The Venture Capital Deformation (eBook)

Darek Klonowski is Professor of Business Administration at Brandon University, Canada. Prior to joining academia, he worked in the venture capital and private equity industry. He has published three books with Palgrave Macmillan: The Venture Capital Investment Process (2010), Private Equity in Poland (2011), and Private Equity in Emerging Markets (2012).

Dedication 5
Preface 6
The Structure of the Book 7
The Book’s Unique Perspectives and Features 8
Acknowledgments 10
Contents 11
List of Figures 13
List of Tables 15
List of Boxes 16
Part I: Introduction to Venture Capital 17
Chapter 1: Venture Capital: A Closer Look Behind the Curtain 18
Venture Capital: Definitions, Characteristics, and Forms 18
Venture Capital and Other Modes of Entrepreneurial Finance 23
Perspectives on Venture Capital: Advantages and Disadvantages 26
Advantages of Venture Capital for LPs and Entrepreneurs 29
LPs’ Perspectives on Venture Capital 30
Entrepreneurial Perspectives on Venture Capital 31
Disadvantages of Venture Capital 37
Disadvantages for LPs 38
Disadvantages for Entrepreneurs 39
Illuminating the J-Curve in Venture Capital Investing 40
The “n”-Curve in the Venture Capital Industry 42
The Venture Capital Investment Process 43
Bibliography 46
Chapter 2: Maturation, Segmentation, and Competition in the Venture Capital Industry 48
The Maturation of the Venture Capital Industry 48
Venture Capital in the United States 58
The Dual-Segment Structure of the Venture Capital Industry 61
Overview of Industry Analysis 61
An Industrial Analysis of the Venture Capital Industry 63
The Investee Firms Market Sub-segment 65
The LP Market Sub-segment 68
Interactions Between the Two Market Sub-Segments 72
Bibliography 77
Part II: Venture Capital Deformations Throughout the Investment Process 79
Chapter 3: Fund Formation: Structural and Operational Deformations in Venture Capital 80
Structure and Operations of Venture Capital Funds 81
Corporate Governance and Agency Issues in Venture Capital 85
Information Disclosure by Venture Capital Firms 92
Legal Documentation in the Venture Capital Structure 94
Compensation in Venture Capital 96
Components of Venture Capital Compensation 100
The Distortion of LP Behaviors 112
The Ultimate Decision Makers in Venture Capital: The Investment Committee 113
Weaknesses in the Operations of Investment Committees 115
Human Resource Management in Venture Capital Firms 118
Team Composition 118
Turnover 121
Succession 124
Bibliography 126
Chapter 4: Deal Generation: Optimal Modes of Entrepreneurial Value Creation 129
Entrepreneurs and Value Creation 131
Optimal Entrepreneurial Growth and Value Generation 133
Value Creation Patterns: “Natural” Versus “Accelerated” 138
“Natural” Value Growth Pattern: The Entrepreneurial Style 140
“Accelerated” Value Growth Pattern: The Venture Capital Preferred Mode 142
Consolidating “Natural” and “Accelerated” Modes of Value Creation 149
Value Creation and Value Recognition 151
Bibliography 154
Chapter 5: Screening and Evaluation: Misguided Investigation of Entrepreneurial Firms 156
Venture Capital Investigation of Entrepreneurial Firms 156
Venture Capital Decision Making 160
Cognitive Biases in Venture Capital Decision Making 164
Commercial Attractiveness of Entrepreneurial Firms 167
Management 169
Market 172
Meaning 174
Merchandise 177
Market Share 178
Mode of Operations or Business Model 179
Margins and Money Management 180
Conclusions on Venture Capitalists’ Commercial Analysis 181
Venture Capitalists’ Rejected Deals 182
External Due Diligence 183
The Costs and Benefits of External Due Diligence 188
Bibliography 190
Chapter 6: Deal Completion: Inequitable Agreements in Venture Capital Contracting 194
Agency Considerations 196
Asymmetric Information 198
Moral Hazard and Adverse Selection in Venture Capital 199
Moral Hazard 200
Adverse Selection 202
Financial Contracting in Venture Capital 207
Deal Pricing 208
Security Type and Design 215
Rights and Provisions in Venture Capital Deals 217
Bibliography 230
Chapter 7: Monitoring: The Venture Capital Barren Toolbox for Entrepreneurial Firms 231
Understanding Venture Capital Beyond  Its Cash Contribution 235
Profiles of Venture Capitalists and the Futility of Their Hands-on Involvement 237
The Venture Capital “Professionalization” Toolbox 246
Entrepreneurial Professionalization Versus Corporatization 256
Venture Capital and Innovation: Breaking the Myth 258
Conflicts Between Venture Capitalists and Entrepreneurs 262
Bibliography 265
Chapter 8: Exiting: Distressed Value Realization in Venture Capital 268
Modes of Venture Capital Value Realizations 269
Venture Capitalists’ Adverse Behavioral Patterns in Exits 274
The European Experience in Venture Capital Exits 279
Bibliography 281
Part III: Conclusions: The Venture Capital Industry at the Crossroads 283
Chapter 9: Venture Capital: “Subprime” Returns and the Value Chain Analysis 284
Venture Capital’s “Subprime” Financial Performance 284
Quantitative Measures of Venture Capital Performance 288
Databases of Venture Capital Performance 293
Venture Capital Returns from the United States 296
Financial Returns from Buyout Deals 301
The Value-Chain Analysis of Venture Capital Performance 305
Bibliography 313
Chapter 10: Improving the Substandard Venture Capital Model 317
What Business Is a Venture Capitalist Really In? 317
LPs’ Tolerance of “Subprime” (and Declining) Returns from Venture Capital 319
Adjustments to the Venture Capital Industry 322
“Right-Allocating” Capital to the Venture Capital Industry 323
Improving Human Resources in Venture Capital 325
Venture Capital Decision Making 327
Fund Selection by LPs 327
The Pursuit of Superior Venture Capital Experience by Entrepreneurs 328
Bibliography 330
Index 331