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New Zealand venture capital funds and access to new financing: an exploratory study
Abstract
Purpose
– This paper aims to explore the challenges the Venture Capital (VC) funds industry in New Zealand (NZ) faces when sourcing new capital. In NZ, there is a significant gap currently for companies seeking VC funding of between $2 and $10 million to commercialise new products and ideas. Also, the estimated financing needs of the next generation of early stage NZ enterprises are around $2 billion of investment over the next 10 years (NZVIF, 2011).
Design/methodology/approach
– A qualitative research design is applied, given the exploratory nature of this research. In this study, 15 face-to-face semi-structured interviews with VC fund managers, investors and intermediaries were undertaken.
Findings
– The findings suggest that the lack of observable proven historical returns from NZ domiciled VC funds is a significant impediment to raising new equity capital. Fund managers and intermediaries also note that there is a lack of domestic entities in NZ that have the capacity and current appetite to invest in VC. In part, this may indicate that VC investors are unwilling to invest further capital in NZ VC funds until the current funds realise their existing investments.
Originality/value
– Overall our findings support recent initiatives by the NZ VC funds industry to track and monitor the performance of NZ VC funds.
... In the finance literature, there is a general consensus that firm factors have a moderating influence on the link between PE and financial performance in organizations despite variations in research methodology and study context (Gatauwa, 2014;Kalidas, Kelly & Marsden, 2014;Salerno, 2019;Gatauwa, 2020). However, Lahmann et al. (2017) found that growth potential was a key factor in enhancing the financial performance of PEbacked firms. ...
... The study used secondary data and 9 semi-structured interviews via telephone with the management team and supervisory board members and investors. Kalidas et al. (2014) have similar findings where they found that firm size does not moderate the link between PE and financial performance. Simply, they contend that small firm size of NZ companies is not an advantage for innovation or firm success. ...
Private equity is fast becoming an alternative source of capital for firms with a high growth potential as compared to the main stream sources of capital. The pertinent question here is; does private equity financing translate to better performance for firms that receive private equity? This paper examines the extent to which private equity funds affect the performance of firms in the Fintech sector in Kenya using a conceptual approach. The agency theory and diffusion of innovations theory underpin the direct and indirect relationships examined in this paper while also reviewing empirical literature. There are mixed findings on the link between private equity and financial performance whereby on one hand, private equity-backed firms have better financial performance than non-private equity-backed firms while other studies support the converse. Nevertheless, firm factors have generally been found to have a moderating influence on the link between private equity and financial performance in firms.
... enous businesses that:While government policy has been active in support of Maori business during recent times financial support remains slow with insufficient venture capital available to support Māori entrepreneurial ventures and in a timely manner. Time taken to approve finance remains too long, preventing exploitation of business opportunities.Kalidas, Kelly and Marsden (2014), observe that the NZ VC market continues to struggle to source new capital as most NZ institutions do not see investing in VC funds as a priority, principally 14 because the NZ VC industry remains relatively immature. Through their interviews, the authors observe that the NZ VC industry has a lack of observable proven historical returns ...
New Zealand has a reputation for being a nation reliant on the economic contributions of small- and medium-sized enterprises (SMEs), as well as renowned for its creativity and use of its geographical advantage. This positive image needs to be tempered by the country’s failure to reach its full potential through embracing widespread entrepreneurship. Much of this suboptimal achievement can be attributed to the below OECD-average investment in research and development (R&D) activities and a fledgling venture capital (VC) market. Fiscal investment by the public and private sectors has been low, notwithstanding an increasingly number of government initiatives. The lack of certainty for businesses has been exacerbated by politics, evidenced by numerous changes to R&D-related legislation. The evidence until early 2020 indicated steady improvement in investment until the untimely impact of COVID-19. As of late 2021, the level of investment is mixed in part reflecting the impact of COVID-19. This chapter seeks to provide an overview of New Zealand’s (NZ’s) efforts to encourage entrepreneurship through incentivising R&D activities and other fiscal-related measures.
... Time taken to approve finance remains too long, preventing exploitation of business opportunities. Kalidas et al. (2014) observe that the NZ VC market continues to struggle to source new capital as most NZ institutions do not see investing in VC funds as a priority, principally because the NZ VC industry remains relatively immature. Through their interviews, the authors observe that the NZ VC industry has a lack of observable proven historical returns and is stuck in a "chicken and egg" situation. ...
