Investment Behavior of Venture Capitalists
Submitted to: Dr. Smita Mehendale
Authors: Shivam Ganatra B-4, Sonu Kumar Mishra B-23, Navneet Sahu B-27
Abstract: Venture capital investment decision-making process is the most vital part of a venture
capital investment selection. There is a lot of uncertainty and complexity in the investment
decision-making process. As this is the most important step, it becomes essential to analyze what
makes a venture capitalist decide a company to invest in – whether it is by analyzing the results of
the prospect company or just sheer gut feeling? This review focuses on reviewing existing
literature in this field and extract out content which guides us towards understanding how these
venture capitalists choose to invest in a company.
Keywords – systematic literature review, investment behavior, venture capitalist, rationality,
irrationality, company selection parameters
The market of venture capital has captured a significant attention among various section of
business community. Whether big multinational companies or latest trend of startups, every
section of industry is vying up to seek heavy funding for investing in their innovation and future
growth (Liu, 2009). The investment from these financial heavyweights creates lot of opportunities
for the small startups to flourish themselves in the midst of settled market giants ready to crush
them in the competition. These investment not only gives a chance to start the business idea but
also to grow for the future competition (Liu, 2009).
The venture capitalists provide a better infrastructure and support to these startups to plan their
business operation and assistance for their logistics, human resource, partnership regulations, legal
formalities and many more. Their financial and non-financial support makes their brand to
establish a better portfolio in the market. However, the venture capital market is not so coherent
and the strategy with which the venture capitalists invest in a company has no specific parameters
to select. Whether they get emotional or look only at the monetary benefit or view the business
idea with a sense of social responsibility, it is hard to clarify (Liu, 2009). Hence this review of
literature is conducted to understand and analyze the behavior and the pattern of venture capitalists
and find out what drives them to invest their hard earned money in a business idea. This study is
carried out under various sections resuming with the rational or irrational approaches of venture
capitalists followed by sector or type of business do they invest in. The study is then focuses on
the cognitive and demographic aspects of venture capitalists in the decision making of the
company (Dimov & Shepherd, 2005). Lastly, the review is then followed by post investment
behavior of venture capitalists with respect to the decision they took to invest in a particular
company (Zacharakis & Shepherd, 2001).
A financial specialist can pick up certainty on a methodology that worked previously and on the
procedure set up to quantify and guarantee that the system is repeatable. Financial specialists ought
not to centre around things outside of their control, i.e. securities exchange costs, but instead on
what they truly control, data and learning. Enthusiastic torment of a budgetary misfortune is brief,
yet stopping is lasting. Nothing is more troublesome, and thusly more valuable, than to have the
capacity to choose (Mitroi, 2014).
Post analysis in all the areas mentioned previously and assessing their strong point and flaws, we
conclude by recognizing the limits of our present evaluation and providing proposals for the
2. Systematic Literature Review Method
Following the general rules of the methodical writing audit technique, we show in the
accompanying subsections the extent of this survey, the way toward recognizing applicable
writing, and the papers incorporated into this survey.
1.1 2.1 Scope of the literature review
The extent of this audit is characterized by two arrangements of criteria identifying with shape and
substance. This audit incorporates scholastic articles, which are affirmed since they experience
basic survey by associated analysts, and it avoids book sections and in addition non-scholarly
articles, comprising of short magazine articles, perspectives, meetings, and publications.
Regarding content, the focal point of this survey is on the investment behavior of venture
capitalists, the parameters they set when they choose a company to fund and behavioral biases and
patterns associated with such investments.
1.2 2.2 Identification of Appropriate Literature
The process of appropriate literature identification and review of the same resumed in July 2018.
In this stage, we looked for mixes of the catchphrases ‘investment behavior’, ‘venture capitalist’,
‘rationality’, ‘irrationality’, ‘company selection parameters’ in five databases: Emerald, Ebsco,
HBR, Jstor and Scopus. These databases were picked in view of the measure of value scholastic
substance they give, and additionally their significance to administration and business research. In
our ongoing search for articles we found 240 research papers from all the databases by using
keyword search. The extracted information included the article’s title, author(s), journal name,
document type, and database from which the article is extracted. All the group members read the
abstracts of the papers and sorted out relevant papers for the research. 30 research papers were
eliminated due to duplicate records. This step planned to guarantee the consistency of the literature
screening, as inability to establish it makes content examination futile. An aggregate of 123 articles
were rejected for not matching to our scope. This brought about a set of 87 articles. Next, these
articles were divided, and their full messages analyzed for conclusive consideration in the review,
in light of the previously mentioned criteria. Joint appraisal brought about further barring 31
articles, bringing about 34 articles for the audit.
