The use of effectuation in venture capitalist early-stage investment decision making in China.

Abstract

This study investigates how venture capitalists in China make early-stage investment decisions under uncertainty. Within this context, it examines why early-stage venture capitalists use effectuation (involving emergent strategy) in contrast to prediction (concerned with planned strategy) and how the experts and novices differ in their use of effectuation. Venture capital is important for entrepreneurship development. The topic of how venture capitalists make investment decisions has attracted extensive research efforts over the last few decades. The majority of these studies assume venture capitalists’ decision making is a rational process based on prediction. However, early-stage venture development is fraught with uncertainty and ambiguity. Prediction does not work effectively in such a context. Several recent studies have shown expert entrepreneurs use effectuation, which consists of a specific set of heuristics, to tackle uncertainty. This knowledge about entrepreneurs is relevant to venture capitalists as they participate in a similar environment. This study develops a theoretical framework based on early-stage venture investment expertise and proposes a series of hypotheses along five specific dimensions contrasting effectuation and prediction. An extensively used qualitative method for researching expertise-Protocol analysis-was adopted in this study. 62 participants, including 32 expert early-stage venture capitalists and 30 novices, were asked to think aloud continuously as they solved problems associated with early-stage venture investment decision making. The findings supported the central hypothesis that expert venture capitalists use effectuation to a significantly higher extent than novices. Specifically, expert venture capitalists are more likely than novices to emphasise execution, be sceptical about market data, and emphasise own personal knowledge of the product. Experts place significantly more emphasis on entrepreneurs’ resources and on how venture capitalists’ own means could add value to the venture. In addition, experts are more likely to consider the business development cost and partnership. They are more aware of unexpected contingencies and among the participants who acknowledged so, experts are more likely to emphasise the importance of exploiting opportunities arising from contingencies. This study also found that expert venture capitalists do not completely abandon prediction in early-stage venture investment decision making. Expert venture capitalists do not differ from novices in emphasising entrepreneurs’ goal setting and competition. It is also found that experts place even more emphasis on expected return than novices do. Overall, this study suggests that expert venture capitalists' thinking process is more comprehensive, elaborated, and complex than novices’. The study makes a significant contribution to the literature by challenging the conventional wisdom about how venture capitalists think and what actions they intend to take in relation to early-stage investment decision making. The knowledge generated may not only help early-stage venture capitalists improve their decision process and investment outcomes, but also allow entrepreneurs to secure venture capital more effectively and efficiently. Learnable elements are identified for training novice venture capitalists and fresh perspectives are presented to venture capital limited partners and entrepreneurship policy-makers for consideration. A future research agenda is proposed at the end of the thesis.