Small technology based companies have become a dynamic backbone of most developed economic systems. We define technology based companies as those companies intending to commercialize a technology for the first time and thereby expecting to derive a significant source of competitive advantage from the technology. Examples might include software and biotechnology companies. Throughout this manuscript, when the term ‘company’ is referred to as the unit of analysis, it will be assumed to imply ventures which are new and small -- and will not encompass firms which are established and large in size.

At the early stages, most technology based companies require access to sources of outside capital (other than their own personal funds) for them to achieve their potential. Unfortunately, one of the main difficulties that they face is obtaining the capital to aid growth. A high proportion of the small companies do not make it past the early stages simply because they can not find adequate venture capital [Sharwood, 1989]. Venture capital is broadly defined as capital which is not secured by assets and is invested in or loaned to a company by an outside investor. It is often referred to as risk capital since it is not only unsecured, but it generally lacks liquidity as well.

Entrepreneurs who are just starting out typically have very different needs than those well established and ready to expand their companies. Many investors have found that their own skills are better suited to helping one type of entrepreneur than another. As a result, investors tend to define their investment preferences by stages in the company’s development. The early stages encompass seed, start-up and first-stage, at each of which the company has different requirements for financing [ACVCC, 1992].

Seed stage financing is normally provided to prove a concept and is typically used for developing a prototype.

Start-up stage financing is provided to companies for use in product development and initial marketing. Companies may be in the process of being organized or may have been in business for a short while (usually a year or less), but have not yet sold their product commercially.

First-stage financing is provided to companies that have expended their initial capital and started to sell their product, but require additional funds to initiate full commercial production and sales.

Many early stage technology based companies differ from most other new firms by their lack of tangible resources. They begin with only the entrepreneur's intelligence and drive as inventory [Roberts, 1990]. The assets in technology based companies may literally "walk out at the end of the day." With such intangible assets, many entrepreneurs approach formal financial institutions as their first stop when shopping for capital. Unfortunately, due to the lack of tangible collateral, their search is generally fruitless. Many financial institutions simply do not want to take high risks and do not want to lend money to companies with no assets. They are primarily in the business of debt financing rather than equity investing. The next possible source of capital that often comes to the mind of an entrepreneur is ‘venture capital’ [Roberts, 1990]. Unfortunately, the bulk of investors known as venture capitalists show a greater willingness to invest in ongoing firms, rather than raw startups [Roberts, 1991].

Business Angels (BAs), also known as private or informal investors, are individuals, aside from the entrepreneurs or their family and friends, who invest their own funds in private companies. BAs are known to invest their time as well as money in ventures [Wetzel, 1981] with the hope of nurturing them to a size and stage that alternate sources of financing may be provided by larger venture capital players [Dal Cin, 1993]. Private Venture Capitalists (PVCs), also known as professional or institutional investors, assume equity or equity-type positions in private companies. On behalf of their professional venture capital companies, they mostly participate along with the management of the companies they invest in, often with the intent of developing the company to the point where an initial public offering (IPO) is possible. Their investments are expected to be relatively long-term (three to eight years). Public Venture Capital Funds (PVCFs) are similar to PVCs. The main difference between the two types of investors is their source pool of capital. While PVCs are funded by private institutions, all PVCFs consist primarily of government funding. In PVCFs, the final decision to invest in an opportunity is made by a board of directors which typically consists of individuals external to the PVCF. The investment managers are responsible for screening investment opportunities. After evaluating a selective few that they feel will conform to the guidelines for investments, they present a summarized investment proposal to the board for approval.

The objective of this study was to better understand the decision making criteria used by Canadian equity investors when evaluating technology based companies seeking early stage financing. Specifically, it focused on understanding the criteria used by the three primary sources of equity capital for these companies in Canada: PVCs, PVCFs and BAs. To keep within the focus of this study, only those Canadian were considered who have invested and do invest in early stage technology based companies. We focus on the decision making criteria used for equity investments in private companies, as opposed to publicly traded companies. It has been argued that investing venture capital in private companies is different from equity financing in publicly traded companies [Tyebjee and Bruno, 1984].

This study involved questioning Canadian equity investors on the importance of specific decision making criteria they use when evaluating early stage technology based companies. These criteria were grouped into five distinct categories, namely 1) general characteristics of the entrepreneur(s), 2) characteristics of the market targeted by the venture seeking capital, 3) characteristics of the venture offering (product or service), 4) characteristics of the investment proposal from the venture to the investor(s) and lastly, 5) the investor(s) requirements. Data were collected using survey questionnaires administered through personal interviews with the three types of equity investors across Canada.



The activities of an equity investor can be described in the form of a multi-stage decision making process. Researchers have studied the decision making process used by equity investors when evaluating new ventures seeking financing [Wells, 1974], [Tyebjee and Bruno, 1984], [Silver, 1985], [Hall, 1989], [Schilit, 1991]. Their results tend to show that the activities carried out by equity investors making investment decisions involve at least two distinct stages: screening and evaluation. It seems highly probable that different criteria are used at different stages of the decision making process. While some researchers have used methodologies to capture the decision making criteria used at the various stages of the process, others have studied the decision making criteria used generally by these investors.

Tyebjee and Bruno (1984) outlined the activities of US venture capitalists as an orderly process involving five sequential steps. In the deal screening stage, they identified a broad range of screening criteria including: size of the investment, investment policy of the venture capital firm, technology and market sector of the venture, geographic location of the venture and stage of financing. They tested for use of 23 additional criteria in the deal evaluation stage. The five main characteristics used by venture capitalists in evaluating companies included: market attractiveness (represented by size, growth, and accessibility); product differentiation (which combines the uniqueness of the product, the profit margin, and the patentability); managerial capabilities; environmental threats; and finally, cash-out potential (reflecting the venture capitalists’ ability to liquidate the investment).