Table 1. Database Search Results
Database Scope and search criteria Search Date Number
Search: All journals Abstract, keywords, and
titles Document type: research papers
Ebscohost Search: All journals Abstract, keywords, and
titles Document type: research papers
Scopus Search: All journals Abstract, keywords, and
titles Document type: research papers
Jstor Search: All journals Abstract, keywords, and
titles Document type: research papers
HBR Search: All journals Abstract, keywords, and
titles Document type: research papers
Figure 1. Flow chart of the screening process for the research paper “Investment Behavior of
Screening based on
for not matching with
the research scope
Articles included in
the review (n=65)
after final assessment
and 31 exclusions in
the review (n=34)
2.3 Systematic literature review results
The 34 articles finally considered this review between 1994 and 2017, with articles published
throughout the first ten-year, few re?ecting the same pattern and few with similar mentions of
steady research on investment behavior and pattern lately picked up in the next five-ten years of
the 21st century at more frequency overall. This can be explained by the fact that the study on the
investment pattern by venture capitalist, emerged more in numbers in last few years. The last
decade has witnessed a huge rise of MNCs in terms of revenue growth and the rapid change in
technology lead to multiple startups craving for funding’s by Venture capitalists.
Figure 2. Number of articles included in the literature review by the year of publication
3. Methodological review
This methodological review expects to give an outline of the strategies utilized as a part of research
on venture capitalist’s behavior, without altogether depicting the examination plans and systems
of the assessed writing. As far as methodology is concerned, portions portraying the connected
techniques were separated from each article. A joint work session and interview with every one of
the writers prompted naming article strategies (a) blended techniques, consolidating both
qualitative and quantitative methodologies; and (b) non-empirical research, comprising principally
of reasonable papers and re?ective papers. Non-empirical research strategies were utilized as a
part of 62% of the investigated articles, trailed by blended techniques in 38% of the writing. This
methodological fracture can be clarified by the examination attempted in the inspected article. The
Numbers of Articles published
predominance of non-observational in this audited writing can be clarified by the peculiarity of the
subject. Research in new zones is ?rst centered on de?nitional issues, trailed by investigation
before consideration is moved towards hypothesis, strategies, and measures. In this way, early
investigations on investment behavior of capitalists would be comprised of reasonable papers,
hypothetical discourses, preparing for more hypothesis based and quantitative research.
4. Thematic Review
After careful review of the selected research papers for the systematic literature review, the team
members have identified 3 themes emerging out of all the selected papers.
The themes are chosen keeping in mind the keywords selected for the systematic literature review
and the overall objective of the review.
The approach we have taken is based on the belief that if we can better understand the drivers and
uncertainties that are involved in and around the Venture Capital investment drivers, we will have
a better chance of understanding the related decision processes and behaviour of Venture
Capitalists. In traditional finance theory, the investors are expected to be rational decision-makers
going along with the expected utility theory. Behavioural finance, in contrary to this, criticizes this
rational perspective and they argue that the investors tend to deviate from rationality whenever
making investment decisions. In the 1980’s, behavioural finance emerged as a new concept
combining behavioural and psychological aspects in economic and financial decision-making.
When looking at different studies done in relation to the behavioural biases, most of the top
researchers in the field have focused on such behavioural biases as overconfidence, disposition
effect, herd behaviour and home bias (Kumar & Goyal, 2016). According to Kumar and Goyal,
“herding” refers to the situation wherein rational people start behaving irrationally by imitating the
judgements of others while making decisions. This behaviour is considered to be rational for less
sophisticated investors, who attempt to mimic financial gurus or follow the activities of successful
investors, since using their own information/knowledge would incur a higher cost (Chiang &
Zheng, 2010). In Venture Capital markets, the information overload and the “fear of missing out”
increase the pressure on VC investors which pushes them to adopt a herding behaviour towards
reputed and/or familiar ecosystems instead of analysing the available information to choose other
locations that could be less risky and get potentially higher returns over time. The fear of missing
out on continued gains (i.e. regret) outweighs the potential psychic and economic benefit of
moving against the trend (Wood & Zaichkowsky, 2004). Every financial investment balances risks
and returns, and Venture Capital is no exception. When herding occurs risk perception is
underweighted that results in to low abnormal returns (Kumar & Goyal, 2016). Bias factors also
include overconfidence, inconsistency, habit and framing (Mitteness, Sudek, & Cardon, 2012).
VCs may perceive the same information differently based on their past beliefs, experience and
biasness. When arguing about gender biasing, recent work has attempted to interpret the features
of entrepreneurial ventures, which are most important to evaluators. In a paper using experimental
variation in startup profiles, studies have shown that information on co-founder background is
most salient (Bernstein, Korteweg, & Laws, 2016) and that attributes such as gender and
attractiveness have a strong impact on the evaluation idea quality. In the case of startup evaluation,
there are aspects of new venture that are observable to the judges and directly inform the potential
performance of the venture: for instance, the quality of the thought 8 informing the choice of
market and technology. Even in cases where objective performance evaluation is available, it is
possible that men and women are judged using different yardsticks. Through field and
experimental evidence, scholars have demonstrated more stringent evaluation criteria being
applied to women relative to their male counterparts, a phenomenon called “double standards”
(Foschi, Lai, & Sigerson, 1994). A number of cognitive factors are present in decision process that
may affect the VCs decision making, but only a few of them received the attention in VCs decision-
making process. This provides the opportunity for future research and unfolds the other areas.
