bachher3

METHOD

The method for this study followed the survey research approach. We used a questionnaire administered through interviews. Quantitative methods were employed to analyze data obtained from closed-ended items in the survey questionnaire. Remarks made by investors during the completion of the questionnaire were captured and summarized qualitatively. In the following sections, we describe the samples and procedures used to gather the data for our study.

Samples

Our study involved three sample groups, each of which represented a different type of equity investor. They were BAs, PVCs and PVCFs. Within each group, 20 investors completed the survey. Each of these sample groups will be discussed in turn. Despite the fact that there are no public directories of BAs or records of their investment transactions, we were able to identify these individuals through referrals from PVCs and PVCFs. The latter were located through the membership directory of the Association of Canadian Venture Capital Companies (ACVCC), which is easily accessible to the public. The most recent edition of this directory (July 1993) as of the time of data collection was used. Using the snowball sampling approach, within two months we were able to generate a database of 50 business angel investors across Canada. All PVCs interviewed were either the managing partners, presidents, or chief executive officers of the venture capital companies. In each of these companies, the senior executives use their own decision making criteria to evaluate a company seeking early stage financing. The intent of the study was to collect data from those individuals who were involved in evaluating and making actual investment decisions. The sample of PVCs from which data were collected in this study approached 100% of the population of potential Canadian PVCs that fall under the guidelines of the study. From the ACVCC directory, a total of five companies were classified as crown corporations, each of which obtain their primary pool of capital from the government. Investment managers of these crown corporations were interviewed. From each of the PVCFs studied, more than one individual was interviewed for his or her subjective opinions.

Procedures

This section describes the procedures used to gather data using the survey questionnaire. All surveys were administered during an interview with the investor, and the same questionnaire was used across all three investor types, in order to allow for meaningful comparisons across the groups. Data were collected from a total of 60 equity investors. The time required for completion was approximately one hour.

The investors were requested to consider a recent example of an investment proposal from an early stage technology based venture that they had accepted to invest in. In order to increase consistency across the groups of investors, all key terms used in the survey were defined. This included definitions for risk capital, seed stage financing, start-up stage financing, first-stage financing and technology based companies.

The investors began by identifying the characteristics of the investment proposal. Next, we requested the investor to consider a list of decision making criteria they use when evaluating technology based ventures at their early stages of development. These decision making criteria were grouped into five categories: 1) General Characteristics of the Entrepreneur(s) 2) Characteristics of the Market Targeted by the Venture 3) Characteristics of the Venture Offering (Product or Service) 4) Investor(s) Requirements and 5) Characteristics of the Investment Proposal from the Venture to the Investor(s).

All investors were requested to rank the five categories in order of importance to their overall decision making, with "first" signifying the most important category and "fifth", the least important. The investors were then presented with five different color coded sheets arranged in the order of importance of the criteria as they had indicated. This helped to ensure that they were answering questions pertaining to their most important criteria first, hence capturing their motivation and interest.

They evaluated all 95 criteria from the five categories using a seven point Likert scale -- an importance scale. The investors were requested to indicate the degree of importance of each criteria to them at the time of investment, when deciding to accept the investment proposal. A response of ‘1’ on this scale represented that the criteria was not important, ‘7’ signified it was very important, and ‘4’ on this scale implied that the criteria was not influential in their decision making. Investors also had an optional choice, N/A, defined to imply that the criteria did not apply to that investment proposal.

RESULTS

Investors ranked each of the five categories of decision making criteria in order of importance. Within each of the three types of investors, 20 subjects ranked the five categories. A Friedman two-way analysis of variance by ranks was used for testing the null hypothesis that the five categories were drawn from the same population. If the null hypothesis is in fact true, then the distribution of ranks in each category would be a matter of chance, and thus we would expect the ranks of ‘1’, ‘2’, ‘3’, ‘4’, and ‘5’ to appear in all categories with about equal frequency. The table below summarizes the Friedman two-way ANOVA test results [Siegel, 1956]. For each of the three types of investors, p<.05 (significance level), implying that the rank sums differ significantly across the five categories.

