Amsterdam Business School MSc Business Economics, Finance track
Master's Thesis Finance (6314M0246)
The Effect of Venture Capital Syndication on
Portfolio Company’s Duration
Marili Merendi (6003834)
Supervisor: M. A. Dijkstra
2 Statement of Originality
This document is written by Student, Marili Merendi, who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
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ABSTRACT
This paper presents an empirical study on the role of syndication on duration of venture capital-backed companies. Using a sample of 11,466 venture capital-capital-backed companies for both Europe and the US from January 1995 to December 2014, this paper finds that an increase in the number of venture capital firms investing a portfolio company and an increase in the number of syndicated financing rounds, result in longer duration. With regard to syndication in the first round, the results exhibit a negative relationship between syndication and duration.
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TABLE OF CONTENTS
ABSTRACT ... 3
TABLE OF CONTENTS ... 4
INTRODUCTION ... 5
1. VENTURE CAPITAL INDUSTRY ... 7
2. THEORETICAL FRAMEWORK AND LITERATURE REVIEW ... 9
2.1. Syndication ... 9
2.2. Duration ... 13
2.3. Empirical Evidence on Syndication and Duration ... 14
3. METHODOLOGY ... 18
4. DATA ... 22
5. RESULTS AND DISCUSSION ... 27
5.1. Results ... 27
5.2. Discussion ... 32
6. CONCLUSION ... 34
REFERENCES ... 36
APPENDICES ... 40
Appendix A. Venture Capital Fund Life Cycle ... 40
Appendix B. Exit Vehicles ... 41
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INTRODUCTION
Venture capital firms are financial intermediaries that provide financial capital to young and innovative companies. In 2011, venture capital firms invested $29.5 billion in 3,834 separate deals, for an average investment of about $7.7 million per deal (Berk, 2011). Gompers and Lerner (2003) argue the roles of the VC firm are pre-investment screening and post-invest support– both of which, along with financial capital, should lead to improved performance of portfolio companies and thereafter profitable returns for venture capitalists (Manigart, et al., 2002).
The purpose of this thesis is to investigate the role of syndication on venture capital-backed companies’ investment duration measured in years. The motivation of the study is derived from the desire to add to the limited academic coverage of duration and syndication and their relationship with regard to each other. Furthermore, an existing large number of literature covers venture capital divestments through the initial public offering (IPO), and does little on divestments through other forms of exits (trade sale, secondary sale, reverse takeover and buyback).
Research question: Does the degree of syndication accelerate or decelerate the exit of a
venture capital-backed investment?
An impact of syndication on duration is estimated using an ordinary least squares (OLS) method that allows the study of the effects of both syndication presence and magnitude on duration. The database used is the Thomson One and the timeframe of the study is from 1995 to 2014, capturing the VC-backed companies’ exit announcements. The final sample includes 11,466 VC-backed exits of which the US observations represent 9,543 data points and Europe 1,923 data points.
The remainder of this paper is organized as follows. After introduction, the paper proceeds with presenting key terms, an empirical framework and notations used in this paper. In particular venture capital industry is explained in detail. Section 2 considers previous literature in the field of interest of this study. Section 3 describes the method employed to determine the validity of
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the study and section 4 introduces the data applied in empirical analysis. Section 5 focuses on empirical findings, and the conclusion is given in section 6.
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1.
VENTURE CAPITAL INDUSTRY
Venture Capital (VC) constitutes an asset class where institutional investors provide capital to non-exchange traded corporations. Strictly speaking, VC is a subset of private equity (PE) and refers to equity investments made for the launch, early development, or expansion of an entrepreneurial business. It has a particular emphasis on entrepreneurial undertakings rather than on mature businesses (EVCA, 2007). The venture capital market structure consists of VC firms, funds and portfolio companies.
Venture Capital Firm
A venture capital firm is a limited partnership that specializes in raising money to invest in the private equity of young firms (Berk, 2011).The funding is provided by institutional investors or wealthy individuals (referred to as limited partners or LPs) and the capital management is done by the VC firm (referred to as general partner or GP). The LPs are liable only for the amount of capital they have provided and do not play an active role in the management of the investments, whilst the GP has unlimited liability for the investment (Bottazzi and Da Rin, 2002; EVCA, 2007).
Venture Capital Fund
A venture capital fund is established by the venture capital firm and its main objectives are to collect capital from limited partners, use this capital to buy companies over a set period and help these companies to create value by providing them with the specific skills and capital needed to develop the business (Gompers and Lerner, 2003; EVCA, 2007). The funds are considered illiquid investments for the limited partners that usually cannot withdraw from the fund before the term when all the investments in the portfolio have been exited and the VC fund closed (EVCA, 2007). One VC firm may establish multiple VC funds with the specialization in certain industries or at a certain stage of development of entrepreneurial company.
