18 June 2024

Why investment selection leads to investment success

Banking & Finance
| The European |

Investors and entrepreneurs must bridge a range of unknowns in order to secure early-stage funding, says Job Andreoli of Nyenrode Business University

Would you ever consider marrying someone you barely know? Could you imagine doing so willingly and eagerly, with mutual consent from both parties? If your answer is a resounding “no”, you will be surprised to learn that something similar to this happens every day in the West. In fact, our economies are reliant on it, and we would suffer greatly if these sorts of relationships stopped forming.

Of course, I’m not talking about romantic relationships here, but the relationship that develops between investors and entrepreneurs which are crucial to the success of new business ventures. This is especially true of early-stage startups with limited market proof. Some examples from my home country of the Netherlands, include the grocery store Picnic when they were just starting out in 2015, or the payment service provider Mollie, or even the Dutch bicycle retailer VanMoof. All too often, the deals agreed between investors and entrepreneurs are even more irrevocable than marriage.

Going through the early stages of launching a new venture is one of the most important times in a business’s development. Entrepreneurs have to attract investment before they have a product or service to evaluate – they need an injection of capital first. This is the point at which the information asymmetry between entrepreneur and investor is largest, but so is the potential for mutual benefit. Both parties need one another in order to grow ventures and form successful companies, but far too often entrepreneurs and investors are perfect strangers with their own goals and priorities.

"All too often entrepreneurs and investors are perfect strangers"

Closing a deal requires them to navigate the unknowns and find common ground. This challenge applies to all financing and investment decisions; however, it is magnified in early-stage startups. Coming on board a venture early in its development is riskier due to the evolving proposition, limited market proof and lack of collateral. Nevertheless, early-stage ventures are also of high societal interest because they have a significant role in generating economic growth. But money doesn’t grow on trees, so in order to generate revenue, startups have to acquire initial funding from somewhere. Investment selection appears to be the most important determinant for investment success, even more so than (for example) the “treatment effect” – which refers to the coaching and networking opportunities investors can provide for an entrepreneur after they have elected to fund the venture.

Yet selecting the right candidate to invest in is a challenge not helped by the fact that a good understanding of what determines a promising venture has been sorely lacking in practice and academia. Whether casual or not, persisting low rates of successful investments are apparent as well. Historically, the field of entrepreneurial finance has not been given much attention in academic circles until relatively recently, about 20 years ago. In this respect, it is very different to the more mature discipline of corporate finance, which has held academia’s attention for some 70 years now. Although it is younger, the study of entrepreneurial finance has been growing steadily since its foundation. In the four and a half years I spent as a PhD at Nyenrode Business University from 2017-2022, scientific and societal interest in entrepreneurial finance rose steeply.

This interest is apparent from the growing amount of private capital invested, the increasing number of startups seeking capital and published articles, and from the growth in the variety of funding sources available. At the same time, the investment success rate of venture capital has remained low, reinforcing the “spray and pray” approach of this more traditional private funding source.

Prepare for the ride

In both practice and academia, only two points of assessment are really considered in the investment selection process: “the jockey and the horse”. The jockey is the entrepreneur and their qualifications. For instance, their level of education, work experience, and whether they have set up a venture before, are all factors that can be taken into account when investors decide whether to offer funding. Then there’s the horse, which refers to the venture itself. Considerations may include the business model, level of competition, specifics of the industry, and so forth. With just these two aspects for investors to assess and select their investments, current understanding of the field acknowledges the inability of investors and entrepreneurs to have access to the same level of information.

While as points of assessment, the jockey and horse are natural and informative first steps to making investment decisions, and provide abundant empirical proof, the spread of information they ultimately provide is, in my opinion, limited. Steps can be taken to examine these two traits in greater detail, thus obtaining a more granular understanding of their respective merits and drawbacks, but I still find this restrictive. For this reason, we need to introduce a third category – that being the assessment of prior funding sources.

"Startups have proven to benefit society at large"

The point of reference I use when determining “prior” funding is venture capital, or, in other words, the earliest professional source of funding. Venture capital is engaged with investing someone else’s funds for a limited time, frequently in early-stage ventures. Its primary objective is to secure a significant financial return. However, there are various kinds of external funding which may precede venture capital. Crowdfunding, ICOs (or blockchain-based funding), and business angels are all good examples of this. Not only do these investors inject some early-stage capital into a startup, the fact that they decided to favour this particular entrepreneur or venture acts as a vote of confidence that may convince venture capitalists to select it for further investment. By taking prior funding sources into consideration, investors can thus obtain extra information to better substantiate their investment.

Furthermore, by analysing the signalling value of crowdfunding and ICOs, it is possible to create a “pecking order” of fintech funding sources. This can provide information for both entrepreneurs and investors, and allow entrepreneurs to step outside their more passive role in the investment process so investors can “self-select”.

Reliability and efficiency

Again, both in practice and academia, the field of entrepreneurial finance is developing rapidly in response to a growing number of private funding sources. Increased legislation around public funding also seems to have contributed to the level of capital investment in early-stage startups from private sources accelerating over funding obtained through the stock market.

Shareholder activism and investor impact on a firm’s decisions can have an especially vociferous effect in entrepreneurial finance. This is due to the closeness of investors and entrepreneurs, as well as the additional involvement of investors beyond simply putting up cash – venture capitalists also help budding business people by offering their knowledge, networks, and experience.

In times of economic hardship, it is more important than ever that we make the investment selection process as reliable and efficient as possible, particularly for early-stage ventures. Entrepreneurial startups have proven to benefit society at large in terms of innovation and employment, even more than many established corporations. I hope that adding a third point of consideration will provide a broader spread of information for venture capitalists, allowing them to gather more evidence before investing their money into a new company. In this way, hopefully we can create more Picnics, Mollies, and VanMoofs.


Dr Job J. Andreoli is Assistant Professor and leads the Nyenrode Incubator in Amsterdam. He is part of Nyenrode’s Faculty Research Center for Corporate Reporting, Finance & Tax. He previously worked as a strategy consultant for Ernst & Young (EY) and Capgemini and was responsible for setting up the Strategy & Innovation practice of Atos Consulting.

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