Venture Capital and Other Private Equity: a Survey

We review the theory and evidence on venture capital (VC) and other private equity: why professional private equity exists, what private equity managers do with their portfolio companies, what returns they earn, who earns more and why, what determines the design of contracts signed between (i) private equity managers and their portfolio companies and (ii) private equity managers and their investors (limited partners), and how/whether these contractual designs affect outcomes. Findings highlight the importance of private ownership, and information asymmetry and illiquidity associated with it, as a key explanatory factor of what makes private equity different from other asset classes.     

Relational venture capital financing of serial founders

I study how often and why a serial founder receives financing for his new company from a venture capital (VC) firm that also invested in his previous company. One in 10 VC investments leads to a repeated relationship and one in three serial founders enters into a repeated relationship with any previous VC firm. A repeated relationship is more likely when the relational VC firm has acquired more private information about the founder, but less likely if the founder’s new venture has a bad fit with the VC firm’s geographic or industry focus. My findings add to the literature on relational financing by showing that the preservation of information is an important motivation for relational financing when screening and monitoring costs are high. Yet, repeated relationships are discontinued because investors also respond to information problems by specializing in certain types of firms. Finally, I find evidence of non-relational investments being passed onto trusted VC syndication partners.     

CARE Conference Hong Kong Polytechnic University,June 9, 2014: Equity Financing for Early‐Stage Companies in China

Many of the smaller private‐sector Chinese companies in their entrepreneurial growth stage are now being funded by Chinese venture capital (VC) and private equity (PE) firms. In contrast to western VC markets, where institutional investors such as pension funds and endowments have been the main providers of capital, in China most capital for domestic funds has come from private business owners and high net worth individuals. As relatively new players in the market who are less accustomed to entrusting their capital to fund managers for a lengthy period of time, Chinese VCs and their investors have shown a shorter investment horizon and demanded a faster return of capital and profits. In an attempt to explain this behavior, Paul Gompers and Josh Lerner of Harvard Business School have offered a “grandstanding hypothesis” that focuses on the incentives of younger, less established VCs to push their portfolio companies out into the IPO market as early as they can—and thus possibly prematurely—to establish a track record and facilitate future fundraising. This explanation is supported by the under‐performance of Chinese VC‐backed IPOs that has been documented by the author's recent research. Although they continue to offer significant opportunities for global investors, China's VC and PE markets still face many challenges. The supervisory system and legal environment need further improvement, and Chinese funds need to find a way to attract more institutional investors—a goal that can and likely will be promoted through government inducements.     

Limited partner performance and the maturing of the private equity industry

We evaluate the performance of limited partners? (LPs?) private equity investments over time. Using a sample of 14,380 investments by 1,852 LPs in 1,250 buyout and venture capital funds started between 1991 and 2006, we find that the superior performance of endowment investors in the 1991–1998 period, documented by prior literature, is mostly due to their greater access to the top-performing venture capital partnerships. In the subsequent 1999–2006 period, endowments no longer outperform, no longer have greater access to funds that are likely to restrict access, and do not make better investment selections than other types of institutional investors. Nevertheless, all investor types? private equity investments continue to outperform public markets on average. We discuss how these results are consistent with the general maturing of the industry, as private equity has transitioned from a niche, poorly understood area to a ubiquitous part of institutional investors? portfolios.     

Venture capital reputation and investment performance

I propose a new measure of venture capital (VC) firm reputation and analyze its performance implications on private companies. Controlling for portfolio company quality and other VC-specific factors including experience, connectedness, syndication, industry competition, exit conditions, and investment environment, I find companies backed by more reputable VCs by initial public offering (IPO) capitalization share (based on cumulative market capitalization of IPOs backed by the VC), are more likely to exit successfully, access public markets faster, and have higher asset productivity at IPOs. Further tests suggest VCs’ IPO Capitalization share effectively captures both VC screening and monitoring expertise. My findings have financial implications for limited partners and entrepreneurs regarding their VC-sorting activities.     

