Firms with Venture capital vs Firms not backed by VC

Firms with Venture capital vs Firms not backed by VC

Contents

TOC o "1-3" h z u Literature review PAGEREF _Toc141790945 h 1Introduction PAGEREF _Toc141790946 h 11.1 Venture Capitalists PAGEREF _Toc141790947 h 11.2 Involvement in IPOs PAGEREF _Toc141790948 h 21.2.1 Underpricing PAGEREF _Toc141790949 h 41.2.2 long run performance of IPOs PAGEREF _Toc141790950 h 41.3 Performance & Growth PAGEREF _Toc141790951 h 51.4 Survival PAGEREF _Toc141790952 h 7Literature gap PAGEREF _Toc141790953 h 9References- PAGEREF _Toc141790954 h 10

Literature reviewIntroductionThe idea for venture capital (VC) is crucial for the expansion and success of creative startups as well as fast-growing businesses all over the globe. Venture capital is emerging to be a crucial source of finance for numerous business endeavours across Europe. With an emphasis upon their accomplishments, development, under-pricing, participation in IPOs, etc., the following literature will examine the fundamental differences and similarities among enterprises financed via venture capital versus non- VC backed firms.

1.1 Venture CapitalistsVenture capitalists (VCs) use professionally operated funds through money pools to make investments into outside equity. Within an investment pool called a venture capital fund, VCs gather money through diverse participants (mainly institutional capitalists) who act as limited partners. Limited Partners aren't directly involved within the individual choices regarding investments to ensure that liability is limited. As a result, the VC administers the investment on behalf of their own limited partners via investing in a variety of business projects (Sahlman, 1990).

While investing, VCs are motivated by business expansion as well as enhancing the company's worth. Consequently, for VCs, the development opportunities for startup businesses & the leadership team's capacity to realize this development have the utmost importance. VCs frequently pay attention to the entrepreneurs successes and failures. The entrepreneurs reputation being outstanding leaders is particularly crucial during their initial phases. The proven capacity of the chief executive officer to launch a venture into the market becomes more significant over time. As the businesss success skyrockets, it isnt uncommon that the CEO to have his position changed (Wright & Robbie 1998; Tybjee & Bruno 1984). VCs maintain a close relationship with the businesses within their portfolio of companies & demand frequent updates from the companys founders to allow them to support expansion and track performance (Fried, et al 2005). While keeping their ownership authority over the business remains a major concern for business owners, VCs are just remotely concerned with this matter. VCs arent interested in managing the entrepreneurs firm; instead, their goal is to ensure that the founder remains committed. Nevertheless, VCs sometimes demand that the authority of the corporations board of directors as well as prospective equity dilution choices remain in the grasp of a syndicated team of venture capital shareholders, even though the single VC rarely purchases a majority position within the firm. Such personal tastes suggest that business owners shouldnt appear to be fixated about ownership proportions. Instead, business owners ought to present themselves as seeking an impartial deal to everyone.

A trade sales & an Initial Public Offering (IPO) represent the preferred methods of departure among VCs. Most likely, an escape strategy is prepared prior to an investment takes place. To reduce unexpected interpersonal tension amongst shareholders & the business owners, the VCs have devised extremely standardized conditions for the agreements & would prefer letting their legal representatives negotiate the specifics of the deal alongside the entrepreneurs lawyers.

1.2 Involvement in IPOsAfter the groundbreaking research byIbboston along with Jaffe (1975) as well as Ritter (1991), numerous research has shown the fact that Initial Public Offerings (IPOs) tend to be underpriced as well as underperform reference portfolios. Each of these research studies used various sample sets across time periods. Venture capitalist participation with IPOs is viewed as factual proof of both under-pricing as well as profitability over the long run. As an example, this is said that IPOs supported via venture capital (VC) are seen by prospective buyers as low-risk businesses, consequently issuers aren't obligated to underprice in order to draw in shareholders (Megginson & Weiss, 1991). Another widely held belief is the concept that venture capitalists regularly introduce the companies within their investment portfolio into the IPOs market; as a result, they've got a strong incentive to build a reputable track record which will enable them to gain a place in the IPO market in future years on advantageous terms. A trustworthy image will also assist the venture capitalist build excellent bonds among everyone the initial offering's participants, including the auditors, underwriters, pension fund managers, along with institutional shareholders.

