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Value Creation in Venture Capital

Giuseppe Donvito, Partner of P101 Ventures | June 20th, 2018

Talent scouting and coaching, here’s how VC funds help companies and investors grow their assets

The subject of value creation of an asset class such as VC has become more and more important to the Italian system, which is growing fast. In our country, according to a study by PwC dedicated to the economic impact of private equity and venture capital, companies that have VC funds among their shareholders have seen employment accelerate by 5.2% between 2004 and 2014, when Italian companies in general were experiencing a decline by 0,3%. In the same decade, VC-backed companies also recorded much higher revenues than the benchmark (+6.8%).

These numbers suggest that the creation of value is not an “esoteric” concept: on the contrary, it refers to classical financial notions and is ultimately crystallized in exits. Having this general concept as a firm point in mind, there are several ways in which venture capital can generate value for investors and companies.

First of all, VC solves the classic problem of information asymmetry. Indeed, before investing in a company, venture capital funds use their deep vertical skills to perform very thorough due diligence, in order to reveal if a business is healthy. The ability of venture capital (and, consequently, value generation for investors) lies in identifying potential hidden information about start-ups (so-called “upsides”) that may or may not lay at the basis of a successful investment.

This is why sometimes investors can accept higher risk, which of course (because of what we said above) is linked to higher expected return.

In general, the market cannot analyze a start-up in such detail or monitor and control its management at the same level as a VC fund. This gives VC funds a competitive edge over other potential investors: they can invest in risky assets in very uncertain markets, since they are able to select the best companies, monitor them and promote their development effectively.

For all the above-listed reasons, venture capital funds can be seen as talent scouts. Besides, they play an equally decisive coaching role. Indeed, their skills don’t just lie within the field of selecting good investment opportunities (scouting), but also in helping young companies grow (coaching).

This means that VC skills are useful to both investors and invested companies. According to a study by MIT that was conducted in 2006 by Paul Gompers, who interviewed entrepreneurs from US companies that had been VC-backed between 1986 and 2000, support from the best VCs (those with more average experience) increases the chances of success for companies and creates the conditions for founders to become serial entrepreneurs.

How can a VC fund coach companies?

  • First of all, it acts as a proactive and non-invasive investor
  • In the pre-investment screening and due diligence processes, the fund identifies what can add value to the business by identifying, among other things, innovations and their chance of success
  • It has a fundamental role in contributing to a company’s internal organization, from the point of view of human resources and processes. VC-backed companies become more professionalised faster than other companies, both at the top and middle management levels.

 

In particular, if we look at the methodologies that are used by P101 VC fund, value creation starts from a very pragmatic hands-on approach. P101 contributes to the structuring of all internal, operational, financial, budgetary, fiscal and legal processes. It gives strategic counselling to companies’ boards, it looks for potential clients and partnerships with its own network and contributes to the development of strategic business agreements with key partners. Furthermore, P101 offers support in the case of M&A or exit processes, it plans financing rounds, it helps recruiting employees, consultants and specialists.

The ability of venture capital funds to create value over a medium-long period of time is also at the basis of one of the most interesting features of this asset class: decorrelation. Indeed, compared to more traditional asset classes such as equity or bonds, VC decorrelation is higher and makes it an indispensable part of a correct portfolio strategy.