Venture Capital Portfolio Company
A venture capital portfolio company refers to the firm that receives an investment from the VC fund. The fund makes several investments in the first years of the VC fund into companies that require capital to drive growth and innovation, but lack sufficient funds on their own (Berk, 2011). For the return of the financial capital, the VC firm usually takes an equity position in the portfolio company and places a representative of the VC firm to the portfolio company’s board
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in order to influence the company’s development via strategic advice and operational improvements (such as advising on asset optimization, quality improvement, value engineering, project execution) (EVCA, 2007).
The main purpose of VC firms investing in risky ventures is to create a return for their stakeholder at the end of the investment. This return can be achieved through a variety of exit vehicles (such as initial public offering or IPO, trade sale, secondary sale, reverse takeover and buyback), in which the VC firm reduces its stake in the portfolio company (Amit, Brander et al., 1998; Cumming and MacIntosh, 2003a). For detailed exit definitions, please refer to appendix B.
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2.
THEORETICAL FRAMEWORK AND LITERATURE
REVIEW
2.1.
Syndication
Syndication refers to the situation where two or more VC firms participate together in at least one round out of total number of financing rounds that the portfolio company receives (Tian, 2012).1 As syndication tends to occur mostly in the first and last rounds of the total number of
financing rounds, not only the overall level of syndication per portfolio company is studied, but also specific syndicated rounds are observed (Deli and Santhanakrishnan, 2010).
The traditional approach, originating from finance theory, sees the main motivation for syndication as the means of spreading financial risk through diversification (Bygrave, 1987; Bygrave, 1988). Syndication allows to reduce risk by allocating its resources over a greater number of investments (Bygrave, 1987). However, a well-diversified portfolio may be difficult to achieve in VC markets for a single VC firm acting alone, given the presence of asymmetric information, illiquidity and investing restrictions inherent in VC firms investing in a limited number of portfolio companies (Lerner and Schoar, 2004). This argument is especially relevant to small VC firms that make investments into a small number of portfolio companies and therefore lack the diversification options that are available for larger VC firms and firms investing in listed companies. The lack of diversification stems not from the VC investors’ limited partners perspective, but rather from the VC firm’s general partner perspective – while VC investors themselves are able to diversify their risks by participating in various investments across the asset classes (for example equity, bond, real estate markets), the VC firms are facing asymmetric information given the uncertainty related to investing in non-listed early stage companies that are lacking a proven track record. Therefore, syndication is considered as risk mitigation for VC firms as it allows the sharing of risks in a high risk environment (Wright, Robbie et al., 2000).
Syndication is also considered helpful to avoid an over- or underinvestment in particular portfolio companies by managing the level of concentration of VC investments (Cumming,
1 A broad definition of syndication refers to the situation where two or more VC firms come together to take an
equity stake in an investment (Filatotchev, Wright et al., 2006). However, the definition allows each funding round to have only one investing VC, given that there are at least two VCs investing in the company over the total number of financing rounds (over the life time of an investment).
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2008). For example, VC firms may commit large amounts of capital relative to the size of their funds into selected portfolio companies. If the risk associated with those portfolio companies turns out to be higher than anticipated, it may be difficult to adjust the portfolio by exiting the investments because of the illiquid nature of the VC markets compared to the exchange traded companies (Lockett and Wright, 2001). On the other hand, VC firms may lack the financial or legal capabilities to make the required investments in full due to the allocation restrictions outlined in investment policy (for example restrictions on making investments into particular industry or country) or the amount exceeding the investments’ size allowed to allocate per single company. Syndication provides a means of risk sharing on a deal-by-deal basis and gives VC firms the opportunity to invest in a larger number of portfolio companies than they could do without syndicating, thereby spreading risks across a larger pool of investments while managing the concentration and risk of each of the portfolio companies (Cumming, Fleming et al., 2005).
The resource sharing perspective sees syndication as a way to share or access information in the selection and management stages of investments by benefitting from additional due diligence carried out by other VC firms (Bygrave, 1987; Brander, Amit et al., 2002; Manigart, Baeyens et al., 2002; Lerner and Hardymon, 2002). The collaboration in syndication between VC firms increases the quality of an assessment of the portfolio firm and decreases the uncertainty related to investments (Brander, Amit et al., 2002). The likelihood for adverse selection is reduced by syndicating at the deal selection stage through superior selection of investments (Wright, and Lockett, 2003; Sahlman, 1990). Since each VC firm in syndication should have a unique expertise that is considered valuable for the VC investment, syndication results in a larger knowledge pool that a company seeking VC funding can utilize (Brander, Amit et al., 2002). The VC firm that is lacking necessary knowledge or skills benefits from collaboration and knowledge sharing in syndication with other VC firms by expanding its expertise and converting the new information into its own knowledge (Grant and Baden‐fuller, 2004; Lane and Lubatkin, 1998). Syndication expands investment opportunities across industries and geographies by allowing the increase of skills and experience brought in by additional VC firms that usually invest in other types of portfolio companies (Manigart, Lockett et al., 2002).
