Venture Capital Returns Research Articles

Private Equity Performance around the World

We construct a novel dataset to explore the returns of private equity in international markets (i.e., other than North America). We investigate fund performance and persistence and compare the findings to the extensive evidence on North American funds. We find that both investment strategy and investment geography characterize the performance and return persistence of private equity. Buyout funds have the highest returns in Europe, while growth equity funds perform better in Asia-Pacific. Venture capital returns are modest across all international geographies. As documented in the literature for North America, large capital inflows result in lower returns in Europe, while this does not affect other investment geographies. We also find evidence of important market segmentation and strong return persistence for buyout and growth funds in Europe, as well as for a sample of globally diversified, US-sponsored buyout funds. We do not find evidence of persistence in Asia-Pacific or other world locations. Our results are robust to different performance measures and various tests for selection effects. They also hold important implications for both fund managers and investors targeting international markets.

Antecedents of Return on Venture Capital Investment – Evidence From Chinese Growth Enterprise Market

This study examined how enterprise growth factors affect the return on venture capital investment for enterprises listed on Chinese Growth Enterprise Market (GEM). Using a sample of 235 venture capital backed enterprises listed on Chinese GEM over three years, we collected data from each company’s prospectus and listing documents. We also collected data from Chinese QINGKE Research Center Database. We found that (1) three growth factors (profitability, operational capability and innovation capability) were positively associated with venture capital return. (2) Both the composite growth indicator and the optimized composite growth indicator are positively related to venture capital return. The theoretical and practical implications are discussed.

Practical Applications of The Role of Contracts in Venture Capital Returns

In <ext-link><underline><bold>The Role of Contracts in Venture Capital Returns</bold></underline></ext-link>, published in the Fall 2021 issue of <bold><italic>The Journal of Alternative Investments</italic></bold>, <bold>Sarina Liu</bold> of <bold>Wells Fargo</bold> creates a novel dataset to empirically test the hypothesis that traditional methods overestimate the post-money value of startup firms. Data about contract terms display four general convertible preferred stock types that are often provided to venture capitalists (VCs). After combining the data on contract terms with two additional datasets, the author analyzes cash flows to the VCs, revealing several interesting statistics regarding early- and late-stage investors in small and large acquisitions for each of the four types of convertible preferred stocks. While possible outcomes include failures, acquisitions, or initial public offerings (IPOs), most involve small acquisitions. Importantly, the traditional method for estimating the post-money value is inaccurate because the assumption of using common stock does not capture the significant added value of preferred stock.

Practical Applications of The Role of Contracts in Venture Capital Returns

In <b>The Role of Contracts in Venture Capital Returns</b>, published in the Fall 2021 issue of <b><i>The Journal of Alternative Investments</i></b>, <b>Sarina Liu</b> of <b>Wells Fargo</b> creates a novel dataset to empirically test the hypothesis that traditional methods overestimate the post-money value of startup firms. Data about contract terms display four general convertible preferred stock types that are often provided to venture capitalists (VCs). After combining the data on contract terms with two additional datasets, the author analyzes cash flows to the VCs, revealing several interesting statistics regarding early- and late-stage investors in small and large acquisitions for each of the four types of convertible preferred stocks. While possible outcomes include failures, acquisitions, or initial public offerings (IPOs), most involve small acquisitions. Importantly, the traditional method for estimating the post-money value is inaccurate because the assumption of using common stock does not capture the significant added value of preferred stock.

Practical Applications of The Role of Contracts in Venture Capital Returns

In The Role of Contracts in Venture Capital Returns, published in the Fall 2021 issue of The Journal of Alternative Investments, Sarina Liu of Wells Fargo creates a novel dataset to empirically test the hypothesis that traditional methods overestimate the post-money value of startup firms. Data about contract terms display four general convertible preferred stock types that are often provided to venture capitalists (VCs). After combining the data on contract terms with two additional datasets, the author analyzes cash flows to the VCs, revealing several interesting statistics regarding early- and late-stage investors in small and large acquisitions for each of the four types of convertible preferred stocks. While possible outcomes include failures, acquisitions, or initial public offerings (IPOs), most involve small acquisitions. Importantly, the traditional method for estimating the post-money value is inaccurate because the assumption of using common stock does not capture the significant added value of preferred stock.

