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Legality and Venture Governance Around the World
Abstract
We analyze governance with a 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 find that cross-country differences in Legality 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 board representation of the investor. We also show better laws reduce the probability that the investor requires periodic cash flows prior to exit, which is in conjunction with an increased probability of investment in high-tech companies.
... However, it has been found that venture capitalists focusing on early stage investments place significantly less emphasis on valuation methods based on past performance information (Wright and Robbie, 1996;Wright et al., 1997). When assessing the quality of human capital, past oriented interviews and work samples tend to increase the decision accuracy for early stage investors (Smart, 1999), even though this process is usually less time-consuming for seed and start-up investments with smaller entrepreneurial teams with little or no track record (Cumming et al., 2006b). ...
... First, venture capital contracts typically give investors cash-flow rights, voting rights, board rights, liquidation rights, as well as non-compete and vesting provisions . Prior studies suggest that these rights are more often granted to early stage investors, fraught with information asymmetries and hold-up problems (Carter and Van Auken, 1994;Kaplan and Strömberg, 2001;Cumming et al., 2006b). Second, there is some empirical evidence indicating that convertible preferred equity may minimize the expected agency problems associated with start-up and expansion stage investments (see, for instance, Gompers, 1997;Bascha and Waltz, 2001;Kaplan and Strömberg, 2001;Cumming 2002), 4 whereas debt and common stock are more appropriate at the later stages of venture financing (Trester, 1998). ...
... Ruhnka and Young (1987), in their turn, suggest that venture capitalists may elicit risks by distributing their investments across various investment stages. Finally, several authors suggest that the risk sharing motivation for syndication is significantly more important for early stage venture capitalists than to venture capital firms investing in later stages only (Bygrave, 1988;Lerner 1994;Gompers and Lerner, 2001;Lockett and Wright 2001;Lockett et al., 2002;Kut et al., 2005;Cumming, 2006;Cumming et al. 2006b). ...
... Furthermore, to mitigate the agency conflicts arising at the financing of young growth companies with few tangible assets (Amit et al., 1998), venture capitalists typically use a relatively complicated contractual design consisting of, among others, financing instruments such as convertible securities and staging Strömberg, 2003, 2004;Antonczyk et al., 2008). The feasibility of using these contracts depends on the legal regime (Lerner and Schoar, 2005;Cumming et al., 2010). Cumming et al. (2006) illustrate that, for the Asia-Pacific region, a higher quality of a country's legal system is related with a greater likelihood of exit through IPO or trade sale. ...
... Consistent with this thought, Jeng and Wells (2000) even find a negative relationship between the quality of accounting standards and VC activity. On the other hand, Cumming et al. (2010) show that a higher legality index, including accounting standards, has a positive impact on the governance structure of investments in the VC industry. ...
... Table 4 indicates that the strength of accounting standards has a positive influence on VC availability. This result is in line with the arguing -but not the empirical findings -in Jeng and Wells (2000) and the findings in Armour and Cumming (2006) and Cumming et al. (2010). However, our result in relation to the impact of accounting standards is only weak insofar that the significance merely holds before simultaneously controlling for other variables. ...
This study extends the current state of research on venture capital (VC) determinants by introducing a behavioral perspective. We focus on individuals’ risk perception and connect it to Hofstede’s cultural dimensions of individualism and uncertainty avoidance. Individualism is related to overoptimism and uncertainty avoidance is related to overcaution, and hence affect the perception of risk. In a cross-country empirical analysis with 49 countries, we find that individualism is positively associated with VC activity, whereas uncertainty avoidance is negatively associated with VC activity. Our results are robust to controlling for other determinants as well as using other proxies of VC activity, other time periods, and subsamples of countries.
... Empirical studies that account for the virtuous effects of VC on technology entrepreneurship (TE) have focused on developed economies (Cetindamar & Kozanoglu, 2014 ). In Latin America, the few studies on the topic underline institutional weaknesses that condition such virtuous effects at a theoretical level (Bruton et al., 2009 ;Cumming et al., 2004 ), and similar results are found by the descriptive studies referred to the region (Stein & Wagner, 2019 ;Khoury et al., 2015 ). To date, there are no empirical studies that explore the relationship between VC availability and the level of TE in Latin America. ...
... More specifically, studies focused on Latin America have highlighted the weaknesses of the VC industry (Bruton et al., 2009 ;Cumming et al., 2004 ) after analysing it from the perspective of institutional theory. Stein and Wagner (2019 ) make a detailed analysis of the profile of VC investments in Latin America under a comparative approach with other regions of the world. ...
The purpose of this chapter is to investigate whether the venture capital (VC) availability influences the technology entrepreneurship (TE) in Latin America by adopting a comparative approach with high-income economies. By applying panel data methodology in a sample of 21 Latin American countries over the period 2006–2017, we find a positive effect of VC availability on the TE only in the sample of Latin American countries. This result contrasts with that obtained for the sample of high-income countries, where no significance is found. Based on the findings, we propose some policies to improve the entrepreneurial ecosystems of Latin American countries.
... 43 Figure 6 summarizes the typical scheme through which a merger LBO transaction is undertaken. 44 Phase 1: Creation of a new company (holding company or newco) A new company (newco) is established as special purpose vehicle (SPV), with the aim of acquiring a specific firm (target). The newco generally takes the form of an Srl (Limited Liability Company). ...