However, the more portfolio companies the VC firm has, the higher the cost associated with the management of those companies. VC firms are only able to manage a certain number of
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companies in their portfolio due to resource constraints (Kanniainen and Keuschnigg, 2004). Jaaskelainen and Maula (2006) introduce a concept of optimal portfolio that is comprised of the optimal amount of companies per VC fund manager. The theory is based on the limited time and resources the manager has per single investment. They argue that the number of successful exits in VC manager’s portfolio initially increases when the number of companies in the portfolio increases, because the VC firm is able to interpret and act on new information on the basis of existing experiences. However, the benefits of having an additional company in the portfolio out-weighs costs only up to the certain level, called optimal portfolio. Beyond that level, benefits, relative to the costs of keeping the company in the portfolio, start to decline as the VC firm is unable to allocate the resources efficiently across its investments (as a more diversified portfolio makes the VC firm slower to adapt to each specific situation). They conclude that syndication therefore allows the expansion to optimal portfolio size, as with the increased number of VC firms participating in syndication, the management capability increases.
The aspect of knowledge sharing in syndication is not only beneficial for VC firms, but also for portfolio companies. Portfolio companies benefit from advice received on strategic decisions and investment opportunities, and an enlarged access to third-party industry participants (such as suppliers, consultants, lawyers, customers) (Gompers, Lerner et al., 1998). Furthermore, different VCs contribute actively to the firm, often by taking a chair in the board on a rotation basis, which attributes to the monitoring of the portfolio company (Gorman and Sahlman, 1989; Lerner, 1995; Gompers and Lerner, 2001). Therefore, syndication helps to mitigate some of the adverse selection scenarios over the life time of an investment. Furthermore, at the end of the investment’s life cycle, syndicated portfolio companies have an expanded network of valuable contacts available when looking for potential buyers for the VC-backed company’s exit (Schwienbacher, 2008b). The stronger presence and establishment of VC firms may also result in a higher valuation and deal price for portfolio companies.
The lead VC firm is the one that initiates the deal and its main objective in syndicating is a reduction of its financial risk (Brander, Amit et al., 2002). Non-lead VC firms, however, join the syndication mainly for other motives (such as reputation, skills spillover or access to future deal flow) that come with collaboration with other VC market participants. Furthermore, VC deals with multiple rounds of financing may inhibit the lead VC’s superior position by being able to access more information with regard to investment compared to the other syndicate
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members where non-lead VCs enter in later rounds (Filatotchev, Wright et al., 2006). This superior position may increase influence in negotiations that benefits the lead VC in an expense of other syndicating VC firms. Additionally, competition over the influence in syndication between VC firms may emerge also among the non-lead VCs, where more established and larger VC firms in syndication may abuse their influence over smaller VC firms to achieve their own unique objectives specific to each VC firm (for example having a syndicated VC’s representative in the board of portfolio company that represents its own VC firm’s interests instead of the interest of all VC firms in syndication). However, as the number of VC firms in the VC industry is typically small and VC firms are well known to each other, the aim of keeping good relationships in syndication is usually prioritized (Black and Gilson, 1998).
Good relationships in syndication are associated with being able to partner with VC firms that have proved to be able to assess and manage portfolio companies, have a track record of performance and a network with industry participants that can benefit VC firms in syndication. Having a strong reputation and large syndication network increases the status and visibility of VC firms and VC firm’s likelihood of being invited to the future syndicates (Barry, Muscarella et al., 1990; Megginson and Weiss, 1991; Lerner, 1994; Hellmann, 2002; Brander, Amit et al., 2002). Additionally, syndicating with the same partners builds trust and credibility at being able to conduct investment appraisals and to monitor duties and value added activities that increase the portfolio companies’ value (Sorenson and Stuart, 2001; Wright and Lockett, 2003).
