A pilot study of venture capital investment appraisal in Australia

Illiquidity, volatile returns and lack of information are sources of the high risk that characterise the investments made by venture capitalists (VCs). Despite the importance of such investments in the contemporary business and technological environment, and the associated risk-related difficulties, little Australian research has been conducted into the decision-making processes of VCs. This study investigates both the investment process and some of the strategies used by VCs for reducing selected risks. The specific source of risk examined is information asymmetry, which is caused by lack of information on the part of the VCs, and which can lead to the added risks of adverse selection and moral hazard. Four Australian VC firms were surveyed using a comprehensive open-ended questionnaire. A manual content analysis was employed to analyse the questionnaire responses. Consistent with prior research, the Australian VCs sampled are found to employ Berger and Udell' three steps of investment: selection, contracting and monitoring. Furthermore, the semi-formal selection step of the investment process is found to consist of three distinct stages: deal sourcing, screening and evaluation. A number of techniques are used to minimise the risks of information asymmetry during the screening and evaluation stages, as well as during the later steps of contracting and monitorin.     

How do legal differences and experience affect financial contracts?

We analyze venture capital (VC) investments in twenty-three non-US countries and compare them to US VC investments. We describe how the contracts allocate cash flow, board, liquidation, and other control rights. In univariate analyses, contracts differ across legal regimes. However, more experienced VCs implement US style contracts regardless of legal regime. In most specifications, legal regime becomes insignificant controlling for VC experience. VC firms that do not use US style contracts fail significantly more often, even controlling for VC experience. The results are consistent with US style contracts being efficient across a wide range of legal regimes.     

Whom You Know Matters: Venture Capital Networks and Investment Performance

Many financial markets are characterized by strong relationships and networks, rather than arm's‐length, spot market transactions. We examine the performance consequences of this organizational structure in the context of relationships established when VCs syndicate portfolio company investments. We find that better‐networked VC firms experience significantly better fund performance, as measured by the proportion of investments that are successfully exited through an IPO or a sale to another company. Similarly, the portfolio companies of better‐networked VCs are significantly more likely to survive to subsequent financing and eventual exit. We also provide initial evidence on the evolution of VC networks.     

Does religiosity influence venture capital investment decisions?

Theories on contextual behavior (e.g., social norm, self-identity, and legitimacy theories) suggest that the religiosity of the geographical area in which an organization operates influences its behavior. Using a sample of 91,020 VC investments in the U.S., we study whether religiosity influences VC investment decisions. Based on prior literature that finds a positive relation between religiosity and risk aversion, we posit that VCs located in more religious counties make less risky investments. We find that VCs located in more religious areas are more likely to be involved in staging and syndication and have a greater propensity to invest in later and expansion stages of portfolio companies. Taken together, our results suggest that VCs located in religious counties tend to be more risk averse.     

Local bias in venture capital investments

This paper examines local bias in the context of venture capital (VC) investments. Based on a sample of U.S. VC investments between 1980 and June 2009, we find more reputable VCs (older, larger, more experienced, and with stronger IPO track record) and VCs with broader networks exhibit less local bias. Staging and specialization in technology industries increase VCs' local bias. We also find that the VC exhibits stronger local bias when it acts as the lead VC and when it is investing alone. Finally, we show that distance matters for the eventual performance of VC investments.     

Venturing beyond the IPO: Financing of Newly Public Firms by Venture Capitalists

Contrary to conventional wisdom, we document that approximately 15% of venture capitalist (VC)-backed firms raise additional capital from VCs in the five years after going public. We propose two explanations for why firms revert to VC financing post-IPO (initial public offering). First, we hypothesize that VC participation in post-IPO financing represents an efficient solution to informational problems that would otherwise constrain firms’ abilities to exploit value-increasing investments. Analyses of firm and VC characteristics, together with the finding that these investments are value-increasing for both VCs and the underlying companies, support this hypothesis. We find no support for the alternative that agency conflicts motivate these investments.     

Venture Capitalists, Business Angels, and Performance of Entrepreneurial IPOs in the UK and France

Abstract:  Using a unique sample of 444 entrepreneurial IPOs in the UK and France, this paper analyses the investment patterns and the stock-market performance effects of two types of early stage investors: venture capitalists (VCs) and business angels (BAs). Extending existing research, we identify important endogeneity and institutional effects. Our findings indicate that UK IPOs have a higher retained ownership and lower participation ratio by BAs, but a lower retained ownership and participation ratio by VCs than in France. BA and VC investments are substitutes, and they are endogenously determined by a number of firm- and founder-related factors, such as founder ownership and external board 'interlocks', and underwriter reputation. UK VCs are effective third-party certifying agents who reduce underpricing in UK IPOs, whereas in French IPOs they increase it by appearing to engage in grandstanding. This certification effect is more significant in UK IPOs involving both high VC and BA ownership. Finally, underpricing increases with VC participation ratio, where the higher exit of VCs seems to increase the risk premium required by outside investors, in particular in the UK.     

