From Business Plans to Public Companies - part 1
I have worked for a couple of start-ups (Mexico Analytics and JackBe), with different responsability and involvement levels. My life have been influenced so much by these experiences that I have moved from an absolutely technical oriented guy to a guy interested in a wider number of topics, including business models and in particular the start-up lifecycle.
There are some papers which study venture capital-financed firms from early business plan to initial public offering (IPO) to public company (three years after the IPO). In particular that of Kaplan, et. al. is very insightful. A major part of the following thoughts comes from a draft they publish in their homepage. They describe the financial performance, business idea, point(s) of differentiation, non-human capital assets and technology, frowth strategy, customers, competitors, alliances, top management, ownership structure, and board of directors. They then consider how firm financial mesasures and firm characteristics evolve by describing the firms at the IPO and the third annual report after the IPO. It’s very interesting to pay particular attention to measuring if those characteristics remain constant, change, or disappear.
Of course not all VC-funded firms goes to IPO neither the opposite is true. However, VC-funded firms represent a substantial fraction of all IPOs (at least 39%) and a higher fraction of all start-ups that ultimately go public. Yes, I have to focus on start-ups that get acquired in order to round up this vision. I will performe this task on the following months.
Several theories emphasize the difference between non-human and human assets. For example, the basic assumption of the Hart-Moore framework is that firms are defined by their non-human assets. Holmström (1999) comes to similar conclusion, but argues that firm ownership of non-human assets allows the firm to structure internal incentives and to influence external parties (e.g., suppliers) who contract with the firm.
Kaplan et. al, among other goals, try to identify the “glue” that holds firms together and determine the extent to which the glue derives from non-human or human assets.
Another point of view is that of the critical resources, this is the case of Wernerfelt (1984) and Rajan and Zingales (2001b). A critical resource may be a person, “an idea, good customer relationships, a new tool, or superior management technique.” According to these theories, a “firm is a web of specific investments built around a critical resource or resources… At some point, the critical resource becomes the web of specific investment itself.” [Zingales (2000)].
The theories above also have implications for how rents are divided between providers of human (founders) and non-human capital and the ability of firms to raise outside financing. When specific human capital is more crucial, these models suggest that the specific human capital will capture more of the rents and make it more difficult to finance firms.
There are opposite points of view, for example, Zingales (2000) and Rajan and Zingales (2001a) found that today’s new firms differ from the old, traditional firms of the early 20th century. Old firms are “asset-intensive and highly vertically integrated … [their] boundaries are clear cut and sufficiently stable that one can take them for granted”. New firms, on the other hand, tend to be “non-vertical integrated, human capital intensive organizations operating in highly competitive environments.” Rajan and Zingales (2001a) argue that alienable assets have become less important relative to human capital and inalienable assets (e.g., business processes or knowledge). In fact, Zingales (2000) suggests that in today’s corporations “human capital is emerging as the most crucial asset.”
Related to the theoretical questions concerning the role of human and non-human capital assets is an old and ongoing debate among VCs. Some VCs believe that the company’s business and market are the key determinants of success while others believe that the key determinant is the company’s management team. While VCs try to invest in companies with both strong businesses and strong management (see Kaplan and Strömberg (2004)), different VCs claim to weigh one or the other more heavily at the margin. For example, Kaplan, et. al. says, Donald Valentine of Sequoia Capital, the VC investor in Cisco, is a well-known proponent of the business/market view. Others favor the best available managemente team view. Quindlen (2000) discusses these two views from the VC perspective. This debate is often characterized as whether one should bet on the jockey (management) or bet on the horse (the business/market).
