DOES VENTURE CAPITAL REQUIRE AN ACTIVE STOCK MARKET?

The United States has both an active venture capital industry and well-developed stock markets. Japan and Germany have neither. The authors argue that this is no accident— that venture capital flourishes especially, and perhaps only , when venture capitalists can exit from successful portfolio companies through initial public offerings (IPOs), which in turn require an active stock market.
Understanding the link between the stock market and the venture capital market requires understanding the contractual arrangements between entrepreneurs and venture capital providers, particularly (1) the importance of exit by venture capitalists and (2) the implicit contract over control between venture capitalists and entrepreneurs created by the possibility of exit through an IPO. This possibility gives entrepreneurs a valuable option that, in the event they are successful, allows them to reacquire control of their enterprises from venture capitalists.     

Entrepreneurial finance: Banks versus venture capital

We analyze how entrepreneurial firms choose between two funding institution: banks, which monitor less intensively and face liquidity demands from their own investors, and venture capitalists, who can monitor more intensively but face a higher cost of capital because of the liquidity constraints that they impose on their own investors. Because the firm's manager prefers continuing the firm over liquidating it and aggressive (risky) continuation strategies over conservative (safe) continuation strategies, the institution must monitor the firm and exercise some control over its decisions. Bank finance takes the form of debt, whereas venture capital finance often resembles convertible debt. Venture capital finance is optimal only when the aggressive continuation strategy is not too profitable, ex ante; the uncertainty associated with the risky continuation strategy (strategic uncertainty) is high; and the firm's cash flow distribution is highly risky and positively skewed, with low probability of success, low liquidation value, and high returns if successful. A decrease in venture capitalists’ cost of capital encourages firms to switch from safe strategies and bank finance to riskier strategies and venture capital finance, increasing the average risk of firms in the economy.     

Public Policy for Venture Capital

This paper proposes a simple partial equilibrium model to investigate the effects of government policy on venture capital backed investments. Giving up an alternative career, entrepreneurs focus their effort on a single, high risk venture each. Venture capitalists acquire an equity stake and offer a base salary as well. In addition to providing incentive compatible equity finance, they support the venture with managerial advice to raise survival chances. We analyze several policy measures addressed at venture capital activity: government spending on entrepreneurial training, subsidies to equipment investment, and output subsidies at the production stage. While these measures stimulate entrepreneurship, only cost-effective government services can improve welfare.     

Convertible securities and optimal exit decisions in venture capital finance

We study the interaction between exit decisions and contract design in venture capital finance. One of the main characteristics of venture capital funds is that they need to divest their holdings in the portfolio firms after a limited period of time. However, venture capitalists and entrepreneurs often have diverging interests with respect to different exit solutions (e.g., IPOs or trade sales). We show that with convertible securities, the ex-ante agreed optimal exit policy can be implemented. Thereby, we give an explanation for the widespread use of convertible securities in venture capital finance.     

Experience,screening and syndication in venture capital investments

We consider a theoretical model that offers a rationale for the syndication of venture capital investments: syndication improves the screening process of venture capitalists and prevents competition between investors after investment opportunities are disclosed. The analysis identifies the costs of syndication in terms of investment decisions or post-investment involvement of venture capitalists. These costs depend crucially on the level of experience of venture capitalists. The model generates empirical predictions concerning the determinants of syndication and the characteristics of syndicated deals.     

Debt financing,venture capital,and the performance of initial public offerings

We examine the roles of two financial intermediaries, lenders and venture capitalists, in a sample of more than 6000 IPO firms during 1980–2012. Venture capitalists and lenders generally fund different types of firms and, on average, are substitutes; however, in some instances we observe interactions and complementary roles between the two funding sources. Firms with high debt have lower valuation uncertainty, and lower initial day returns than those backed by venture capital. However, firms with high debt levels underperform in the long-run, especially those without venture capital. We provide some evidence that firms backed by reputable venture capitalists perform better.     

Taxation and Venture Capital Backed Entrepreneurship

In recent years, venture capital has increasingly become a factor in the financing of new firms. We examine how the value of mature firms determines the incentives of entrepreneurs to start up new firms and of venture capitalists to finance and advise them. We examine how capital gains taxes as well as subsidies to start-up costs of new firms affect venture capital backed entrepreneurship. We also argue that dividend and capital gains taxes on mature firms have important consequences for start-up firms as well.     

