UPSIDE-DOWN VENTURE
INTRODUCTION
INEVITABLE PROGRESSION. ‘‘This is a cottage industry in its in- fancy – it will mature and move into the organizational form of more- mature industries.’’ {GP in early-stage California firm}
FAILED EXPERIMENT. ‘‘This is an artisans’ business, full of special- ists, that doesn’t lend itself to pyramids. It’s like a surgeon’s busi- ness.’’y‘‘At the end of the day, it’s an art. Would you really think that Mozart could’ve been a lot more productive if, instead of writing his own music, he stayed at the top and reviewed and edited what his people did?
Would it work?’’ {GP and COO of California firms}
Until the 1920s, the Dutch accounting industry was dominated by ‘‘P- form’’ organizations consisting of small firms with only partners (Lee and Pennings 2002). However, in the 1920s, several early-mover firms transiti- oned to a ‘‘PA-form’’ that included both partners and more-junior ‘‘asso- ciate’’ professionals, an organizational form that soon dominated the industry in that country and enabled the development of large accounting firms. During the 1900s, similar large-scale transitions occurred in other professional services industries, such as law (Sherer and Lee 2002), man- agement consulting (McKenna 2001), and investment banking (Eccles and Crane 1988; Hayes III and Hubbard 1990). Small ‘‘non-pyramidal’’ pro- fessional services firms (PSFs), which had previously been comprised of senior partners transformed themselves into the large ‘‘pyramidal’’ organ- izations that dominate these industries today. To do so, they significantly increased their ratio of junior staff to senior staff, created processes with which the senior people could leverage the time and efforts of their junior employees, and developed junior and mid-level specialists who could per- form their tasks with increased expertise and efficiency. Moving to pyram- idal structures enabled these firms to increase their effectiveness and scope of operations, to economize on coordination and governance costs (Galan- ter and Palay 1991), and to increase their chances of survival compared to firms that did not change their models. The fact that large number of firms changed their structures, capabilities, and processes helped each industry escape from its ‘‘cottage industry’’ status (e.g.Baumard 1999) and changed the overall competitive landscape within the industry.
Past studies (e.g.McKenna 2001;Lee and Pennings 2002;Sherer and Lee 2002) have assessed these transformations retrospectively, often decades
after they occurred. Therefore, they were not able to directly study the process of transformation and the range of issues faced by the people ex- periencing and participating in the transition. In addition, as analyses of completed transitions, these ‘‘ex post’’ studies were susceptible to the as- sumption that the change was the inevitable next stage in an evolution (Lamoreaux, Raff et al. 2003). In contrast to these studies, this chapter focuses on current changes in venture capital (VC), an industry in which non-pyramidal firms have predominated for several decades (Wasserman 2002), and does not take it for granted that a transition toward pyramidal structures will be completed and be a positive development for the firms involved. In the late 1990s, several VC firms, such as Crescendo Ventures (Wasserman 2003), Atlas Venture, and Battery Ventures, began attempting to transition toward pyramidal structures by undergoing the same ‘‘insti- tutionalization and professionalization’’ (McKenna 2001:673) that had pre- viously occurred in management consulting firms and other PSFs. However, as described below, many of the firms ran into problems transitioning to- ward the pyramidal models adopted on a widespread basis in other pro- fessional services industries, raising questions about whether VC can evolve in a similar way. The debate over this evolution is captured in the competing quotes at the beginning of this chapter.
Therefore, consistent with past studies, this study explores the reasons why some firms began to change. However, it also focuses on the barriers that might prevent such a change from becoming widespread or permanent.
Doing so can help illuminate the challenges faced by ‘‘organizational en- trepreneurs’’ who attempt to pioneer new organizational structures, much like Nike did in its industry (Abrahamson and Fairchild 2001), in that success in the ‘‘introduction’’ stage must be followed by success in the ‘‘dif- fusion’’ stage or else the organizational innovation will not be sustained.
The focus on barriers to change can also inform past entrepreneurship re- search that has examined the persistence of organizational characteristics and strategies. For instance, founding strategies often persist for decades after founding (Stinchcombe 1965; Boeker 1989), and this chapter sheds light on structural and strategic persistence in the context of the VC indus- try, an industry where research has neglected to study the internal organ- izational characteristics of firms (Gompers and Lerner 2001; Wasserman 2002).
In this chapter, I draw primarily on extensive field research with first- mover firms who began transitioning, but also use illustrative data from a unique large-scale panel dataset of 327 VC firms.1 The sections below in- tegrate the analyses into a model of the motivations for and obstacles to Upside-down Venture Capitalists and the Transition Toward Pyramidal Firms 153
achieving structural transformation toward a pyramidal model. The dia- gram below summarizes the issues addressed in these sections regarding the trigger events, barriers to transitioning, and organizational contexts that facilitated or hindered the adoption of pyramidal structures.
I. Trigger Events 1. Generational transitions 2. Market uptick: Fund raising,
scale, and growth 3. Strategic changes
• Geographic expansion
• Stages of investment
II. Barriers to Transitioning 1. Costs to the firm
• Imperiling returns
• Endangering firm culture
• Weakening firm reputation 2. Market downturn
3. Internal and external resistance
III. Organizational Context 1. Past firm performance 2. GP backgrounds
3. Compensation arrangement