The Role of Contracts in Venture Capital Returns

During contract negotiations with startups, venture capitalists (VCs) can receive preferred stock with additional cash flow rights to yield a higher return than the common stock return. The common share price is currently used to calculate payoffs to limited partners (LPs), but incorporating contract terms can considerably change the payoff distribution. Realized proceeds to LPs reveal that VCs exercise all available cash flow rights. Such choices are most financially significant when startups have relatively low acquisition prices, which is also the most frequent outcome. Consequently, the current post-money valuation method is an overvaluation of the true price of all outstanding securities. <b>Key Findings</b> ▪ After constructing a novel dataset of realized proceeds to LPs, the author found that VCs exercise all the preferred stock cash flow rights available to them in their contracts. ▪ VCs invest relatively the same amount of money into startups that become failures, small acquisitions, large acquisitions, or IPOs. Because they are not able to accurately predict a startup’s exit outcome, the cash flow rights accumulate into a significant amount for a fund. ▪ The post-money valuation calculation assumes common stock, and it is an overvaluation of the startup’s true value that considers all outstanding securities.

Investment Proximity and Venture Capital Returns

Using a large dataset of 82,818 investments in start-up firms from December 1965 through August 2019, we document that the biggest group of investors are venture capital firms (about 79% of all observations). The majority of in-state investments are found clustered in California (with the San Francisco VC Hub), Massachusetts (with the Boston VC Hub) and New York. Early round investors get a higher return than late stage investors, and IPO exits entail the highest return. We find that geographical proximity is significantly and positively associated with cumulative returns or annualized returns, when we use actual distance (in km) between the VC investment firm HQ and portfolio firm HQ, or a cross-region indicator variable when the portfolio firm HQ is out-of-state as compared to VC investment firm HQ. The relation between investment proximity and returns continues to be robust even after controlling for selection bias, and in a matched-sample analysis where we pair each proximate investment with a matched distant investment. We find that VC Director and other outside directors as a proportion of all Directors on the boards on portfolio companies is significantly higher, on average, for in-state and shorter distance investments as compared to out-of-state and longer distance investments, indicating higher involvement of VCs in their more proximate investments.

The Role of Contracts in Venture Capital Returns

During contract negotiations with a startup, a venture capitalist (VC) can receive preferred stock and additional cash flow rights, which result in a higher return than that of common stock. Incorporation of contract terms into the payoff to investor calculation not only changes the across-financing returns distribution but also results in a better approximation of actual distribution to a limited partner (LP) than common stock. Realized returns to LPs reveal that VCs exercise all cash flow rights available in their preferred stock. Such choices are most financially beneficial in startups with relatively low exit valuations, which is also the most frequent outcome. Consequently, post-money valuation, based on common share price, becomes an overvaluation of the true price that considers all outstanding securities.

Investment Proximity and Venture Capital Returns

Using a large dataset of 82,818 investments in start-up firms from December 1965 through August 2019, we document that the biggest group of investors are venture capital firms (about 79% of all observations). The majority of in-state investments are found clustered in California (with the San Francisco VC Hub), Massachusetts (with the Boston VC Hub) and New York. Returns generated from early round investing to late round decrease generally: early investors generate a higher return than late stage investors, and IPO exits entail the highest return. We find that geographical proximity is significantly and positively associated with cumulative returns or annualized returns, when we use actual distance (in km) between the VC investment firm HQ and portfolio firm HQ, or a cross-region indicator variable when the portfolio firm HQ is out-of-state as compared to VC investment firm HQ. The relation between investment proximity and returns continues to be robust even after controlling for selection bias, and in a matched-sample analysis where we pair each proximate investment with a matched distant investment. We find that VC Director and other outside directors as a proportion of all Directors on the boards on portfolio companies is significantly higher, on average, for in-state and shorter distance investments as compared to out-of-state or longer distance investments, indicating better involvement by VCs in their more proximate investments.

Insider Financing and Venture Capital Returns

Staged financing of venture capital-backed firms is valuable to both investors and entrepreneurs, but comes with a potential cost: hold-up. With asymmetric information and strong control rights, financial intermediaries may earn rents on their inside knowledge. We find that environments where insiders have the significant potential to hold-up the entrepreneur -- financings where only previous investors participate -- have predictable outcomes and returns. However, in contrast to predictions from the theory of hold-up, we show that these inside financings lead to a higher likelihood of failure, lower probability of IPOs, and lower cash on cash multiples than rounds with new (outside) investors. Inside financings also appear to be negative NPV, suggesting that investors make inefficient continuation decisions. We propose a novel alternative and show how the findings are consistent with a manifestation of an agency problem driven by changing opportunity costs over the VC fund life-cycle.