... For an empirical analysis of the impact of ownership structure on market opportunities see: uk (2005). 44 For further discussions on the financial structure of LBOs in Italy see, among others: Forestieri (2007), Capizzi (2005 a, b); Caselli, Gatti (2005); Forestieri, Tasca (1994). 45 In the majority of LBO deals completed in Italy so far, the newco has always acquired 100% of the capital of the target company. ...
The institutional environment regulating mergers and acquisitions (M&A) is crucial for the private equity industry, especially for leveraged buyout (LBO) transactions, which are currently at the center of an intensive debate in the US, as seen in many European countries over the last decade. One of the most controversial issues of an LBO deal is associated with its ultimate economic result, often perceived as an indirect and fraudulent example of financial assistance provided by the acquired firm for the purchase of its own shares, to the detriment of its assets and stakeholders. Given the potential damage to the target's stakeholders, LBOs have been strongly debated and even prohibited in Italy. The institutional uncertainty surrounding the legitimacy of LBOs had a negative impact on the Italian private equity market. Recently, Italy issued an innovative corporate governance reform which offered a more favorable legal environment to this type of transactions and represented an important turning point for the domestic private equity market. The institutional change, induced by the above reform, provides scholars and policy makers with guidelines on how PE transactions may be spurred with an appropriate regulation aimed at legalizing LBOs, as well as protecting the interests of the target firm and its stakeholders. Notwithstanding the new reform, several issues remain unsolved and the admissibility of certain types of LBOs is still under debate. The purpose of this paper is two-fold: a) to shed some light on the debate on the legitimacy of LBOs by emphasizing, from an economic and financial point of view, the critical features of this class of transactions, and b) to highlight unsolved problems associated with the new LBO reform, particularly with reference to the investors' liability. The Italian buyout market, whose transactions were previously prohibited and only recently legalized, offers a unique example in order to better understand the current international debate on the admissibility of LBOs and the related consequences for the target's stakeholders.
... Cumming et al. (2006) find that the quality of a country's legal system is much more directly connected to facilitating PE backed exits than the size of a country's stock market. Cumming et al. (2008) extend this, and show that cross-country differences in legality, including legal origin and accounting standards, have a significant impact on the governance of investments in the PE industry. Better laws facilitate deal screening and deal origination. ...
... He points to the importance of shareholder protection for the establishment of a vibrant capital market. Cumming et al. (2008) show that differences in legality have significant impact on the governance of investees by PE funds. Cumming et al. (2006) comment on the quality of a legal system to facilitate PE-backed exits. ...
IntroductionInternational ComparisonWhat Determines Emerging Market PE Activity?Survey among Institutional Investors on the Importance of Emerging Markets' Allocation CriteriaConclusion
NoteAbout the Author
... In the context of venture capital, studies have shown that different pieces of the legal framework relate to the size of the countries' venture capital industries (Armour & Cumming, 2006;Leleux & Surlemont, 2003), to the valuations and returns (Cumming & Walz, 2010;Lerner & Schoar, 2005), to the quality of support that VCs provide to their PCs (Bottazzi, Da Rin, & Hellmann, 2009), as well as to the contract design (Lerner & Schoar, 2004). Some studies also examine the impact of different legal and institutional systems on contracts, governance structures and types of securities in domestic and cross-border deals (Cumming, Schmidt, & Walz, 2009;Kaplan, Martel, & Strö mberg, 2007;Lerner & Schoar, 2005). ...
... Quality of a country " s legal system has a direct connection with private equity backed exits than the size of a country " s stock market (Cumming, Flemming, & Schwienbacher, Legality and Venture Capital Exits, 2006). In an extended research, Cumming et al (2008) show that cross-country differences in legality, including legal origin and accounting standards, have a significant impact on the governance of investments in the private equity industry. By analyzing private equity transaction structures of developing countries Lerner & Schoar (2004) found that the choice of securities is driven by the legal and economic circumstances of the nation and of the investing private equity group. ...
Private equity can be described as the risk capital invested in the direct equity ownership of any non-listed private companies with a high growth potential. It has some solid advantage over other financial options; like private equity backed firms are efficient innovators and generate more employment and growth than their peer firms. Modern private equity industry have passed several decades to reach its present level. By the end of 2014, freshly committed dry powder hit a global record of USD 1.2 trillion, including USD 452 billion earmarked for buyouts alone (Bain & Company, Inc, 2015). Emerging markets from Asia region also have a vibrant private equity market with large number of active funds. While private equity market is almost absent in Bangladesh. Recently the market has received a few private equity funds coming in, setting up their offices here, and there are one-off investments that are done in conjunction with the International Finance Corporation (IFC). For a prospering private equity market to support investments, growth, competitiveness, and entrepreneurial activities policymakers should focus on the creation of an adequate setting. This paper is just a foot step towards this vast field of study. More intensive theoretical modeling; law and regulatory reforms etc. can be focused in future research work.