基于信号模型及天使投资人参与下的风险投资

在风险投资过程中,由于信息的不对称,一方面风险投资家要找到优质项目往往需要付出高额成本;另一方面众多优质项目亟须风险投资家的青睐。针对该问题,本文在传统的风险投资家(venture capitalists,以下简称VC)与企业家所构成的风险投资博弈模型的基础之上引入了天使投资人(Angel),充当筛选优质项目以及信息传递者的角色,并且在多阶段风险投资过程中引入了二次信号模型,揭示项目进展情况。研究发现:天使投资人的存在及信号模型的引入对风险资本形成了很好的保护机制,并且提高了风险资本对于优质项目的配置效率,有利于风险投资多方达到共赢。     

Firm-level implications of early stage venture capital investment — An empirical investigation

We analyze the impact of venture capital finance on growth and innovation of young German firms. On the basis of statistical matching procedures we confirm findings that venture-funded firms have a higher number of patent applications than those in the control group. However, these are obtained even before the venture capitalists' investment, hence venture capitalists choose firms with demonstrated innovative output. After investment, the number of firms' patents does not differ significantly anymore, however their growth rates are significantly larger. This suggests that the higher innovativeness of venture-funded firms is due to the selection process of the venture capitalist prior to the funding rather than to the venture funding itself. Venture capitalists seem to focus rather on commercialization of existing innovations and growth of the firm.     

Venture Capitalist Certification in Initial Public Offerings

This paper provides support for the certification role of venture capitalists in initial public offerings. Consistent with the certification hypothesis, a comparison of venture capital backed IPOs with a control sample of nonventure capital backed IPOs from 1983 through 1987 matched as closely as possible by industry and offering size indicates that venture capital backing results in significantly lower initial returns and gross spreads. In effect, the presence of venture capitalists in the issuing firms serves to lower the total costs of going public and to maximize the net proceeds to the offering firm. In addition, we document that venture capitalists retain a significant portion of their holdings in the firm after the IPO.     

FINANCIAL CONTRACTING BETWEEN MANAGERS AND VENTURE CAPITALISTS: THE ROLE OF VALUE‐ADDED SERVICES,REPUTATION SEEKING,AND BARGAINING POWER

I analyze manager and venture capitalist bargaining over the financial contract in the face of double‐sided moral hazard problems. The allocation of cash flows depends on the combined effects of value‐added services, reputation seeking, and bargaining power. Welfare is maximized when the venture capitalist has high value‐adding capabilities, the market for reputation is informationally efficient, and the manager has bargaining power. Furthermore, I consider the effect of exit strategies on the financial agreement. I also consider bidding between venture capitalists of differing abilities. Generally, the superior venture capitalist wins with a lower bid, but in some cases the inferior venture capitalist can win.     

Optimal Investment,Monitoring, and the Staging of Venture Capital

This paper examines the structure of staged venture capital investments when agency and monitoring costs exist. Expected agency costs increase as assets become less tangible, growth options increase, and asset specificity rises. Data from a random sample of 794 venture capital-backed firms support the predictions. Venture capitalists concentrate investments in early stage and high technology companies where informational asymmetries are highest. Decreases in industry ratios of tangible assets to total assets, higher market-to-book ratios, and greater R&D intensities lead to more frequent monitoring. Venture capitalists periodically gather information and maintain the option to discontinue funding projects with little probability of going public.     

Venture capital budgeting — Carry and correlation

We analyze venture capital budgeting in a model with agency conflicts among entrepreneurs, venture capitalists, and investors. Our three-player setting is crucial for the analysis of compensation to venture capitalists. We focus on the venture capitalist's decision to invest in correlated enterprises, and we emphasize the importance of information and the venture capitalist's role in resolving adverse selection on the entrepreneurial side. The importance of information increases the minimum carried interest offered to the venture capitalist, whereas correlated projects decrease it. The carried interest is determined by the size and level of correlation in his portfolio. Our analysis provides predictions in line with a number of empirical observations, e.g. that venture capitalists typically receive a carried interest which is “sticky” around a 20% level.     

Venture Capital and Private Equity: A Review and Synthesis

This paper reviews the existing literature on venture capital and private equity. The paper emphasises the importance of examining venture capital in the light of recent developments in corporate finance and its distinctiveness from other forms of finance. In order to understand current developments, the paper adopts a framework which combines industry/market and firm levels of analysis. Existing literature is reviewed using this framework. Industry level issues relate to rivalry between firms, the power of suppliers and customers, and the threats from new entrants and substitutes. Firm level issues concern deal generation, initial and second screening, valuation and due diligence, deal approval and structuring, post-contractual monitoring, investment realisation, and entrepreneurs' exit and recontracting with venture capitalists. This is followed by a review of the evidence on the performance of venture capital firms. The paper suggests potentially fruitful areas for further research including the extension of analysis to cover all stages of venture capital investment, examination of the inter-linkages between industry and firm level issues and between stages in the venture capital process, as well as further analysis of deal structuring issues and investment realisation and recontracting.     