A Method for the Solution of Educational Investment

In order to improve the performance of higher education in the United States, the Goodgrant Foundation intends to donate a total of $100,000,000 (US 100 million) to an appropriate group of schools per year, for five years, starting in July 2016. For this, our team puts forward upon an optimal investment strategy, which includes the schools to invest, the investment amount of each school, and the return due to investment, to solve this problem. Our main idea is as follows. First of all, we choose suitable investment school universities in the United States. Secondly, we use Analytic Hierarchy Process to get the rate of return on investment and venture capital. Thirdly, we establish a venture capital return model. Finally, solving the mathematical model ensures the investment amount of each school and the return due to investment. To implement this strategy, first of all, we obtain the candidate school based on students score card. Then, according to the factor analysis, we analyze the factors which mainly affect the choice of school. Secondly, we employ Analytic Hierarchy Process to get the rate of return on investment and capital risk. In the end, we establish a risk return model to get investment amount for each school, amount of risk and return. In order to ensure the minimum risk and the maximum return, we set up a multi objective programming model and solve it by using the constraint method. We get the result that includes the maximum net profit of the investment and risk loss rate. According to statistical analysis, we can get the overall return of net income within five years. Finally, we choose 320 candidate schools and get the investment amount of each school according to the principle of as many schools as possible. We have proved that the foundation will receive a return of more than 295.363 million in the next 5 years. After-verification, our strategy can be directly applied to the investment field and get good results.

Risk-adjusting the returns of private equity using the CAPM and multi-factor extensions

This paper develops a novel Public Market Equivalent (PME) measure to evaluate the risk-adjusted performance of private equity investments using the standard CAPM and multi-factor extensions. Using a comprehensive sample of 7732 fully realized venture capital investments, the paper estimates PMEs using the standard CAPM, the Fama–French three-factor model, and a four-factor model that also includes the Pastor–Stambaugh traded liquidity factor. The results highlight that venture capital investments substantially outperform traded stocks and that their returns resemble those of small growth stocks. Additionally, the results show that the exposure of venture capital returns to the traded liquidity factor is negligible.

No Financial Cleanup: A Study of Venture Capital Returns on Cleantech IPOs

We studied the financial returns of 52 venture-capital-backed cleantech companies that had IPOs between 2000 and 2010. The median IRR for the first round of venture capital was 26.1% with a range from -10.4% to 140.0%. The median IRR on the third round was 24.5% with a range from 8.1% to 184.6%. We found that the returns on venture capital invested in cleantech companies were not satisfactory because the median returns on our study fell way short of the 80% that venture capitalists expect for successful early-stage investments and the 40% for successful later stage ones. To put it in perspective, the median venture capital return of first round investments in Internet companies was 506.9%; in software companies 124.8%; and computer hardware companies 148.9%. We believe that a median annual return of around 25% is not high enough to sustain venture capital investment at its current level.

Which venture capital selection criteria distinguish high-flyer investments?

This study is based on an analysis of 64 ventures that were funded by German Venture Capital (VC) firms in order to identify VC selection criteria that distinguish non-high-flyer exits from high-flyer exits (exits that returned more than five times the VC's first-round money invested). Based on highly sensitive data, which are the venture's first-round business plan and the VC's return rate of the particular venture at exit, three high-flyer predictors were identified: company, product and market related. Logistic regression and discrimination analysis revealed that ventures with the following characteristics have the best chance of generating a VC high-flyer exit: targeting the business-to-customers market, being location in a metropolitan cluster and close to the lead investor, raising VC financed prior to the proof of concept level and having strategic partners raising the first round of VC investment. Ventures that have spun out from corporate institutions perform below average in terms of VC exit performance.

Nonlinearity and smoothing in venture capital performance data

Abstract Performance indices for illiquid investments are known to suffer from returns smoothing, and the purpose of this paper is to investigate the presence and nature of such smoothing in the context of venture capital. We find that while the standard techniques may or may not indicate the presence of smoothing, significant evidence of smoothing exists when a nonlinear regime-dependent model is specified. Further, the model suggests the presence of regime-specific responsiveness of venture capital returns whereby different weights are placed on newly arrived information in different regimes.

