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December 29, 2003

VCs and extra-financial value

It is part of the received wisdom that who you get money from is often more important than the terms of the financing. Top-tier VCs arguably provide the following items of "extra-financial" value:
* certification: especially for first-time entrepreneurs, affiliation with a big-name backer can confer a degree of credibility that is useful in dealing with customers and suppliers, recruiting employees and attracting follow-on investors.
* VC network: access to high-quality managerial talent, strategic alliances and partnerships, etc. (The "value-added" component often touted by VCs)
* Mentoring

Given these sources of extra-financial value that present ways for VCs to differentiate their "value-adds", it is reasonable to suspect that VCs who enjoy a higher reputation and are more plugged-in would be able to price deals at a discount with respect to their competition. Via Infectious Greed comes a link to this study which asks (and attempts to empirically address) the following two questions: "Is there a market for affiliation with reputable partners? If so, what are the prices for such affiliation?" In other words, given the sources of extra-financial value identified above, how much of a discount does a reputable VC command (in terms of price paid per share) compared to less-reputable investors? The analysis looks at 149 Series A deals of which 51 received multiple financing offers. Interestingly,

only 43% of the start-ups among those receiving multiple offers accepted their best financial offer. Moreover, the start-ups not accepting their most generous financial offer left a considerable amount of value “on the table,” amounting to $173.9M in aggregate pre-money valuation. This was calculated as the sum of the differences between their best financial offer and the accepted offer. For the group of multiple offer firms declining their best financial offer, the foregone pre-money value as a fraction of the accepted offer ranged from a low of 3.6% to a high of 217%, with an average of 33.2% for the sample.

The punchline of the analysis seems to be that "A financing offer from a high reputation VC is approximately three times more likely to be accepted by an entrepreneur. [Moreover], highly reputable VCs acquire start-up equity at a 10 to 14% discount."

Of course, there are a number of possible objections to the results obtained, many anticipated by the author: (1) sample size and selection biases, (2) measures of VC reputation, (3) use of the pre-money valuation as the sole measure of deal pricing (excluding other dimensions of the termsheet such as liquidation preferences, ratchets, warrants, etc.), etc. However, given the lack of transparency around deal terms and the offers received by startups, this work represents an interesting start.

Posted by Narasimha Chari at 10:08 PM in Economics, ventures | Permalink


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» Is a name worth 10-14% discount from Om Malik's Broadband Blog
Did you know that top venture capital firms with a certain reputation get a 10-to-14 percent discount when it come to making an investments in start-ups, according to this study. The evidence suggests that VCs’ “extra-financial” value... [Read More]

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