Governments around the world have been trying to encourage domestic innovation and entrepreneurship as an important means for reducing the unemployment rate, enhancing gross domestic product (GDP) growth, and deepening the knowledge-based economy. Government policies to promote innovation and entrepreneurship include both tax and non-tax incentives. Nevertheless, many governments often use only tax incentives and do not pay sufficient attention to non-tax incentives. Furthermore, some governments limit the incentives to post startup stages without considering the pre-startup stage. Such an approach raises a question about the appropriate mix of government incentives for stimulating innovation and entrepreneurship. To answer this question, this chapter aims to identify and examine the proper mix of tax and non-tax incentives that capture various stages of the process of innovation and entrepreneurship development. The chapter employs qualitative research methods to analyze archival data and primary data (obtained from a focus group study of experts from academia, industry, and government). The government incentives are matched with each stage of the innovation and entrepreneurship development process, taking the specific nature of each stage into account. In the pre-startup/ideation stage, more weights should be given to non-tax incentives to build the entrepreneur/innovator capacities through training and helping them to access various business services to launch a new business. In the startup or conversion stage, both tax and non-tax incentives are important, requiring a combination of incentives that reduce the costs of launching a new business, access to finance and providing preferential tax treatment to venture capital/crowd funding and implementing patent box. In the scale-up/diffusion stage, more weight should be given to tax incentives to minimize the tax burden on innovation and entrepreneurship. This include implementing a reduced tax rate or giving tax exemption for a limited period. In addition, the chapter also recommends granting research and development (hereafter R&D) tax incentives in all stages and taxing the labor income of scientists and engineers at a reduced rate.
Small and Medium Enterprises (SMEs) play a vital role in the economic growth. However, the industry has been facing challenges due to lack of access to finance among entrepreneurs. This chapter explores alternative financing platforms for SMEs and proposes specific solutions to the credit risk of SMEs. Authors used a structured literature review approach to analyse relevant publication to provide evidence on the application of cash Waqf as a viable source of Islamic finance for the SME sector. The donation-based cash Waqf model for SME financing is developed under the lens of stakeholder theory and Maqasid al-Shari'ah. The model is expected to provide greater insight to Waqf institutions on their role to operationalise the conceptual model in fostering the growth of SMEs and change the perception of stakeholders about the dynamics and potential of cash Waqf in economic development.
Marketing challenges facing leaders operating kiosk businesses include money/venture capital; time; inadequate knowledge and skills; apparent absence of concrete business plan and performance review. The objectives of the study are to identify motivational forces that drive the leaders to set up kiosk business and the current challenges facing the leaders operating kiosk businesses in flyover area of Kwangila-Zaria. This is a cross sectional and mixed method [quantitative and qualitative] research survey adopting descriptive research design. The population of the study consists of 73 leaders/heads operating kiosk businesses at flyover area of Kwangila-Zaria. Simple random sampling technique was utilized to select 31 respondents based on Roscoe’s Rules of Thumb. The findings indicate that the leaders of the kiosk businesses are motivated by entrepreneurship knowledge acquired from higher educational institutions and success of peer group in the similar businesses. Over 74% of the leaders face marketing challenges in kiosk business and the problems they faced include acute shortage of electricity supply refrigerating perishable items and soft drinks. Another major challenge is associated with vehicles parked in the front of kiosks shops. This prevents several customers accessing some kiosks and reduces the sales volumes of the kiosks affected. There is also a challenge of low capital base that prevents kiosk leaders from stocking variety of items demanded by the customers. Also, over 40% of the respondents started kiosk businesses through personal savings and majority started with venture capital of less than N10,000. This study therefore recommends continuity of entrepreneurship course in higher institutions of learning because it has immensely influenced graduates of the programme to set up kiosk businesses at flyover area of Kwangila-Zaria. Also, they should store varieties of items needed by customers. This is done in stocking few quantities of each product demanded by customers on daily or weekly basis.
The private equity and venture capital industry began in the U.S. and then extended worldwide. As it expanded into other markets, there was a deliberate effort to duplicate U.S. industry practices. It is argued that private equity PE/VCcan be considered one of the most effective ways of promoting small and medium enterprises and the economic growth of a nation. However, the success of the PE/VC industry does not occur incidentally, especially in developing countries. This article shows how PE/VC operates in one emerging economy, namely, Egypt. The article concludes with a discussion of the implications for research.
