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Legality and Venture Capital Governance Around the World
Abstract
We analyze governance with a new dataset on investments of venture capitalists in 3848 portfolio firms in 39 countries from North and South America, Europe and Asia spanning 1971–2003. We provide evidence that cross-country differences in legality, including legal origin and accounting standards, have a significant impact on the governance structure of investments in the VC industry: better laws facilitate faster deal screening and deal origination, a higher probability of syndication and a lower probability of potentially harmful co-investment, and facilitate investor board representation of the investor. We also show that country-specific differences exist apart from legal and economic development.
... Some papers specifically related to venture capital in an international context include an early contribution by Megginson (2004) and a comparison of the legal environment in 16 countries, which emphasizes the importance of (colonial) legal origin in determining a country's level of venture capital activity (Cumming, et al, 2010). ...
... In this section, we compare our findings with those from a previous study that employed static measures of institutional quality, namely legal origin. Cumming, et al (2010) argued that the historical (often, colonial) legacy of a country's legal system affects the development of financial markets, and, in particular, the functioning of venture capital markets. They categorize countries based on their origin as either English (Common Law), French, German, or Scandinavian. ...
... Contracts is a variable taking higher values for countries with judicial systems that are more likely to enforce contracts. Legal origin variables from Cumming, et al (2010). Parentheses contain T-statistics (Panel A) or Z-statistics (Panel B). ...
Economists examine foreign direct investment, which mostly constitutes flows to established firms (sometimes characterized as “multinational corporations”) that might or might not engage in truly innovative activity in the FDI target country. Conversely, finance scholars have studied the pipeline of entrepreneurial finance from limited partnerships (LPs) to venture capitalists (VCs) or private equity general partners (GPs) to portfolio firms. Few studies examine relationships between general and limited partners, and those that do often examine only the United States, or a limited number of countries in a given region. This paper uses a novel dataset (LP Source) to examine secular trends in cross-national flows from the LP to the GP (in the form of various investment funds) to the portfolio firm. We find evidence for “home bias” and demonstrate that cross-border flows are affected by GDP per capita, export orientation, and country-level measures of the entrepreneurial environment.
... L'implication de la part des SCR fait également l'objet d'une étude réalisée par Schwienbacher (2008) (Hege et al., 2009). Par ailleurs, une seconde analyse relative à des investissements réalisés dans 3848 entreprises prouve que les différences entre les pays en matière juridique, y compris l'origine légale et les normes comptables, ont un impact significatif sur la structure de gouvernance des investissements dans l'industrie du capital-risque (Cumming et al., 2010). ...
... Initialement prévu pour apporter des incitations fiscales en contrepartie des financements en R&D, l'efficacité de ce système est parfois remis en cause, en particulier quant à l'existence d'un lien entre l'efficience du dispositif de subventionnement fiscal et la production d'innovations (Negassi et Sattin, 2016;Pommet et Sattin, 2016). Une autre problématique concerne la multiplicité des offres et dispositifs, susceptibles de tourmenter les investisseurs pour lesquels de meilleures lois facilitent une sélection et un montage plus rapide des opérations (Cumming et al., 2010). En effet, l'établissement de ces « solutions » juridiques nécessitent de s'interroger sur le rôle et l'utilité de certaines de ces règlementations (Pommet et Sattin, 2016 (Battini, 2017). ...
... Dans la perspective d'uneamélioration, les apporteurs en capitaux doivent renouer avec un climat de confiance. Toutefois, fiscales mises en place semblent favoriser cette croissance (LaPorta et López-de-Silanes, 1998;Gompers et Lerner, 1999;Bottazzi et al., 2008;Cumming et al., 2010). Pour conclure, nous pouvons constater que l'initiative privée a joué un rôle majeur dans la professionnalisation et l'institutionnalisation du capital-risque aux États-Unis. ...
This thesis focuses on the unexplored issues of the relationship between public and private venture capitalists in France. This research mobilizes agency and incentive theory as well as cognitive theories of governance, in particular the Resource Based View. These theoretical frameworks are considered from the perspective of complex network theory and public-private partnerships. Our empirical analysis is divided into three stages. After a qualitative study with an exploratory dimension, carried out with venture capitalists and actors of innovation networks, we carried out a first quantitative study covering the period from 2005 to 2019, based on 516 financings carried out in 283 French companies. Subsequently, we conducted a second quantitative study that counts 585 financings carried out in 322 companies over the same period. The first part of this study focuses on deals completed in the early stages of financing: Seed, Early and Expansion; the second, focuses on those completed in the Development stage. The objective here is twofold: first, to study the effects of syndication financing and also of public and private actors on the innovation of companies, measured here by R&D expenditures and patent filings (Input and Output). The other purpose of this research is to observe whether the issues of innovation financing in terms of financial performance are the same for private and public venture capital. To test all our hypotheses, we use a dynamic panel approach (OLS, fixed effects, MMG).The first part of our study allows us to propose a more precise definition of the relationship between public and private venture capitalists and to reveal the existence of a specific phenomenon linked to the presence and intervention of public actors, identified as a crowding-out effect. The second and third parts of this work highlight several other results. First of all, the choice of using variables dependent on R&D expenditure and patent registrations in our study is of interest. Indeed, these measures of innovation make it possible to distinguish between the financing methods specific to certain types of actors. Thus, this study shows that the financial resources granted by public or private investors as leader of a syndication can have an influence on the innovation strategy of firms. This doctoral work proposes a contribution by highlighting the role played by public and private actors in the governance of private equity-backed firms. Indeed, the overlap between results confirms the interest for a private equity firm to position itself as a leader within a syndication. This research also indicates that the investment strategy pursued in mixed syndication seems to be the most efficient. Finally, our results show that the use of mixed syndication financing led by a private equity investor tends to "optimize" both the effects on innovation and the financial performance of the firm. In the opposite case, we observe that the financing of public capital-investors has a negative and significant effect on patent filings and on the ROA variable. In the end, our conclusions are nuanced, highlighting investment logics between public and private venture capitalists that are neither perfectly similar nor completely opposed, but complementary under certain conditions.
... Political uncertainty also intensifies information asymmetry between VC firms and startups, making the business prospects of early-stage startups even more ambiguous (Dushnitsky & Shapira, 2010;Ruhnka & Young, 1991). High political uncertainty complicates the decision-making process of VC firms and makes investment criteria more blurred and unstable (Baker et al., 2005;Cumming et al., 2010;Nanda & Rhodes-Kropf, 2013). As illustrated in Fig. 1b, we expect that VC firms, reacting to high political uncertainty and intensified information asymmetry, tend to avoid early-stage investments, leading to a U-shaped relationship between governors' tenure and such investments. ...
... Vol:. (1234567890) of government on VC firms' investment decisions from the broad environmental perspective, focusing on the market and legal conditions indirectly caused by regional government (e.g., Cumming et al., 2010;Guler & Guillen, 2010;Khoury et al., 2015). Despite this body of evidence, our understanding of how VC firms' decisions are jointly influenced by both direct and indirect government effects remains limited. ...
Drawing on the subnational institutional perspective, the study examines the role of governors in shaping the institutional environment and altering venture capital (VC) firms’ perceived risks associated with early-stage investments. Using data about provincial governors and VC investments in China from 2000 to 2016, we find that VC firms’ early-stage investment relates to the local governor’s tenure in a U-shaped manner considering the varying level of political uncertainty jointly shaped by the governors’ incentives and capabilities over the tenure. The U-shaped relationship is steeper when the provincial governor is promoted to the current position and has substantial local experience, while is flatter for government-backed VC firms. Incorporating the political business cycle perspective, the study contributes to the institutional theory literature by highlighting the role of politicians who serve as subnational institutional agents in VC firms’ risky decisions. It also enriches the VC literature by adding a novel explanation of early-stage investments.
... Empirical evidence highlights that FIs are relatively easier to change in the short term, whereas informal institutions tend to endure longer (Ahlstrom and Bruton, 2006) and thus serve as antecedents of FIs (Williamson, 2000). Although some FIs are recognized as determinants of VC activity (Cumming et al., 2010), there is no consensus on the influence of informal institutions on investors (Grilli et al., 2019). Research on international VC reveals a significant gap in understanding VC firms' behaviour across country borders prompting the exploration of resource-based, capabilities, institutional, and network theories to fill this void (Wright et al., 2005). ...