One of the problems of syndication is the principal-principal problem that is derived from the principal-agent problem. The principal-principal problem results from the very nature of syndication, where there are multiple VC firms and thus the decision-making is shared between parties with various objectives (compared to the principal-agent problem which is the result of the presence of asymmetric information between VC firm and VC-backed company). Filatotchev, Wright et al. (2006) argue that multiple VC firms in syndication have diverse objectives specific to each VC firm (such as preferences with regard to the duration of investment, exit strategy chosen and management style applied). These incentives lead to a conflict of interest and inefficient cooperation among syndicated VCs due to the time-consuming nature of coordination (Filatotchev, Wright et al., 2006). Such inefficiencies present in syndication reduce the availability of time and other resources spent on the portfolio company by VC firms and in the worse case have a negative monetary impact on the company’s valuation at exit. Furthermore, in the case where VC firms are interested in participating in only one round
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of syndication, they may be governed by their individual objectives related to this specific investment round and therefore may have additional investment specific objectives that do not consider the following rounds, the further development of the portfolio company after exit or the interests of other VC firms in syndication (Filatotchev, Wright et al., 2006).
2.2.
Duration
Duration refers to the length of an investment made by the venture capitalists into the portfolio company over the entire life cycle of the investment, and may involve several rounds of financing and syndication among different VC firms.
Cumming and MacIntosh (2001) argue that reduced information asymmetry leads to better performing portfolio companies and therefore more profitable exits for VC firms. A VC firm has a value-adding impact on its portfolio companies that reduces the information asymmetry over time (Grant and Baden‐fuller, 2004; Hsu, 2004). The positive impact for the portfolio company from the collaboration with the VC firm, however, can only occur over time and therefore the VC-backed company’s potential to increase its value is linked to the duration of an investment. As the VC firm spends more time on their investments and is better able to accumulate knowledge about the company, the longer investment duration should therefore lead to reduced information asymmetry, reduced discount rate of VC-backed investment’s future cash flows and higher valuation of the company at exit (Dimov and Shepherd, 2005; Healy and Palepu, 2001). The argumentation refers to the positive relationship between duration and the performance of an investment, where information asymmetries can be mitigated over longer duration (Barry, Muscarella et al., 1990; Healy and Palepu, 2001; Rosenberg, 2002).
Contrary to the theory of information asymmetries, the theory of diminishing marginal benefit favors shorter duration (Cumming and Johan, 2010; Giot and Schwienbacher, 2007; Cumming and MacIntosh, 2001). The theory stems from the simple economic notion that once the investment’s expected marginal costs exceed the fund’s expected marginal benefits, the investment's performance by the portfolio company starts to decrease (Cumming and MacIntosh, 2003b). The value-added services provided by the VC firm include expert advice, replacing or adding senior management and providing useful contacts; the costs include direct costs, overhead costs and opportunity cost. A VC firm is anticipated to exit at the point where costs are larger than the benefits and where the VC firm’s marginal contribution is no longer
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increasing the value of the portfolio company due to the company’s reduced dependency on VC firm’s advice in later stages of its life cycle.
Duration is also related to funding rounds or stages. Investing in several stages allows the VC firm to monitor the progress of the company and to assess whether milestones have been achieved (Ruhnka and Young, 1987). Increased number of funding rounds mean more capital and advice from the VC firm that contribute to the development of the company (Dai, Jo et al., 2012; Gompers, 1995). Therefore, the longer the VC’s involvement is, the greater the VC’s ability to monitor and add value the portfolio company (Wang and Zhou, 2004). Investing in stages over the longer duration mitigates the risks associated with the investment, and as with syndication, informational asymmetry is mitigated between the VC firm and the company (Gompers, 1996).
2.3.
Empirical Evidence on Syndication and Duration
Manigart et al. (2006) study the motivations for syndication in six European countries based on the survey conducted in 2001. Using a data of 317 VC firms, they find that the main motivation for syndicating is driven by portfolio management considerations as means to improve the management of the VC’s overall portfolio. The main purpose of syndication is to increase portfolio diversification, to allow VC firms to invest in deals that otherwise would be too large relative to their fund size, and to improve access to future deal flow.
Lockett and Wright (2001) find that VC firms in the UK syndicate in order to spread financial risk in syndication, achieved with additional due diligence, prior investment and extra monitoring capabilities during an investment. Syndicated investments are evidenced to be less risky investments, resulted from the study by Brander et al. (2002) that show a smaller volatility in the performance of syndicated investments compared to that of non-syndicated investments, based on a sample of 393 VC exits in Canada during 1992-1997. Syndication therefore gives the VC firm the opportunity to participate in a larger number of investments, thereby increasing diversification and reducing the overall risk of the VC fund.