We present a model of the effects of legal protection of minority shareholders and of cash-flow ownership by a controlling shareholder on the valuation of firms. We then test this model using a sample of 539 large firms from 27 wealthy economies. Consistent with the model, we find evidence of higher valuation of firms in countries with better protection of minority shareholders and in firms with higher cash-flow ownership by the controlling shareholder.
Using a new database of the compensation terms, ownership structures (capital commitments), and quarterly cash flows for a large sample of private equity funds from 1984-2010, we investigate the determinants of manager compensation and ownership and how these contract terms relate to the funds' cash flow performance. Market conditions during fundraising are an important driver of compensation, as pay rises and shifts to fixed components during fundraising booms. We find no evidence that higher compensation or lower managerial ownership are associated with worse net-of-fee performance, in stark contrast to other asset management settings. Instead, compensation is largely unrelated to net cash flow performance. Our evidence is most consistent with an equilibrium in which compensation terms reflect agency concerns and the productivity of manager skills, and in which managers with higher compensation earn back their pay by delivering higher gross performance.
We survey the literature on venture capital and institutions and present a case study comparing the development of the venture
capital market in the United States and Sweden. Our literature survey underscores that the legal environment, financial market
development, the tax system, labor market regulations, and public spending on research and development correlate with venture
capital activities across countries. Our case study suggests these institutional differences led to the later development
of an active venture capital market in Sweden compared with the United States. In particular, a later development of financial
markets and a heavier tax burden for entrepreneurs have played a key role.
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.
Evidence on the “funding gap“ for investment innovation is surveyed. The focus is on financial market reasons for underinvestment that exist even when externality-induced underinvestment is absent. We conclude that while small and new innovative firms experience high costs of capital that are only partly mitigated by the presence of venture capital, the evidence for high costs of R&D capital for large firms is mixed. Nevertheless, large established firms do appear to prefer internal funds for financing such investments and they manage their cash flow to ensure this. Evidence shows that there are limits to venture capital as a solution to the funding gap, especially in countries where public equity markets for VC exit are not highly developed. We conclude by suggesting areas for further research.
While venture capital has received a tremendous amount of attention, prior research has predominantly looked at venture capital firms (VCFs) post raising their first fund. In this paper, we move the point of analysis back further and ask what type of founding team experience best predicts VCF success, controlling for firm strategy, firm size, and the environment upon which the firm was born. Empirical results show that venture capital, senior management, and consulting experience aids VCF success, while entrepreneurial experience impedes it. None of the control variables affect a VCF's ability to raise subsequent funds.
This Handbook charts the development of venture capital research in light of the global financial crisis, starting with an analysis of the current venture capital market and the changing nature of the business angel market. Looking at governance structures, the performance of venture capitalists in terms of investments, economic impact and human capital, and the geographical organization of business angels and venture capital global 'hotspots', this book also analyses the current state of venture capital research and offers a roadmap for the future.
Leading researchers use their outstanding expertise to investigate various aspects in the context of innovation and entrepreneurship such as growth, knowledge production and spillovers, technology transfer, the organization of the firm, industrial policy, financing, small firms and start-ups, and entrepreneurship education as well as the characteristics of the entrepreneur. © David B. Audretsch, Oliver Falck, Stephan Heblich and Adam Lederer 2011. All rights reserved.
This paper analyses the determinants of venture capital for a sample of 21 countries. In particular, we consider the importance of IPOs, GDP and market capitalization growth, labor market rigidities, accounting standards, private pension funds, and government programs. We find that IPOs are the strongest driver of venture capital investing. Private pension fund levels are a significant determinant over time but not across countries. Surprisingly, GDP and market capitalization growth are not significant. Government policies can have a strong impact, both by setting the regulatory stage, and by galvanizing investment during downturns. Finally, we also show that different types of venture capital financing are affected differently by these factors. In particular, early stage venture capital investing is negatively impacted by labor market rigidities, while later stage is not. IPOs have no effect on early stage venture capital investing across countries, but are a significant determinant of later stage venture capital investing across countries. Finally, government funded venture capital has different sensitivities to the determinants of venture capital than non-government funded venture capital. Our insights emphasize the need for a more differentiated approach to venture capital, both from a research as well as from a policy perspective. We feel that while later stage venture capital investing is well understood, early stage and government funded investments still require more extensive research.