Corresponding to this, venture capital-backed companies are anticipated to have favourable abnormal profits during the post-IPO phase. Their expectation originates from knowing that venture investors typically offer their investment portfolios considerably beyond simply funding. Venture capitalists are actively and directly engaged with the portfolio firms they invest within, as opposed to other passive providers of financing (like banks). Based on earlier research, their main responsibilities include offering commercial and financial guidance, keeping an eye on things, helping venture managers establish strategies, acting as a sounding board at the company, & offering social networks to prospective clients as well as vendors (Fried & Hisrich, 1995; Steinar, 2003). Additionally, compared to alternative investors that are always demanding short-term evaluations of performance, venture capitalists are patient shareholders that maintain a long-term focus upon investment gains which helps enable management to concentrate more on long-term challenges (Brau et al., 2004; Lam, 1991; Bygrave and Timmins, 1992). According to the long-term viewpoint, the reputation of venture capitalists conveys to potential staff, customers, and vendors good messages about the companys long-term survival (Cornell & Shapiro, 1988; Campbell & Frye, 2006).

Most of the research that has been conducted within the United States regarding venture capitalists influence and function has focused upon their participation with startups. However, the VC business differs across shape globally due to disparities in social and economic frameworks as well as in legal and financial systems (Chahine et al., 2007; Bygrave & Timmins, 1992). For example, venture capitalists within the United States usually make investments in early-stage & seed businesses, but those in the UK typically make investments in late-stage businesses (Murray, 1999). Furthermore, this is commonly accepted that the level of a venture capitalists participation is dependent upon the phase at which the firm is currently in its development, having later-stage businesses requiring a smaller amount of involvement compared to start-ups (as they primarily need funding) (Sahlman, 1994). Therefore, the notion that venture capitalists offer far more beyond just cash may not apply to investments within late-stage businesses. This raises the problem of whether venture capitalist participation with IPOs is viewed as a factor that may mitigate IPO under-pricing along with long-term underperformance.

Through comparing the outcomes of IPOs supported via venture capital using a control sample of IPOs that weren't funded via venture capital, Belghitor & Dixon (2012) explore the contribution of United Kingdomventure capitalists with initial public offers & throw additional light upon IPO irregularities. The discussion in this paper of various methodological challenges pertaining to the calculation for abnormal profits constitutes a key component. In order to correct for new listing as well as rebalancing biases, the study compares the initial public offering (IPO) profits to size-matched portfolios that have been carefully created. Secondly, the study evaluates the profitability over the long run utilising the methods of calendar-time along with the event time techniques because these abnormal earnings were sensitive to the technique of measures (Fama, 1998; Lyon et al., 1999; Mitchell as well as Stafford, 2000) along with their robustness. Thirdly, the importance of Buy-and-Hold Abnormal Returns (BHAR) has been examined using bootstrapped-skewness adjusted t-statistics.

1.2.1 UnderpricingThe participation by venture capitalists within an IPO is regularly used as actual data to examine under-pricing concepts. According to Baron (1982), issuers as well as investors possess diverse informational backgrounds on the valuation of offering firms. It is thought that issuers may be motivated to withhold or postpone the disclosure of unfavourable data, if any, to dispose of stocks at a greater price. Considering they have a chance to be persuaded that accurate information disclosure hasnt yet taken place, rational investors would simply give a low average pricing for the issue because they are aware of it. On the contrary, if a third party, like venture capitalists, is supporting the issue as well as holds reputational capital at risk, they will suffer more financially & negatively given that the data turned out to be false. Shareholders therefore view the participation of venture capitalists within a public offering like a certification which lowers the offerings risk. Gompers (1994), for instance, suggested that because venture capitalists frequently participate within initial public offerings (IPOs), investors are unwilling to be affiliated with IPO failures because they desire to preserve their current image within the marketplace. As a result, investors tend to be less inclined to overprice the issue. Barry et al. (1990) made a related claim suggesting investors lack trustworthy knowledge regarding the issuer's capital as well as possibilities for investment. Since venture capitalists frequently participate within the capital markets which puts their image on the line, investors are dependent uponthem for knowledge.