Provision of financial information and its impact on the relationship between executives and venture capital managers: A study of the private equity market in Egypt

This study makes an attempt to further understand the practices of private equity/venture capital (PE/VC) in developing markets. We focus our attention on the relationship between PE/VC firms and the investee companies (ICs) and its development. We investigate the provision of financial and non-financial information and its effects on the development of the relationship between chief executive officers (CEOs) and PE/VC managers in Egypt as one of the developing markets. Data were collected from Egyptian PE/VC firms via semi-structured interviews. Both similarities and differences were found between Egyptian PE/VC in respect of developing the relationships with their ICs. Results show that the provision of timely information allows PE/VC managers to: (i) have a higher degree of trust on CEOs; (ii) be more supportive of the CEO's strategic decisions; and (iii) interact more frequently with the ICs. The origin of the PE/VC firms seems to have an effect on the Egyptian PE/VC firms’ behaviours. International PE/VC firms are also more likely to get involved in every decision at the strategic level of the ICs. The current study provides some implications for both CEOs of the ICs and PE/VC managers. It is important for PE/VC managers to develop and maintain successful relationships with ICs, which will promote a positive image of the PE/VC firms that can be used for marketing purposes, which in turn can be translated into more deals in the future.     

The effects of private equity and venture capital on sales and employment growth in small and medium-sized businesses

We study the effects private equity (PE) and venture capital (VC) financing have on small and mid-sized single entity business establishments from 1995 to 2009. We focus on single entity establishments to cleanly examine the impact of PE and VC financing on establishments’ organic growth. This study reveals that PE and VC financing have positive impacts on single entity business establishments’ net sales and employment growth. The impact of PE financing on establishments’ growth is slower and smaller than VC financing. However, we find that the benefit of PE financing lasts longer than VC financing. We also find that ethnic minority, female, and foreign business owners are less likely to receive PE and VC financing. Finally, we find evidence that although establishments with government contracts are more likely to receive PE and VC financing, those contracts fail to produce marginal post-funding growth and employment benefits.     

Strategic alliances,equity stakes,and entry deterrence

I study how strategic alliances and their impact on future competitive incentives can motivate interfirm equity sales. In the model, an alliance between an entrepreneurial firm and an established firm improves efficiency for both. However, the requisite knowledge transfer heightens the established firm's incentive to enter one of its partner's markets. I show that equity can eliminate the entry incentive, but accommodation is sometimes chosen to encourage entrepreneurial effort on future growth options. I analyze stake sizes, block pricing, and welfare effects. The results have implications for equity alliances, corporate venture capital, and the organization of research activities.     

The size of venture capital and private equity fund portfolios

We propose a model that examines the optimal size of venture capital and private equity fund portfolios. The relationship between a VC and entrepreneurs is characterized by double-sided moral hazard, which causes the VC to trade off larger portfolios against lower values of portfolio companies. We analyze the structural relations between the VC's optimal portfolio structure and entrepreneurs' and VC's productivities, their disutilities of effort, the value of a successful project, and the required initial investment in a venture. We also test the model's predictions using a small proprietary dataset collected through a survey targeted to VC and private equity funds worldwide.     

Private equity alliances in mergers

This paper examines reasons for alliance formation between private equity bidders when compared to sole-sponsored private equity deals. Testing a comprehensive set of hypotheses, we find strong evidence for the relative-risk hypothesis of Robinson (2008), as private bidders are more likely to form an alliance in a diversifying acquisition. We also find that private equity alliances involved more profitable target firms when compared to sole-sponsored private equity deals. Finally, we find that the significantly lower abnormal returns for target firms in private equity alliance deals are eliminated once we control for differences in the types of target firms acquired by private equity alliances and single private equity bidders. The last result suggests that private equity alliances do not generate significantly lower target returns because of collusion.     