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.
The objective of this study is to identify realized strategies of venture capital firms when undertaking portfolio investments. We analysed data for the period 1994 through 1997 on a sample of Finnish venture capital firms representing virtually the entire population of the Finnish venture capital industry. The results indicate that, over time, the venture capital firms specialized the industry scope of their portfolio. Further, the venture capital firms consistently diversified geographically throughout the 4 year period of the study, and they diversified their portfolio in terms of stage-of-growth by investing in increasingly later stage companies through the first years of the study, before entering a period of equilibrium in which this degree of stage-of-growth diversification held relatively constant. Finally, the importance of accumulated experience was illustrated by the finding that less experienced venture capital firms showed a time lag in these investment patterns compared to more experienced firms.
This Handbook, edited by Hans Landström, provides a timely and valuable addition to the body of knowledge in the field of venture capital research, especially from the managerial perspective. . . the book will make a valuable addition to any library that caters to the needs of those interested in entrepreneurship and new venture creation, be it academics, practitioners or policy-makers.
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 chapter provides an overview of the fundamentals of private equity and venture capital and highlights important differences between American and European approaches to funding startups and the typical characteristics of the business. The European definition proposes that private equity and venture capital are two separate clusters based on the life cycle of the firm. Venture capitalists provide the funding for start-up businesses and early-stage companies, whereas private equity operators are involved in deals with older firms. Different from the American definition, the European definition does not consider the expansion phase as a part of venture capital, but more of an autonomous subcategory. Although there are differences in definition, private equity and venture capital create a strict relationship between the investor and the entrepreneur. Private equity and venture capital investment are used to invest in equity; for this reason, operators specializing in these kinds of deals decide on the firm's strategy and day-by-day management. This participation, or the admission of a new subject among the original shareholders, generates a metamorphosis in the decision process.
We study the relations between management contract terms and performance in private equity using new data for 837 funds from
1984–2010. We find no evidence that higher fees or lower managerial ownership are associated with lower net-of-fee performance.
Nevertheless, compensation rises and shifts to performance-insensitive components during fundraising booms. Further, the behavior
of distributions around contractual fee triggers is consistent with an underlying agency conflict between investors and fund
managers. Our evidence suggests that managers with higher fees deliver higher gross performance, and highlights that agency
costs are an inevitable consequence of the information frictions endemic to agency relationships.
The authors find that private equity and venture capital funds that employ a proactive origination strategy have consistently higher returns, driven by both greater quantity and higher relevance of incoming investment opportunities. These proactive investors are using both traditional tools (cold calling) and more innovative tools (internet research, Web scraping, social media, and expert networks). The authors expect use of social media in particular to increase as more millennials reach decision-making roles in the investment industry. The Web and social media might seem to threaten the discretion and exclusivity that private equity and venture firms traditionally prize by increasing information leakage. However, the authors’data show that increased deal flow and brand recognition offsets any loss of confidentiality. This research study draws on a wide range of data: the authors’ in-depth interviews with over 150 private equity and venture investors; their proprietary dataset of information regarding th...
The purpose of the present study is to increase knowledge regarding Chilean venture capital funding, emphasising on technology investment. Qualitative research methodology, exploratory-descriptive was used. The results show characteristics of Chilean venture capital funds, highlighting that the number of funds and capital raised was low, which could be the explanation for the few investments carried out by venture capital funds. Chile has a venture capital market averse to risk, the results of the present study indicate that the investments are not achieving CORFO's objectives for innovation and technology investment. The possibility of incorporating more attractive incentives for investment in the technology sectors, such as tax reduction to venture capital funds, must be evaluated.
This article examines the recent Brazilian experience with the creation of venture capital funds which facilitate institutional investor participation, the Emerging Company Investment Funds. Such funds were authorized only since 1995. Thus any evaluation of their performance may be premature. 20 such funds existed at the end of 2003. They have raised only slightly more than US $100 million to date and have invested in 74 firms. To date the funds have had, on balance, slightly negative nominal returns. This behavior to date is hardly encouraging for venture capital financing in Brazil. Organizational factors that have affected accumulated annualized fund returns to date positively include fund size, the of management fee, and, negatively the success fee. The 71% of fund returns not explained by structural factors is attributed to differences in portfolio selection.