Economic freedom and cross-border venture capital performance

We investigate the determinants of cross-border venture capital (VC) performance using a large sample of 10,205 cross-border VC investments by 1906 foreign VC firms (VCs) in 6535 domestic portfolio companies. We focus on the impact of a domestic country's economic freedom on the performance of both VC investments and portfolio companies using a probit model and the Cox hazard model. After controlling for other related factors of domestic countries, portfolio companies, VCs and the global VC market, as well as year and industry fixed effects, we find that a domestic country's economic freedom is crucial to cross-border VC performance. In particular, in a more economically free country, as measured by the raw values of, quartiles of or the ranking in the index of economic freedom (IEF), a foreign VC-backed portfolio company is more likely to pull off a successful exit through an IPO (initial public offering) or an M&A (merger and acquisition), and a foreign VC firm is likely to spend a shorter investment duration in the portfolio company. We also identify interesting evidence on the impact of many other level factors of domestic countries, portfolio companies, VCs and the global VC market on cross-border VC performance.     

Venture-Capital Investment in Minority Business

This study analyzes the performance of mature investments made by venture-capital (VC) funds that specialize in financing minority business enterprises. We explore the hypothesis that VCs focusing on investing in minority businesses earn attractive returns because this market niche is underserved. Minority VC funds collectively earned yields on their realized investments that were estimated to be broadly equivalent to those of the mainstream VC industry. However, these yields vary greatly from fund to fund. VC fund traits that predict high yields on individual investments are identified by estimating multivariate regressions explaining net investment returns.     

An Entrepreneur's Guide to Understanding the Cost of Venture Capital

Entrepreneurs who deal with a venture capital firm (VC) for the first time often find themselves unprepared for the experience. The deal structure language used to describe financing terms, and the methods used to value the investment, are unique to the VC world. The authors have two objectives in preparing this entrepreneur's guide to venture capital finance: First, they explain why VCs require rates of return that are considerably higher—even after adjusting for difference in risk—than the returns required by the shareholders of established companies. Their explanation focuses on differences of opinion between overly optimistic entrepreneurs and less sanguine VCs. Second, the authors discuss the difficulty faced by entrepreneurs when trying to understand the actual cost of VC financing (including the dilution of value that occurs when entrepreneurs fail to meet targets or milestones). The problem can be traced to deal structure terms that typically call for the VC to receive preferential treatment in the event the entrepreneur's scenario does not turn out to be accurate. More specifically, entrepreneurs often grant VCs control rights as well as liquidation rights that, when things go wrong, dramatically increase the effective cost to entrepreneurs of venture financing.     

Does cross-border syndication affect venture capital risk and return?

Venture capital (VC) cross-border syndication has increased significantly in recent years. This study examines the risk and returns of investments of US–European cross-border syndicates in US portfolio companies. We use a large sample of investments across four financing stages, and highlight several noteworthy differences between cross-border syndicates and previous US-only evidence. By comparison, US–European syndicates are larger than US-only syndicates, involve younger VCs, and focus more on later financing stages. Controlling for sample selection bias caused by the endogenous choices of exit route and exit timing, we examine the risk and returns of investments backed by cross-border syndicates. Consistent with evidence from US-only syndicates, alpha and beta decrease monotonically from the earliest (start-up) stage to the later stages of financing.     

Investor abilities and financial contracting: Evidence from venture capital

Using a large, new database of contractual provisions governing the allocation of cash flow rights in venture capital (VC) financings, we investigate how contract design is related to VC abilities to monitor and provide value-added services to the entrepreneur. We find that more experienced VCs, who have superior abilities and more frequently join the boards of their portfolio companies, obtain weaker downside-protecting contractual cash flow rights than less experienced VCs. Several pieces of evidence suggest that this relation is unlikely to be driven by selection effects. The results suggest that VCs with better governance abilities focus less on obtaining downside protections, which entail risk-sharing costs, and more on other aspects of the contract (such as obtaining board representation) during negotiations with entrepreneurs. The results also imply that previous estimates of the amount entrepreneurs pay for affiliation with high-quality VCs are overstated.     

On the Life Cycle Dynamics of Venture‐Capital‐ and Non‐Venture‐Capital‐Financed Firms

We use data over 25 years to understand the life cycle dynamics of VC‐ and non‐VC‐financed firms. We find successful and failed VC‐financed firms achieve larger scale but are not more profitable at exit than matched non‐VC‐financed firms. Cumulative failure rates of VC‐financed firms are lower, with the difference driven largely by lower failure rates in the initial years after receiving VC. Our results are not driven by VCs disguising failures as acquisitions or by certain types of VCs. The performance difference between VC‐ and non‐VC‐financed firms narrows in the post‐internet bubble years, but does not disappear.     