... First, operationalizing institutions into a set of variables forced us to leave aspects of each nation's characteristics out of the study, such as the role of government policies (Bianchini and Croce, 2022), programmes such as accelerators (Robinson, 2022), or other legal variables (Smith et al., 2022), or other cultural dimensions such as Schwartz (1994) religion (Chircop et al., 2020). 2 Secondly, in striving for global applicability, this study could not capture detailed, non-comparative information that might prove valuable and better suited for more context-specific research. For example, Cumming et al. (2010) argue that certain VC-backed firms relocated to countries with more developed legal frameworks. Future research can address this gap by focusing on the migration patterns of ventures or entrepreneurs instead of monetary flows. ...
Grounded in Hofstede cultural dimensions theory, we examine how informal institutional factors shape cross-country venture capital (VC) flows. Separating VC activity into flows, our method studies how an increment in inflows supports ventures, and an increment in outflows more investing activity. Results suggest that (1) uncertainty avoidance negatively affects investors and ventures (the last with a larger effect), (2) individualistic attitudes equally support both investors and ventures, and (3) a higher level of power distance contributes to a larger private investors sector, an effect that is greater under strong formal institutions (FIs). Effects of masculinity, long-term orientation, and indulgence are inconclusive. Results are robust to various specifications, use of instruments, and endogeneity treatments. The implication is that the optimal characteristics of informal institutions for fostering VC activity differ depending on the level of FIs, as both institutions interact to affect both investors and ventures.
... Lastly, our paper explores studies on labor law and VC investment (eg. Cumming et al., 2010;Cumming and Li, 2013;Castellaneta et al., 2016;Xing et al., 2017;Gu et al., 2022 andYung, 2024). Castellaneta et al. (2016) document how a court ruling in favor of the Inevitable Disclosure Doctrine (IDD) boosts VC investments by assuring investors that the core employees and trade secrets of the VC-backed companies can be retained. ...
... Using a sizable sample of companies that underwent an initial public offering between 1983 and 2013, Xing et al. (2017) discover that companies that receive VC funding and operate within industries with high levels of unionization tend to have a lower Tobin's Q and a decreased likelihood of survival. Furthermore, Cumming et al. (2010) argue that cross-country differences in legality have a significant impact on the governance structure of investments in the VC industry. They further argue that better laws facilitate faster deal screening and deal origination. ...
Using state-level data from the United States covering the period 1980 to 2020, we explore the effect of right-to-work (RTW) laws on venture capital (VC) investment. Employing a difference-in-differences strategy, we find that the passage of right-to-work laws increases venture capital investment. The results are robust to omitted variable bias, reverse causality and unobservable local economic conditions. We find that the positive effect of RTW laws on VC investments remains significant in states that are highly unionized and technological.
... Using principal components analysis, Berkowitz et al. (2003) propose the « Legality » index, an index measuring the strength of the legal system (Aggarwal & Klapper, 2003;Cumming, Schmidt, & Walz, 2010;Tiede, 2018). ...
The purpose of this paper is to identify and study the most relevant factors that explain the debt-equity choices of firms in emerging markets. Using data from 4,735 non-financial listed firms from 18 emerging markets over the "special" period 1990-2007, results indicate that asset tangibility, firm size, private credit to GDP, and the creditor protection index are associated with higher leverage ratios, while profitability, growth opportunities, the shareholder protection index, stock market size, the legality index, GDP growth rate, and inflation rate are associated with lower leverage ratios. Using the panel data approach, results also indicate that the tangibility of assets and the shareholder rights index are the most prominent determinants of capital structure. Furthermore, the research suggests that the debt-equity choice decisions of firms differ according to geographical origin, legal origin, and financial system development. Differences also exist at the sectoral level. Results finally show that the Asian financial crisis had effects on capital structure determinants. We detect significant upward trends in four different leverage ratios before and during the eruption of the financial and banking crisis. After the crisis, asset tangibility, profitability, and the creditor rights index influence the firm’s capital structure determinants differently.
... Good laws facilitate faster deal screening and origination, increase the probability of syndication, and help investor board representation. Thus there are country-specific distinctions in the law systems that affect entrepreneurial finance (D. Cumming et al., 2010). ...
... It is well documented that the legal environment has a significant effect on entrepreneurship and VC both in developed and emerging markets (Cumming, Schmidt & Walz, 2010;García-Cabrera & García-Soto, 2022;Schüler, 2022). The literature indicates that VC fundraising is influenced by various factors, including accounting standards, as demonstrated by Jeng and Wells (2000), and regulations, particularly those pertaining to disclosure (Cumming & Knill, 2012;Cumming & Zambelli, 2013) and the safeguarding of property rights (Groh & Liechtenstein, 2011). ...
The paper explores the association between financial development and venture capital fundraising, and how that relationship varies with institutional quality. We analyze a dataset of thirty-one countries between 2005 and 2017 using a dynamic two-step system generalized method of moments (GMM) estimation technique. We find that financial development and its two components, namely financial markets, and financial institutions, exert a significant positive effect on venture capital fundraising. However, the relationship shifts with institutional quality, with positive and large effects in countries with robust legal frameworks but not in those with weak legal frameworks. The results are robust to the use of different data sources and proxies for institutional quality, as well as estimation techniques.
... Cross-border VC investments face multiple disadvantages, such as information asymmetry, agency risks, and geographical, institutional, and cultural differences (e.g., Sorenson and Stuart 2001;Portes and Rey 2005;De Clercq and Sapienza 2006;Chan et al. 2005;Bell et al. 2012;Cumming et al. 2010;Bruton et al. 2005). These disadvantages motivate cross-border VC investors to find ways to reduce information uncertainty and asymmetry. ...
In the context of the Chinese market, foreign cross-border venture capitalists have devised specific strategies to mitigate the challenges associated with the liabilities of foreignness, such as risks and information asymmetry. They have strategically leveraged social capital to not only decrease investment risk but also to influence their investment preferences and behaviors. To investigate the influence of different types of social capital on the investment decisions of cross-border venture capitalists, hypotheses are proposed and tested using regression analysis. Our research reveals several key findings in this regard. Firstly, cross-border venture capitalists with a robust structural social capital network exhibit a greater propensity to invest in early-stage companies. This suggests that well-established connections and partnerships within the Chinese entrepreneurial ecosystem provide a level of comfort and confidence when investing in ventures at their infancy. Interestingly, relational and cognitive social capital, though undoubtedly valuable, do not significantly impact the decision to make early-stage investments. Furthermore, we have observed that venture capitalists with higher levels of structural and cognitive social capital are more inclined to form syndications. Collaborative partnerships and shared knowledge networks seem to be crucial factors that drive syndication decisions. Lastly, venture capitalists endowed with substantial structural and relational social capital tend to allocate larger investment amounts, signifying the influence of business or personal relationships and network connections on the scale of their investments.
... To capture possible variations in venture creation processes, the population interviewed includes independently registered ventures of all legal forms (excluding sole proprietorship and liberal professions) that were registered between 2004 and 2014 1 in the information technology (IT) and renewable energy (RE) industries in Germany, Italy, the US, the Netherlands, and the UK. The five countries were selected in line with the varieties-of-capitalism literature in order to control for different institutional backgrounds: Germany, Italy and the Netherlands have strong banking systems, whereas the Anglo-Saxon countries have equity-based financial systems (Cumming, Schmidt, and Walz 2010;Cumming and Zhang 2019). From this population, founders were randomly selected and invited to participate in an interview about the venture creation process of their company until a sample of 762 cases had been obtained. ...
... It is also recommended to address, shortly, a European regulation that favors an ecosystem of social entrepreneurship in the EU so that the scope of action of SE is specified to establish an adequate legal and fiscal framework for this type of enterprise, which unifies criteria among the different member countries, and that it takes into account their characteristics and objectives. According to Cumming et al. (2010), better-quality legal systems are beneficial for more entrepreneurial activity. Legal, administrative, and fiscal burdens should not be too onerous to make it easier for enterprises to focus on both social and economic activities. ...