European VC firms syndicate less when the number of portfolio companies in their portfolio increases, unlike what the resource based view would suggest and in contrast to their American colleagues (Jaaskelainen, Maula et al., 2006). Using a sample of 25,009 investments in 6,044
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portfolio companies over 12 year period, they show empirically that increasing the size of the portfolio divides the VC manager’s attention, thereby producing two counteracting effects. On one hand, the larger the size of the portfolio, the more companies the VC manager has that can potentially reach desirable outcomes. On the other hand, the larger the size of the portfolio, the less time the VC manager has to be involved in each company, and the smaller the value of involvement. However, the number of portfolio companies a VC firm can optimally manage is moderated by syndication activity: the more a VC syndicates, the larger its optimal portfolio size is.
Sorenson and Stuart (2001) conduct a study on the sample of 80,406 cases involving 1,025 VC firms and 7,590 target companies in the US during 1986-1998. They show that the probability that a VC firm engages in cross-border syndication increases if there is a VC firm in the syndicate with whom they have previously coinvested, and if that syndicate partner is located close by the portfolio company abroad. Furthermore, the social network in the VC community, resulting from syndicated investing, enables the sharing of information more frequently with distant companies.
With regard to duration of the investment, Giot and Schwienbacher (2007) conduct a study on the US sample of 22,042 investment rounds for 5,817 venture-backed companies. They show that across all transactions and exit vehicles, there are considerable differences in investment durations, indicating 3.4 years for IPOs and 4.6 years for trade sales. In addition, biotech and internet firms demonstrate the fastest IPO exits in the sample. Earlier exit is preferred given the reduced ambiguity of an investment return.
Barry et al. (1990) look at the difference between VC-backed and non-VC-backed IPOs in the US. Based on the sample of 433 IPOs during 1978-1987, they find that VC-backed firms go public earlier than non-VC-backed companies. Investors have a number of mechanisms to ensure portfolio firms go public at times perceived to be optimal, including board representation and advice to the entrepreneur or management. Furthermore, as the number of VCs increases in syndication in these IPOs, more knowledge is available and used, that increases the monitoring and work on any single investment, resulting in increased likelihood of profitable exit in shorter duration.
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Schwienbacher (2008a) finds that while the US VCs add value to their portfolio companies via financial resources (such as greater monitoring, greater involvement and legally more complex contracts), their European counterparts place more emphasis on providing the financial support over active involvement by indicating that control rights in Europe are not commonly used. His findings are based on survey responses from the US and European VCs in 2001. He shows that the US VCs tend to exit between half a year and a full year earlier than their European peers due to the less liquid capital markets in Europe.
With regard to the relationship between exit choice and the number of funding rounds, IPOs are in general financed in more rounds compared to other exit vehicles (Giot and Schwienbacher, 2007; Gompers, 1995; Hochberg, Ljungqvist et al., 2007; Hege and Schwienbacher, 2003; Sorenson and Stuart, 2001), given that more uncertainty regarding the future prospects of the company is resolved, less agency costs are present and a better performance is therefore achieved. In addition, the total investment is larger for IPOs as the listing requirements on exchange usually dictate the minimum equity amount required, which might be higher compared to other exiting requirements. To conclude, funding duration increases in later rounds and more for the companies exiting through an IPO compared to the other exit vehicles (Gompers, 1995).