Advice and monitoring in venture finance

This paper provides empirical insight into the role of contracts and legal systems for managing investor–investee relationships along two dimensions: providing advice and addressing conflict. We examine a new detailed dataset from European venture capital (VC) funds. We match very specific contractual terms in VC contracts with the effort (total time spent) and advice that VCs provide to their entrepreneurial investee firms. We also analyze VC–entrepreneur conflicts. We compare the importance of contractual versus non-contractual governance mechanisms, as well as the role of legal systems in different countries for facilitating VC–entrepreneur relationships. The data indicate VC cash-flow and control rights significantly facilitating effort and advice that VCs provide to entrepreneurs. VC–entrepreneur conflicts are closely tied to the quality of laws in which the entrepreneur resides: higher quality legal systems mitigate VC–entrepreneur conflicts. The data further indicate that non-contractual governance mechanisms significantly facilitate VC advice and mitigate VC–entrepreneur conflicts. The results provide a unique unifying look into the role of actual VC contracts and legal settings versus non-contractual governance mechanisms, risk, and success potential on VC–entrepreneur relationships in an international context.      

The value of ongoing venture capital investment to newly listed firms

We examine whether the market values continuing venture capital (VC) investor involvement in firms post-IPO. Compared to the US, Australian VC investors exit their investments post-IPO by on-market sales rather than distribution of holdings to their investors. Lockup periods tend to be longer and ownership thresholds for reporting trades lower. We find that the market responds positively to buy transactions, negatively to sell transactions of VC investors and negatively to the resignation of VC directors. These results are consistent with VC investors in the firm having a positive influence and creating value from which the VCs and other shareholders benefit.     

Does Reputation Limit Opportunistic Behavior in the VC Industry? Evidence from Litigation against VCs

We examine the role of reputation in limiting opportunistic behavior by venture capitalists towards four types of counterparties: entrepreneurs, investors, other VCs, and buyers of VC‐backed startups. Using a hand‐collected database of lawsuits, we document that more reputable VCs (i.e., VCs that are older, have more deals and funds under management, and syndicate with larger networks of VCs) are less likely to be litigated. We also find that litigated VCs suffer declines in future business relative to matched peers. These declines are larger for more reputable VCs, and for VCs that are defendants to multiple lawsuits or sued by entrepreneurs.     

Venture Capital Backing and Overvaluation: Evidence from the High‐Tech Bubble

We investigate the association between venture capital (VC) backing and the likelihood of firm overvaluation in the high‐tech bubble period. We find strong evidence that a VC‐backed firm is more likely than a non‐VC‐backed firm to be overvalued during the bubble period. A further investigation suggests that such an association exists only for VC‐backed firms that have gone public recently and VC‐backed firms over which venture capitalists (VCs) have high ownership or control. But outside the bubble period, all the differences in overvaluation between VC‐backed and non‐VC‐backed firms disappear. Our findings provide additional evidence supporting VC opportunism in boom periods.     

VC investments and global exits

This paper examines exits of UK venture capital backers (VCs) from portfolio companies around the world. Mergers and acquisitions (M&A) are the most frequently used exit route for all investments, both in the UK and abroad. Exit through M&A is particularly common for investments in the UK while the probability of an exit through an initial public offering (IPO) is substantially lower for investments made in the UK than abroad. We are able to explain these country differences in terms of variations in the characteristics of VCs, portfolio companies, legal systems and market conditions. Portfolio companies backed by experienced VCs have high probabilities of exits through M&A or IPO. A successful exit is more likely when a VC syndicate includes an experienced member. The likelihood of a successful exit through M&A, IPO or management buyouts is high in countries with, and at times of, high stock market liquidity. Legal systems that provide more investor protection facilitate exits through IPO or M&A.     

创业板公司IPO前后业绩变化及风险投资的影响

本文以创业板市场为样本,通过实证分析发现:风险投资在控制盈余管理方面有积极正面的影响;在上市时机选择方面,由于我国上市仍采用审批制,有风险投资和无风险投资在这一点上没有明显差异;同等资本下有风险投资持股的企业募集资金的金额少于无风险投资持股的企业,同时普通VC引入资金少于国有VC引入资金;有VC持股的企业发行后经营业绩的情况好于无VC持股的企业,风险投资的介入对于企业经营业绩有明显的正向作用。此外研究发现由于多数项目集中于政府手中,很多优质资源民间资本投资渠道不畅通,在这一点上具有国资背景的风险投资具备明显优势,容易以较低的风险进入。     

Monitoring or colluding: the role of venture capital investors in the IPO process

We argue and provide evidence that instead of playing a monitoring role, venture capital (VC) investors collude with controlling shareholders in the IPO process of Chinese non‐state‐owned enterprises (non‐SOEs). We show that VC‐backed IPOs’ applications are more likely to be approved by regulators, especially in firms with excess control rights, but have worse post‐IPO performance. Through investing in firms with excess control rights, VC investors are able to make higher exit returns. We further document that VC investors’ role in the IPO process is stronger when they have political connections, hold higher ownership, and when they make pre‐IPO investment.