TABLE 1

Categories of Decision Making Criteria

Decision Making Criteria Categories	BAs	PVCs	PVCFs
	*Rank Sum*
General Characteristics of the Entrepreneur(s)	45.5 (1)	41.0 (1)	40.0 (1)
Characteristics of the Market Targeted by the Venture	56.0 (3)	52.0 (2)	52.5 (2)
Characteristics of the Venture Offering (Product or Service)	52.0 (2)	58.0 (3)	56.5 (3)
Investor(s) Requirements	67.0 (4)	65.0 (4)	76.0 (5)
Characteristics of the Investment Proposal from the Venture to the Investor(s)	79.5 (5)	84.0 (5)	75.0 (4)

In the table above, for a particular type of investor, as the rank sum increases, the importance of the category decreases. Hence, a rank of (1) implies the category of decision making criteria is most important to the investor, and (5) implies the category is least important. The frequency responses were also used to rank the five categories for each of the investor types. Identical results were obtained. For each criterion, the number of investors who responded (N), the mean degree of importance (M), and the standard deviation (SD) were calculated. Means range from (1) to (7), with (1) implying that the criterion is not important to the investors’ decision making and (7) implying that the criterion is very important to their decision making. For criteria with N<20, it implies that some of the investors indicated that it did not apply to their decision making.

For each type of investor, we decided to classify their responses concerning degree of importance of the criteria into four classes of varying importance. The rationale for setting a priori guidelines was that working with the full 95 criteria would often be too cumbersome and some indication of criteria salience would be useful. The following selection guidelines were used.

TABLE 2

Selection Guidelines for Decision Making Criteria

Selection Guideline	Classes	Characteristics of Criteria
I	Key Criteria	Mean (M) = 6.00 Std. Dev. (SD) = 1.00 N = 20
II	Important Criteria	Mean (M) = 5.5 Std. Dev. (SD) = 1.5 Not part of Key Criteria
III	Moderately Important Criteria	Mean (M) = 5.00 Not part of Key and Important Criteria
IV	Least Important Criteria	Not part of Key, Important, and Moderately Important Criteria

The results associated with the degree of importance for specific decision making criteria within each of the five categories suggest that all investors use a set of key and important criteria when evaluating early stage technology based companies. In summary, Tables 3 and 4 below outlines all of these key and important criteria, as described by Canadian BAs, PVCs and PVCFs.

TABLE 3

Key Criteria Used by Investors

Decision Making Criteria	BAs		PVCs		PVCFs
	Mean	SD	Mean	SD	Mean	SD
General Characteristics of the Entrepreneur(s)
The entrepreneurs' familiarity with product and market	6.75	0.72			6.20	0.83
The entrepreneurs' familiarity with customer requirements	6.60	0.68			6.50	0.69
The entrepreneurs' ability to anticipate need for change	6.55	0.61
The entrepreneurs' familiarity with technology enablers	6.35	0.75
The entrepreneurs' commitment to success	6.35	0.99			6.50	0.69
The entrepreneurs' ability to react to changing risk	6.30	0.80
The entrepreneurs' ability to bring about change	6.05	0.95	6.00	0.97	6.15	0.93
The entrepreneurs' willingness to work and cooperate with investors	6.05	0.95			6.05	0.95
The entrepreneurs’ ability to sustain intense effort					6.15	0.81
The entrepreneurs’ managerial capabilities and business awareness					6.10	0.64
Characteristics of the Venture Offering
Venture offering is superior and unique (compared to competing products)	6.45	0.51			6.45	0.51
Venture offering is highly innovative					6.00	0.92
Characteristics of the Investment Proposal
Evidence of truthfulness in the proposal	6.70	0.73			6.65	0.59
Quality of competitor analysis					6.20	0.77
Quality of product analysis					6.10	0.72
Quality of market analysis					6.05	0.83
Characteristics of the Market
Attractive growth potential of market			6.40	0.68	6.45	0.61
Proposed venture will create a new market or niche					6.00	0.86
Investor(s) Requirements
Cash out potential expected by the investor(s) (e.g. going public)			6.40	0.60	6.05	0.76
Expected rate of return on investment to the investor(s)			6.40	0.68
Expected market risk to the investor(s)			6.05	0.83