1.2.2 Long run performance of IPOsBecause venture capitalists exclusively invest into promising, high-growth businesses, previous research indicates that IPOs supported by VC ought to perform better over the long term than IPOs without VC backing (e.g., Brav & Gompers, 1997). Additionally, venture capitalists stay active at the board of directors afterwards the initial public offering (IPO) and might keep providing the availability of funds which non-VC-backed IPOs are lacking. They also have connections with the wealthy commercial as well as investment banking professionals and might be capable to draw in elite analysts to research their businesses, thereby reducing the information asymmetry among shareholders as well as businesses. This could encourage investors from institutions, the primary source of funding in venture funds, to obtain shares in companies which venture capitalists sponsored and helped go public. Jain as well as Kini (1995) contrasted the operating results of VC-backed or non-VC-backed initial public offerings (IPOs) within the USA and discovered that VC-backed IPOs outperformed non-VC-backed IPOs on two cash flow-related metrics: operating earnings on assets as well as operating earnings deflated by total assets. Mikkelson et al. (1997), using similar methodology as Jain & Kini, failed to find any proof to support the higher operational efficiency of VC-backed companies during the three years after the IPO. In a different research, Brav & Gompers (1997) used a case study method to analyse the results from IPOs with and without venture capital backing. Findings from the research seemed responsive to the standards. For example, a weighted return analysis revealed a significant contrast among the two groups, the VC-backed IPOs outperforming non-VC-backed IPOs. However, examination using value-weighted returns showed no distinction among the contrasted samples. (Belghitar & Dixon, 2011)

1.3 Performance & GrowthAccording to Brav and Gompers (1997), VC-backed companies outperform non-VC-backed companies on average over the long term. The function of venture capitalists (VCs) during the initial public offering (IPO) has been examined by several authors. This research claims that VCs aid IPO firms in two important ways: monitoring (Barry et al., 1990) and certification (Megginson and Weiss, 1991). This study, quantifies how VCs affect newly public companies' operational procedures after their initial public offerings (IPOs). Since the IPO typically serves as the IPO firm's means of obtaining funds to support expansion, VCs have an interest to assist the firms they finance continue strong performance even following the IPO. Years after the IPO, VCs continue to hold equity positions (Barry et al., 1990). As a result, it is anticipated that VCs, long-term investors, will play a significant part in enhancing the companys success after the IPO.

There is a large body of empirical research that indicates venture capital firms play a substantial role in the achievement of start-up businesses. According to Barry et al. (1990), this is typically attributed to the VCs superior skills in vetting potential portfolio firms as well as in monitoring and offering advising services to portfolio companies. Three factors are listed by Brav & Gompers (1997) as potential differences between VC-backed and non-VC-backed IPOs. First, VCs put in place management structures that support the running procedures of the portfolio company. Furthermore, VCs may apply their industry knowledge to better the business operations and offer insightful advice on how to acquire money. Second, VCs could have an impact on who owns the companys stock following an IPO. Because venture capitalists have ongoing contacts with sizable, more reputable investment banks, bigger investors own shares of IPOs sponsored by VCs. After the IPO, these connections to influential investors as well as investment banks frequently result in new joint ventures. Then, long after the IPO, VCs continue to hold these positions on the boards of directors of start-up companies. The experience in capital raising that VCs bring to the board may be absent in a start-up company. Therefore, the question that arises is whether these attributes influence the firm's operational practises over time, i.e., is there a distinction over time in the financial policies of VC-backed IPOs as well as non-VC-backed IPOs?

