Venture Capitalists’ Confidence, Asymmetric Information, and Liquidity Events

Abstract

Venture capitalists, in assessing and advising their portfolio firms and seeking viable exit strategies for them through discussions with investment bankers and corporate acquisitors, develop early and sophisticated insight in high potential new ventures and alternative liquidity events for them. Given this early and unique perspective that VCs have of their portfolio firms and potential liquidity events, in this paper, relying on an information asymmetries perspective, we examine whether changes in venture capitalists’ confidence, as informed by VCs’ unique informational advantage, may precede changes in the volume of liquidity events (IPOs and M&As) of venture-backed firms. To explore this notion, we conducted quarterly surveys of VCs for 3.5 years with regard to their confidence in the future high-growth entrepreneurial environment and compared our results with archival data of the volume of IPOs and M&As of venture-backed firms over the same period. We find, in fact, that changes in VC confidence do precede changes in the dollar volume of exits of venture-backed firms in both anticipated and unanticipated ways. Specifically, we find that an increase in VC confidence precedes an increase in IPO activity one quarter later and a decrease in M&A activity two quarters later. These relationships hold while controlling for changes in NASDAQ level. Our findings contribute to the venture capital literature by highlighting the significance of asymmetric information in venture capital markets. Our findings also suggest that entrepreneurs may benefit from monitoring VC confidence as changes in VC confidence appear to have temporal precedence to changes in liquidity opportunities for venture-backed firms.