... Cumming et al. (2006), mediante el análisis de una muestra de empresas proveniente de 12 países de la región asiática, encuentran que las salidas a bolsa son más probables en países con un entorno legal favorable, medido a través de un índice ponderado que recoge diversos aspectos del entorno legal de cada país. También a través del estudio de un índice similar, Cumming et al. (2008) muestran, para un conjunto de 39 países, que un entorno legal favorable facilita la selección de inversiones, incrementa la probabilidad de sindicar, facilita la representación de los inversores en el equipo directivo de la empresa y potencia el uso de títulos que no requieren el reparto de flujos de caja previo a la desinversión. Por último, Bottazzi et al. (2009), mediante un análisis basado en 17 países, y utilizando tres proxies acerca de la calidad del sistema legal, encuentran que los gestores de una ECR proporcionan más apoyo no financiero y utilizan títulos más similares a la deuda cuanto mayor es la protección legal. ...
This work analyses the efficacy of two regulatory changes on private equity fundraising. In particular. the efficacy of changes in the capital gains tax and the introduction of a new legislation regulating private equity activity are analysed. Considering the population of private equity institutions in Spain during the period 1991-2007. the results show the effectiveness of the introduction of specific regulation intended to limit double taxation and provide confidence to investors. On the contrary. no firm evidence is found about the effect of a reduction of the tax in capital gains at the personal income tax. maybe due to the indirect relationship with the demand for private equity. These results are important to the regulator since they show the effectiveness of several measures aimed It contributing to the development of private equity markets.
... Cumming et al. (2006), mediante el análisis de una muestra de empresas proveniente de 12 países de la región asiática, encuentran que las salidas a bolsa son más probables en países con un entorno legal favorable, medido a través de un índice ponderado que recoge diversos aspectos del entorno legal de cada país. También a través del estudio de un índice similar, Cumming et al. (2008) muestran, para un conjunto de 39 países, que un entorno legal favorable facilita la selección de inversiones, incrementa la probabilidad de sindicar, facilita la representación de los inversores en el equipo directivo de la empresa y potencia el uso de títulos que no requieren el reparto de flujos de caja previo a la desinversión. Por último, Bottazzi et al. (2009), mediante un análisis basado en 17 países, y utilizando tres proxies acerca de la calidad del sistema legal, encuentran que los gestores de una ECR proporcionan más apoyo no financiero y utilizan títulos más similares a la deuda cuanto mayor es la protección legal. ...
This work analyses the efficacy of two regulatory changes on private equity fundraising. In particular, the efficacy of changes in the capital gains tax and the introduction of a new legislation regulating private equity activity are analysed. Considering the population of private equity institutions in Spain during the period 1991-2007, the results show the effectiveness of the introduction of specific regulation intended to limit double taxation and provide confidence to investors. On the contrary, no firm evidence is found about the effect of a reduction of the tax in capital gains at the personal income tax, maybe due to the indirect relationship with the demand for private equity. These results are important to the regulator since they show the effectiveness of several measures aimed at contributing to the development of private equity markets.
... Lerner and Schoar (2004) look at emerging markets in Eastern Europe and elsewhere and find a strong reliance on straight equity and direct board control. Cumming, Schmidt and Walz (2008) show that an increase in legality accelerates the first investment, and facilitates syndication and board representation of venture investors for a sample drawn from North and South America, Asia and Europe. Similarly, Cumming, Fleming and Schwienbacher (2006) find evidence for Asia-Pacific in support of the relevance of legal systems for exit choices. ...
... This is in line with Desai et al (2006), when they investigated the influence of institutional settings of 33 European countries in addressing the issue of fairness as protection of property rights on the entry of entrepreneurs into the market. In addition, Cumming et al (2010) concluded that, the quality of a country's legal system matters more than the country's stock market. Unexpectedly, according to Liechtenstein (2009a and2009b), institutional investors in PE are not impressed by government programs to spur local risk capital markets. ...
There is a great debate on the significance of the stable economic and well structure legal system on the commercialization, innovation and employment in modern economies. Private equity activities play a significant role in these three aspects. The purpose of this work is to investigate the macroeconomic and environmental determinants of private equity investment in nine major Asian countries. The estimations are based on a data set running from 2004 to 2013. Applying robust estimation techniques Extreme Bounds Analysis, this work identifies growth in domestic product growth, corporation tax rate, disclosure index and investors' protection index as 'robust' set of determinants of private equity. Also, inflation, stock market value, property right index, legal costs, lending rate and time in days to start business as likely robust. The result suggests the need to enhance business confidence in the country not only through robust monetary and fiscal policy but also legal system.
... For instance, laws should consider treating funds used by banks to buy shares in VC firms as 'Mudaraba' financing and therefore are exempt from taxation. Cumming et al (2004) outlined that differences in laws between countries have a significant impact on the governance structure of investments in the VC industry: better laws smooth deal screening, a higher probability of syndication and a lower probability of possibly harmful co-investment, and enable board representation of the investor. Also by providing special courts according to international standards to judge in suits related to venture capital investments. ...