This research examines the impact of social entrepreneurship (SE) on sustainability and innovation by considering the determining factors of entrepreneurship as identified in the literature. The authors undertake an empirical analysis with structural equation modeling for ten European Union countries with supportive regulations related to SE: Belgium, Holland, Slovenia, Spain, Finland, Greece, Italy, Luxembourg, Portugal, and Romania. The data used is obtained primarily from the Global Entrepreneurship Monitor-Specific report on SE (GEM), Eurostat Database, and SDG Index database. The findings show that social and economic factors are positively related to SE. The impact of SE on sustainability and innovation is also found to be positive. SE becomes an important asset by creating economic benefits through innovation and sustainable welfare. This research contributes to the gap in current empirical research. The authors identify reasons for these findings and offer some practical insights to design policies, such as an adequate legal and fiscal framework, to promote social entrepreneurship.
... The inaccessibility of overseas VC firms to a portfolio company can be mitigated by the participation of local VC firms as co-investors, which are in a better position to oversee and provide guidance to the company (Chemmanur et al., 2016). It has been observed that ventures of Asia-Pacific region are relocating their operations to the United States for a various reason, with the country's more business-friendly legislative climate being one of the primary factors (Cumming et al., 2010). It should be underlined that neither authoritarian nor democratic administrations are universally characterised by excellent governance. ...
... The inaccessibility of overseas VC firms to a portfolio company can be mitigated by the participation of local VC firms as co-investors, which are in a better position to oversee and provide guidance to the company (Chemmanur et al., 2016). It has been observed that ventures of Asia-Pacific region are relocating their operations to the United States for a various reason, with the country's more business-friendly legislative climate being one of the primary factors (Cumming et al., 2010). It should be underlined that neither authoritarian nor democratic administrations are universally characterised by excellent governance. ...
... Lerner and Schoar (2005), p 223 et seq.; see alsoLerner and Schoar (2004).19 Cumming et al. (2010), p 54 et seq. ...
This is the first European study to conduct an extensive empirical research of startup charters. Our aim is to test whether the significant reforms of the law on the Italian società a responsabilità limitata (the GmbH -type limited liability company) were successful in making Italian corporate law more amicable towards startups and venture capital contracting techniques. We explain why, in the Italian context, charters provide significant information on financing deals, and we analyse more than 5000 charters of Italian startups. We find almost 200 charters that reflect the features predicted by the financial contracting theory, albeit with some significant variations in comparison to the US experience. The main one is that convertible preferred shares are not used. We report the large use of (non-convertible) participating preferred shares but also the increasing adoption of preferred shares that are functionally equivalent to US convertible non-participating preferred shares. The absence of convertibility mechanisms also explains the different structure of antidilution clauses in the Italian market. Hybrids are used to provide SAFE- and KISS-like contractual solutions. Co-sale clauses (tag-along and drag-along) are widespread and also highly standardized. US-like vesting schemes are equally observed. Some of the peculiarities we report depend on Italian law idiosyncrasies that are mainly the product of doctrinal constructions. However, corporate practice is pushing the envelope in its efforts to adapt Italian charters to startuppers’ and investors’ needs. From this standpoint, the Italian reforms look, though not completely, successful. Startup law appears to be transforming the European corporate law tradition.
Research Summary
This study reviews four decades of fragmented and contradictory empirical literature on the real effects of private equity (PE) buyouts on portfolio companies, differentiating between efficiency and growth outcomes. We hypothesize how institutional forces, including regulatory, cognitive, and normative institutions explain heterogeneity in post‐buyout efficiency and growth across time and countries. We argue that competition and population‐level learning have shifted the cognitive frame underlying value creation in buyouts from financial engineering toward operational engineering and strategic entrepreneurship. Using meta‐analysis, we find support for several of our hypotheses using samples from 66 empirical studies across the finance, management, economics, and entrepreneurship disciplines.
Managerial Summary
This study delves into four decades of fragmented private equity (PE) literature to unravel the practical implications for post‐buyout efficiency and growth. Using meta‐analysis, we explore the role of institutional forces—regulatory, cognitive, and normative—in shaping outcomes across diverse temporal and geographical contexts. We observe an overall paradigm shift in PE value creation over time, transitioning from focusing on financial engineering to operational value creation and strategic entrepreneurship. This transformation is driven by heightened competition and widespread population‐level learning. Validating our hypotheses through a thorough examination of 66 empirical studies spanning finance, management, economics, and entrepreneurship disciplines, our findings offer insights for policymakers and practitioners navigating the nuanced landscape of PE buyouts.
Despite the limited financial resources available for technological entrepreneurship in Iran, particularly in terms of bank-oriented financing, venture capital (VC) plays a relatively minor role in financing knowledge-based and technology-driven companies. Strengthening the legal infrastructure through appropriate incentives could promote VC growth. This article, after reviewing the theoretical foundations, performs an importance-performance analysis of the legal components affecting VC in Iran at two levels: macro policies and specific regulations related to VC funds. This analysis was carried out by distributing a semi-structured questionnaire among CEOs and vice presidents of VC funds, non-governmental research and technology funds, and other private companies. The current state of the legal infrastructure for VC was then examined by analyzing relevant laws and comparing them with prioritized legal components. The aim was to suggest solutions to address legal gaps and enhance relevant laws. The findings indicated that, except for tax incentives, other key legal components necessary for VC development are not adequately addressed in the existing laws. To address this deficiency, it is recommended that the social security law be revised to consider the nature of startups and technology companies, and that the intellectual property system be organized to increase demand for venture capital. Additionally, policymakers are advised to continue and streamline processes related to existing tax exemptions, provide tax exemptions for profits reinvested in production rather than distributed among shareholders, and impose taxes on speculative activities outside the innovation ecosystem to channel financial resources into technological entrepreneurship.
As found in behavioral decision theory, venture capitalists (VCs) rely on heuristics and bias, owing to their bounded rationality, either by limited alternatives or information and resources. India’s booming startup scene challenges VCs in decision-making owing to information overload from numerous evolving ventures, which hinders informed judgment. VC investment behavior, due diligence, and cognitive factors related to decision-making have always drawn the attention of researchers. We provide an alternative approach for an optimal decision by VCs by identifying the attributes that influence investment or funding decisions at an early stage of a venture in tech-based industries. Through a literature review, we identify eight attributes, both on internal and external criteria, that venture investors consider when making investment decisions. Based on interviews with 20 experts, we further identify eight key tech-based sectors. Using grey system theory, we then determine the rankings of eight tech startups for investors’ early-stage investment decisions. This study presents a linguistic variable-based approach of grey numbers to decide weights and ratings, the grey possibility degree to compare and rank different tech startups, and based on the results, suggests the ideal tech startup. We find that agritech ranks first; thus, investors should prefer venturing into such startups for early-stage investment. E-commerce and edutech ranked second and third, respectively, followed by electric vehicle infrastructure, insurtech, fintech, space tech, and software as a service.
The second international scientific conference of the Universidade Europeia Business and Social Sciences School is "Navigating The Future of Management". We want to address the future of management by evaluating its primary functions—Finance, Marketing, Human Resources, Information Systems, Operations, Quality, Research, Development, and Innovation—and current and future scientific and technological advances. Big data, 3D and 4D prints, cryptocurrency, genetic therapies, costless and inexhaustible energy sources, intelligent transport, the new generation of logistics, quantum computing, augmented reality, virtual reality, IoT, robotics and its growing impact on task implementation, nanotechnology, E-learning, the genome, the organoid, and the substantial increase in life expectancy are driving future Educational institutions, especially universities, must develop prospective studies and exercises to trace contrasting scenarios and develop predictive approaches to illuminate the future while promoting more flexible decision-making systems and enterprise adaptability. The conference scientific committee chose 30 papers from academics and PhD students. Select themes encompass several management science fields. The Universidade Europeia of Lisbon thanks everyone who contributed to this conference's success through papers, presentations, or scientific and organizing committee work.
This is the second international scientific conference of the Universidade Europeia Business and Social Sciences School on the subject of "Navigating The Future of Management". It is our goal to face the future of management considering its major functions – Finance, Marketing, Human Resources, Information Systems, Operations, Quality, Research, Development, and Innovation – and the present and future changes within the scientific and technological panorama.