Do venture capitalists imitate portfolio size?

Venture capitalists face the challenge of determining how many entrepreneurial ventures they should invest in. Kanniainen and Keuschnigg (J Corp Finance 9:521–534, 2003) develop a theoretical model based on economic factors that shows how a venture capital fund should set its portfolio size in order to achieve optimal returns. Determining the required economic inputs to this model is difficult in practice however, given the informational asymmetries, uncertainties and ambiguities present in the decision-making environment of venture capitalists. Hence, we contend that general partners of venture capital funds also use their prior venture capital fund management experience, which we refer to as social capital, to overcome the difficulties they face in solving the above optimization problem. Our results support our hypotheses that portfolio size is explained by the interplay of economic and social factors.      

Biomarker of Quality? Venture‐backed Biotech IPOs and Insider Participation

Corporate financial managers of biotech firms need long‐term financing to reach key milestones, and that requires a long‐ term capital structure. They must balance a mix of investors with different objectives and different investment horizons that includes traditional venture capitalists and also hedge funds and mutual funds. This study helps practitioners understand the complex role of exit decisions, as venture capitalists seek better exit strategies and performance. IPOs are financing but not “exit” moves. In addition to certifying firm value, insider purchasing of shares in the IPO offering has two major consequences. First, venture capitalists reallocate large sums of capital from early‐stage to late‐stage deals that are expected to have lower risk (but also lower expected return) and shorter time to exit. Second, the speed at which VCs exit after the IPO depends on the firm ownership structure after the IPO and the stock liquidity. Going public with a significant participation by venture capitalists will probably increase the post‐IPO ownership and decrease the free float of the stock, implying a delay of the exit and the realization of the capital gains from the investments. Although this study has focused exclusively on the biotechnology industry, insider participation is not unique to it. Biotech's venture brethren in the software and technology industries also have insider participation in IPOs. During 2003–2015, approximately 41 venture‐backed firms outside of the biotechnology sector had insider participation.     

Venture Capitalists and the Oversight of Private Firms

This article examines the representation of venture capitalists on the boards of private firms in their portfolios. If venture capitalists are intensive monitors of managers, their involvement as directors should be more intense when the need for oversight is greater. I show that venture capitalists' representation on the board increases around the time of chief executive officer turnover, while the number of other outsiders remains constant. I also show that distance to the firm is an important determinant of the board membership of venture capitalists, as might be anticipated if the oversight of local firms is less costly than more distant businesses.     

On the role of inexperienced venture capitalists in taking companies public

We use venture-backed initial public offerings (IPOs) to identify and examine the comparative advantage of inexperienced venture capitalists. We argue that, vis-a-vis more established counterparts, younger venture capital firms have a comparative advantage at producing soft information about relatively opaque start-up companies due to their organizational structure. We then quantify an outcome—IPO initial return—from the matching of venture capitalists and start-up companies that demonstrates how this comparative advantage arises. Our findings thus reveal an important aspect of how inexperienced venture capitalists support start-up companies.     

Does the Presence of Venture Capitalists Improve the Survival Profile of IPO Firms?

The role of venture capital in the creation of the public corporation is now widely recognized. This study investigates whether venture capitalists add value to the going public process by improving the survival profile of IPO issuers. The survival of IPO issuers is not only likely to depend on managerial actions but also on the effectiveness of key market participants such as investment bankers and analysts. The form and function of the venture capital industry allows venture capitalists to influence the actions of managers, investment bankers, and analysts, and attract institutional interest. Conducting survival analyses using the Cox hazard methodology, we find that the involvement of venture capitalists improves the survival profile of IPO firms. Several other variables that are potentially influenced by VC involvement like R&D allocations, analyst following, investment banker prestige, and success on road shows are also positively related to the survival time of IPO issuers.     

Should Venture Capitalists Put All Their Eggs in One Basket? Diversification versus Pure‐Play Strategies in Venture Capital

Managing the different companies in which they invest while at the same time performing portfolio optimization for themselves, venture capitalists position themselves as a pure-play or diversified conglomerate through their cumulative portfolios. I examine the effects of two investment strategies of venture capitalists:  1)  a specialist "pure-play" strategy that maximizes venture capital involvement and  2)  a more generalist strategy of diversification at the "firm" level that minimizes portfolio risk. I find that neither strategy optimizes both venture capital growth and time to entrepreneurial exit, which highlights a need for institutional investors to clarify fund objectives at the time a fund is established.