Evidence about the benefits and drawbacks of having VC firms as part of a company's capital is provided by Pommet (2017). Entrepreneurs should consider the possibility that specific kinds of venture capitalists may be able to participate in the process of monitoring and value addition. According to Bruton et al. (2010), agency theorys claim that concentrated ownership enhances IPO performance is supported. They demonstrate that the two categories of private equity investorsventure capitalists and angel investorshave varied effects on performance and that these effects are moderated by the legislative framework of a particular nation.

Knowing corporate culture is crucial, according to Kreps (1990) as well as Hermalin (2001), if we want to comprehend organisations policy decisions and eventually their performance. Therefore, several of their significant findings are consistent with a cultural explanation for the distinction in financial practises and persistence among VC-backed and non-VC-backed enterprises. Corporate culture is defined in a wide variety of ways. The idea that corporate culture is a particular collection of standards, beliefs, values, and tastes held by an organizations executives and employees is a prevalent one in economic theory. According to Kreps (1990), a firms culture can influence its policy decisions because it specifies the right behaviour for actors to exhibit when faced with unforeseen circumstances or alternative equilibria.

VCs look for young, risky, high-growth businesses that have the potential to develop game-changing goods and services and experience rapid expansion. As a result, they frequently invest in a beginning phase of development, when the chances of success are dim. According to Serrasqueiro, Sardo, as well as Flix (2019), debt seems more significant for smaller VC-backed investments than for larger ones. The VC ownerships moderating influence lessens the magnitudes of both the positive and negative effects of debt and growth possibilities on investments in smaller as well as larger VC-backed companies. Consequently, VCs have a significant impact on the companys investment & financing decisions as well as its strategic evolution. They participate actively in the businesses activities, in addition to providing money. In comparison to non-VC-backed enterprises, VC-backed businesses may be more inclined to issue equity over debt, which would result in lower levels of leverage. According to Serrasqueiro, Sardo, as well as Flix (2020), there is evidence that enterprises become less reliant on debt after VC participation in their stock, preferring internal financing to fund assets that are unique to the company or include an intangible nature and cannot be committed as security.

1.4 SurvivalAccording to research by Kunkel & Hofer (1990) & Timmons (1994), VC-backed businesses are more likely to survive compared to similar non-VC-backed businesses. First, VC firms have strict investing requirements, only accepting those that are most promising startups. Secondly, according to Diamonds (1991) reputation-based theory, inside investors like venture capitalists could give off important signals to other participants. The simple fact that a VC firm has made investments in an unquoted business sends a favourable message regarding the business & may result to additional funding from others, less expensive sources because screening comprises one of the functions of VC firms and because the investing procedure is exceptionally selective (Sapienza 1999; Sahlman 1990 &Manigart). Some long-standing VC firms have an impeccable image, & their inclusion within the capital structure conveys a powerfully favourable message for other stakeholders as well as investors (Megginson & Weiss 1991). The investment portfolio firm might find it simpler to recruit additional resources including people, suppliers, or customers, along withmore capital, as a result of this good. Thirdly, in order to address issues with moral hazard, VC managers spend their time and energy monitoring once the investment has been made (Barry et al. 1990, Admati & Pfleiderer 1994, Lerner 1995). In industries with a high concentration of growth opportunities, intangible assets, and asset specificity (Gompers 1995), monitoring skills are particularly essential for business owners (Sapienza and Gupta 1994; Amit et al. 1998). Finally, venture capitalists offer their portfolio businesses value-creating services like networks, moral backing, general business knowledge, and discipline (Sapienza et al. 1996; Fried and Hisrich 1995). If VC firms successfully carry out their separate selection, monitoring, and value-adding functions, and if a signalling as well as certification impact exists, then this should result in:

H1a: enterprises with VC backing are more likely to survive than equivalent non-VC

backed companies.

