Should Investors Bet on the Jockey or the Horse? Evidence from the Evolution of Firms from Early Business Plans to Public Companies

Abstract

We study how firm characteristics evolve from early business plan to initial public offering (IPO) to public company for 50 venture capital (VC)-financed companies. Firm business lines remain remarkably stable while management turnover is substantial. Management turnover is positively related to alienable asset formation. We obtain similar results using all 2004 IPOs, suggesting that our main results are not specific to VC-backed firms or the time period. The results suggest that, at the margin, investors in start-ups should place more weight on the business ("the horse") than on the management team ("the jockey"). The results also inform theories of the firm. SINCE COASE (1937), ECONOMISTS HAVE ATTEMPTED TO UNDERSTAND why firms exist and what constitutes firms. 1 Despite the long history of theory and empirical work, there is little systematic or noncase evidence concerning what constitutes a firm when it is very young and how a young firm evolves to a mature company. In this paper, we provide such evidence by studying 50 venture capital (VC)financed firms from early business plan to initial public offering (IPO) to public company (3 years after the IPO). We explore financial performance, line of business, point(s) of differentiation, nonhuman capital assets, growth strategy, *

Performance reversals and attitudes towards risk in the venture capital (VC) market

“…In this respect, our findings are consistent with the conclusion in Kaplan et al (2007) that investors are better off backing horses (business plans) rather than jockeys (entrepreneurs or management teams).…”

“…Under the assumption that VCs' monitoring and managerial abilities cannot make 'bad' projects 'good', portfolio quality, or equivalently, the ability to identify and/or attract superior quality projects is more important for success in the VC market, in comparison with managerial and monitoring abilities. In this respect, our findings are consistent with the conclusion in Kaplan, Sensoy, and Stromberg (2007) that investors are better off backing horses (business plans) rather than jockeys (entrepreneurs or management teams).…”

Determinants of start-up firm external financing worldwide

“…Cole et al (2004) report that the characteristics of the small business owners are crucial determinants in obtaining loans from small banks. Kaplan et al (2009) also examine the role and dynamic evolution of alienable assets, business lines, and human capital for start-up firms. They find that alienable assets and business lines of a successful start-up firm are more stable than its human capital.…”

Extraordinary acquirers

“…Chang, Dasgupta, and Hilary (2010) provide evidence consistent with managerial effects explaining corporate performance. Kaplan, Sensoy, and Strömberg (2009) study the evolution of firms from early-stage to initial public offerings (IPOs) and conclude that investors bet on the business (the horse) rather than the management (the jockey). In contrast, Gompers, Kovner, Lerner, and Scharfstein (2010) find persistence in the success of serial entrepreneurs across their ventures.…”