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Venture Capital Incubation Period, Underpricing, and Firm Performance

Venture Capital Incubation Period, Underpricing, and Firm Performance . NTU International Conference on Finance December 2006 Scott Hsu. Overview. VC incubation period. Definition: The findings on the effect of the VC incubation period:

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Venture Capital Incubation Period, Underpricing, and Firm Performance

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  1. Venture Capital Incubation Period, Underpricing, and Firm Performance NTU International Conference on Finance December 2006 Scott Hsu

  2. Overview VC incubation period • Definition: • The findings on the effect of the VC incubation period: • Firms with a longer incubation period are less underpriced at the IPO stage • Firms with a longer incubation period are more likely to survive three years after the IPOs • Firms with a longer incubation period exhibit better post-IPO operating performance Founding date First VC investment date IPO date

  3. Also important to study the determinants of the VC incubation period because.. • VCs play a dual role of “incubators” and “short-term investors” • Incubators: Hellmann and Puri (2002) • Short-term investors: “Google’s founders would have preferred to wait longer to do their IPOs, but had to rush it because venture capitalists,…, wanted to cash in” -The Economists, November 27, 2004 • It is thus important to find a measure to examine whether and under what circumstance VCs behave as “incubators” versus “investors”, and consequences that follow

  4. The significance of studying the determinants of the VC incubation period and its impact • The conflicting role of VCs in incubating startups - Screening and monitoring: Jain and Kini (1995); Hellman and Puri (2002); Wang et al. (2003) • Certification in the IPO market: Megginson and Weiss (1991); Lee and Wahal (2004); Ljungqvist and Wilhelm (2003) • Most studies in this vein focus on the “binary comparison” between VC-backed and non-VC-backed firms. However, the “magnitude” of the VC effect could matter for firm success • A large proportion of IPOs were backed by VCs in recent years • 50.33% of IPOs were backed by VCs in 2000; 34.58% in 2001 • Thus, the investment strategy of VCs could have a profound impact marketwise

  5. Data and methodology Data • 1502 venture-backed IPOs that went public from 1980 to 2003 • SDC Venture Xpert database • Supplemented by SDC New Issues database, CRSP, Compustat, and Jay Ritter’s firm founding dates and underwriter ranking data Methodology • OLS to study both the determinants and effects of VC incubation period • Robustness check: Heckman’s two step procedures and survival analysis

  6. VC incubation period and investments over time

  7. Univariate result: VC incubation period and IPO underpricing High (Low) incubation period group: Firms whose incubation periods are ranked in the top (bottom) quarter of the whole sample

  8. Determinants of the VC incubation period

  9. Determinants of the VC incubation period

  10. Firm Survival and the VC incubation period • Definition of non-survivors: Firms that are delisted within 3 years after the IPO for reasons other than mergers and acquisitions

  11. Firm survival probability and the VC incubation period

  12. IPO underpricing and the VC incubation period • The IPO underpricing decreases with the length of the VC incubation period • The effect of firm age at IPO on the underpricing mainly come from the incubation period, not from the period before the VCs’ investment

  13. IPO underpricing and firm age at IPO

  14. IPO underpricing and VC incubation period

  15. The level of post-issue ROA and VC incubation period

  16. Robustness Check 1. The effect of VC participation or merely natural maturation? A further investigation 2. Does there exist a potential selection bias of venture financing? -Heckman’s two-step procedure 3. A survival analysis of the determinants of the VC incubation period

  17. “Age” effect is more pronounced for venture-backed firms

  18. Underpricing and VC incubation period: Heckman’s two-step procedure

  19. Level of post-issue ROAs and VC incubation period: Heckman’s two-step procedure

  20. Determinants of VC incubation period-A survival analysis

  21. Conclusion • This paper finds that the strategic choice of VCs as “incubators” versus “short-term investors” determines the length of the VC incubation period, which has positive impacts on firms: • Less underpricing • Higher surviving probability • Better operating performance • This paper suggests that VCs play a positive role in incubating startups • This paper provides implications on the issues of corporate governance—the internal conflicts of large shareholders could affect the performance of firms

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