The aim of this paper is to demonstrate the fundamental requirements for building an Islamic Venture Capital. There is an extremely high youth unemployment rate in Islamic Countries. This is due to few numbers of SME companies and inability of governmental sector to offer jobs for all youth. Also Conventional banks finance big companies with long history of operation and refuse to finance new companies. So this new companies do not have any institution to support them. Islamic banks have inability to make a lot an adequate profit and loss sharing (PLS) financing, because the nature of Islamic banks as depository institutions. There is a need for different type of institutions that can play this role and offer PLS financing on a wide scale. The Western practice of VC had some violation to Shariah, so we have to develop a model of venture capital that is fully compliant with the Shariah principles. The paper discuss Venture Capital Investments and its Compatibility with Islamic Principles of Investment. Also we discuss Similarities and difference between Islamic Banks and VC investments to confirm that Islamic bank can’t be used as a replacement of VC investment. Moreover the paper explains the current financing methods Used by VC investments and their compatibility with Shariah Rules. We proposed structure for an Islamic Venture Capital Model. the paper highlighted the challenges facing VC in Islamic countries and providing an approach to overcome these challenges. Finally, the paper explores the importance of governmental support to VC investments in the Islamic countries.
... In the context of venture capital, studies have shown that different pieces of the legal framework relate to the size of the countries' venture capital industries (Armour & Cumming, 2006;Leleux & Surlemont, 2003), to the valuations and returns (Cumming & Walz, 2010;Lerner & Schoar, 2005), to the quality of support that VCs provide to their PCs (Bottazzi, Da Rin, & Hellmann, 2009), as well as to the contract design (Lerner & Schoar, 2004). Some studies also examine the impact of different legal and institutional systems on contracts, governance structures and types of securities in domestic and cross-border deals (Cumming, Schmidt, & Walz, 2009;Kaplan, Martel, & Strö mberg, 2007;Lerner & Schoar, 2005). ...
... Cumming et al. (2006) show that the quality of a country's legal system matters more than the size of a country's stock market when it comes to facilitating PE-backed exits. Building on this result, Cumming et al. (2010) conclude that cross-country differences in legality have a significant impact on the governance of investments in the PE industry. The underlying idea is that better laws facilitate investors' board representations and simplify the origination and the screening of the deals. ...
A strong private equity (PE) market is a cornerstone for commercialization and innovation in modern economies. However, substantial differences exist in the relative amounts raised and invested in PE across European countries. We investigate the macroeconomic determinants of PE investment in Europe, focusing on the comparison between Central and Eastern European (CEE) and Western European countries. Our estimations are based on a data set running from 2001 to 2011 that covers 16 countries. Applying robust estimation techniques, we identify a ‘robust’ set of determinants of PE activity in both regions. We find similarities as well as differences in the driving forces of PE investments in Western European and CEE countries. Our results suggest that economic activity, the inflation rate, equity market capitalization, unit labour costs, the unemployment rate as well the the institutional and legal environment are significant determinants of PE activity.
... Cumming et al. (2006), mediante el análisis de una muestra de empresas proveniente de 12 países de la región asiática, encuentran que las salidas a bolsa son más probables en países con un entorno legal favorable, medido a través de un índice ponderado que recoge diversos aspectos del entorno legal de cada país. También a través del estudio de un índice similar, Cumming et al. (2008) muestran, para un conjunto de 39 países, que un entorno legal favorable facilita la selección de inversiones, incrementa la probabilidad de sindicar, facilita la representación de los inversores en el equipo directivo de la empresa y potencia el uso de títulos que no requieren el reparto de flujos de caja previo a la desinversión. Por último, Bottazzi et al. (2009), mediante un análisis basado en 17 países, y utilizando tres proxies acerca de la calidad del sistema legal, encuentran que los gestores de una ECR proporcionan más apoyo no financiero y utilizan títulos más similares a la deuda cuanto mayor es la protección legal. ...
... 14 The papers of Cumming, Schmidt and Walz (2004), , Schmidt (2004) and Schmidt, Steffen and Szabo (2007) give detailed insights about the index construction and its composition. series' will eventually adjust to equilibrium. ...
Most monthly return distributions of alternative as sets are in general not normally distributed. Further, some have biases (e.g. survivor ship bias) that distort the risk-return profile. For that reason every portfolio optimization in the mean-var iance framework which includes alternative assets with not normally distributed re turn distributions and/or biases will most likely be sub-optimal since the risk-return is not covered adequately. As a result the biases and higher moments have to be taken into account. For that reason the return series are corrected for biases in a first step. In the next s tep the empirical return distributions are replaced with two normal distributions to approxima te a best-fit distribution to cover the impact of the higher moments. This procedure is kno wn as the mixture of normal method and is widely used in financial applications. In order to build a strategic asset allocation for a mixed asset portfolio traditional investments (stoc ks and bonds) and the vast majority of alternative investments (asset backed securities, h edge funds, venture capital, private equity (buy out), commodities, and REITs) are considered. Furthermore real investor's preferences are considered in optimization procedure. In order to test the results for stability robustness tests which allow for the time-varying correlation structures of the strategies are applied.
... The Venture Economics database has been used for empirical studies on the private equity industry a number of times over the last decade (Lerner, 1994a;1994b CEPRES contains exact data on each of the investor's cash injections into the portfolio company and each of the company's cash distributions to the investor. Empirical studies by Cumming and Walz (2004), Cumming, Schmidt and Walz (2004), and Schmidt (2004) offer a more detailed introduction to the CEPRES database that also forms the empirical basis of a recent publication by Knigge, Nowak and Schmidt (2006). Details of the merged dataset of this study were first introduced by Calanog, Krohmer and Lauterbach (2006). ...