Big data, 3D and 4D prints, cryptocurrency, genetic therapies, costless and inexhaustible energy sources, intelligent transport, the new generation of logistics, quantum computing, augmented reality, virtual reality, IoT, robotics and its growing impact on task implementation, nanotechnology, E-learning, the genome, the organoid and the substantial increase in life expectancy are at the root of future changes. It is up to educational institutions, and particularly universities, to develop prospective studies and exercises, to trace contrasting scenarios and therefore to conceive predictive approaches, enabling the illumination of the future while promoting more flexible decision-making systems and improving enterprise adaptability.
The scientific committee of the conference has selected 30 papers submitted mostly by researchers and PhD students. The chosen themes cover different areas of management science.
The Universidade Europeia of Lisbon would like to thank all those who have contributed towards the success of this conference either through their papers, speeches or collaboration in the scientific and organization committees.
The study examined important external elements that have an impact on the technical universities (TUs) in Ghana's entrepreneurial financial governance methods. It highlights the difficulties TUs have managing their finances and the critical role that entrepreneurial finance plays in overcoming these financial limitations. A questionnaire was used by respondents as the data gathering tool in the researcher's quantitative investigation. Purposive sampling was utilised in the study to choose the 160 respondents that participated. According to the study, external environmental factors like political and economic factors, regulatory boundaries set by the state, competition between TUs, insufficient budgetary allocation, inefficient financial monitoring systems, and a lack of dynamic capabilities all have a significant impact on entrepreneurial financial governance strategies. According to the study, technical universities (TUs) in Ghana can increase revenue production, augment government financing, and satisfy their objective of offering high-quality education by applying creative initiatives and improving financial governance processes. This study offers policymakers and key stakeholders in the education sector useful insights to improve the financial sustainability and performance of Technical Universities (TUs) in Ghana. It does this by doing a thorough examination of the external environment and its impact on financial governance initiatives. Through an analysis of the effects of political and economic variables, insufficient budgetary provisions, and inadequate financial monitoring frameworks, this research highlights the imperative for Technical Universities in Ghana to give special consideration to these external elements
This study explores the critical institutions and challenges influencing the attraction of international venture capital (VC) investment in emerging economies. By examining governance indicators such as "Voice and Accountability" and "The Rule of Law," the research highlights the importance of strong democratic institutions and robust legal frameworks in creating an attractive investment environment. It also identifies the complexities of regulatory frameworks, political stability, and corruption control in this context. The findings suggest that while effective governance fosters VC investment, over-reliance on government assistance can be counterproductive. The study emphasizes the need for collaboration among governments, regulatory bodies, and local organizations to create an investor-friendly climate, unlocking the potential for innovation and economic growth in emerging markets. Further research is recommended to understand the nuanced interactions between these factors and VC investments across diverse settings.
Wrongful discharge laws (WDLs) provide limits to the employment-at-will doctrine, and thus impair operating flexibility, increasing expected financial distress costs by making it costly to fire employees. This impairment is detrimental to start-ups, leading to a decline in venture capital (VC) investment. Using a difference-in-differences framework enabled by the staggered adoption of WDLs across the U.S. states, we show VC investment declines after a state adopts the good faith exception (the strongest form of WDL). This decline is most pronounced in sectors with high labor dependency.
This paper was accepted by Victoria Ivashina, finance.
Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2023.01936 .
This study proposes a hybrid model of initial trust formation that highlights the role of social categorization and its interplay with both institutional trust and the individuating information about the party. Using data on 1,474 corporate venture capital (CVC) investments in European ventures and a case-control research design, we find that ventures more likely form initial CVC ties with investors whose parent companies are located in countries considered more trustworthy. This effect is weaker but does not disappear when social defenses safeguard ventures from misplacing trust and when there are social ties between CVC investors and ventures’ independent VC investors.
What type of investment strategies are effective for foreign venture capital (VC) firms investing in transition economies? This is the research question we address in this paper by analyzing recent institutional developments and investment activities of foreign VC firms in China. We find that foreign VC firms identify China as lacking fully developed institutions necessary to effectively support VC investing. We further find that foreign VCs have evolved unique proactive, hands-on investment strategies via a bumpy road of investing in China: initially dominating the Chinese VC industry, but since the great financial recession playing a still-significant but reduced and disadvantaged-role subservient to the rapidly increasing role of domestic VC firms. We developed a novel triangulation research methodology that allows us to provide significantly more depth in our analysis of how foreign VCs compete in transition economies. This research contributes to both the institutional theory and VC investing literatures. We suggest that foreign VCs can increase their competitive advantage by developing hands-on value-added investing strategies, when investing in transitioning markets.
Business angels (BAs) and venture capitalists (VCs) play major roles in the early funding stages of a venture. Although a significant proportion of venture funding rounds results from multiple investor types, most existing research takes an isolated view of either BAs or VCs. Research on the conditions and reasons for the formation of co-investments by BAs and VCs remains scarce. This study closes this gap by considering the impact of investor characteristics of BAs and VCs on the likelihood of co-investment. We focus on investor reputation, prior investment ties, and geographic proximity between the new venture and the investor. We address the questions of how these investor characteristics predict the probability of a co-investment between BAs and VCs in the first funding round of a new venture. Relying on the resource-based view and agency theory, we examine conditions that are in place when the two types of investors co-invest. Using a large-scale dataset with more than 7300 funding rounds of US-based ventures between the years 2005 and 2017, we find support for our hypotheses that investor reputation, prior investment ties, and geographical proximity impact the likelihood of co-investment and that these associations differ depending on the investor type.
This study introduces the novel construct of bridge-economy partners, which can assist Western firms in learning how to collaborate with local partners when entering unfamiliar foreign countries that have substantially different socioeconomic characteristics. We offer initial empirical evidence regarding the relevance of establishing such interorganizational partnership triads among Western, bridge-economy, and local firms for the entries of Western venture capital firms (VCs) into Mainland China between 1997 and 2008. Venture age, regional legal maturity, and the Western VCs’ accumulated local experience are identified as relevant contingency factors for the likelihood of adopting this type of collaboration, which involves partners from three different types of economies. We supplement our quantitative analyses with anecdotal qualitative evidence from interviews with VC executives and fund managers.
Full article link: https://authors.elsevier.com/a/1hvfX38%7EUTt2Z2
Academic studies assume a positive association between development of finance and logistics performance, however, few empirical studies examine the relevance and strength of this relationship. To cover this gap, this paper tests the association between development of finance and logistics performance incorporating the countries’ governance quality and global competitiveness variables into the model. We use the PLS-SEM method to concurrently examine whether the countries’ good governance and financial sophistication spur superior logistics performance, which stimulates better global competitiveness for the countries. The results strongly support the conceptual assumptions. Notably, one unit increase in development of finance leads 0,517 unit increase in logistics performance. It is also shown that logistics performance has the greatest direct impact on global competitiveness compared to governance quality and financial development. Key Words: Financial development, financial sophistication, logistics performance, good governance, competitiveness. JEL Classification: G20, O47
This study investigates the effect of historical military conflict (between the home countries of venture capital (VC) firms and portfolio companies) on the performance of cross‐border VC investments. Using exhaustive data on global cross‐border investments during 1986–2017, we find that adverse memories imprinted by historical military conflict have a negative effect on cross‐border performance as measured by internal rate of return and public market equivalent. We show that nation‐dyadic (i.e. political affinity) and ownership control strategy (i.e. board seat and syndication)‐related contingencies moderate the relationship between historical military conflict and cross‐border performance. Collectively, our findings shed light on the presence of intergroup interaction challenges and mistrust when investing in cross‐border VC deals and demonstrate channels to mitigate their adverse effects.
Venture capital (VC) refers to investments provided to early-stage, innovative, and high growth start-up companies. A common characteristic of all venture capital investments is that investee companies do not have cash flows to pay interest on debt or dividends on equity. Rather, investments are made with a view towards capital gain on exit. The most sought after exit routes are an initial public offering (IPO), where a company lists on a stock exchange for the first time, and an acquisition exit (trade sale), where the company is sold in entirety to another company. However, VCs often exit their investments by secondary sales, wherein the entrepreneur retains his or her share but the VC sells to another company or investor buybacks, where the entrepreneur repurchases the VC's interest and write-offs (liquidations). This publication provides a comprehensive picture of all the issues dealing with the structure, governance, and performance of venture capital from a global perspective.
