Investment Timing, Risk, Uncertainty, and Return: Evidence From Venture Capital Backed IPOs

Abstract

We explain the returns obtained on venture capital (VC) investments in all VC backed companies going public in the U.S. between 2003 and 2017. Using a unique data set of 1,921 investor-IPO returns, we show that later investments obtain higher returns, even after controlling for observed and unobserved IPO company and VC investor characteristics. This is counterintuitive as later investments are believed to be less risky than early investments because business risk declines as firms mature. We show that the positive relationship between investment timing and return can be explained by risks and uncertainty related to the exit, in this case IPO. High returns for late investments are obtained in more risky and uncertain IPOs and particularly by VC investors with high IPO reputation. We exclude other possible explanations, such as IPO ratchets for late investors, exit pressure due to short VC fund lifespan cycles, or unexpected funding needs before IPO that expropriate early investors.