For the uninitiated, it can be easy to assume that venture capital firms select the startups they invest in in the same way stock market investors pick companies – by looking for a promising opportunity to grow their capital, based on historical trends, business plans, and other rational decision factors.
The truth is that venture capital investment is a lot more complicated than that.
The volume and quality of historical financial data available on most startups is sparse compared to the information a stock market investor would have when assessing a public company’s investment potential, because they are not governed by the financial reporting requirements that bind publicly listed companies, for instance.
Read more: The golden rules of venture capital funding
The earlier the stage of investment – Series A, Series B, or later – the more VCs will rely on intuition to make their investment choices.
The relationship between a VC firm and an investment target therefore takes on a much more human dimension. Both VCs and startup founders would do well to remember that, as they position themselves for investments, the quality of the startup’s management team will matter as much as, if not more than, the business itself or its product.
Face-to-face contact between VCs and startups is therefore vital at the formative stages of the relationship to make sure there is a good fit on both sides. In short, VCs find it easier to support a promising founder rather than a promising business idea because the person driving the business is viewed as more integral to success than the idea.
However, the face-to-face element of this relationship shouldn’t end with the close of a funding round. It’s just as important for the two teams to build their relationship as it is for the VC to support and add value to the growth of the startup.
Research we’ve undertaken proved there is a direct causal relationship between the face-to-face time spent between VCs and the startups in their portfolios and the portfolio companies’ likelihood of delivering innovation and success. Put simply: VCs do contribute to the successes of their investments, it isn’t just that they select companies destined to do well.
We found that the introduction of a new direct airline route between venture capitalists and their portfolio companies increases the opportunities for face-to-face interaction. In addition, we confirmed direct flights reduce the time and cost associated with supporting startups, which ultimately improved their performance.
Looking at the data for the companies that were affected by the airline flights, we confirmed the number of patents filed rose by 3 per cent, and the citations per patent rose by almost 6 per cent, indicating an increased quantity and quality of innovation. In addition, the probability of these startups completing an IPO rose by 1 per cent, and the likelihood of successful exit rose by 1.4 per cent.
By controlling the impact of “local shocks”, we confirmed that pre-existing trends were not driving these results and that VCs really are adding value to their investments.
Even as technology continues to reduce the distances between VCs and their portfolio companies, albeit virtually, the value-boost delivered by increasing face-to-face contact shows no discernible sign of diminishing.
The research we conducted was in the US, where the distances involved are obviously much greater than in the UK – hence us looking at the availability of direct flights as a proxy for ease of access to portfolio companies.
But the same issues exist in the UK, albeit on a smaller scale. As various initiatives aim to support the development of UK technology clusters outside of London, my research suggests that improving transport infrastructure to enable VCs and portfolio companies to more easily meet should be a high priority.