This study investigates venture capital (VC) reputation impact on the pre-IPO performance of the entrepreneurial firms backed by three kinds of VCs. This study employs backward stepwise regression models following prior theoretical frameworks to examine the research question. Based on a database of the top 50 VC firms ranked during 2016 to 2020 and their portfolio firms. This study shows some contingent contribution to pre-IPO firm performance. Firstly, the reputation of the Chinese government-owned VCs is negatively associated with their portfolio firm performance. Still, there is a positive relationship between foreign and local private VCs. Secondly, entrepreneurial firm performance is significantly associated with industry policy and entrepreneur’s performance than VC reputation. This study has practical implications for entrepreneurs and limited partners regarding their corporation relationships with the Chinese VCs.
JEL codes: G24, G34
This is the first study examining the key role played by venture capital and private equity (VCPE) firms in the private debt market. Private debt funds invest in companies owned (sponsored) by VCPEs and in other companies without VCPE sponsors. Using novel data, we find that private debt without VCPE sponsors generates a premium. Further analysis shows that this sponsorless premium compensates for higher risk and costs of risk mitigation as sponsorless lenders adopt a more hands-on approach emulating VCPE sponsors’ roles. Our results are robust and provide important lessons for investors and investee firms in private debt, venture lending, and VCPE.
This paper was accepted by Victoria Ivashina, finance.
Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2022.4664 .
Building on the upper echelon and signalling theories, we hypothesize that perceptions about the corporate ethical behaviour in the country of origin of a venture's founders may provide an important piece of information to the selection committees of impact‐oriented accelerator programmes that serves as a signal for the trustworthiness and opportunistic behaviour of the founding team. In turn, this could have implications for the decision regarding admission into a programme. Using a sample of over 16,000 early‐stage ventures from 131 countries that applied to 287 accelerator programmes, we find evidence consistent with this hypothesis. Our results show that better perceptions about the ethical behaviour of the founding team enhance the likelihood of admission into an impact‐oriented accelerator programme. The role of perceived ethics appears to be stronger in the case of programmes that guarantee some kind of financing. Further analysis shows that the strength of both formal and informal institutions moderates the relationship between the ethical perceptions and the admission likelihood.
RICAFE Working Paper, n° 001/2004
Working Paper. Please do not quote or cite without authors ’ permission. © 2002 G. Dushnitsky & M. LenoxCorporate Venture Capital and Incumbent Firm Innovation Rates In this paper, we focus on the potential innovation benefits to corporate venture capital, i.e. equity investments in entrepreneurial ventures by incumbent firms. In particular, we ask do firms that invest corporate venture capital learn about and appropriate new technologies and practices from those ventures they invest. Our investigation builds on two theoretical pillars. First, incumbent firms operating in competitive markets are inclined towards introducing innovations. Second, the knowledge necessary to generate innovation may likely reside outside the boundary of the incumbent firm and in entrepreneurial ventures. Thus, we propose that corporate venture capital programs may be instrumental in harvesting innovations from entrepreneurial ventures and thus an important part of a firm’s overall innovation strategy. We hypothesize that these programs are especially effective in weak intellectual property regimes. To this end, we explore the relationship between corporate venture capital and incumbent firm innovation by analyzing a large panel of public firms that pursued venturing activity or patented over a twenty-year period. We find that increases in corporate venture capital investments are associated with subsequent increases in firm patenting. The findings of this study have important implications for the study of inter-organizational learning and the development of firm’s dynamic capabilities.
This paper examines legal rules covering protection of corporate shareholders and creditors, the origin of these rules, and the quality of their enforcement in 49 countries. The results show that common law countries generally have the best, and French civil law countries the worst, legal protections of investors, with German and Scandinavian civil law countries located in the middle. We also find that concentration of ownership of shares in the largest public companies is negatively related to investor protections, consistent with the hypothesis that small, diversified shareholders are unlikely to be important in countries that fail to protect their rights.
We analyze financial statements from 34 countries for the period 1985-1998 to construct a panel data set measuring three dimensions of reported accounting earnings for each country - earnings aggressiveness, loss avoidance, and earnings smoothing. We hypothesize that these three dimensions are associated with uninformative or opaque earnings, and so we combine these three measures to obtain an overall earnings opacity time-series measure per country. We then explore whether our three measures of earnings opacity affect two characteristics of an equity market in a country - the return the shareholders demand and how much they trade. While not all results are consistent for our three individual earnings opacity measures, our panel data tests document that, after controlling for other influences, an increase in overall earnings opacity in a country is linked to an economically significant increase in the cost of equity and an economically significant decrease in trading in the stock market of that country.
Using two complementary theoretical perspectives, we develop hypotheses regarding the determinants of the return required by venture capitalists and test them on a sample of over 200 venture capital companies (VCCs) located in five countries. Consistent with resource-based theory, we find that early-stage specialists require a significantly higher return than other VCCs when investing in later-stage ventures. Consistent with financial theory, we find that acquisition/buyout specialists require a significantly lower return than other VCCs when investing in expansion companies. Furthermore, in comparison to specialists, highly stage-diversified VCCs require a significantly higher return for early-stage investments. Independent VCCs require a higher rate of return than captive or public VCCs. In general, higher required returns are associated with VCCs who provide more intensity of involvement, have shorter expected holding period of the investment, and being located in the US or UK (in comparison to those in France, Belgium, and The Netherlands).
We consider the provision of venture capital in a dynamic agency model. The value of the venture project is initially uncertain and more information arrives by developing the project. The allocation of the funds and the learning process are subject to moral hazard. The optimal contract is a time-varying share contract which provides intertemporal risk-sharing between venture capitalist and entrepreneur. The share of the entrepreneur reflects the value of a real option. The option itself is based on the control of the funds. The dynamic agency costs may be high and lead to an inefficient early stopping of the project. A positive liquidation value explains the adoption of strip financing or convertible securities. Finally, relationship financing, including monitoring and the occasional replacement of the management improves the efficiency of the financial contracting.
This paper analyzes the relationship between public and private sources of venture capital in Europe and the development of the industry, controlling for characteristics of the legal systems, in 15 European countries over the period 1990–1996. Large public participation is correlated with smaller VC industries, but analyses do not support the view that public venture capitalists are acting to seed the industry or that are they crowd-out private funds. On the contrary, public involvement seems to cause greater amounts of money to be invested in the industry as a whole. We argue that the effects of public intervention, whatever the motives, are real and probably result from demonstrating/sanctioning the social merit of venture capital and from signaling an enduring commitment to it.
Preliminary Draft, 9 July 2001 This paper was presented at the conference on Designing Financial Systems in East Asia and Japan: Toward a Twenty-First Century Paradigm. This two-day conference was co-organized by the International Monetary Fund and the CEI. It was held during September 24-25, 2001 at Hitotsubashi Memorial Hall in Tokyo, Japan. A select group of academics, researchers and policy makers from around the world gathered to examine the timely issue of how the financial systems and corporate governance in East Asia and Japan should be redesigned in order to achieve sustainable economic development. The conference included six sessions with 17 papers. All the presented papers were added to the CEI series of working papers. The series, as well as the contents of the conference, can be reached at http://cei.ier.hit-u.ac.jp. Using a newly constructed data set, we compare sources of funds and investment strategies of venture capital (VC) funds in Germany, Israel, Japan and the UK. Sources of VC funds differ significantly across countries, e.g. banks are particularly important in Germany, corporations in Israel, insurance companies in Japan, and pension funds in the UK. VC investment patterns also differ across countries in terms of the stage and sector of financed companies, as well as in the geographical focus of investments, and these differences are significantly related to the variations in funding sources. However, the influence of particular classes of institutions differs across countries. For example, bank backed VC firms in Germany and Japan are as involved in early stage finance as other funds in these countries, whereas in Israel and the UK they tend to invest in relatively late stage finance. While these financial institutional factors account for some of the differences in investment patterns across countries, other considerations (such as supply of entrepreneurs) are of greater significance.