Private Equity,the Rise of Unicorns,and the Reincarnation of Control‐based Accounting

This article discusses the rise of intangibles‐intensive companies and private equity (PE) since the late 1970s, and the role of both in bringing about the creation of a streamlined, more flexible set of accounting rules that, since their approval by the IASB and FASB in 2009, have been used by private companies and their investors. The PE industry comprises both venture capital (VC) firms that fund high‐growth enterprises and leveraged buyout (LBO) firms that fund more traditional, cash‐generating operations. Mainly because of the greater risks associated with both VC‐backed firms and LBOs—risks that make them ill‐suited for most public investors—such companies tend to require the more direct and active oversight provided by PE investors. And as the author goes on to argue, the more direct and active ownership of PE investors, as compared to the governance provided by most public‐company boards, suggests that financial accounting and reporting play a fundamentally different role in private than in public companies. Whereas the primary role of public‐company GAAP has increasingly (since the creation of the SEC in 1933) been to provide information for outside investors when valuing companies, the most important function of accounting reports in private companies is internal control—more specifically, ensuring that the interests of the managers of their portfolio companies are aligned with those of all the providers of capital. And recognizing this difference in the role of accounting, both the IASB and FASB responded to the requests of various parties (including private companies) by approving in 2009 the use by private companies of a streamlined and more flexible set of accounting standards. To the extent that the workings of PE markets continue to reduce the numbers of U.S. public companies, the author predicts that the resulting increase in the use of private‐company GAAP will continue to shift the primary role of accounting away from valuation and back toward its traditional roots in internal control and corporate governance.     

The potential for expropriation through joint ventures

We examine the potential expropriation of a firm's intellectual capital that results from joint venture agreements when a firm's joint venture partner becomes the target of an acquisition attempt. We find that: (1) non-targeted joint venture partners often suffer losses in value upon the announcement of the acquisition; (2) the magnitude of the loss increases with the R&D intensity of the non-targeted joint venture partner; and (3) average bidder returns are less negative for acquirers if the affected joint venture partners report R&D spending and are in the same line of business as the acquirer. Our estimate of the average loss is $843 million per firm, roughly 3% of the non-targeted firm's pre-announcement equity value. Our evidence suggests a previously unrecognized merger motive in that joint ventures expose a firm's intellectual capital to the risk of expropriation.     

对我国风险投资组织模式选择的研究

有限合伙制以其特有的产权和责任安排而被认为是最符合风险投资行业特点和要求的组织形式。我国在对建立有限合伙制风险投资企业的认识上存在一定的分歧，本认为随着我国经济的不断向前发展，相关法律法规的完善，有限合伙制必然会成为我国风险投资企业组织模式的首选。     

The impact of venture capital backing on the corporate governance of Australian initial public offerings

This study explores the role of venture capitalists on investee boards at the time of listing for 552 initial public offerings. Australian board structures and mechanisms are more similar to those in the US and the United Kingdom, but market activity characteristics are more similar to Japanese and German systems. Further, the Australian private equity market is relatively young compared to US and European markets. IPOs backed by venture capital have more independent boards, similar to US IPOs. Venture capitalists improve governance by using their networks to recruit specialist independent directors with industry experience.     

Liquidity,Technological Opportunities,and the Stage Distribution of Venture Capital Investments

This paper explores the determinants of the stage distribution of European venture capital investments from 1990 to 2011. Consistent with liquidity risk theory, we find that the likelihood of investing in earlier stages increases relative to all private equity investments during liquidity crisis years. While liquidity is the main driver of acquisition investments and, to some extent, of expansion financings, technological opportunities are overall the main driver of early and late stage venture capital investments. In contrast to the dotcom crash, the recent financial crisis negatively affected the relative likelihood of expansion investments, but not of early and late stage investments.     