We Have Met the Enemy…and He is Us: Lessons from Twenty Years of the Kauffman Foundation's Investments in Venture Capital Funds and the Triumph of Hope Over Experience

Venture capital (VC) has delivered poor returns for more than a decade. VC returns haven’t significantly outperformed the public market since the late 1990s, and, since 1997, less cash has been returned to investors than has been invested in VC. Speculation among industry insiders is that the VC model is broken, despite occasional high-profile successes like Groupon, Zynga, LinkedIn, and Facebook in recent years.The Kauffman Foundation investment team analyzed our twenty-year history of venture investing experience in nearly 100 VC funds with some of the most notable and exclusive partnership “brands” and concluded that the Limited Partner (LP) investment model is broken1. Limited Partners—foundations, endowments, and state pension fund—invest too much capital in underperforming venture capital funds on frequently mis-aligned terms. Our research suggests that investors like us succumb time and again to narrative fallacies, a well-studied behavioral finance bias.

Innovation in Health Care: Time for a Gut Check

O the past several decades, advances in science and technology have yielded great strides in our ability to reat major medical conditions such as heart disease and cancer. he genesis of many of these technologies has been innovative iopharmaceutical, medical device, and diagnostic start-up ompanies often formed by physicians and researchers within cademic medical institutions and hospitals. These start-up companies often have taken on venture captal funding to complete product development and clinical rials. As a reward for successful clinical trials, these companies ere historically able to raise additional capital through muliple investment rounds and sometimes through an initial pubic offering of their stock to public investors. Indeed, there are several very successful examples of new herapies that followed this playbook in the area of gastroenerology including treatments for morbid obesity, hepatic enephalopathy, hepatitis C, reflux disease, and Barrett’s esophaus, all developed by small companies that effectively developed nd launched these products with the backing of high-risk nvestment capital and in concert with thought-leading physiians and inventors. Over the past 30 years, this ecosystem of physician, acaemia, start-up, and venture capital fostered a very successful ilieu for the advancement of innovation in health care and as yielded many new drugs and devices in use today by phyicians. Indeed, it has been shown previously that contrary to opular belief, venture capital returns from health care start-up nvestments actually have exceeded the returns from informaion technology and Internet investments since 2000 by a very ide margin.1 Today, however, we are at serious risk of dismantling this medical innovation ecosystem. There are 3 major reasons for this looming crisis in financing innovation in health care.

Short and long-term interactions between venture capital returns and the macroeconomy: evidence for the United States

The main purpose of this paper is to empirically model the influence of macroeconomic and financial variables on the performance of risk capital in the US. We start our investigation using a static long-run equilibrium model. In contrast to previous studies, we analyze the effect of several factors simultaneously within the framework of a vector error correction model (VECM). This allows us to study short- and long-term interactions to overcome the problem of endogeneity, and to discover causal mechanisms. The results show that the value of venture capital investments is positively related to industrial production, the exit channel Nasdaq, and the long-term interest rate. However, the value of venture capital investments is negatively related to the short-term interest rate. According to the short-term dynamics, VEC Granger causality confirms that only industrial production influences venture capital performance, while venture capital returns Granger causes Nasdaq performance.

Right-Sizing the U.S. Venture Capital Industry

The U.S. venture capital industry is at an inflection point. It has had many successes over the last three decades, and is prominent worldwide for its role in financially catalyzing notable, high-growth companies. More recently, however, venture capital returns have stagnated and declined, with the industry having seen little recovery since its go-go days of the late 1990s.There is a growing and important debate about where the venture industry goes from here. No one is seriously arguing that the venture capital industry will cease being crucial in driving the growth of important companies in information technology, clean technology, and biotech, all of which are risky and, to a greater or lesser degree, capital-intensive. But there is ample reason to believe that the venture industry, at least in the United States, will be differently sized and structured in the future. This change will not come easily. Many venture industry participants are comfortable with their industry’s size, structure, and compensation model, which is tied to assets under management and can be highly remunerative. At the same time, the industry has become conflated with entrepreneurship in the popular imagination as well as in policy circles, with the result being a widespread and incorrect belief that venture capital is a necessary and sufficient condition in driving growth entrepreneurship. The result is strong resistance to change, as well as much support for the venture industry in its current form.This short paper considers one aspect of the future of the venture capital industry, its size. How big should it be in terms of the aggregate underlying financial commitment to venture partnerships? Does it need to be larger to better equip entrepreneurs to solve the important problems we as a society face? Should it be smaller to take more risks, drive higher returns, and thus keep investors satisfied? How should we think about the role of venture capital in the future?