Wharton | San Francisco Survey Looks at Future of the Investor-Startup Ecosystem

When it comes to entrepreneurship, many Wharton faculty are world-renowned thought leaders. A recent Knowledge@Wharton article featured their take on a survey of alumni in the San Francisco area about the future of the investor-startup ecosystem. Here’s an edited excerpt of that article:

These days, technology start-ups want more than just a check from venture capital backers and other investors. They are increasingly looking for operational help and industry expertise as well, a recent survey of Wharton alumni in the San Francisco area shows.

In a marked departure from the dot-com era of the 1990s, these companies also put more value on market know-how and connections over snagging a high valuation or a venture capitalist with a marquee name, according to a November 2013 survey of 126 mostly senior tech executives or managers who work at young companies.

Such a shift in the trend is a result of venture capitalists also raising the bar on their investment criteria. No longer are VC firms content to just take a stake in a company in a hot industry with growing market share, at least for startups beyond the seed stage of investment. Now investors are also insisting on start-ups having a business model with a path to profitability.

“Investors are no longer just blindly supporting a company, and startups are no longer just doing well by virtue of being in a hot new market space,” says Saikat Chaudhuri, Wharton adjunct associate professor of management and executive director of the Mack Institute for Innovation Management, who helped craft the survey questions. “Companies really are expected to think about profitability.”

As investors ask for proof of sustainability, startups in turn want backers to help them grow instead of just writing a check. The explosion of incubators and accelerators like Y-Combinator, 500 Startups, RocketSpace, Rock Health, Plug and Play and others is in large part attributable to this need. Even many institutional VC firms, such as Andreessen Horowitz, Kleiner Perkins, and Sequoia, are selling more than money. “Other things like the operational metrics, recruiting capability, marketing and industry expertise and connections, these things have become hugely important,” says Chaudhuri.

In the survey, 32% of respondents said they chose backers based on industry expertise and connections. It was the second most popular answer — topped only by the level of capital required — at 35%. Other factors included the strategic and commercial benefits brought by the investor, speed of the investment decision and personal chemistry.

Raffi Amit

Wharton management professor Raffi Amit says the VC industry already is going through a “seismic” change. “The industry is contracting,” he states, noting that there were 1,000 VC firms in 2000, but now only 300 remain active. But while the number of VCs has declined, the overall investment pot for start-ups is larger because the number of alternative sources for funding — including “super angels,” incubators and crowd-funding platforms — has “exploded,” Amit adds.

Doug Collom

Wharton | San Francisco vice dean Doug Collom has a different view. “There is a well-known phenomenon occurring today in the industry call the ‘Series A crunch’ — and more recently, the ‘Series B crunch’ — that has resulted in part from a lot of institutional VCs spreading modest, seed-level amounts of money in early stage companies, with little or no diligence,” Collom says. “Then, when these startups burn through their seed capital and seek to step up to institutional levels of financing, i.e., in the range of $2 million to $5 million or more, the VC investor only at that time will take a more deliberate look to see if a follow-on financing at that level can be warranted. The number of companies that are failing because of the ‘crunch’ that occurs when the institutional VCs fail to make these follow-on investments is massive.”

Click here to read the full article in Knowledge@Wharton.

Click here to read the full report in the Wharton | San Francisco Review, Building Bridges to Innovation.