The Prospect Theory is a behavioural economic theory developed by Daniel Kahneman & Amos
Tversky in 1979. It divides the decision process in two phases: the first phase of framing and the
second phase of evaluation (Jha, 2016). The theory explains the obvious anomaly in human
behaviour when evaluating risk under scenarios where there is uncertainty. The theory says that
humans are not constantly risk-averse; relatively they are risk-averse in gains and risk-takers in
losses (Jha, 2016). This explains why not all investing decisions taken are successful; only few out
of the total firms invested in by the VCs generate considerable return on the investment. The
decision to invest in a firm is made under considerable pressure, there is a pressure to meet the
deadline and the risk of the investment going into loss. Another pressure for the VCs is adverse
selection. Two companies outright may seem good to invest in; but one of them is a lemon (good
from the outside but is not a viable investment once you get into the operations). This issue is
aggravated when under market pressure to choose lucrative looking companies faster than the
competition. The market uncertainty makes venture capital firms to delay investing at each round
of financing, whereas competition, project success/failure uncertainty make venture capital firms
invest sooner in prospect companies (Zhang, 2012). So, under such a scenario it becomes
challenging to determine if an investment made in a company is a rational decision or an irrational
one. Economics assumes that consumers (in our case, investors) make rational decisions. Finance,
as well as Behavioural Finance, has come from Economics as a science so this assumption holds
true for our context too. The various behavioural biases mentioned in the first theme affect the
rationality of the decision making process for Venture Capitalists.
4.3 Venture Capitalist’s Experience
Does more experience at being venture capitalist results in better decision making?
Past research on the same shows that experienced VC’s often get an edge over others as they keep
doing the same task time & again. For instance, they learn to focus attention primarily on the key
dimensions—the ones that contribute most variance to the outcome of decisions (Chase and
Simon, 1973). Experienced decision-makers create categories of information based on a deep
structure that involves more and stronger links between concepts (Gobbo and Chi, 1986). They
also adopt decision policies that utilize a rich connection among concepts (Chi and Koeske, 1983).
Taken together, this evidence suggests that decision-makers experienced in a given task may
indeed utilize superior decision processes relative to those with less experience (Anderson,1983)
and, by extrapolation, that VCs may become more accurate in choosing the ”right” companies as
their experience increases.
However, past research in the area of judgment/decision-making suggests that increasing
experience does not always lead to better decisions. The answer may involve a curvilinear
relationship between experience with the venture capital task and the accuracy or efficiency of
their decision processes.
It is found that as VCs experience increases, intrajudge reliability at first increases but then
decreases. This may be true for several reasons. First, experienced decision makers appear to rely
on various heuristics and other forms of mental shortcuts to the same extent as those lacking
experience and this can lead them into equally serious errors (Libby and Lewis, 1982). Similarly,
with high levels of experience, decision-makers may become increasingly susceptible to the pitfall
of cognitive or mental ruts. In short, their thoughts may tend to become increasingly channelled
by their past experience. Such effects may make it more difficult for them to recognize new
opportunity or to notice that the scenario has changed and thus requires new approaches (Tversky
and Kahneman, 1974).
This prediction, in turn, raises a key issue: How can VCs’ decision-making be assessed? One
possibility is to examine their actual decision accuracy: To what extent do they make good (i.e.,
accurate or successful) decisions? Another possibility is to focus decision process rather than
decision outcome: The manner in which VCs combine information to form an overall decision.
However, there are obstacles to determining ”actual” decision accuracy. For instance, many
unforeseen circumstances can impact new venture performance during the elapsed time from when
a VC makes a decision to invest and when the outcome of that decision is known. The issue brings
a whole new subject for future research and explore more facts.
This is a systematic literature review which uses keyword search to find out relevant research
papers for a review. This kind of a search may lead to elimination of certain relevant research
papers for review only because of the fact that the keywords do not match.
Another limitation of this research is that the paucity of time to conduct the review. We had to
finish the review up in a month which is a short time to complete a systematic literature review.
This review also has a limitation that the group did not have direct contact to venture capitalists
for getting real-time insight into their investment behavior. This limitation hinders our findings of
6. Directions for Future Research
All the research papers reviewed by the group have had less empirical research and focus is more
on the American or the European perspective. There has not been major research in the Asian
context especially the Indian context that shows substantial findings which can be applied here.
Another direction for future research is doing a quantitative study and using regression models on
quantitative primary data collected. Many papers have regression models run but they are on
codified qualitative primary data. This kind of an analysis becomes subjective and thus does not
allow for an objective interpretations of the findings.
Post review of the selected research paper, the group members have had a comprehensive idea
regarding the investment behaviour of the venture capitalists and the biases involved in the same.
The biases affect the choice of the company and determine if the decision is a rational one or an
irrational decision. A general perception is that if the VC is experienced, the decisions taken by
him will be rational and there will be lower rate of failures. The investment behaviour of the
venture capitalist in that sense is not rational entirely. It is dependent upon a lot of behavioural
aspects than just effective evaluation of the prospect companies.
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