17 S tu d y R e s e a rc h F o c u s M e th o d o lo g y D a ta R e g io n F in d in g s M an ig ar t e t a l. (2 00 6) M ot iv at io ns f or sy nd ic at io n St at is tic al a na ly si s of s ur ve y da ta : R eg re ss io ns 31 7 V C f irm s. P er io d: 2 00 1 E ur op e T he m ai n pu rp os e of s yn di ca tio n is to in cr ea se p or tf ol io 's d iv er si fic ati on , t o al lo w V C f irm s to in ve st in de al s th at ot he rw is e w ou ld b e to o la rg e, a nd to im pr ov e ac ce ss to f ut ur e de al f lo w . S yn di ca tio n, a s m ea ns to im pr ov e pr e-in ve st m en t s el ec tio n of in di vi du al d ea ls a nd to e nh an ce p os t-in ve st m en t m on ito rin g an d va lu e ad di ng in s pe ci fic d ea ls , i s le ss im po rt an t. L oc ke tt an d W rig ht ( 20 01 ) Fi na nc e, r es ou rc e-ba se d an d de al flo w e xp la na tio ns fo r sy nd ic ati on St at is tic al a na ly si s of s ur ve y da ta : R eg re ss io ns 60 V C f irm s U K Fi na nc e pe rs pe cti ve p ro vi de s an e xp la na tio n of m ot iv es f or s yn di ca tio n, b ut th e re so ur ce -b as ed v ie w is fo un d to b e m uc h m or e im po rt an t f or th os e fir m s in vo lv ed in a t l ea st s om e ea rly s ta ge tr an sa ct io ns . B ra nd er e t a l. (2 00 2) D ue d ili ge nc e in sy nd ic at io n St at is tic al a na ly si s of d at a: R eg re ss io ns 39 3 ex its . P er io d: 19 92 -1 99 7 C an ad a Sy nd ic at ed in ve st m en ts h av e hi gh er r et ur ns , f av or in g th e va lu e-ad de d in te rp re ta tio n. Ja as ke la in en e t a l. (2 00 6) O pt im al p or tf ol io si ze a nd th e m od er at io n ro le s of s yn di ca tio n St at is tic al a na ly si s of d at a: R eg re ss io ns 25 ,0 09 in ve stm en ts in 6 ,0 44 p or tf ol io co m pa ni es . P er io d: 19 86 –1 99 8 U S T he la rg er th e si ze o f th e po rtf ol io , t he m or e fir m s th e ve nt ur e ca pi ta lis t h as th at c an p ot en tia lly r ea ch de si ra bl e ou tc om es . H ow ev er , o n th e oth er h an d, th e la rg er th e si ze o f th e po rt fo lio , t he le ss ti m e th e ve nt ur e ca pi ta lis t h as f or b ei ng in vo lv ed in p or tf ol io c om pa ni es , a nd th e sm al le r th e va lu e of th is in vo lv em en t. So re ns on a nd St ua rt ( 20 01 ) C ro ss -b or de r in ve stm en ts a nd sy nd ic at io n St at is tic al a na ly si s of d at a: R eg re ss io ns 1, 02 5 V C f irm s an d 7, 59 0 po rt fo lio co m pa ni es . P er io d: 19 86 -1 99 8 U S So ci al n et w or ks in th e V C c om m un ity — bu ilt u p th ro ug h th e in du st ry ’s u se o f sy nd ic at ed in ve st in g — al lo w in fo rm at io n sh ar in g ac ro ss b ou nd ar ie s an d th er ef or e ex pa nd th e in ve st m en t o pt io ns in d iff er en t re gi on s an d in du str ie s. G io t a nd Sc hw ie nb ac he r (2 00 3) E xi t t im in g St at is tic al a na ly si s of d at a: S ur vi va l an d ris k m od el s 22 ,0 42 in ve stm en t ro un ds f or 5 ,8 17 ve nt ur e-ba ck ed co m pa ni es U S D ur at io n of d iff er en t ty pe s of e xi ts : 3 .4 y ea rs f or I P O s, 4 .6 y ea rs f or tr ad e sa le s an d 3. 3 ye ar s fo r w rit e-of fs . B io te ch a nd in te rn et fir m s de m on st ra te d th e fa st es t I P O e xi ts in th e sa m pl e. R eg ar di ng w rite -o ff s, in te rn et f irm s ar e al so th e fa st es t t o liq ui da te , w hi le b io te ch f irm s ar e th e sl ow es t. M eg gi ns on a nd W ei ss ( 19 91 ) V C -b ac ke d an d no n-V C -b ac ke d IP O s St at is tic al a na ly si s of d at a: R eg re ss io ns 32 0 V C -b ac ke d an d 32 0 no n-V C -ba ck ed I P O . P er io d: 1 98 3-19 87 U S V C -b ac ke d fir m s go p ub lic e ar lie r th an n on -V C -b ac ke d co m pa ni es , h av in g th er ef or e a sh or te r du ra tio n. V C ’s r ep ut at io n ca n ce rt ify th e qu al ity o f an o ff er in g, r ed uc e in fo rm at io n as ym m et rie s an d at tr ac t h ig he r qu al ity u nd er w rit er s an d au di to rs . Sc hw ie nb ac he r (2 00 8) E xi t b eh av io r of V C s St at is tic al a na ly si s of d at a: R eg re ss io ns 17 1 su rv ey re sp on se s (1 04 fr om E ur op e, 6 7 fr om U S) U S an d E ur op e C on si de ra bl e di ff er en ce s be tw ee n th e U S an d E ur op e: U S ve nt ur e ca pi ta lis ts te nd to r ep la ce th e en tr ep re ne ur m or e of te n w ith n ew m an ag em en t a nd te nd to e xi t b et w ee n ha lf a ye ar a nd a f ul l y ea r ea rli er th an th ei r E ur op ea n pe er s. D iff er en ce s re su lt fr om th e fa ct th at E ur op ea n ve nt ur e ca pi ta lis ts f ac e ill iq ui d ca pi ta l m ar ke ts . C um m in g an d M ac In to sh ( 20 01 ) D ur ati on o f V C in ve stm en ts St at is tic al a na ly si s of s ur ve y da ta : R eg re ss io ns 35 V C s, 2 46 e xi ts . P er io d: 1 99 2-19 95 U S an d C an ad a A ve ra ge d ur ati on in th e U S fo r se co nd ar y sa le s is th e lo ng es t ( 6. 3 ye ar s) a nd f or b uy ba ck s is th e sh or te st (4 .0 y ea rs ). A ve ra ge d ur at io n in C an ad a fo r IP O s is 5 .9 y ea rs c om pa re d to 4 .7 y ea rs f or I P O s in th e U S. N eu s an d W al z (2 00 4) E xi t t im in g of IP O s C on ce pt ua l m od el lin g N o em pi ric al re su lts N o em pi ric al re su lts O pt im al ti m in g fo r ex its r eq ui re s a ba la nc e be tw ee n op po rt un ity c os ts a nd th e de gr ee o f in fo rm at io n as ym m et rie s. L on ge r du ra tio n be ar s hi gh er o pp or tu ni ty c os ts . O n th e ot he r ha nd e ar ly d iv es tm en ts c an be ar h ig h in fo rm at io n as ym m et ry c os ts , w hi ch ty pi ca lly r es ul t i n lo w er v al ua tio n. T a b le 1 . L is t o f E m p ir ic a l S tu d ie s
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3.