This study empirically evaluates the certification and value-added roles of reputable venture capitalists (VCs). Using a novel sample of entrepreneurial start-ups with multiple financing offers, I analyze financing offers made by competing VCs at the first professional round of start-up funding, holding characteristics of the start-up fixed. Offers made by VCs with a high reputation are three times more likely to be accepted, and high-reputation VCs acquire start-up equity at a 10-14% discount. The evidence suggests that VCs' ''extra-financial" value may be more distinctive than their functionally equivalent financial capital. These extra-financial services can have financial consequences.
This paper examines three rationales for the syndication of venture capital investments, using a sample of 271 private biotechnology firms. Syndication is commonplace, even in the first-round investments. Experienced venture capitalists primarily syndicate first-round investments to venture investors with similar levels of experience. In later rounds, established venture capitalists syndicate investments to both their peers and to less experienced capital providers. When experienced venture capitalists invest for the first time in later rounds, the firm is usually doing well. Syndication also often insures that the ownership stake of the venture capitalist stays constant in later venture rounds. I argue that the results are consistent with the proposed explanations.
This paper introduces a new dataset from 50 venture capital and private equity funds from 17 countries in Africa, North and South America, Europe and Australasia. We analyse compensation in regard to fixed management fees (as a percentage of fund size), performance fees (the carried interest percentage), clawbacks (reduced fees for poor performance), and cash versus share distributions (payment to institutional investors). We control for a variety of factors including market conditions, institutional investor and fund manager characteristics. The data indicate that legal conditions by far have the most robust statistically and economically significant effect on compensation across countries: fixed fees are higher and performance fees are lower in countries with poor legal conditions; clawbacks are more likely in countries with poor legal conditions; and cash-only distributions are much more likely to be mandated among offshore funds.
Ninety percent of new entrepreneurial businesses that don't attract venture capital fail within three years.
This paper uses UK survey data to investigate the different motives that venture capital firms have for syndicating equity investments, partner selection, and the link between competition and syndication in the market. The traditional finance perspective views syndication as a response to the need to diversify away risk, whereas the resource-based theory views syndication as a means of accessing a competitor's firm-specific resources. The results of the study indicate that syndication is more a response to the need to spread risk than share information and manage investments. Also, when the sample was subdivided according to minimum investment preference the resource-based perspective was found to be even less important for those firms who only invested sums of 5 million and greater. This result also held for the finance theory perspective for syndicating deals. The above findings were mirrored in the results relating to partner selection as the financial characteristics and resource-base of the firm were not found to be important factors in selecting a syndicate partner. Rather, partner selection was found to be far more influenced by a past interaction, reputation and investment style. Finally, evidence was found to suggest that competition in the venture capital market exerts a negative influence over a firm's decision to syndicate out a deal; however, this influence is significantly less for the decision to syndicate in to a deal.
Three principal aspects of venture capital (VC) are empirically explored: fundraising, investing, and exiting those investments. Despite the recent attention to VC, misconceptions abound that the authors attempt to correct. Throughout, the discussions are based on examinations of a large sample of firms, VC funds, and investments. Three themes are elaborated in the volume: (1) The great incentive and information problems venture capitalists must overcome; (2) the interrelatedness of each aspect of the VC process and how it proceeds through cycles; and that (3) the VC industry adjusts slowly to shifts in the supply of capital or the demand for financing. The VC partnership is the intermediary between investors and high-tech start-ups. The fundraising aspect is examined in terms of its structure, means of compensation, and the importance of the structure of the limited partnership form used by most VC funds. The need to provide incentives and shifts in relative negotiating power impact the terms of VC limited partnerships. Covenants and compensation align the incentives of VC funds with those of investors; covenants and restrictions limit conflicts among investors and venture capitalists. Supply and demand and costs of contracting determine contractual provisions. VC contracting may not always be efficient. During periods of high demand and capital flows, partners negotiate compensation premiums. The investing aspect is discussed in terms of why investments are staged, how VC firms oversee firms, and why VC firms syndicate investments. Four factors limit access to capital for firms: uncertainty, asymmetric information, nature of firm assets, and conditions in the financial and product markets. These factors determine a firm's financing choices. Asymmetries may persist longer in high-tech firms, thus increasing the value of delaying investment decisions. Exiting VC investments is examined, in regard to the market conditions that affect the decision to go public, whether reputation affects the decision to go public, why venture capitalists distribute shares, the performance of VC-backed firms, and the future of the VC cycle. Exiting investments affects every aspect of the investment cycle. Venture capitalists add value to the firms in which they invest. The VC cycle is a solution to information and inventive problems. (TNM)
Based on 412 control transactions between 1990 and 2000 we construct a measure of the private benefits of control in 39 countries. We find that the value of control ranges between -4% and +65%, with an average of 14%. As predicted by theory, in countries where private benefits of control are larger capital markets are less developed, ownership is more concentrated, and privatizations are less likely to take place as public offerings. We also analyse what institutions are most important in curbing these private benefits. A high degree of statutory protection of minority shareholders and high degree of law enforcement are associated with lower levels of private benefits of control, but so are a high level of diffusion of the press, a high rate of tax compliance, and a high degree of product market competition. A crude R-squared test suggests that the 'non traditional' mechanisms have at least as much explanatory power as the legal ones commonly mentioned in the literature. In fact, in a multivariate analysis newspapers' circulation and tax compliance seem to be the dominating factors. We advance an explanation why this might be the case.
A largely neglected question in the literature on private equity investing is how the competitive environment influences the activities of private equity firms. In this study, we examine the impact of market concentration and interfirm networking through syndication on the price private equity firms pay to acquire investment targets. As such, we provide insights on the sources of returns in the private equity market. We test our hypotheses by studying the price private equity firms pay to acquire buyout targets using a unique hand-collected dataset of UK buyout transactions in the period 1993 to 2002. Our results show that lower levels of market concentration in the market for private equity increase the price private equity investors pay to acquire target firms. Our results did not indicate a consistent effect from the extent of interfirm networking through syndication. Implications for theory and practice are suggested.
The capital structures of venture capital-backed U.S. companies share a remarkable commonality: overwhelmingly, venture capitalists make their investments through convertible preferred stock. Not surprisingly, a large part of the academic literature on venture capital has sought to explain this peculiar pattern. Financial economists have developed models showing, for example, that convertible securities allocate control depending on the portfolio company's success, operate as a signal to overcome various kinds of information asymmetry, and align the incentives of entrepreneurs and venture capital investors. In this Article we extend this literature by examining the influence of a more mundane factor, tax law, on venture capital structure. A firm that issues convertible preferred stock to venture capitalists is able to offer more favorable tax treatment for incentive compensation paid to the entrepreneur and other portfolio company employees: Instead of being taxed currently at ordinary income rates, the entrepreneur and employees can defer tax until the incentive compensation is sold (or even longer), at which point a preferential tax rate is available. No tax rule explicitly connects the employee's tax treatment with the issuance of convertible preferred stock to venture capitalists. Rather, this link is part of tax "practice" - the plumbing of tax law, familiar to practitioners but, predictably, opaque to those, including financial economists, outside the day-to-day tax practice. Despite its obscurity, this tax factor is likely to be of first order importance. Intense incentive compensation for portfolio company founders and employees is a fundamental feature of venture capital contracting. Favorable tax treatment for this compensation is a byproduct and, we believe, a core purpose of the use of convertible preferred stock. We also highlight an important but low visibility tax subsidy for the venture capital market, and the early stage, usually high technology, firms that are financed there. Although this subsidy arose inadvertently, it has an interesting structure. Funds are not provided directly to companies selected by the government (a familiar technique outside the United States), or to all companies. Instead, venture capital investors are enlisted as the subsidy's gatekeeper. As a practical matter, only companies that can attract venture capital investment receive this subsidy. Our analysis thus adds a different twist on the familiar debate about providing subsidies through the tax system, instead of through direct expenditures or favorable regulatory treatment.