Yet, there may be justifications for assuming the reverse relationship. At first according to Amit et al. (1990), an adverse selection problem prevents VC firms from making investments into most promising companies. Across Europe, necessary rates of return for venture capital (VC) investments range from 15% 45%, based upon the phase of growth that exists in the investee business (Manigart et al. 1997). The most beneficial initiatives are probably going to be funded by others, less expensive sources. This means that the top initiatives won't be available to VC businesses, while only those with second-greatest ideas are going to submit proposals for financing (Amit et al. 1998). According to this logic, VC-backed businesses wont fail more frequently compared to non-VC-backed ones. Furthermore, according to Manigart & Sapienza (1999; Bamford & Douthett (2000), VC firms are mainly interested in improving value than in lowering risk under high-growth situations. Without the substantial risk, there additionally exists a large risk of failing before there are potentially significant rewards. According to this way of thinking, businesses with venture capital backing might actually be riskier compared to those without it, which would result into lower survival rates, all else being equal. Lastly, effective use of the limited time which VC executives have may lead them to dissolve so-called living dead businesses (i.e., ventures which are still operating although are now incapable to provide shareholders with sufficient profits) (Gifford 1997; Ruhnka et al. 1992). The survival of a single portfolio business isnt about the actual interests of the venture capitalist; rather, it is in maximising his profit on his financial investment & the returns on his labour (Gorman & Sahlman 1989). A VC must decide strategically whether to seek to revive its living dead portfolio businesses or to sell them off & focus on top performers. According to Fredriksen et al. (1997), Swedish venture capitalists have been fire fighters they devote more effort into underperforming businesses to bring them up to par with other businesses. The fact that 56% among the living dead enterprises showed signs of recovery implies that this approach may be workable. Nevertheless, Sapienza (1992) discovered a significant beneficial relationship among the engagement of US VCs and their perceived performance and made the case suggesting VCs might want to increase the value of their top-performing portfolios businesses as a homerun tactic. The latter approach will likely result in fewer portfolio businesses for VCs, which leads to the reverse conclusion:

H1b: enterprises with VC backing are less likely to survive than equivalent non-VC

backed companies.

Literature gapThe effect of funding from venture capitalist for the development and success of businesses has been extensively studied within the literature. According to research, VC-backed businesses develop more quickly, innovate more frequently, and have greater market awareness than non-VC-backed businesses. The literature emphasises how VC investors' knowledge, connections, as well as financial backing help startups in emerging businesses flourish. Nevertheless, a thorough analysis regarding the long-term durability of such expansion and if VC-backed enterprises can hold onto their competitive edge as time passes is frequently lacking within the current studies. Contrasting VC-backed along with non-VC-backed enterprises' financial risk profiles as well as exit options seems crucial. VC organisations frequently make investments in high-risk, high-potential businesses, whereas non-VC corporations may take an extra cautious stance. The literature looked at the way the push for quick development and exit puts VC-backed companies at increased risk. The success of various departure tactics, their influence upon business performance, as well as how they correspond with the objectives of both kinds of companies, however, require additional study.

In deciding the companys overall strategy as well as process for making decisions, good corporate governance seems a key consideration. Board members for companies with VC backing frequently reflect the objectives of the VC shareholders. The decision-making authority among non-VC-backed businesses might be greater, yet they might not have access to the expert strategic advice provided via VC investors. The research that is now available has examined the effects of such governance arrangements, however it does not adequately compare the influence over the years upon business behaviour & performance, particularly as companies evolve and expand.

The key to a company's competitive edge and success has been innovation. VC-backed companies frequently exhibit greater degrees of innovation because they have access to funding & professional guidance. Nevertheless, a more thorough examination regarding the kinds of innovation which arise via venture capital funding, the long-term viability of innovative practises, and the way non-VC-backed businesses may make the most of their assets to promote innovation despite outside support constitute the gaps in the literature. Without considering prospective regional or sectorial disparities, current research frequently provides generalised conclusions regarding how venture capital funding affects business performance. VC ecosystems varies between geographies and sectors; thus, these differences may provide differing results for VC-backed enterprises in various circumstances. Future studies must concentrate upon figuring out how the success of venture capital funding varies depending upon where the company is located and what sector it works in.

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