Using a unique private equity fund dataset, we examine the antecedents and performance implications of style drift in private equity investments. For the first time, we show that drifts from an investment focus are associated with a higher IRR and that both market and fund characteristics influence the occurrence of style drift. We specifically find that style drifts occur mainly from early stage investment to the later stages and increase the IRR while simultaneously decreasing the inherent risks. Overall, our results support Gompers and Lerner's (2000) "money chasing deals" hypothesis as well as Barberis and Shleifer's (2003) theoretical work. We would like to thank Venture Economics and CEPRES for providing the data. We are grateful to Mark Wahrenburg and Philip Krohmer for useful comments and suggestions. All views expressed and errors committed are our own.
... The data is derived from detailed due diligence and (partially) audited monitoring information of PE and VC Funds collected by the Center of PE Research (CEPRES), Germany. A more detailed introduction of the CEPRES database is provided in the empirical studies of , Cumming, Schmidt and Walz (2004) and Schmidt (2004). ...
The stepwise allocation of capital from an investor to a company is described as staging. The importance of staging as a mechanism to control an investment and to affect its success has been confirmed uniformly by several authors. But the findings on the direction of the influence of staging on investment performance have created a not yet solved puzzle. To measure this influence precisely we create a unique dataset by merging the Venture Economics and CEPRES * databases. We analyze 712 matched Private Equity and Venture Capital investments including 1.549 financing rounds and 2.329 precisely dated cash injections. We take a new approach by segmenting the post-investment period in three phases of equal lengths and analyzing the influence of staging on the overall investment performance for each of these investment phases. Our findings shed light on the bright and dark side of staging. Our results show that during the initial investment phase, the investor uses staging foremost as monitoring instrument to mitigate agency problems and to provide added-value resources to the company resulting in significant positive influence on the investment performance. Staging has little impact on performance during the maturity phase. However, during the pre-exit phase we find evidence that investment managers face a termination dilemma and do not rigorously use staging as an option to terminate unsuccessful investments in time. They rather use staging for the attempt to turn around critical situations and partially for window dressing purposes. By this staging behaviour they throw good money after bad.
... We also add to the small number of studies that explore geographical difference between VC contracts and deal structuring. Unlike studies of international differences in VC contracts (Lerner & Schoar, 2005;Kaplan, Martel & Stromberg, 2007;Hellman et al, 2008) and VC investment decisions ( Cumming et al, 2008), our sample is restricted to companies that are located in the U.S. The fact all our contracts come from the same country is important because it means that our results cannot be explained by differences in the legal system, rule-of-law, accounting transparency, bankruptcy procedures, taxation, etc. 4 Our findings have important implications for the empirical testing of models that explain why different types of convertible securities are used in VC investments (Berglof, 1994;Hellman;Cornelli & Yosha, 2002;Casamatta, 2003;Schmidt, 2003;Repullo & Suarez, 2004). Since cultural and geographical factors play an important role in how cash flow rights are allocated in VC contracts, they should be included as controls in any analysis of cash flow rights, and when distance is studied it is important to separate Silicon Valley and California from other locations. ...
This paper shows that geographical and cultural elements could form an essential component of contract design in addition to more "traditional" ingredients such as information and agency problems and the quality of legal institutions. Contracts between U.S. venture capitalists (VCs) and entrepreneurial companies include significantly fewer investor-friendly cash flow contingencies if the company is located in California and in particular in Silicon Valley. Contract solutions also carry over between markets, with contracts being less investor-friendly if a VC is located in California or if a non-California VC has had large exposure to investments in California. Although we find that a larger concentration of VCs and venture-backed companies in a region is associated with less investor-friendly contracts, this pattern alone cannot explain why California is different. We show that, after controlling for these important regional differences, contracts include fewer cash flow contingencies when the geographical distance between VC and company is shorter. This finding supports the view that that monitoring and soft information decrease with distance but can be substituted with high-powered incentive contracts.
... Cressy et al. also find that buyouts by PE firms with industry and stage specialization perform even better. assess the returns to buyouts from the investor's perspective in an international context (see also Cumming, Schmidt and Walz, 2004). The authors compare buyout returns to the returns to other stages of venture capital and private equity investment. ...
This paper provides an overview of the literature on private equity and leveraged buyouts, focusing on global evidence related to both governance and returns to private equity and leveraged buyouts. We distinguish between financial and real returns to this activity, where the latter refers to productivity and broader performance measures. We also outline a research agenda on this topic.
... While cross-country differences are analyzed in several studies (e.g., Jeng and Wells 2000;Black and Gilson 1998;Armour and Cumming 2006;Cumming et al. 2004), little is known about the impact that different types of private equity providers have on the investment and divestment patterns within one country, which is the focus of this research. 1 This lack of knowledge may be due to several reasons, but one reason is almost certainly the lack of data on private equity firms and their investments and divestments. ...
Empirical literature emphasizes a positive contribution of private equity investors, which results from their combined provision of capital, monitoring, and management support. The aim of this study is to show that these previous results, which are based mostly on the analysis of US independent closed-end private equity funds, cannot be generalized since the private equity industry should not be treated as homogenous. We argue that it is necessary to distinguish between different types of private equity providers because their differing governance structures, strategic goals and experiences have a decisive influence on their value adding activities. The results of this study - which uses a data set of 179 German private equity-backed companies - are consistent with the conjecture that independent and corporate private equity providers tend to have a more pronounced role in corporate governance and monitoring of the companies they finance, than bank-dependent and governmental funds which often serve only as bridge investors.