METHODOLOGY
As a baseline, a model (1) is estimated first to study the effects of syndication presence and syndication magnitude on duration.
= + + + _ + _ + __ + _ __
+ _ + !_ + "# _ + $,
Durationis the dependent variable that indicates the time (in years) from the first round of financing date to issue date for IPOs and completed exits. Firms is the independent variable indicating the total number of VC firms participating in at least one investment round over the total number of investment rounds that the VC-backed company receives. Bearing in mind that the link between the number of VC firms and the duration may follow a U-pattern, also the squared term of Firms is added, referred to as Firms2. Rounds_Synd represents the total number of financing rounds that are syndicated from the first financing round to the exit. In the current study, the criteria to be defined as a syndicated investment requires two or more VC firms participating together in at least one round out of the total number of financing rounds the portfolio company receives. Rounds_Synd2 is included to control for the effects of having an additional syndicated round over the entire length of duration. Firms_to_Rounds is a ratio, measuring the total number of VC firms to the total number of investment rounds. The ratio is calculated as Firms / Rounds. Rounds_Synd_to_Rounds is a ratio, measuring the total number of syndicated investment rounds to the total number of investment rounds. The ratio is calculated as Rounds_Synd / Rounds.
To control for time effects, Year_Dummy is included to represent the fixed effects for each of the twenty years in the period 1995-2014 to prevent the occurrence of spurious correlation in the analysis. Year dummies are based on the year the exit takes place, to control for overall economic effects or time patterns occurring in these years. For example, if the exit took place in 1996, the year dummy representing 1996 would be assigned 1, while the other years are assigned zero.
To control for macro fixed effects that possibly affect the explanatory variable, Regional_Dummy is added to represent the regional fixed effects for the VC-backed company’s
19
headquarter location (either in the United States or Europe). It takes into consideration the relatively homogenous regions (the US as a developed VC market and Europe as rather a novel VC market) that the VC operates in, in order to control for possible regional effects (such as business environment, cultural approach towards venture capital), given it has found to have an influence on exit options (Shepherd, Zacharakis et al., 2003). Furthermore, in the current study it is a proxy for the regional development due to the data collection limitations that do not allow to distinguish specific state or country level data from the regional data.
To control for VC-backed company’s fixed effects, proxies are included in Company_Dummy to take into account the company size, development stage and the exit strategy pursued. Stage represents the VC company’s life cycle and is a proxy for the development stage of the company. It is expected that the VC firm investing in the first development stage (seed and startup stage) will participate for longer than investing only in later development stages (such as expansion and acquisition). Exit_Type is inserted to control for the exit strategy for the VC investment chosen by the VC firm, and represents the portfolio company’s characteristics given the approach taken in developing the company towards its exit. For each of the observations, it is ascertained whether the exit is indicated as an IPO or trade sale and a dummy variable is created. Exit_Size_log represents the logarithmic value of deal value at exit date (in EUR Million) for trade sales and valuation at transaction date (in EUR Million) for IPOs. It is a proxy for the size of the assets of the VC-backed company at the time of the exit.
As a baseline regression (1) looks at the syndication at an investment level without taking into account specific investment rounds, a model (2) is specified to look at the syndication in the first round and its impact on duration.