Recent changes to the Australian Securities Exchange (ASX) listing rules allow unprofitable entities, termed Commitments Test Entities (CTEs), to become quoted on the ASX based on commitments to spend the funds raised under an Initial Public Offerings (IPO). Using a comprehensive sample of 350 companies we examine subsequent IPO returns of these CTEs. We find that initial returns to CTEs of 24 percent on average were achieved by subscribing investors (although these returns are cyclical and vary widely between industries). The returns for the first three years after listing are negative and are significantly less compared to both the market and respective industry returns.
Despite the significance of venture capital (VC) in entrepreneurial financing and increasing interest in VC by institutional investors, the literature has not examined what forces drive the return on VC funds as an alternative investment class and how. This paper studies this important topic using U.S. quarterly data between 1987 and 2004. Beginning with seven financial variables that might be important determinants of the VC fund return based on theory and practice in the venture capital cycle, we use a structural vector autoregressive (VAR) model to examine whether these factors are important for the return on venture capital funds. Dynamic impulse response analysis illustrates that the excess return on venture capital funds has positive and significant response to shocks in the stock market excess return, IPO underpricing factor, and number of VC-backed IPOs, and negative and significant response to the book to market value factor and increase in delinquency rate on business loans. Variance decomposition further demonstrates that the general stock market performance and IPO variables have the greatest contribution to explaining time-series variations in the VC fund excess return. Macroeconomic variables such as growth in industrial productions and change in unemployment rate do not appear to add explanatory power beyond the above financial determinants.
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.
The Taiwanese venture capital industry provides an intriguing study. The primary objective of this paper is to present a general overview of the industry that captures the realities of Taiwanese venture capitalists' everyday business activities while explaining issues and trends through historical analysis and discussions of future possibilities. Utilizing statistical information, previous research, and extensive interviews with the island's venture capitalists, we discuss the emergence of the four current models of venture capital activity in Taiwan—financial subsidiary, industrial subsidiary, independent and associatecompanies. This leads to an introduction of the four paths most commonly cited by Taiwanese VCs as roads to future growth: new industries, new markets, the bridge proposition and the real VC. Each of these paths provides a springboard for tackling deeper issues the industry has wrestled with and will continue to wrestle with, including: its relationship with the island's core industries, its ability to successfully operate in foreign markets, the value of potential cross-Pacific synergies, and the value proposition for the variety of business services Taiwanese VCs provide. We conclude with a discussion on the fate of the island's innovation system, specifically the potential for Taiwan to strengthen its new-product innovation capacity and the future of professionalism in the Taiwanese VC industry.
Insight into the flow of capital into venture capital (VC) funds is fundamental to our understanding of the overall flow of capital into entrepreneurial ventures. To understand the processes and criteria utilized by limited partners (LPs) in the selection of the VC funds in which they invest we studied 21 European fund-of-fund investment management firms that actively invest in VC funds. We have demonstrated that such LPs utilize structured selection processes and criteria that are comparable to those used by VCs themselves, but with important differences. Notably, we found that LPs build early consensus within the investment team via a stage we have termed ratification. In selecting VCs, quantitative measures of reputation via historical performance are important, consistent with previous findings, but we found that reputation also captures opinions from entrepreneurs, other LPs and other VCs. We found that nurturing informal relationships outside the formal limited partnership agreement is an important component of LPs' decisions to invest and that LPs may pre-allocate capital to VCs with whom a relationship exists already. We conclude that early relationship building with potential LPs is an essential prerequisite for VCs aiming to raise a first fund.
In observing the growing presence of venture capital firms in our financial landscape, most commentators concentrate on the structural questions of size of deals, sector investing focus, and the issues of risk and reward. Little, if any, consideration is given to the source of the venture capitalist's own funding, and how this may affect the structure, investing behaviour, and informational strategies of the venture capital firm itself. This study examines the management styles and investment preferences of the two primary types of venture capital firms, 'captives' and 'independents', in an effort to gain insight into the sorts of structural and behavioural considerations that help determine a firm's investment strategy, and which may help a firm to capitalize on the structure of its relationship with fund providers. Such considerations may critically determine a firm's performance, if not its ultimate fate.
