment managers in the largest

funds2 (Corfitzen 2013, F. Knudsen 2013, J. Knudsen 2013, Roested 2013, Wylonis 2013). This

led us to conduct a cluster sampling of portfolio companies based on their geography, type of

VC fund, and industry focus (Barnett 1991).

3.1.1 GEOGRAPHY

The geographical restriction focused on portfolio companies who have received investments

from Venture Capital institutions with a physical presence in Denmark. The Danish market has

portfolio companies receiving Venture Capital from foreign funds, but this assignment is limited

to the transfer of value-added competencies from Danish funds. This is not equivalent to a

national focus, however, as portfolio companies are not subject to geographical limitations. Our

sample includes firms based in the USA, Germany, Switzerland, United Kingdom, Finland,

Hungary, Norway, and Sweden, as well as Denmark.

3.1.2 INSTITUTION TYPE

The Danish Venture Capital and Private Equity Association (DVCA) is a national trade

association, with over 200 members throughout the Venture Capital chain, from business angel

to private equity fund (DVCA 2013). They categorize 18 of their members as Venture Capital

funds, ranging across all industries. Of these, four are pure innovation incubators, two are

corporate venture funds, one is an innovation branch of a university, and 11 are Venture Capital

funds backed by either public or private investors. This thesis includes innovation incubators in

its sample due to their centrality and strong presence, while disregarding the corporate venture

funds and the university branch. While these institutions might be important actors in the

Danish Venture Capital environment, notably Novo Fonden, which is the largest Life Science

Venture Capital fund in the world, they operate quite differently as evergreen funds and are

subject to different management regulations and structure of investments.

Based on interviews (J. Knudsen 2013; Corfitzen 2013; Wylonis 2013; Appendix I), this thesis

also includes the remaining two innovation incubators, the Swedish VC fund Creandum which

invests in Denmark and is particularly prominent in the entrepreneurial environment, as well the

dual accelerator and investment program Accelerace. Although Accelerace is different compared

1 Interviews were conducted with Vkstfonden, Erhvervs- og Vkstministeriet, Innovation incubator DTU Symbion, Professors of Entrepreneurship and Venturing, Venture Capital funds, individual investors, Business Angels, startup accelerators, and entrepreneurs. 2 Sunstone Life Science, SEED Capital, VF Ventures, Creandum, Accelerace

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to a VC fund, our interviews revealed it to be a significant institution in the Danish market for

Venture Capital3. Its inclusion is warranted by a similar structure to other funds, such as limited

time frame, competency transfer, and Limited Partner pressure (unlike, say, corporate funds).

3.1.3 INDUSTRY

This thesis uses the industry definitions used by the Danish governmental investment fund:

Vkstfonden. It classifies its investments within five areas: Information and Communication

Technology (ICT), Trade and Services, Industrials, Life Science, and Energy. This thesis selects

both Life Science and ICT as these two industries represented 83% of all venture investments in

Denmark in 2011 (Appendix II). Furthermore, two industries were selected to avoid an industry

bias and to ensure the differing competencies and characteristics of the two industries would be

represented. Including both industries would also increase the likelihood of observing both large

and small investments, as the size of an investment varies tremendously across these industries.

All other industries were excluded to avoid small samples, since very few investments have been

made in the past and will be made in the future in other areas (J. Knudsen 2013, Roested 2013).

This in turn meant that specialized venture funds in other areas, such as Insero and NES

Partners who focus on energy, were excluded from our sample.

We thus have in our sample every major Life Science or ICT-focused Danish Venture Capital

institutions in the Danish market. To make sure we had not missed an important institution, our

list was confirmed through interviews with five investment managers from varying funds and

with an employee at DVCA. An overview is visible in Table 1 (below).

3 For the remainder of this thesis, Accelerace will be considered interchangeably as a fund.

TABLE 1: OVERVIEW OF FUNDS PRESENT IN OUR SAMPLE

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The funds respective current industry focus was found through their websites with all

companies not in Life Science and ICT excluded from the sample (Company Websites 20134). If

the specialization was unclear, the portfolio company was initially included in the sample. In total,

our sample includes 246 portfolio companies.