Asset liquidity and venture capital investment

We examine the relationship between asset market liquidity and venture capital (VC) investment and find that it is inverted U-shaped. Asset liquidity and VC investment are positively related for low levels of asset liquidity but negatively related for higher levels of asset liquidity. We also document evidence that VC firms with more industry experience invest more in a liquid asset market than those without industry experience or with significant experience in other industries. Portfolio companies obtained their first investment in a liquid asset market are less likely to exit successfully; however, given a successful exit, they prefer to exit through mergers and acquisitions rather than going public.     

The Capital Structure of PE‐Funded Companies (and How New Debt Instruments and Investors Are Expanding Their Debt Capacity)

The capital structures and financial policies of companies controlled by private equity firms are notably different from those of public companies. The concentration of ownership and intense monitoring of leveraged buyouts by their largest investors (that is, the partners of the PE firms who sit on their boards), along with the contractual requirement of PE funds to return their capital within seven to ten years, have resulted in capital structures that are far more leveraged than those of their publicly traded counterparts, but also considerably more provisional and “opportunistic.” Whereas the average U.S. public company has long operated with roughly 30% debt and 70% equity, today's typical private‐equity sponsored company is initially capitalized with an “upside‐down” structure of 70% debt and just 30% equity, and then often charged with working down its debt as quickly as possible. Although banks supplied most of the debt for the first wave of LBOs in the 1980s, the remarkable growth of the private equity industry in the past 25 years has been supported by the parallel development of a new leveraged acquisition finance market. This financing innovation has led to a general movement away from a bankcentered funding base to one comprising a relatively new set of institutional investors, including business development corporations and hedge funds. Such investors have shown a strong appetite for new debt instruments and risks that banks have been unwilling or, thanks to increased capital requirements and other regulatory burdens, prohibited from taking on. Notable among these new instruments are second‐lien loans and uni‐tranche debt—instruments that, by shifting the allocation of claims on the debtor's cash flow and assets in ways consistent with the preferences of these new investors, have had the effect of increasing the debt capacity of their portfolio companies. And such increases in debt capacity have in turn enabled private equity funds—now sitting on near‐record amounts of capital from their limited partners—to bid higher prices and compete more effectively in today's intensely competitive M&A market, in which high target acquisition purchase prices are being fueled by a strong stock market and increased competition from corporate acquirers.     

Venture Capital Coordination in Syndicates,Corporate Monitoring,and Firm Performance

This paper examines how the coordination of venture capital (VC) investors in their syndicates, as measured by their geographic concentration, affects firm performance and ex ante contractual terms. Using the introduction of new airline routes between the locations of VC investors as a shock to their coordination costs, we find that firms with geographically concentrated VC investors are more likely to exit successfully than other firms. Geographically proximate VC investors are also more likely to form syndicates in follow-up rounds and to use less intensive staged financing and fewer convertible securities.     

Syndication in Venture Capital Financing

We examine syndication in venture capital (VC) investments between 1980 and 2005. We argue that VC firms syndicate investments to mitigate human capital and financial constraints within individual VC firms and to reduce uncertainty about firm value. Our results are consistent with those arguments. We find that syndication is more likely for firms in the earliest stage of development and firms in the last stage of development as private firms (when human capital investments are greatest), for firms requiring the largest amounts of financial capital, and for firms with greater growth opportunities (those that are most difficult to value).     

Venture capital investment cycles: The impact of public markets

It is well documented that the venture capital industry is highly volatile and that much of this volatility is associated with shifting valuations and activity in public equity markets. This paper examines how changes in public market signals affected venture capital investing between 1975 and 1998. We find that venture capitalists with the most industry experience increase their investments the most when public market signals become more favorable. Their reaction to an increase is greater than the reaction of venture capital organizations with relatively little industry experience and those with considerable experience but in other industries. The increase in investment rates does not affect the success of these transactions adversely to a significant extent. These findings are consistent with the view that venture capitalists rationally respond to attractive investment opportunities signaled by public market shifts.