In this paper, we examine the characteristics of acquisition of private firms by public companies and explore the impact that venture capital-backing has on the acquirer's characteristics, form of payment, announcement returns, as well as long-run stock price and operating performance. We find that compared to the acquirers of other private companies, those firms that acquire private venture capital-backed companies tend to be larger, have higher Tobin's Q, and are more likely to use equity in the transaction and buy companies in a related industry. The market tends to react more negative to announcement of the acquisition of a venture capital-backed company, but the long-run stock market and operating performance is superior than other private acquisitions. We find that the use of stock and related transaction predicts better long-run performance. Our results suggest that the acquirers of private venture capital-backed companies do not suffer any adverse selection problem and continue to have superior performance in the long-run.
This paper examines the impact venture capital can have on the development of new firms. Using a hand-collected data set on Silicon Valley start-ups, we find that venture capital is related to a variety of professionalization measures, such as human resource policies, the adoption of stock option plans, and the hiring of a marketing VP. Venture-capital-backed companies are also more likely and faster to replace the founder with an outside CEO, both in situations that appear adversarial and those mutually agreed to. The evidence suggests that venture capitalists play roles over and beyond those of traditional financial intermediaries.
We argue that in the after-market trading of an IPO, the underwriting syndicate, by standing ready to buy back shares at the offer price (price stabilization), compensates uninformed investors ex post for the adverse selection cost they face in bidding for IPOs. This dominates ex ante compensation by underpricing alone. By forming larger syndicates underwriters can increase their capacity to sustain losses associated with after-market price stabilization. Issuer revenues are maximized by trading off the cost of forming syndicates with larger loss capacity versus the benefits of greater capacity for after-market intervention. We show that larger issues are associated with larger underpricing and with syndicates that have a larger loss capacity. Also, "hot issue" periods with a high volume of IPOs are associated with larger underpricing and syndicates with a smaller loss capacity.
This paper introduces a data set on forms of finance used in 12,363 Canadian and US venture capital (VC) and private equity financings of Canadian entrepreneurial firms from 1991 to 2003. The data comprise different types of venture capital institutions, including corporate, limited partnership, government, and labour-sponsored funds as well as US funds that invest in Canadian entrepreneurial firms. Unlike prior work with US venture capitalists financing US entrepreneurial firms, the data herein indicate that convertible preferred equity has never been the most frequently used form of finance for either US or Canadian venture capitalists financing Canadian entrepreneurial firms, regardless of the definition of the term ‘venture capital’. A syndication example and a simple theoretical framework are provided to show the nonrobustness of prior theoretical work on optimal financial contracts in venture capital finance. Multivariate empirical analyses herein indicate that (1) security design is a response to expected agency problems, (2) capital gains taxation affects contracts, (3) there are trends in the use of different contracts which can be interpreted as learning, and (4) market conditions affect contracts.
Venture capitalists functioning as lead investors and the entrepreneur-CEOs of their portfolio companies responded to questionnaire surveys that asked them to rate the venture capitalists' involvement in the ventures. The perceived effectiveness of the investor's involvement weighted by its perceived importance was used as a proxy for the investor's value to the venture. The survey was administered in the early part of 1988. Eighty percent of venture capitalists and 85% of entrepreneurs surveyed responded; in all, 51 matched pairs of lead investor-CEO surveys were completed and returned. Over 50 hours of interviews were also conducted to help clarify information derived through the surveys.
We compare the investment activities and sources of finance of venture capital (VC) funds in Germany, Israel, Japan and the United Kingdom. VC investments differ across countries in terms of their stage, sector and geographical focus. Sources of VC funds also differ across countries; for example, banks are particularly important in Germany and Japan, corporations in Israel, and pension funds in the United Kingdom. Although the differences in investments are related to funding sources—for example, bank and pension fund-backed VCs invest in later stage activities than individual and corporate backed funds—a large proportion of variation within as well as between countries is unrelated to sources of finance. Moreover, differences in the relation between funding source and VC activity are unrelated to the country's financial systems. We conclude that neither financial systems nor sources of finance are the main explanations for the pronounced differences in VC activities.
The paper studies the effects of tax policy on venture capital activity. Entrepreneurs pursue a single high risk project each but have no own resources. Financiers provide funds, covering investment cost plus an upfront payment, in exchange for a share in the firm. The contract must include incentives to enlist full effort of entrepreneurs. Venture capitalists also assist with valuable business advice to enhance survival chances. The paper develops a general equilibrium framework with a traditional and an entrepreneurial sector and investigates the effects of taxes on the equilibrium level of managerial advice, entrepreneurship and welfare. It considers differential wage and capital income taxes, a comprehensive income tax, progressive taxation as well as investment and output subsidies to the entrepreneurial sector.
A model of start-up finance with double moral hazard is proposed. Entrepreneurs have ideas and technical competence, but lack own resources as well as commercial experience. Venture capitalists (VCs) provide start-up finance and managerial support. Both types of agents thus jointly contribute to the firm's success, but neither type's effort is verifiable. We find that the market equilibrium is biased towards inefficiently low entrepreneurial effort and venture capital support. In this situation, the capital gains tax is particularly harmful. The introduction of a small tax impairs effort and advice and leads to a first-order welfare loss. Several other policies towards venture capital and start-up entrepreneurship are also investigated.
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.
We use recent data on firm-level corporate governance (CG) rankings across 14 emerging markets and find that there is wide variation in firm-level governance in our sample and that the average firm-level governance is lower in countries with weaker legal systems. We explore the determinants of firm-level governance and find that governance is correlated with the extent of the asymmetric information and contracting imperfections that firms face. We also find that better corporate governance is highly correlated with better operating performance and market valuation. Finally, we provide evidence that firm-level corporate governance provisions matter more in countries with weak legal environments.
Over the past decade, billions of dollars have been invested by established companies in entrepreneurial ventures—what is often referred to as corporate venture capital. Yet, there is little systematic evidence that corporate venture capital investment creates value to investing firms. Scholars have suggested that established firms face underlying challenges when investing corporate venture capital. Namely, structural deficiencies inherent in corporate venture capital may inhibit financial gains. However, firm value may still be created as a result of other benefits from investing—primarily providing a window onto novel technology. In this paper, we propose that corporate venture capital investment will create greater firm value when firms explicitly pursue corporate venture capital to harness novel technology. Using a panel of CVC investments, we present evidence consistent with our proposition. The findings are robust to various specifications and remain unchanged even after controlling for unobserved heterogeneity in investing firms. Our results have important implications for corporate venture capital in particular, and technology strategy in general.
Venture capitalists (VCs) not only finance but also add value to start-up companies. Advising firms is time consuming and creates a trade-off between intensity of advice and portfolio size. We jointly determine the optimal number of portfolio companies and the intensity of managerial advice. Diminishing returns to advice per firm call for a larger portfolio. With progressively increasing managerial effort cost, however, a larger number crowds out advice to each individual firm. As they receive less support, entrepreneurs request a larger profit share, making further portfolio expansion eventually unprofitable. Comparative static analysis shows how optimal portfolio size responds to venture returns and other parameters.
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.
Venture capitalists, representing informed capital, screen, monitor and advise start-up entrepreneurs. The paper reports three new results on venture capital (VC) finance and the evolution of the VC industry. First, there is an optimal VC portfolio size with a trade-off between the number of companies and the value of managerial advice. Second, advice tends to be diluted when the industry expands and VC skills remain scarce in the short-run. The delayed entry of experienced VCs eventually restores the quality of advice and leads to more focused company portfolios. Third, as a welfare result, VCs tend to provide too little advisory effort and to invest in too few companies. Testable implications are also discussed.
We show that inflows of capital into venture funds increase the valuation of these funds’ new investments. This effect is robust to (i) controlling for firm characteristics and public market valuations, (ii) examining first differences, and (iii) using inflows into leveraged buyout funds as an instrumental variable. Interaction terms suggest that the impact of venture capital inflows on prices is greatest in states with the most venture capital activity. Changes in valuations do not appear related to the ultimate success of these firms. The findings are consistent with competition for a limited number of attractive investments being responsible for rising prices.