... Cumming et al. (2006a) find that the quality of a country's legal system is much more directly connected to facilitating VC/PEbacked exits than the size of a country's stock market. Cumming et al. (2006b) expand on this and show that cross-country differences in legality, including legal origin and accounting standards, have a significant impact on the governance of investments in the VC/PE industry. Better laws facilitate deal-screening and deal-origination. ...
Growth expectations and institutional settings in Central Eastern Europe are assumed to be favorable for the establishment of a vibrant Venture Capital and Private Equity market. Despite this, there is a lack of risk capital. We examine the obstacles to institutional investments in the region through a questionnaire addressed to (potential) Limited Partners world-wide. The respondents provide information about their perceptions of the region. The protection of property rights is the dominant concern, followed by social criteria, such as the belief in the management quality of local people, and the lacking size and liquidity of the Central Eastern European capital markets. However, Limited Partners regard the growth expectations as attractive, and those with exposure in Central Eastern Europe are satisfied with the historical risk and return ratio, they have a good knowledge of the region, are attracted by other emerging regions, and they appreciate the region's entrepreneurial opportunities and the local General Partners. Overall, the region is ranked very favorable compared to other emerging regions, and especially with respect to its economic and entrepreneurial activity.
Résumé Cet article compare les performances des investissements en capital risque aux États-Unis et en Europe au regard de la valeur créée au cours du cycle d’investissement par les entreprises financées par ces fonds en capital risque. Nous montrons que les entreprises financées par des investisseurs américains créent significativement plus de richesse que celles financées par des investisseurs européens. Nous trouvons des différences dans les contrats, notamment sur la fréquence des rounds d’investissement et sur la création de syndicats, et montrons que celles-ci expliquent partiellement les différences de performances. Nous trouvons aussi que les investisseurs américains investissant en Europe n’obtiennent pas de meilleures performances que les investisseurs européens. Les entreprises de pays européens ayant un système juridique de « Common Law » et celles de pays ayant un système juridique codifié obtiennent des performances similaires. De même, le développement des marchés financiers et des aides à l’investissement en capital risque n’ont pas d’impact sur les performances. Les richesses crées par les entreprises dont les investisseurs sont sortis lors d’une introduction en bourse sont identiques des deux cotés de l’Atlantique. Par contre, concernant les sorties lors de ventes de gré à gré, les entreprises européennes sous-performent les entreprises américaines. De manière globale, la sous-performance des investissements en capital risque en Europe relativement aux États-Unis est attribuée au segment des entreprises ayant obtenus des mauvaises performances.
Over the past decade the venture capital industry has become more and more prominent, not just on a global level, but in Hungary, too. Thanks to the JEREMIE Program a large number of new venture capital firms are located in our country, and therefore an investment wave has started. The aim of the paper is to sort micro- and small sized enterprises in terms of how appropriate is a venture capital financing. The main topic of the paper relates to the selection of firms for venture capital investment; therefore, in the first part of the study we briefly summarize a general venture capital investment process, highlighting both the selection process and the criteria used for selection. Then we propose 3 indexes (trustworthiness index, openness index, investment index), which we have created to help venture capitalists to decide whether the targeted enterprises are appropriate for them, or not. In the main part of the paper we provide a classification of micro- and small sized Hungarian firms based on my own survey, and we analyze what kind of relationship exists between the proposed indexes and the type of the classified firms. The result of the classification is that we identify four main firm types and, based on statistical tests, it can be said that there is no significant relationship between the trustworthiness index and the clusters, but that there are between the two other indexes and the clusters.
Die Finanzierung von Unternehmensgründungen durch Venture Capital erfolgt in der Regel in Form syndizierter Verträge. Dieser Beitrag thematisiert Thesen zur Erklärung dieser weit verbreiteten Syndizierungspraxis. Mit Syndikat wird eine Gruppe von Individuen bezeichnet, die eine gemeinsame (Investitions-) Entscheidung unter Unsicherheit treffen. Die zukünftigen Einzahlungen aus der Investition werden von den Gruppenmitgliedern gemeinsam untereinander aufgeteilt. Ziel des Beitrags ist es erstens, einen Überblick über die zahlreichen, sehr unterschiedlichen vorhandenen Erklärungsansätze der Literatur zu gewinnen, diese zu systematisieren und um neue, auch empirische Erkenntnisse zu ergänzen. Zweitens sollen erst kürzlich erschienene Arbeiten, die ganz neue Erklärungsansätze verfolgen und eine ganz neue Entwicklungsrichtung der Forschung andeuten, skizziert werden. Im Fokus der neuen Ansätze stehen Vorteile für die Gründer als Vertragspartner des Syndikats. Der Beitrag zeigt, dass dem Thema Syndizierung bisher in der Forschung zu wenig Bedeutung beigemessen und folglich auch zu wenig Beachtung geschenkt wurde.
Alternative financing mechanisms are needed to deliver on the sustainable development goals that African countries have committed to. Private equity is an asset class that could leverage the geographical factors behind Africa’s economic growth to deliver impact in a variety of areas related to sustainable development. This paper uses a geographic lens to assess the challenges and opportunities presented by global goal setting for achieving development results and the role that can be played by the private equity asset class. Policy options for countries to choose from are identified for effective development of private equity as a solution for achieving selected development results.
