VENTURE CAPITAL ANDPOST IPO PERFORMANCE

Group A-8

David Allison #100326780

Donaldo Madrid #100292425

Eghan Rashidi #100321747

Suzanne Robertson #100621555

Victor Samuel #100326398

Agenda

• Introduction• Previous Studies• Benefits of Venture Capital financing on

start-up firms• Methodology and Data• Results• Implications of study and policy issues• Conclusion• Question

Literature Review

• Main objective was to compare post-IPO performance of venture-backed firms to that of non-venture backed firms

• To develop a model that will measure the success of a firm’s post-IPO performance that accounts for both venture capital financing and the role of the venture capitalists

Post-IPO Performance of Venture Capital Firms

Brav and Gompers (1997)

• Results found that venture-backed IPOs over a five year period outperformed non-venture backed IPOs only when using equally weighted returns

• Underperformance of non-venture backed is not an IPO effect, it is an industry and firm effect

Post-IPO Performance of Venture Capital Firms

Da Silva Rosa, Velaythuen and Walter (2003)• Studied the strength and validation of Brav and

Gompers (1997)• No indications that the long-run performance of

venture capital and non-venture capital-backed IPOs was based on their industry

• Concluded that in the long-run, venture capital-backed firms outperform non-venture capital-backed firms

Post-IPO Performance of Venture Capital Firms

Florin (2005)

• Examined the difference in post IPO performance comparing firms that had received venture capital financing to firms that did not

• Marginal differences were concluded to be insignificant

Monitoring and Reputations of the Venture Capitalists

Brau et al. (2004)

• Found that experience and monitoring of the venture capitalists has no effect on the success of a firm

• Findings were inconsistent

Jain and Kini (1995)

• In the aftermarket venture capital-backed IPOs have stronger operating performance

• Non-venture capital-backed firms experience a decline in operating profits

Monitoring and Reputations of the Venture Capitalists

Jain and Kini (2000)

• Completed a survival analysis which resulted that venture capital-backed firms have a higher survival rate post-IPO

• This is because of prestige, reputation and monitoring of the venture capitalists

Literature Review Conclusion

• Enabled us to better understand how venture capital and capitalists help in the survival of a firm post-IPO

• The trend is that firms that have had venture capital as a source of financing prior to the IPO have a better rate of survival post IPO

Benefits of Venture Capital

•More than just financial value is brought to the firm- expertise, experience, contacts, and credibility

•Venture capitalists can play an integral role in helping the firm in its strategic decisions by bringing knowledge and experience from running other firms

•Efficiently monitoring and overseeing strategy as a counter to managers’ entrenchment and cognitive limitations

Benefits of Venture Capital• Corporate governance: venture capitalists add

detailed knowledge to the development and growth of the firm

• Can also establish contractual constraints on management decisions

• A greater stake in the firm can increase incentives for more effective oversight

• The quality of due diligence and participation in corporate governance can send a positive signal to the markets

Two Perspectives

• The Certification/Monitoring model

– (Megginson & Weiss, 1991; Lin, 1996; Lerner, 1994; Jain & Kini, 1995; Brav & Gompers, 1997)

• The Adverse Selection/Grandstanding model

– (Amit et. al., 1990; Gompers, 1996)

Another Perspective

• Lange, Bygrave, et. al. (2001) found that top venture capitalists, combined with top underwriters, also contribute to the success of a firm.

Hypothesis

• Venture capital-backed firms will exhibit superior financial and equity returns relative to non-venture-backed firms

Methodology

• Fama French (1992)…

• Generalized Least Squares (GLS) estimator

• Dummy Variable

• Expected Returns

• Significance test (t-test)

Data

• Thompson/Mergent and Yahoo! Finance

• Indices ( NYSE, AMEX, NASDAQ, Wilshire 5000)

• 2001- #US Firms IPO

• 2003-BV, ME, Market Beta

• #VC-Backed # non-VC backed

Results

• There is enough evidence from the data to suggest at a 0.10, 0.05, or 0.01 level of significance that venture-backed firms had higher returns than non-venture-backed firms– P-value of 0.004

• Also evidence that venture-backed firms had lower unsystematic risk

Table of regression results R-SQUARE = 0.4593 R-SQUARE ADJUSTED = 0.4161

VARIABLE ESTIMATED STANDARD T-RATIO  

NAME COEFFICIENT ERROR 50 DF P-VALUE

CG -2.48E-02 7.94E-03 -3.122 0.003

BG 1.97E-04 1.55E-03 0.1269 0.9

LNMEG 1.34E-03 3.62E-04 3.705 0.001

LNBTMG -1.34E-03 4.09E-04 -3.289 0.002

DVCG 3.98E-03 1.34E-03 2.978 0.004

R-SQUARE = 0.4592 R-SQUARE ADJUSTED = 0.4273

VARIABLE ESTIMATED STANDARD T-RATIO  

NAME COEFFICIENT ERROR 51 DF P-VALUE

CG -2.46E-02 7.76E-03 -3.174 0.003

LNMEG 1.34E-03 3.58E-04 3.742 0.000

LNBTMG -1.34E-03 4.03E-04 -3.324 0.002

DVCG 3.98E-03 1.32E-03 3.009 0.004

Proof of Unsystematic Risk

• Total risk = unsystematic + systematic risk

• Total risk measured in variance or st. dev.

• Systematic risk measured in market beta

• VB st. dev = 0.0958, NVB st. dev = 0.0868

• VB mkt beta = 0.783,NVB mkt beta =0.582

• Since total risk is very close, but VB has higher systematic risk, suggests VB has less unsystematic risk

• Consistent with theory

IPOs on London’s Alternative Market

• Many venture-backed Canadian firms issue their IPOs on the London Stock Exchange’s Alternative Investment Market (AIM)

• Issue on AIM because of institutional investors interests in small-growth firms

• About 34 Canadian companies on AIM including Ottawa based Ubiquity Software Inc. & March Networks

Success of IPO’s on AIM

• 2005 - the value of IPO’s on AIM more than doubled from $2.37 billion to $5.63 billion

• International IPO’s increased to 76 from 40

• Value of international IPO’s has quadrupled from $2.09 billion to $529.5 billion

• 2005 - AIM’s listing rose 60% compared with TSX Venture growth rate of only 16%

Advantages and Disadvantages of issuing on AIM

• ADVANTAGES• Pursues listings from a

wide variety of sectors• “Light regulation” &

“User Friendly”• European investors are

less skeptical about high-tech startups

• Faster to issue IPO

DISADVANTAGES• Financial statements filed

semi-annually, not quarterly

• Not subject to CEO/CFO or internal control certification

• Analysis and management discussion not required

Implications

• Government should create policy to induce Canadian venture start-ups to IPO in Canada not overseas

• Policy suggestions:– Semi-annual reporting for first few years

• High costs associated with current regulations

– Tax incentives for investors– Examine Canadian security regulations to

attempt to increase liquidity

QUESTIONS