How do venture capitalists see their contribution as owners? Observations from VC accounts on value-added actions and governance

Abstract

Venture capital (VC) is a key source of financing for entrepreneurial firms with high risk profile that do not have access to traditional financing sources. In addition to providing funds, VCs conduct various value-added actions to maximize the value of their portfolio firms. VCs are known as active owners that often hold significant control over portfolio firms, diverging them from the premise of the principal-agent model, where the owner’s control over outcomes is limited.

As investors, VCs can be thought of as operating in value-added and control roles. Control role is based on contracts that VCs use to facilitate managerial intervention, whereas value-added role mostly stems from equity incentives. I interview Finland-based VCs and conduct a multiple case study to analyse how VCs ensure a return on their investment, and present general observations on how value-added role and control role are manifested in practice as seen by VCs.

I find evidence that Finland-based VCs support their portfolio firms especially in recruiting and legal matters, but more important value-added contribution comes from access to additional funding. The interviewees agree that contracts should serve as background frames for stakeholder alignment and that there should be no need to enforce them in practice. Instead, VCs promote reciprocal discussion in problem solving and recall that due to the experimental nature of ventures, formalities should be minimized. VCs help firms to develop their reporting so that they would be investable in subsequent financing events, but avoid creating unnecessary administrative burden. The team is where VCs eventually invest in, so they pay great attention to committing the key persons to stay with the firm and emphasize the importance of committing new hires as many venture firms have urgent recruiting needs as they build teams.

VCs are in business for profitable exits, which are typically their only source of return. My evidence from exit discussion suggests that even though standard contract terms are applied to prepare for exit situations, all firms make unique exit paths. Ultimately, the founding team holds remarkable power in the sale process because in many cases their skills is the firm’s most valuable asset.