Liquidity risk and venture capital finance

This article provides theory and evidence in support of the proposition that peril capitalists adjust their investment decisions according to liquidity conditions upon IPO exit markets. We direct to technological risk as a choice variable in metes of the characteristics of the entrepreneurial firm in which the risk capitalist invests, and liquidity risk as the popular and expected future external exit market conditions. We exhibit that in times of wait fored illiquidity of exit markets (high liquidity risk), risk capitalists invest proportionately more in fresh high-tech and early-stage projects (high technology risk) in order to delay exit requirements. When exit markets are liquid, hazard capitalists rush to exit through investing more in later-stage casts We further provide complementary evidence that present to views that conditions of low liquidity risk give rise to les syndication. Our theory and supporting empirical rises facilitate a unifying theme that links related research upon illiquidity in private equity.

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Policymakers around the world repeatedly express concern about why there is not more investment in privately held early-stage companies. (1) Further, the most remote cyclicality of early-stage investment, and what the drivers are, remains a relatively unexplored issue in private equity and peril capital research. (2) This article introduces a novel and somewhat counterintuitive theory to facilitate an understanding of these issues. The US data examined herein support the theory.

risk capitalists ("VCs") invest in small private extension companies that typically do not have cash roll ons to pay interest on due or dividends on equity. VC invest in private companies above a period that generally ranges from sum of two units to seven years prior to exit. As similar VCs derive their returns [i]or[/i] part of to the other capital gains in exit transactions. IPO exits typically provide VC with the greatest get backs and reputational benefits (Gompers, 1996 and Gomper and Lerner 1999 2001) (3) Liquidity risk in the connected thought [i]or[/i] thoughts of VC finance therefore deliver overs to exit risk, particularly IPO exit risk. That is, liquidity risk leaves to the risk of not being able to effectively exit and thus being forced either to remain a great deal of longer in the venture or to vend the shares at a high discount. (4) The risk of not being able to effectively exit an investment is an important reason wherefore VCs require high returns upon their investments (Lerner, 2000, 2002; Lerner and Schoar, 2004 2005) It is therefore natural to await that exit market liquidity affects VCs' incentives to invest in different emblems of entrepreneurial firms.

Liquidity risk is, of course, not the sole type of risk that VC face when deciding to invest in a particular shoot forward The other types of risk may be clustered into a broad category of what we deliver over to in this article as technological risk, or the risk of investing in a throw out of uncertain quality (particular stamps of technological risk could include the quality of the fruits technology as well as the quality of entrepreneurs' technical and managerial abilities). This article considers whether changes in external conditions of liquidity risk give rise to adjustments in VCs' undertaking of throws with different degrees of technological risk. In particular, we investigate whether exit market liquidity affects the oftenness of VC investment in nascent early-stage firms and high-tech firms with intangible assets. (5) We provide a theory and supporting empirical evidence that present to view the willingness of VCs to undertake throws of high technological risk is directly related to conditions of liquidity risk. We further provide complementary evidence that exhibits that external conditions of high liquidity risk give rise to more prevalent syndication, which in move round shows that while VCs assume more technological risk in periods of depressed liquidity, they take steps to mitigate this risk [i]or[/i] part of to the other syndication. We show that the theory and evidence in regards to liquidity risk introduced herein provides a unifying theme that links the rises in a number of related papers upon venture capital finance.

We introduce a theoretical prototype that shows that VCs will rationally trade-off liquidity risk against technological risk by means of investing more in early-stage throw outs when the liquidity of exit markets is depressed and thus the exit risk is high. The intuition underlying our archetype is as follows. By adjusting their portfolio of investments for long-term positions, VC bring their exposure to liquidity risk. This is important in explaining the choice of casts according to their stage of unfolding (early stage versus expansion stage), and the decision whether to invest in completely of recent origin projects or to limit investments to ongoing throws In contrast, when the liquidity of exit markets is high, VC keep to invest proportionately more in later-stage throw outs in order to rush for exit and thus to clutch short-term positions and technologically les risky throw outs The theory therefore gives rise to a somewhat counterintuitive theory of a positive correspondence between conditions of external exit market liquidity risk and VCs' contemporaneous undertaking of a greater amount of technological risk.