Criteria distinguishing successful from unsuccessful ventures in the venture screening process

Abstract

Venture Capitalists responded to a questionnaire in which they rated a highly successful and a highly unsuccessful venture on 25 screening criteria and on several performance criteria. In all, 150 ventures were rated by 67 venture capital firms. Cluster analysis revealed three broad classes of unsuccessful ventures. The first type is the bane of all venture capitalists—the venture in which the venture team is lacking in experience or staying power, the product has no prototype, and there is no clear market demand for the product, yet the venture somehow slips through the screens and gets funded. The second type is one in which the venture team is very well credentialed, but the venture faces early competition and the team has no staying power and runs out of steam. The third major class of venture is one in which the team has exceptional staying power, so much so that by perserverance it demonstrates that a market exists, only to lose that market to competition because of a lack of protection for the product. Cluster analysis also showed that there are four broad classes of successful ventures. First is the high-tech venture with a well-qualified venture team that has the staying power needed to face competitive attack. Second is the class of venture where the venture team does not have much in the way of credentials, but the product has a very high level of protection and turns out to be highly successful. Third is a class of “market makers”—a venture team with exceptional perseverance that demonstrates that there is in fact a market for the product, but also has some form of product protection once that market has been demonstrated. It can be seen that each of these classes of successes has a look-alike class of failures that is very similar except for some flaw in the venture team. A final class of successful venture is a small group of low-tech products in which distribution skills are critical. We suspect that these ventures tend to be for consumer goods. An important finding is the identification of two major criteria that are predictors of venture success. These are 1) the extent to which the venture is initially insulated from competition and 2) the degree to which there is demonstrated market acceptance of the product. Regression analyses indicate that only these two screening criteria correlate pervasively across several performance criteria. Interestingly, neither of these criteria were rated as essential in an earlier study. Much more importance needs to be attached to these criteria in screening venture proposals. The final analysis was a factor analysis, which indicates that the 150 ventures were screened according to five major classes of criteria, each class corresponding to some facet of risk management of the venture. These were as follows: 1. Criteria that screen out ventures where there is a risk of failure due to unqualified management; 2. Criteria that screen out management that may well be qualified but lack experience; 3. Criteria that screen out ventures where basic viability of the project is in doubt; 4. Criteria that screen out ventures where there is high exposure to competitive attack and profit erosion before the investment can be recouped; 5. Finally, criteria that avoid ventures that lock up the investment so that it cannot be cashed out for long periods of time.