One of the most widely quoted distinguishing features of high-growth firms is that they often receive funding from venture capitalists (VCs). While this may be true, there is very little knowledge about companies that grow fast in the absence of VC-funding. A number of competing theories exist about these firms: some believe that they are very similar to VC-backed firms, while others suggest that they are fundamentally different. Three academics at MIT – Christian Catalini, Jorge Guzman, and Scott Stern – have developed an innovative three-step methodology to find out what high-growth firms are like in the absence of VC-funding to offer clarity on these firms and the potential benefits of encouraging VC activity as a means to economic development.
First, reverse-engineer the way VCs think.
The research began by analyzing companies that were backed by a VC, to identify what they had in common. Next, they reverse-engineered the VC selection process and developed a strategy to pick companies that would be eligible for VC-funding based on the founding team and the way they were set up, which they called “VC-likelihood.” Third, they matched every company funded by a VC to one that had VC-potential but did not end up being funded. This way, they were no longer comparing apples to oranges, but truly focused on 1. what benefits VC-support offers when isolated from the fact that VCs are good at picking winners, and 2. if high-growth firms are essentially all similar in some ways.
Non-VC-backed scaleups are strikingly similar to the ones with venture funding.
Catalini et al. conclude that, while there is a very large group of companies that achieve scale in the absence of venture capital, these companies are strikingly similar to those with venture funding. In fact, almost 50 percent of high-growth companies that never raise VC are nonetheless in the top 5 percent of their estimated VC likelihood. In other words, if a company managed to reach scale without VC-backing, there is a 50-50 likelihood that it was one of the most eligible candidates for VC funding based on the authors’ calculations.
VCs are good at startup support, but they are even better at picking winners.
The authors admit that these calculations are imperfect because of their inability to capture company characteristics that are not part of the due diligence screening process that investors use. But, based on the above, it seems that, the perceived contribution of VC-funding to startup growth may be overestimated, while the importance of their vetting and selection-process underestimated in the academic literature and general knowledge alike. Finally, it seems that there may be a single type of high-potential firm that is a lot more likely to grow fast based on its characteristics at the time of founding than other companies.
Contributed by Lili Torok.
To access the original article called Hidden In Plain Sight: Venture Growth with or without Venture Capital, please click here.