The United States has many banks that are small relative to large corporations and play a limited role in corporate governance, and a well developed stock market with an associated market for corporate control. In contrast, Japanese and German banks are fewer in number but larger in relative size and are said to play a central governance role. Neither country has an active market for corporate control. We extend the debate on the relative efficiency of bank-and stock market-centered capital markets by developing a further systematic difference between the two systems: the greater vitality of venture capital in stock market-centered systems. Understanding the link between the stock market and the venture capital market requires understanding the contractual arrangements between entrepreneurs and venture capital providers; especially, the importance of the opportunity to enter into an implicit contract over control, which gives a successful entrepreneur the option to reacquire control from the venture capitalist by using an initial public offering as the means by which the venture capitalist exits from a portfolio investment. We also extend the literature on venture capital contracting by offering an explanation for two central characteristics of the U.S. venture capital market: relatively rapid exit by venture capital providers from investments in portfolio companies; and the common practice of exit through an initial public offering.
Venture capital is a major source of financing for entrepreneurial businesses. Given the importance of venture capital financing to venture creation and regional economic development, it is not surprising that venture capital has emerged as a topic of interest to entrepreneurs and public policy makers, as well as a subject of some academic research. This research has mainly focused on the composition of venture capital fund portfolios, decision-making criteria used by venture capitalists, and the post-investment role of the venture capitalists. The role of the investor in the venture capital fund — the people whose money fuels the entire process — has been largely ignored (Fried & Hisrich, 1988).
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)
This paper examines whether a truly global market for venture capital and private equity is emerging or whether the current situation of segmented national markets is likely to endure. We document very rapid growth in venture capital fund raising and investment over the past decade in the United States, Western Europe and in certain Asian countries, but not in Japan or in most developing countries. We compare contracting practices, investment patterns and returns between the U.S. and Europe, and find that there has been considerable convergence between these two large VC markets, particularly during the past five years. This convergence is likely to continue. Nonetheless, we conclude that the major national markets will remain effectively segmented and suggest that venture capital will continue to be much more important in common law countries than in civil law countries for the foreseeable future.
Employing a large dataset of venture capital investments in US Internet firms, we analyze the effect of the current financial crisis on the venture capital market. Using regression analysis, we find that the financial crisis is associated with a 20% decrease in the average amount of funds raised per funding round. This effect, however, can only be found in later funding rounds. We argue that firms in later financing rounds that need capital to survive cannot avoid a deduction induced by the financial crisis, whereas firms that seek initial funding postpone their funding and expansion plans until the capital markets have stabilized. Fur-thermore, firms in later phases of the venture cycle are more likely to be negatively affected by the weak IPO market than firms seeking initial funding. Our results suggest that the finan-cial crisis can lead to a severe ‘funding gap’ in the financing of technological development and innovation.
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.
This survey reviews the growing body of academic work on venture capital. It lays out the major data sources used. It examines the work on venture capital investments in companies, looking at issues of selection, contracting, post-investment services and exits. The survey considers recent work on organizational structures of venture capital firms, and the relationship between general and limited partners. It discusses the work on the returns to venture capital investments. It also examines public policies, and the role of venture capital in the economy at large.
SUBJECT AREAS: Emerging markets, Privatization, Venture capital CASE SETTINGS: London; Securities & investing; 300 employees; 2000-2001 In 2001, CDC Capital Partners is facing the greatest challenge in its 53-year history. Founded as part of the U.K. government's post-war colonial reconstruction, it had operated as a developmental finance institution, largely issuing debt to the world's poorest countries. Now, however, it must transform itself to become a public-private partnership (PPP) dealing in private equity projects, but still restricted to the world's poorest countries. Can CDC succeed?
This is the second of a two-part article that provides a detailed review of the business terms usually found in a Private Equity Fund's limited partnership agreement. Part II focuses on governance and. "softer," terms: Limited liability, conflicts of interest, exit rights, LP transfers, reporting obligations, debt limits and confidentiality covenants. Part I, in a separate article, deals with economic matters.
We study the relations between management contract terms and performance in private equity using new data for 837 funds from 1984-2010. We nd no evidence that higher fees or lower managerial ownership are associated with lower net-of-fee performance. Nevertheless, compensation rises and shifts to performance-insensitive components during fundraising booms. Further, the behavior of distributions around contractual fee triggers is consistent with an underlying agency conflict between investors and fund managers. Our evidence suggests that managers with higher fees deliver higher gross performance, and highlights that agency costs are an inevitableconsequence of the information frictions endemic to agency relationships.