As a replication and extension of the study reported by Tyebjee and Bruno (1984), MacMillan, Siegel and SubbaNarasimha (1985) studied the decision making criteria used by US venture capitalists. They classified 27 criteria into six groups: the entrepreneur’s personality, entrepreneur’s experience, characteristics of the product or service, characteristics of the market, financial considerations, and the venture team. The most significant criteria were related to the entrepreneur and the team; protectability of the product; market growth; and the required rate of return (identified as ten times the investment within five to ten years). The authors also distinguished essential criteria; the absence of or shortfall on any of these would result in rejection of the proposal regardless of any other redeeming characteristics. Five of the ten criteria most commonly rated as essential were associated with the entrepreneurs themselves: their capability for sustained effort, demonstrated leadership, track record relevant to the venture, reaction to risk, and capability of articulating the venture well.

Bogle and Reuber (1992) investigated issues involved in the financing of Canadian biotechnology firms by Canadian venture capitalists. Their objective was to identify those concerns which biotechnology firms might address to obtain venture capital financing. They concluded that the ratings of the investment criteria from their study were consistent with findings in cross-industry studies from the US. This work suggested that venture capitalists approach biotechnology investments in much the same way as they approach other investments, and that Canadian venture capitalists make decisions on bases that are similar to those used by US venture capitalists. They believed that investing in experienced, high-quality people makes good business sense.

Hall and Hofer (1993) studied the decision making process used by US venture capitalists when evaluating companies, and presented a refined set of stages which they claimed comprise an improved process. Using semi-structured interviews and verbal protocol analysis, they identified the criteria used in each of these stages. The two key criteria used by venture capitalists for initial screening were fit of the company seeking financing with the venture firm's lending guidelines and long-term growth and profitability of the industry in which the proposed business will operate. In the proposal assessment, emerging key criteria were: a) source of the business proposal (which played a role in the venture capitalists’ interest in the plan), and b) proposal previously reviewed by persons known and trusted by the venture capitalist. Both criteria received a high level of interest. They found a lack of importance attached to the entrepreneur or entrepreneurial team and strategy of the proposed venture during the early stages of the venture evaluation process. This was contradictory to all other studies described previously.

We believed that replicating a single previous study in the area of venture capital decision making was not sufficient for our case. Our study was focused on understanding the decision making criteria used by equity investors when evaluating technology based companies seeking early stage financing. We could locate little published literature that had attempted to study this area. It was therefore deemed to be important to realize that, even though the previous studies may have provided a direction for our area of research, we would have to develop our criteria specific to the focus of this study.

Most previous studies requested the investors under study to evaluate the relative importance of their decision making criteria. As the results obtained from these studies were similar, we sought as much consistency as possible but with minor changes to the criteria list. Prior studies did not elaborate the criteria that investors might use when evaluating the technology component of a company. Because of our focus, we derived criteria from extensive work which has been done on new product and service formulation and on the factors that determine the success of new products. Cooper (1988, 1990) has developed a tool that can be used by companies when evaluating several product ideas. From a set of prospective ideas, a company can choose only a selected few to invest their research and development funds. We considered this to be analogous to the situation with venture investors. The latter are evaluating technology based companies seeking early stage financing whereas the former are evaluating new product or service concepts to invest in and subsequently develop a company’s existing business. In reality, they are both investing fundamentally in a new product or service idea. Cooper (1988) has identified criteria which he believes should be considered when evaluating new product ideas, we therefore decided to merge his factors in creating our list of criteria.

A review of studies on investors’ decision making criteria revealed that the authors have not attempted to specifically describe the criteria used by Canadian equity investors when evaluating technology based companies seeking early stage financing. By Canadian equity investors, we are referring to BAs and only those venture capitalists (private and public) who invest in early stage technology based companies.

In his study on initial capital for the new technological enterprise, Roberts (1990) recommended that "despite increasing numbers of studies on the decision processes of venture capitalists ..., additional comparable research is needed on the decision criteria of informal investors." We could locate little published literature that described the decision making process and criteria used by BAs. The research literature on this type of investor primarily focuses on their characteristics and motivations for financing early stage companies [Wetzel, 1983]. Considering that BAs are known to be a primary source of equity capital for technology based companies at their early stages, we believe it is important to understand the criteria they use to evaluate these types of companies.

In Canada, some of the PVCs and most PVCFs invest in early stage technology based companies. In the last decade, we have seen anecdotal evidence of PVCs slacking off from investment in early stage technology based companies, and PVCFs picking up the slack to make this their focus. With the latter being more focused on making such investments, their decision making criteria may vary from the former; such a mandate enables them to foster development of the Canadian economy and this may motivate them to invest in early stage technology based companies, ventures which the private citizens may not want to invest in. On the other hand, most PVCs are mandated to seek a healthy rate of return to their private shareholders. As a result, they may tend to restrict the amount of risk taken, since it is private money on the line. Due to possible differences in motivation for funding and in source of capital, we believe that PVCFs and PVCs may focus on different sets of criteria when investing in early stage technology based companies.

In summary, to understand the current typical practice among Canadian equity investors, we attempt to explore the research question below for three different types of equity investors, namely Business Angels (BAs), Private Venture Capitalists (PVCs) and Public Venture Capital Funds (PVCFs):

What are the categories of decision making criteria stressed most by the three types of Canadian equity investors when evaluating technology based companies seeking early stage financing ?


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