The use of cost-benefit analysis in venture capital investment decisions

Abstract

This research work focuses on the differences in the approaches and methods used by venture capital firms to evaluate potential investment. This includes: due diligence, sources of information in preparing valuations and the valuation methods used. Then how cost-benefit analysis could be used in such investment in Norway is further explored. The study aims to describe the cost-benefit analysis process by which venture capital firms operating in Norway use to evaluate funds to minimize the loss of capital invested and enhance a good return on investment. The dissertation is based on a 2-staged questionnaire survey process with venture capitalists operating in Norway. In the first phase of the study, fifteen (15) venture capitalist firms participated in a telephone interview followed by a set of questionnaires via email aimed at discussing the differences in the approaches and methods used in evaluating potential investment. In the second phase of the study, five (5) venture capital firms gave insight into the role of cost-benefit analysis in the investment decision processes. The questionnaire survey reveals that a relatively high proportion of Norwegian venture capital firms place special importance on the curriculum vitae of management and interview with entrepreneurs, in evaluating their potential investments. At the same time, they use the payback period and capitalized maintainable earning (P/E multiples) as the valuation method and not cost-benefit analysis. However, it seems that venture capital firms who performed cost-benefit analysis used the internal rate of return as a measure of the discount rate and the determination of the discount rate is the most important factor taking into consideration systematic and non-systematic risk. The discount rate used by Norwegian venture capitalists is more intuitive and have about the same interval as in the rest of the world depending on the company stage.