WHATDO VENTURE CAPITALISTS DO? MICHAEL GORMAN McKinsey & Company WILLIAM A. SAHLMAN Harvard Business School Thispaperpresents the results derivedfrom 49 responses to a questionnaire EXECUTIVE mailed to 100 venture capitalists in late 1984. The purpose of the survey SUMMARY was to shed light on the relationship between venture capitalists and their portfolio companies. The survey revealed that the venture capitalists who responded spend about half their time monitoring nine portfolio invest- ments of these, five are companies on whose boards they sit. For the latter group, a venture capitalist typically devotes 80 hours of on-site time and 30 hours of phone time per year in direct contact with each company. The most frequently performed service for portfolio com- panies is to help raise additional funds, with strategic analysis and management recruiting also mentioned as important roles. Finally, the venture capitalists in the survey had replaced an average of three CE0s during their careers weak senior management was considered to be the dominant cause of venture failure. INTRODIJCTION Over the past five years, there has been an explosion in the level of activity in the venture capital market. In 1984, in excess of $4.5 billion of new capital was committed to the industry, an amount over six times greater than the amount committed in 1980. Over the same period, approximately 148 new venture capital partnerships were formed, while 303 new funds were created by existing venture capital firms. The perceived importance of venture capital in economic growth has grown at a rate at least as high (if not higher) than Address correspondence to Dr. William A. Sahlman, Harvard University, Graduate School of Business Administration, Baker 436, Soldier���s Field, Boston, MA 02163. This article has benefited from the comments of two anonymous referees. Journal of Business Venturing 4, 231-248 Q 1989 Elsevier Science Publishing Co., Inc., 655 Avenue of the Americas, New York. NY 10010 231

232 M. GORMAN AND W.A. SAHLMAN the rate of growth of invested capital. The role of venture capital in the formation and nurturing of companies like Genentech, Apple Computer, Tandem, Lotus Development, Federal Express, and People Express has attracted the attention of academics, investors, and public policymakers. In this context, it seems particularly important to try to understand the process of venture capital investing. Phrased more directly, What do venture capitalists do?��� To begin to answer this question, we developed a questionnaire that was distributed to a group of venture capitalists in December of 1984. A primary goal of the questionnaire was to shed light on the relationship between the venture capitalists and their portfolio companies. Among the general areas covered by the questionnaire were: l How much time do venture capitalists spend with their portfolio companies, and how is that time distributed? l What roles do venture capitalists play in their portfolio companies? l What happens to the relationship between venture capitalist and portfolio company during periods of adversity? This paper is divided into five sections. In the first section (The Survey), the meth- odology is presented and the characteristics of the survey sample are summarized. The second section (The Venture Capital Investment Process) explores the survey results as related to achieving a general understanding of the venture capital business. The third section (The Venture Capitalist/Portfolio Company Relationship) addresses the principal questions motivating this study. The composition of venture capital portfolios, the allocation of each venture capitalist���s time across all activities and among portfolio companies, and the nature of their contributions are each considered in turn. In the fourth section (Coping with Troubled Investments), we examine the role of venture capitalists during periods when the companies in which they invest fall on hard times. The paper concludes with a summary. THE SURVEY During the first week of December 1984, a three-page survey was distributed to approximately 100 venture capitalists. A statistical summary of the survey questions and responses can be found in Appendix 1. Mr. Nissan Boury of E.M. Warburg, Pincus & Co., Inc., a venture capital firm in New York City, was extremely helpful during the preparation of the survey, as were Messrs. Chris Brody, Andy Gaspar, and Jeffrey Harris, also of Warburg, Pincus, as well as Ms. Denise O���Leary of Menlo Ventures. We received 49 responses to the survey. The respondents represented firms that manage in aggregate $5.6 billion of venture capital or roughly 40% of the estimated industry re- sources.* In an industry in which there are many relatively new entrants, respondents were drawn principally from firms that are well established. The mean age of the firms in the sample was 12 years, with the oldest firm claiming 38 years of operation and only three firms less than three years old. Among the respondents themselves, the typical individual had seven years of venture capital experience, with a high of 22 years. Few individuals ���There are a number of useful references on venture capitalists and their role in venture firms. Particularly relevant are Kozmetsky and Smiler (1985). Pratt (1987), Silver (1985), Robinson (1987), Sahlman and Soussou (1985), Sahlman (1986), and Wilson (1985). *Virtually all of the aggregate data on the venture capital industry are drawn from various publications of Venture Economics in Wellesley Hills, Massachusetts. Some of the data are summarized in Appendix 2.

WHAT DO VENTURE CAPITALISTS DO? 233 TABLE 1 Mean Median Std. Dev. High LOW Fi capital under management (S millions) Age of firm (years) Respondent���s experience (years) $147.5 125.0 $112.5 $600.0 $5.0 13.9 13.0 11.6 38.0 1.5 1.4 5.0 5.4 22.0 1.0 from firms with less than $60 million under management were surveyed, even though firms of this size represent a significant share of all venture firms. Only eight of the responding firms were founded in the past four years, a time when venture fund formation was occurring at an unprecedented rate. The sample statistics are summarized in Table 1. Although the respondents worked with generally well-established venture capital firms, many of the respondents had more limited experience than the age of their associated firms might lead one to expect. The majority of those responding, 31 individuals, claimed less than six years of venture capital investing experience. This proportion is approximately the same as that for the overall industry. Indeed, the proportion of individual respondents with more than nine years of experience (18 of 49) is probably higher than the industry norm. Also, venture capital is for the most part a nonhierarchically organized profession: most of the respondents with less than six years��� experience nonetheless entered the business as partners or at most served brief apprenticeships. It is important to note, however, that many of the respondents have been industry participants only during relatively good times for the industry. Moreover, as will be stressed later, the responses to any survey reflect the environment at the time of the survey 1984 was a year of considerable pressure in the industry, given the collapse in high technology stock prices and the decline in new capital being committed to the industry. THE VENTURE CAPITAL INVESTMENT PROCESS The survey yielded interesting information about the investment behavior of venture capi- talists and venture capital firms. For instance, almost all venture capitalists reported an investment horizon fixed at between five and seven years. One venture capitalist claimed a ten year expected term of investment, several cited four years, and the remainder fell in the five- to seven-year category. By contrast, wide variations appeared in the reported rate of new investment. New investments per year per firm ranged from a high of 30 to a low of 4, with a mean of 11.2 new investments per year (standard deviation, 5.6). Furthermore, the rate of new investments was not strongly correlated with firm size. The survey indicates that small venture firms, despite their size, often make substantial numbers of new investments per year relative to medium-size firms, whereas many large firms make surprisingly few investments. The :survey calls into question an allegation against venture capitalists commonly found in the press that they farm out their work to junior associates. When asked to specify the ���number [and function] of individuals currently responsible for monitoring portfolio in- vestments,��� 20% reported that none of their ���associate-level��� individuals were acting in this capacity. The remainder commonly reported that one or two of the firm���s associates dis-