TABLE 4

Important Criteria Used by Investors

Decision Making Criteria	BAs	PVCs	PVCFs
General Characteristics of the Entrepreneur(s)
The entrepreneurs' referral by a trustworthy source	ü
The entrepreneurs' ability to sustain intense effort	ü	ü
Research and development skills of the entrepreneur(s)	ü
The entrepreneurs' personality compatible with investor(s)	ü	ü	ü
The entrepreneurs' familiarity with business drivers	ü		ü
Engineering skills of the entrepreneur(s)	ü
Sales force and/or distribution skills of the entrepreneur(s)			ü
Marketing research skills of the entrepreneur(s)			ü
The entrepreneurs' ability to accept criticism	ü		ü
The entrepreneurs' track record relevant to the venture	ü		ü
The entrepreneurs’ commitment to success		ü
The entrepreneurs’ familiarity with customer requirements		ü
The entrepreneurs’ familiarity with product and market		ü
The entrepreneurs’ willingness to work and cooperate with investors		ü
The entrepreneurs’ familiarity with technology enablers		ü	ü
The entrepreneurs’ ability to anticipate need for change		ü	ü
The entrepreneurs’ ability to react to changing risk		ü
The entrepreneurs’ demonstrated leadership ability in the past		ü	ü
The entrepreneurs’ managerial capabilities and business awareness		ü
The entrepreneurs’ ability to put a balanced management team in place		ü	ü
Characteristics of the Venture Offering
Venture offering has a higher quality compared to competing products	ü	ü	ü
Venture offering is highly innovative	ü	ü
Venture offering can be protected by a patent			ü
Venture offering is proprietary	ü	ü
Venture can demonstrate a defendable competitive position		ü	ü
A functioning prototype has already been developed			ü
Specifications are very clear (exactly what the offering will be)			ü
Venture offering is superior and unique (compared to competing products)		ü
Ventures’ technical aspects are very clear		ü	ü
Characteristics of the Market
Attractive growth potential of market	ü
Existing size of market is attractive			ü
Proposed venture is satisfying an existing market need	ü	ü
Customer need factors are changing rapidly		ü	ü
Technology factors are changing rapidly		ü	ü
Market factors are changing rapidly		ü	ü
Proposed venture will create a new market or niche		ü
There is intense price competition in the market		ü
Venture is protected by effective barriers to entry		ü	ü
Proposed venture will stimulate an existing market		ü
There is a strong dominant competitor with a large market share		ü

Investor(s) Requirements
Cash out potential expected by the investor(s) (e.g. going public)	ü
Expected rate of return on investment to the investor(s)	ü		ü
Size of investment expected from the investor(s)	ü
Financial provisions for investor(s) rights	ü	ü
Decision Making Criteria
Venture performance after first round of investment	ü
Venture's long-term sales will impact on the investor's performance	ü	ü	ü
Ability to attract a viable investor group	ü
Investor(s) influence upon management decisions of the venture		ü
Expected degree of market risk to the investor(s)			ü
Expected degree of technology risk to the investor(s)		ü	ü
Percentage equity share of venture held by the investor(s)		ü
Characteristics of the Investment Proposal
Clear emphasis on key points			ü
Realistic financial projections contained in proposal			ü
Clarity of communication in proposal			ü
Overall quality of proposal			ü
Quality of product analysis	ü
Quality of customer analysis		ü	ü
Quality of market analysis		ü
Quality of competitor analysis		ü

In describing the results from the table above, it should be understood that none of the investors will make a decision to invest on the basis of just one of these decision criteria. As they have all indicated, they look at several things and it is typically a combination of these that help them in deciding to either accept or reject an investment proposal. Even though this combination varies between investment proposals, the general set of criteria that the investors consider key and important were identified.

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