Venture-capital organizations raise money from individuals and institutions for investment in early-stage businesses that offer high potential but high risk. This paper describes and analyzes the structure of venture-capital organizations, focusing on the relationship between investors and venture capitalists and between venture-capital firms and the ventures in which they invest. The agency problems in these organizations and to the contracts and operating procedures that have evolved in response are emphasized. Venture-capital organizations are contrasted with large, publicly traded corporations and with leveraged buyout organizations.
We develop an equilibrium model of contracting, bargaining, and search in which the relative scarcity of venture capital affects the bargaining power of entrepreneurs and venture capitalists. This in turn affects the pricing, contracting, and value creation in start-ups. The relative scarcity of venture capital is endogenous and depends on the profitability of venture capital investments, entry costs, and transparency of the venture capital market. Supply and demand conditions also affect the incentives of venture capitalists to screen projects ex ante. We characterize both the short- and long-run dynamics of the venture capital industry, which provides us with a stylized picture of the Internet boom and bust periods. Our model is consistent with existing evidence and provides a number of new empirical predictions.
We analyze the determinants of effective legal institutions (legality) using data from 49 countries. We show that the way the law was initially transplanted and received is a more important determinant than the supply of law from a particular legal family. Countries that have developed legal orders internally, adapted the transplanted law, and/or had a population that was already familiar with basic principles of the transplanted law have more effective legality than countries that received foreign law without any similar predispositions. The transplanting process has a strong indirect effect on economic development via its impact on legality, while the impact of particular legal families is weaker and not robust to alternative legality measures.
This paper presents the theory that managers can use the liquidity of securities as a choice variable to screen for deep-pocket investors, those that have a low likelihood of facing a liquidity shock. We assume an information asymmetry about the quality of the manager between the existing investors and the market. The manager then faces a lemons problem when he has to raise funds for a subsequent fund from outside investors, because the outsiders cannot determine whether the manager is of poor quality or the existing investors were hit by a liquidity shock. Thus, liquid investors can reduce the manager's cost of capital in future fundraising. We test the assumptions and predictions of our model in the context of the private equity industry. Consistent with the theory, we find that transfer restrictions on investors are less common in later funds organized by the same private equity firm, where information problems are presumably less severe. Also, partnerships whose investment focus is in industries with longer investment cycles display more transfer constraints. Finally, we present evidence consistent with the assumptions of our model, including the high degree of continuity in the investors of successive funds and the ability of sophisticated investors to anticipate funds that will have poor subsequent performance.
This paper measures the mean, standard deviation, alpha and beta of venture capital investments, using a maximum likelihood estimate that corrects for selection bias. Since Þrms go public when they have achieved a good return, estimates that do not correct for selection bias are optimistic. The selection bias correction neatly accounts for log returns. Without a selection bias correction, I Þnd a mean log return of about 100% and a log CAPM intercept of about 90%. With the selection bias correction, I Þnd a mean log return of about 5% with a -2% intercept. However, returns are very volatile, with standard deviation near 100%. Therefore, arithmetic average returns and intercepts are much higher than geometric averages. The selection bias correction attenuates but does not eliminate high arithmetic average returns. Without a selection bias correction, I Þnd an arith- metic average return of around 700% and a CAPM alpha of nearly 500%. With the selection bias correction, I Þnd arithmetic average returns of about 57% and CAPM alpha of about 45%. Second, third, and fourth rounds of Þnancing are less risky. They have progres- sively lower volatility, and therefore lower arithmetic average returns. The betas of successive rounds also decline dramatically from near 1 for the Þrst round to near zero for fourth rounds. The maximum likelihood estimate matches many features of the data, in particular the pattern of IPO and exit as a function of project age, and the fact that return distributions are stable across horizons.
We analyze incomplete long-term financial contracts between an entrepreneur with no initial wealth and a wealthy investor. Both agents have potentially conflicting objectives since the entrepreneur cares about both pecuniary and non-pecuniary returns from the project while the investor is only concerned about monetary returns. We address the questions of (i) whether and how the initial contract can be structured in such a way as to bring about a perfect coincidence of objectives between both agents (ii) when the initial contract cannot achieve this coincidence of objectives how should control rights be allocated to achieve efficiency? One of the main results of our analysis concerns the optimality properties of the (contingent) control allocation induced by standard debt financing.
This dissertation aims at contributing to the body of literature covering the field of entrepreneurial finance. More specifically, the study focuses on the valuation and syndication of venture capital investments. The dissertation comprises a theory review and four essays, each of which makes distinct but complementary contributions to both theory and practice. The first essay of this dissertation constructs and tests a binomial pricing model for staged venture capital investments. Using the valuation data of 421 U. S. venture capital transactions and 176 initial public offerings, the essay finds that the pricing model is consistent with previous knowledge on the risk-return profile of venture capital investments. The results further confirm the hypothesis that early-stage ventures have higher implied risk and implied volatility of returns than more established ones. The results of the essay imply that pricing models that assume constant volatility, unlike the binomial model, are not likely to be applicable in venture capital or similar project valuation settings. The second essay demonstrates how investor prominence affects the valuations of venture capital backed companies. Employing a thorough data set of over 32,000 U. S. venture capital investments between 1990 and 2000, the essay shows that certification ability gives prominent venture capitalists bargaining power that they utilise when investing in ventures for the first time. In line with the asymmetric information and signalling theories, it is found that the reputation of existing venture capital investors adds value in future financing rounds. The results are robust to potential selection biases, alternative measures of investor prominence, the existence of additional value adding mechanisms, and different sampling periods. The third essay examines the relationship between investment syndication and the efficiency of venture capital firms. Arguments derived from the theoretical motives for syndication predict that syndication relationships allow venture capitalists to be more efficient in completing investments and in making their portfolio companies public. Utilising an extensive data set on the venture capital investments of the 100 largest U. S. venture capital firms between 1986 and 2000, the essay demonstrates that syndication has an impact on venture capitalists' efficiency in both of these areas. The frequency of syndicating investments accelerates the process of investing in new portfolio companies, whereas the diversity of the syndication relationships improves the venture capitalists' ability to create public companies from their portfolio companies. Furthermore, the essay demonstrates that uncertainty moderates the impact of syndication on firm efficiency. Firms with uncertain venture portfolios benefit more from syndication relationships. The fourth essay compares resource-based and social structural explanations for the network positions and the performance of venture capital firms. A distributed lag analysis of an extensive data set of the 100 largest U. S. venture capital firms and their syndicate structures between 1986 and 2000 suggests that venture capital firms in central network positions increase their market share of portfolio company initial public offerings in subsequent years. Consistent with the social structural argument, the results further demonstrate that prior network positions tend to determine future positions. An analysis of causality reveals that past network position tends to dominate the observable quality of firm resources as a determinant of the subsequent performance and position of the firm. The results further imply that the structure of venture capital syndication networks is rigid and involves high barriers to entry, and that the acquisition of general partners contributes to changes in existing network positions. Doctoral dissertations / Helsinki University of Technology, Department of Industrial Engineering and Management, Institute of Strategy and International Business, ISSN 1457-6929; 2003 / 1
This paper explores factors that affect portfolio size among a sample of venture capital financing data from 214 Canadian funds. Four categories of factors affect portfolio size: (1) the venture capital funds' characteristics, including the type of fund, fund duration, fund-raising, and the number of venture capital fund managers; (2) the entrepreneurial firms' characteristics, including stage of development, technology, and geographic location; (3) the nature of the financing transactions, including staging, syndication, and capital structure; and (4) market conditions. The data further indicate decreasing returns to scale in the number of entrepreneurial firms financed by a venture capital fund.
This paper examines covenants in 140 partnership agreements establishing venture capital funds. Despite the similar objectives and structures of these funds and the relatively limited number of contracting parties, the agreements are quite heterogenous in their inclusion of covenants. We examine two complementary hypotheses that suggest when covenants will be used. Covenant use may be determined by the extent of potential agency problems: because covenants are costly to negotiate and monitor, they will only be employed when these problems are severe. Alternatively, covenant use may reflect the supply and demand conditions in the venture capital industry. The price of venture capital services may shift if the demand for venture funds changes while the supply of fund managers remains fixed in the short run. The evidence suggests that both factors are important. This is in contrast to previous studies which have either focused exclusively on costly contracting or provided only weak support for the effects of supply and demand on contracts.