The reduction of information asymmetry between institutional investors and private equity (PE) firms is one of the key challenges for the successful fundraising of PE funds in an increasingly competitive market. Social ties provide a potential mechanism to reduce information asymmetry. Therefore, this paper investigates the role of social ties for institutional investments in PE funds. Based on our fieldwork and a data set of 136 institutional investors and PE firms in Germany, we show that both direct and indirect social ties influence the investment decisions of institutional investors for PE firms. This influence is not restricted to functions of information transfer but also includes mechanisms of trust building. Interestingly, direct and indirect ties reveal different effects. Direct ties transfer information and increase goodwill trust. Indirect ties also transfer information but show no effect on trust building. Our results suggest that social ties can reduce information asymmetry between institutional investors and PE firms and thereby help to establish a financing relationship.
This paper examines institutional investors’ propensity to invest in a relatively unknown asset class of listed private equity. Based on data provided by LPEQ, Preqin and Scorpio Partnership covering 171 institutional investors in Europe in 2008–2010, we find allocations are primarily a function of size, type, location, decision-making authority and liquidity preferences. Investment in listed private equity is more commonly made by institutions that are smaller, private (not public) pension institutions, institutions that have a preference for liquidity, quick access, and administrative and cash flow management simplicity, and institutions that are based in the UK, Switzerland, Sweden and the Netherlands. As well, institutions are less likely to invest in listed private equity when investment decision-making is empowered to an alternative asset class team.
We contribute to the knowledge of the capital flow from institutional investors via venture capital (VC) funds as intermediaries to their final destination, entrepreneurial ventures. To this end, we conduct a world-wide survey among limited partners to determine the importance of several criteria when they select VC funds. We find the top criteria to be the expected deal flow and access to transactions, a VC fund's historic track record, his local market experience, the match of the experience of team members with the proposed investment strategy, the team's reputation, and the mechanisms proposed to align interest between the investors and the VC funds. A principal component analysis reveals three latent drivers in the selection process: ‘Local Expertise and Incentive Structure’, ‘Investment Strategy and Expected Implementation’, and ‘Prestige/Standing vs. Cost’. It becomes evident that limited partners search for teams which are able to implement a certain strategy at a given cost. Thereby, they focus on an incentive structure that limits agency costs.
Using new, survivorship bias-free data, we examine the performance and persistence in performance of 4,617 active domestic equity institutional products managed by 1,448 investment management firms between 1991 and 2008. Controlling for the Fama–French (1993) three factors and momentum, aggregate and average estimates of alphas are statistically indistinguishable from zero. Even though there is considerable heterogeneity in performance, there is only modest evidence of persistence in three-factor models and little to none in four-factor models.
We study the conflict of interests between the limited partners (LPs) and the general partner (GP) in a VC fund with a limited life span. LPs commit money to investments in risky projects, while the GP selects projects and provides unobservable monitoring effort. We assume that midway into the project, the GP privately observes its quality and the estimated time to exit and decides whether to continue investing and monitoring. The limited time horizon of the fund forces the GP to dispose of any unfinished projects when the fund is dissolved. This, combined with the informational advantage of the GP, leads to inefficient decisions during the intermediate investment stages. This paper presents a simple model that identifies two types of such inefficiency. We show that when unfinished projects are fairly priced in the market, bad projects are always continued. At the same time, under a wide range of parameter values good projects with a somewhat longer expected completion time may be effectively discontinued, when the GP opportunistically decides not to invest monitoring effort in them. We discuss several contractual amendments to alleviate the problem. First, we show that reduction of the GP's stake in all the unfinished projects can significantly weaken his incentives to prolong bad projects. This in turn may induce the GP to put effort into the delay-prone good projects, since their price increases. An outright termination of all unfinished projects, as practiced by some VC funds, is similar in nature, but leads to suboptimal early write-offs of some good projects. We also show that allocating non-vested cash (but not decision) rights in the unfinished projects to the GP has similar beneficial effects. Finally, we provide some evidence that is suggestive of the significant extent of the problem in the post-2000 period.
The terms of an investment by venture capitalists are the result of cooperative bargaining between the project originators (owners or entrepreneurs) and the financiers. This study examines conditions under which bargains can be consummated, the nature of the bargains, and the way in which bargains are both influenced by venture fund size and also contribute to a theory of fund size. As much as possible, the theory of fund size and earnings is related to required rate of return concepts, with the objective of explaining relative variations in the value of venture capital funds, and of incorporating such investments within the general body of finance theory.