The role of top management team human capital in venture capital markets: Evidence from first-time funds

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Abstract

This paper examines whether the human capital of first-time venture capital fund management teams can predict fund performance and finds that it can. I find that fund management teams with more task-specific human capital, as measured by more managers having past experience as venture capitalists and by more managers having past experience as executives at start-up companies, manage funds with greater fractions of portfolio company exits. I also find that fund management teams with more industry-specific human capital in strategy and management consulting and, to a lesser extent, engineering and non-venture finance manage funds with greater fractions of portfolio company exits. Perhaps counter-intuitively, I find that fund management teams that have more general human capital in business administration, as measured by more managers having MBAs, manage funds with lower fractions of portfolio company exits. Overall, measures of task- and industry-specific human capital are stronger predictors of fund performance than are measures of general human capital.

Section snippets

Executive summary

The rapid growth of venture capital as a source of financing for start-up companies and as a fraction of institutional investors’ portfolios has made gaining an understanding of the determinants of venture capital investment performance an important objective. Prior studies have made progress in documenting some general features of venture capital investment performance.1

Human capital theory, upper echelon theory and venture capital markets

Any hypothesis that investment manager human capital should predict investment performance implicitly invokes upper echelon theory (e.g., Hambrick and Mason, , 1984, Finkelstein and Hambrick , 1996) and the resource-based view of the firm (Barney, 1991, Peteraf, 1993). A fundamental premise of upper echelon theory is that top management teams matter for firm performance. In the case of a venture capital fund characteristics of the fund management team should be able to predict the performance

Data

I use two data sources in my analysis. First, I use the Thomson Financial/Venture Economics VentureXpert data set to identify venture capital funds, the portfolio companies in which they invest and the outcomes of those investments. The basic unit of observation in VentureXpert is a financing deal, or round. VentureXpert records the identities of the participating venture capital funds in each round as well as the portfolio company receiving the investment. The data set also records the

Empirical analysis and results

I now turn to the empirical tests of the hypotheses posited in Section 3. I regress the fraction of portfolio companies in which a fund invests that exit, my proxy for fund returns, on fund-level top management team human capital measures detailed in Section 3.2 and other fund-level and market-level controls detailed in Section 3.3 as in Eq. (1).FracExiti=b0+j=1nbjFraVCCharj,i+k=1mbkXk,i+h=1pbhZh,t+ei.

The subscript i indexes each fund in the sample; the subscript t indexes each fund-year in

Discussion and future research

The preceding analysis has documented that task-specific human capital, defined as human capital specific to the tasks of venture investing and of managing a start-up company, strongly predict better venture capital fund performance in the form of greater portfolio company exits and the ability to raise a follow-on fund. We also saw evidence that more human capital specific to the consulting industry in fund management teams predicts better fund performance. Likewise, industry-specific human

Conclusion

Supplementing data on first-time venture capital funds and their portfolio companies with data on the educational and work histories of the venture capitalists managing these funds, this paper investigated several hypotheses about the impact of task-specific, industry-specific and general human capital of top management teams on venture capital fund performance, as measured both by the fraction of a fund’s portfolio companies that exit via IPO or acquisition and by the ability of a fund

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    A previous version of this paper was circulated under the title “Do venture capitalists affect investment performance? Evidence from first-time funds”. I thank seminar participants at Carnegie Mellon, Duke, the first RICAFE2 conference at the London School of Economics, the 2007 American Finance Association Meetings and the 2007 Western Finance Association Meetings for their comments and Sridhar Arcot, Rudiger Fahlenbrach, Simon Gervais, David Hsu, Laura Lindsey, Manju Puri, David Robinson, Catherine Schrand. Dean Shepherd (the associate editor) and two anonymous referees for their suggestions. I thank Joseba Celaya, Adrian Cighi and Ling Luo for research assistance. All errors are mine.

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