IntroductionThe Buyout Market and Its Puzzling TrendThe LBO Scheme and Related CriticismsThe LBO Legal Environment: Past, Present, and Future TrendsThe Economic Impact of the 2004 ReformConclusion
Appendix 21.A: The Past Debate on the Legitimacy of LBOs in ItalyA Closer Examination of Why LBOs Appeared to Be Illegal in ItalyAppendix 21.B: The Regulation of Financial Assistance in the United KingdomAppendix 21.C: Survey DetailsNotesAbout the Author
IntroductionRelated LiteratureA Simulation Approach for Venture Capital Performance Projection and Risk ManagementSimulation Results for Two Fictitious Venture Capital FundsConclusion
NotesAbout the Authors
IntroductionEvidence of the Real Effects of Private EquityResearch AgendaAbout the AuthorAcknowledgment
Fondovi pribvatnog kapitala i Fondovi zajedniĉkog ulaganja su institucionalni investitori koji su spremni da uloţe sredstva u kompanije koje nemaju dugu istoriju poslovanja. Njihov cilj jeste da prepoznaju kompaniju sa potensijalom rasta, uloţe novac u nju i finansijki, marketinški i tehnološki pomognu njenom razvoju. Kako je ova vrsta investitora ukljuĉena u svakodnevne aktivnsoti kompanije, prisutna je pretopstavka stabilnog ekonomskog i institucionalnog okruţenja. Kada se odluĉe za investiranje u zemlje u razvoju, koriste razliĉite modele za procenu stabilnosti okruţenja. Kljuĉne reĉi: Fondovi zajedniĉkog ulaganja, Ekonomski razvoj, Region Zapadnog Balkana, analitiĉki model Summary: Private equity and Venture capital funds are institutional investors willing to take high risk by investing in companies with no strong tracking record. Their aim is to recognize companies with potential high growth, invest money in it and help company with financial, marketing and technological experience and contacts. Because they are intensively involved in day to day business operation of company, they assume stability of economic and institutional sourandings. When they are making decision to invest in developing countries, different models for enviromental stability analysis are used.
We investigate the determinants of cross-border venture capital (VC) performance using a large sample of 10,205 cross-border VC investments by 1906 foreign VC firms (VCs) in 6535 domestic portfolio companies. We focus on the impact of a domestic country's economic freedom on the performance of both VC investments and portfolio companies using a probit model and the Cox hazard model. After controlling for other related factors of domestic countries, portfolio companies, VCs and the global VC market, as well as year and industry fixed effects, we find that a domestic country's economic freedom is crucial to cross-border VC performance. In particular, in a more economically free country, as measured by the raw values of, quartiles of or the ranking in the index of economic freedom (IEF), a foreign VC-backed portfolio company is more likely to pull off a successful exit through an IPO (initial public offering) or an M&A (merger and acquisition), and a foreign VC firm is likely to spend a shorter investment duration in the portfolio company. We also identify interesting evidence on the impact of many other level factors of domestic countries, portfolio companies, VCs and the global VC market on cross-border VC performance.
In this paper we investigate the risk return relationship of Private Equity (PE) relative to Public Market Equity (PM) investments to assess the adequateness of PE's return premium. We analyze cash flows of PE projects gross of fees and any other externalities. Our analysis is based on simulated PM investments, mimicking the cash flow patterns of the PE investments. The comparison of alternative cash flow based performance measures reveals a substantial impact of the reinvestment hypothesis. Prior to any risk adjustment, PE investments outperform their PM counterparts with varying levels depending on the chosen benchmark (broad, industry specific, local). Next we compare standard risk measures and find downside deviation and shortfall to better describe the characteristics of not normally distributed PE investment returns than standard deviation. Thus, it is not surprising to observe substantially higher Sharpe Ratios for PM relative to PE investments. We adjust the Sharpe Ratio measuring risk in terms of downside deviation and still observe underperformance of PE relative to PM investments, with very heterogeneous results regarding industry, stage and size of the investments. Last we introduce Omega as alternative risk adjusted performance measure, because its risk definition better suits the characteristics of PE investments. For our PE sample we observe adequate excess returns over public stock markets given the higher shortfall risk. Our findings question the existence of an illiquidity puzzle on the fund level. Overall PE returns are highly skewed and very heterogeneous. We find later stage to be more attractive than early stage investments due to higher risk adjusted returns. As the PE investment universe is on average of poor quality compared to public equity markets, investment selection ability is of crucial importance.
This paper shows that geographical elements can form an essential component of contract design in addition to more traditional ingredients such as information problems, moral hazard and legal institutions. We analyze cash flow contingencies included in 1,804 contracts between U.S. venture capitalists (VCs) and U.S. startup companies. These contingencies affect both the pricing of the VC investment and the entrepreneur’s monetary incentives. We construct an index of “contract harshness”. Consistent with theoretical arguments, we show that contracts include fewer harsh contingencies for younger companies and companies that raise larger amounts of VC financing. However, we find that geography plays a crucial role in VC contract design. Our main result is that contracts are considerably less harsh if the startup is located in California, and in particular in Silicon Valley. The effect also carries over between markets: contracts are less harsh for entrepreneurs if a VC is located in California or if a non-California VC has had large exposure to investments in California. We further show that contracts are less harsh if the startup is located in a region with a larger VC market, or if the geographical distance between the VC and the company is shorter. This latter finding supports the view that geographical proximity lowers monitoring costs. However, the “California effect” remains large and significant even after we control for all other factors. Finally, we present evidence that the effect cannot be explained by a substitution between control rights and cash flow contingencies. In fact, California contracts are less investor-friendly on both counts.
