In the last few years, the bull market has made huge amounts of money available for investment. Venture capital is no exception; venture capitalists have continued to pump more cash than ever into startups. But how much money they invest has become a bit controversial. Some industry watchers fear that so much money is flowing through venture capital firms that they are becoming too institutionalized, which could erode their unique role as hands-on incubators of tomorrow's most innovative companies.

Two Business School faculty members have recently offered evidence of venture capital's singular part in nourishing new firms. Their findings serve as an indirect warning that venture capital's special purpose should be preserved. Thomas Hellmann, assistant professor of strategic management, and Manju Puri, assistant professor of finance, believe they are the first to use hard data to investigate the relationship between the type of investor (venture capital rather than banks or others) and the speed with which startups get their products to market. They drew their data from the Stanford Project on Emerging Companies, an ongoing Business School study that has compiled figures on hundreds of young companies in Silicon Valley.

First, Hellmann and Puri looked at the types of firms that receive venture capital funding. They found that firms pursuing an innovator strategy (defined as companies aiming to be first in their markets) are more likely to get venture capital financing and are quicker to do so than those pursuing an imitator strategy (those with a product that has existing competition).

Second, they wanted to determine if the extra value venture capitalists reputedly bring to a deal really makes a difference. For this they looked at operational milestones, because financial landmarks, such as how early a firm holds a public offering, may be affected by other factors. In particular, they looked at what is widely perceived to be a critical turning point in the development of new businesses--the time it takes a company to get its product to market. They found that among all innovator companies, those with venture capital financing were faster to market. Specifically, statistical analysis showed that venture-backed companies were three times more likely to get to market in any given time period than those with other sources of financing.

Perhaps their most interesting finding is that among imitator companies, the presence of a venture capitalist did not speed up time to market. "It is for innovators that time to market is particularly important," says Hellmann. "You are betting on the company being first." An imitator's time to market is still important, but less so because imitator companies already know they have to gain competitive edge in ways other than just being first. These findings, say Hellmann and Puri, are evidence that the venture capitalist plays a critical role in the life of innovative companies.

The uncommon benefit a venture capitalist brings to a startup is twofold: the ability to recruit key managers to the company and the monitoring and discipline that the venture capitalist imposes. "Keeping the founders on track by reaching for key milestones, saying 'no' to distractions, and focusing them on commercial success is tremendously important," says Hellmann.

If venture capital were to become just a money business, it would be a commodity business--another bank that hands out equity instead of debt. The venture capitalist's traditional role could erode if the crush of money shifts his or her focus away from highly involved early-stage investments to safer, later-stage investments that rely on someone else to hover over the critical first stage. Hellmann and Puri hope their research serves as a reminder that the real value of venture capital is in its nurturing of companies, not simply as a source of funding. --Barbara Buell

"The Interaction Between Product Market and Financing Strategy: The Role of Venture Capital," Thomas Hellmann and Manju Puri, GSB Research Paper #1561, May 1999