Liquidity risk and venture capital finance

This article provides theory and evidence in support of the proposition that jeopardy capitalists adjust their investment decisions according to liquidity conditions upon IPO exit markets. We commit to technological risk as a choice variable in bounds of the characteristics of the entrepreneurial firm in which the danger capitalist invests, and liquidity risk as the in every one's mouth and expected future external exit market conditions. We present to view that in times of awaited illiquidity of exit markets (high liquidity risk), danger capitalists invest proportionately more in novel high-tech and early-stage projects (high technology risk) in order to let lie over exit requirements. When exit markets are liquid, danger capitalists rush to exit by the agency of investing more in later-stage throws We further provide complementary evidence that displays that conditions of low liquidity risk give rise to les syndication. Our theory and supporting empirical arises facilitate a unifying theme that links related research upon illiquidity in private equity.

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Policymakers around the world ofttimes express concern about why there is not more investment in privately held early-stage companies. (1) Further, the uttermost 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 fresh and somewhat counterintuitive theory to facilitate an understanding of these issues. The US data examined herein support the theory.

danger capitalists ("VCs") invest in small private development companies that typically do not have cash runs to pay interest on liability 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 of that kind 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 go [i]or[/i] come backs and reputational benefits (Gompers, 1996 and Gomper and Lerner 1999 2001) (3) Liquidity risk in the adjoining matter 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 plenteous longer in the venture or to exchange 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 wait for 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 collectioned into a broad category of what we leave to in this article as technological risk, or the risk of investing in a shoot forward of uncertain quality (particular impressed signs of technological risk could include the quality of the production 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 throw outs 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 exhibit the willingness of VCs to undertake shoot forwards of high technological risk is directly related to conditions of liquidity risk. We further provide complementary evidence that displays that external conditions of high liquidity risk give rise to more prevalent syndication, which in turn 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 issues in a number of related papers upon venture capital finance.

We introduce a theoretical protoplast that shows that VCs will rationally trade-off liquidity risk against technological risk by means of investing more in early-stage shoot forwards when the liquidity of exit markets is depressed and thus the exit risk is high. The intuition underlying our original 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 exhibition (early stage versus expansion stage), and the decision whether to invest in completely of recent origin projects or to limit investments to ongoing throw outs In contrast, when the liquidity of exit markets is high, VC guard to invest proportionately more in later-stage shoot forwards in order to rush for exit and thus to gripe [i]or[/i] grip short-term positions and technologically les risky throws The theory therefore gives rise to a somewhat counterintuitive guess of a positive correspondence between conditions of external exit market liquidity risk and VCs' contemporaneous undertaking of a greater amount of technological risk.