This paper presents novel evidence that a geographically based style matters for the design of financial contracts, in addition to more traditional ingredients. We analyze cash flow contingencies included in 1,804 private equity contracts between U.S. venture capitalists (VCs) and U.S. startup companies. These contingencies affect both pricing and incentives. We document a pronounced “California effect”, namely, that California based entrepreneurs receive less harsh contract terms. We find a similar effect if the VC is located in California, or if a non-California VC had a large exposure to the California market. We further show that contracts are less harsh if the geographical distance between the VC and the company is shorter, which supports the view that geographical proximity can lower monitoring costs. However, the “California effect” remains large and significant even after we control for distance and other factors. Our findings cannot be explained by differences in state laws, bankruptcy and tax regimes, or by VCs substituting less harsh cash flow contingencies for harsher control rights or for more performance-based CEO compensation. In fact, California contracts are more entrepreneur-friendly in all these dimensions.
This survey article summarises the findings of four research projects on the venture capital industry in Europe and the role played by legal institutions and the legal framework. A study on patent litigation insurance argues that insurance can create a level playing field for small innovators, but that compulsory insurance can only be justified as a transitory scheme. The second study argues that intermediaries from countries with a better legal tradition will provide more governance and value-added services, even when investing abroad. It also provides supportive empirical evidence based on an extensive questionnaire study. The third project investigates the relationship between venture investments and a widely used legality index in thirty-nine countries, finding that better laws facilitate faster deal screening and origination, lead to a higher probability of syndication and also facilitate board representation of the investors. The final study documents a significant performance gap between the European and the US venture capital industry, but argues that the difference can not be attributed to differences in legal origin.
The main purpose of this paper is to empirically model the influence of macroeconomic and financial variables on the performance
of risk capital in the US. We start our investigation using a static long-run equilibrium model. In contrast to previous studies,
we analyze the effect of several factors simultaneously within the framework of a vector error correction model (VECM). This
allows us to study short- and long-term interactions to overcome the problem of endogeneity, and to discover causal mechanisms.
The results show that the value of venture capital investments is positively related to industrial production, the exit channel
Nasdaq, and the long-term interest rate. However, the value of venture capital investments is negatively related to the short-term
interest rate. According to the short-term dynamics, VEC Granger causality confirms that only industrial production influences
venture capital performance, while venture capital returns Granger causes Nasdaq performance.
KeywordsVenture capital returns–Macroeconomy–Cointegration test–VECM–Granger causality–Variance decomposition
Using a unique sample of 444 entrepreneurial IPOs in the UK and France, this paper analyses the investment patterns and the stock-market performance effects of two types of early stage investors: venture capitalists (VCs) and business angels (BAs). Extending existing research, we identify important endogeneity and institutional effects. Our findings indicate that UK IPOs have a higher retained ownership and lower participation ratio by BAs, but a lower retained ownership and participation ratio by VCs than in France. BA and VC investments are substitutes, and they are endogenously determined by a number of firm- and founder-related factors, such as founder ownership and external board 'interlocks', and underwriter reputation. UK VCs are effective third-party certifying agents who reduce underpricing in UK IPOs, whereas in French IPOs they increase it by appearing to engage in grandstanding. This certification effect is more significant in UK IPOs involving both high VC and BA ownership. Finally, underpricing increases with VC participation ratio, where the higher exit of VCs seems to increase the risk premium required by outside investors, in particular in the UK. Copyright 2007 The Authors Journal compilation (c) 2007 Blackwell Publishing Ltd.
This volume is a timely and insightful exploration into the issues of corporate governance and the impact of corporate governance practices on investments in developing countries. Sponsored by the World Economic Forum, INSEAD, and Wharton, this book collects original essays from senior researchers at the worlds top academic institutions as well as from key policymakers and business leaders, It analyzes global aspects of governance in relation to such issues as corporate performance, privatization, venture capitalism, and workers. With global financial markets having become more integrated, the book pays particular attention to the role of corporate governance in emerging-market economies and international capital flows. Rich in facts and ideas, Corporate Governance and Capital Flows in a Global Economy is a must read for anyone interested in financial crises, international risk management, and global competitiveness.
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.
There is a simple robust variance estimator for cluster-correlated data. While this estimator is well known, it is poorly documented, and its wide range of applicability is often not understood. The estimator is widely used in sample survey research, but the results in the sample survey literature are not easily applied because of complications due to unequal probability sampling. This brief note presents a general proof that the estimator is unbiased for cluster-correlated data regardless of the setting. The result is not new, but a simple and general reference is not readily available. The use of the method will benefit from a general explanation of its wide applicability.
Economic development, legality, and the transplant Sahlman, W.A., 1990. The structure and governance of venture capital organizations
- D Berkowitz