According to an estimate, venture capital-backed startups account for one-third of the market value of all business startups in the United States each year. In their book, Venture Capital at the Crossroads, authors Bill Bygrave and Jeffry Timmons discuss how venture capital-backed startups are an important source of innovation and technological development and serve as a major source of new wealth creation in the world.

According to these authors, historically, these capital ventures have created approximately 2,30,000 jobs and have spent over $5 billion on research and development annually.

Among these ventures, successful names include Apple Computers, Intel, Federal Express, Lotus Development, and Compaq to name a few. With large industry backing of venture capitalism and the associated successes of starting-up entrepreneurs, it is important to understand the processes of negotiation between these two groups after a venture capitalist-funded business comes about.

One may argue that some degree of mutual cooperation between entrepreneurs and venture capitalists is a necessary (though not sufficient) condition for the successful post-investment performance of venture capital-backed startups. One reasons for this observation is due to knowledge differentiation between entrepreneurs and venture capitalists and the differences in their focus.

Knowledge differentiation means that entrepreneurs and venture capitalists each specialise in the development of different types of knowledge, allowing each group to exploit its comparative advantage.

For example, the business network of venture capitalists is likely to allow them to acquire funds more cheaply than entrepreneurs. In contrast, an entrepreneur is likely to be aware of the unexploited entrepreneurial r opportunities and has some idea about combining intangible and tangible resources to exploit these opportunities in new ways.

Second, entrepreneurs are likely to specialise in the daily development of new business activities.

Venture capitalists, on the other hand, are likely to specialise in creating networks of individuals and institutions to reduce the cost of acquiring and managing capital and to find customers and suppliers for their ventures.

One could argue that because of the complementary nature of these skills and activities between entrepreneurs and venture capitalists, the cooperation simply comes about.

However, many times, venture capitalists and entrepreneurs cooperate for different reasons. For example, obtain monopoly power or to take advantage of economies of scale.

The next question is why cooperation is the best mechanism for managing a healthy relationship between entrepreneurs and venture capitalists?

Some insights are provided by the research work of Daniel Cable of Georgia Institute of Technology and Scott Shane of Massachusetts Institute of Technology. According to these researchers, long-term cooperation is essential to venture-capital backed startups for multiple reasons, each dealing with the lack of an efficient market.

First, the knowledge held by entrepreneurs and venture capitalists is individual-specific. For example, knowing how to develop and exploit a new technology generally is specific to a particular entrepreneur, and a venture capitalist is unlikely to locate another entrepreneur with the skills necessary to exploit that same opportunity.

(The author is a doctoral candidate at Carnegie Mellon University, Pittsburgh, PA. Also, knowledge editor, Financial Chronicle, New Delhi)