Our sample is based on portfolio companies perception of the value-added activities from their

funds, which implies one survey for each VC fund-portfolio company relationship. Certain

individual portfolio companies were therefore represented twice in our sample, due to

syndication and previous funding rounds. Our total sample constitutes 310 portfolio company

investments within 246 portfolio companies from 14 ICT- or Life Science-focused VC funds.

3.1.4 SAMPLING ERROR

Although we attempt to randomize our selection of observations, we suffer from several

potential sampling errors. This section will elaborate on the three main sources of error:

survivorship bias, self-selection bias, and industry bias.

Survivorship bias indicates that while we are interested in all portfolio company investments

from Danish Venture Capital funds, our sample is biased towards portfolio companies currently

active. We thus have no chance of observing a company that is inactive in our sample, although

we would ideally like to have the views of every company the fund has invested in. This is a

significant limitation, but the uncertainty and inability to obtain contact information of all failed

ventures means that this bias is inherently part of any survey assessing portfolio companies.

Self-selection bias implies that we only obtain observations from individuals who volunteer to

complete our survey. Respondents that are highly opinionated are more likely to respond to

express this opinion. We argue that the prompts that govern the respondents opinionated nature

will direct the answers in both directions, thus not exhibiting systematic error qualities. This

error may however influence our regressions through an increased variance.

This bias can sometimes be compensated for by using a Heckman selection model, but this

requires that we are aware of a missing observation. This method is often used in longitudinal

studies or time series, where a specific observation has reported answers some years, but not

4 (Accelerace 2013; CAT Science 2013; Creandum 2013; DTU Symbion Innovation 2013; Innovation Midtvest 2013; Northcap Partners 2013; Northzone Ventures 2013; NOVI Innovation 2013; SEED Capital 2013; Sunstone Capital 2013; Syddansk

Teknologisk Innovation 2013; VIA Venture Partners 2013; Vkstfonden 2013; stjysk Innovation 2013)

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others. However, as we at no point have an observation of the self-selecting funds, such

methods have no corrective effect on our sampling.

3.2 SURVEY CONSTRUCTION

Our survey is constructed around two overarching areas of focus. One section consists of the

questions regarding the effect of value-added contributions by the VC fund from the perspective

of the portfolio company which will be used as dependent variables in the regression. The other

section consists of questions regarding the characteristics of the firm, the founders, and the deal,

which will be used as independent variables.

In the first part we chose to apply validated questions rather than constructing tailored questions,

which would potentially be prone to non-sampling error. Hence, we selected questions from the

VICO project5. This survey was chosen based on a) a high degree of observable validity, and b)

content validity in which the survey questions matched the value-added activities we wished to

investigate.

With regards to validity, the VICO survey is significant and reliable. First and foremost, it has

been applied on a large scale, having more than 8000 respondents across seven European

countries. This sample size is the largest in the literature on value-added activities to the authors

knowledge. Second, the survey was constructed by researchers with more than 45 prior and

relevant studies in the field of entrepreneurship (VICO Project 2013). Third, the survey

questions have been used multiple times in peer-reviewed research (e.g. Bertoni, F., Croce, A.

and A. Quas 2010; Bertoni, F. and T. Tykvov 2011; Luukkonen, T., Deschryvere, M., Bertoni, F.

and T. Nikulainen 2011). Finally, the survey instrument is congruent with previous

methodologies (e.g. Ehrlich et al 1994; Macmillan et al 1988) with respect to the format of the

questions, in that it utilizes a seven-point Likert scale for the importance of the respective value-

added activities. With respect to content validity, the VICO project survey contained a total of 28

questions regarding value-added activities within similar categories as our

Value-Added Activities in Venture Capital and the Effects of Stage- An Empirical Study

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