= + _1_ + _1_ + _1_ + _ + !_ + "# _ + $,
Round_1_Synd is the binary outcome variable that indicates whether or not the VC-backed company’s first round is syndicated; the variable is 1 if the number of VC firms participating in the first investment round of the VC-backed company is at least 2, and 0 if the number of VC firms in the first investment round is 1. Round_1_Firms indicates the total number of VC firms participating in the first investment round regardless whether the round is syndicated (at
20
least 2 VC firms participating together in the first round) or not. Round_1_Firms2 is included to control for the effects of having an additional firm in the syndication in first round.
Although the paper focuses on syndication and its relationship to duration, overall staging is an important variable to examine. The general effect of having multiple rounds over the entire life cycle of investment increases the expected value of the VC-backed company since it may act as an incentive for the VC company to work harder to achieve the milestones (Schwienbacher, 2008a). Therefore, the total number of financing rounds may be looked at as a proxy for the duration and the models (1) and (2) are modified in which the dependent variable Duration is replaced with the total number of financing rounds the VC-backed company has had before the exit (labeled as Rounds).
Table 2 provides an overview of the dependent variables, explanatory variables and control variables employed in empirical analysis.
21
Variable Name Symbol Variable Description Expected
Sign
Dependent Variables
Duration (in years) Duration Investment duration (in years): Time from the first round of financing date to issue date for IPOs and completed exit dates for other exit types.
Number of Rounds in Total Rounds Total number of financing rounds the company has had before the exit. Independent Variables
Number of VC Firms in Total Firms Total number of VC firms participating in at least one investment round over the total number of investment rounds the VC-backed company receives.
+/-Number of Syndicated
Rounds in Total
Rounds_Synd Total number of financing rounds that are syndicated from the first financing round to the
exit. The criteria to be defined as a syndicated investment requires two or more VC firms participating together in at least one round of total number of financing rounds the portfolio company receives.
+/-1st Round Syndicated Round_1_Synd Indicator variable for VC-backed company’s first round syndication: 1 if the number of VC firms participating in first investment round of the VC-backed company is at least 2, 0 if the number of VC firms in the first investment round is 1.
+/-Number of VCs in 1st Round Round_1_Firms Total number of VC firms participating in first investment round regardless whether the
round is syndicated (at least 2 VC firms participating together in first round) or not.
+/-Number of VC Firms in Total
to Number of Rounds in Total
Firms_to_Rounds Ratio, measuring the total number of VC firms to the total number of investment rounds.
The ratio is calculated as Firms / Rounds .
+/-Number of Syndicated Rounds in Total to Number of Rounds in Total
Rounds_Synd_to_ Rounds
Ratio, measuring the total number of syndicated investment rounds to the total number of investment rounds. The ratio is calculated as Rounds_Synd / Rounds .
+/-Control Variables
Year fixed effects Year_Dummy Indicator variables for the period 1995-2014 representing the issue date for IPOs or completed exit dates for other exit types. A value of 1 is assgined if the year of the investment is equal to the particular year the dummy controls for, 0 otherwise. Regional fixed effects Regional_Dummy Indicator variable for the VC company's location. A value of 1 is assigned if the
VC-backed company’s headquarter's location is the United States, 0 if Europe. It is a proxy for the regional development.
VC Company fixed effects Company_Dummy - Stage : Indicator variable that represents the VC company’s life cycle stage at each
investment round and is a proxy for the development stage of the company. It is expected that VC firm investing in the first development stage (seed and startup stage) will participate for longer than investing only in later development stages (such as expansion and acquisition).
- Exit_Type : Indicator variable that represents the exit strategy chosen by the VC firm for the VC investment and therefore represents the portfolio company’s characteristics given the approach taken in developing the company towards its exit. For each of the observations, it is ascertained whether the exit is indicated as an IPO or trade sale and a dummy variable is created.
- Exit_Size_log : Represents the logarithmic value of deal value at exit date (in EUR Mio) for trade sales and valuation at transaction date (in EUR Mio) for IPOs. It is a proxy for the size of the assets of the company at the time of the exit.
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4.
DATA
Data on duration was retrieved from the Thomson One database (former VentureXpert). Given that VC funds are not publicly traded and there is no obligatory reporting requirement for VC firms to provide industry data to public or private databases, Thomson Reuters (among other industry data reporters) collects the relevant market information from the market participants on a voluntary basis. Although many VC firms themselves are using the market information and are interested in self-reporting, self-reporting is still a source for several biases in the data (such as selection bias, survivorship bias, upward bias). Nevertheless, the majority of researchers are using Thomson Reuters as the most comprehensive source of market information available (Cochrane, 2005).
The timeframe of the study is limited to the period from January 1st, 1995, to December 31st,
2014, and captures the VC-backed companies’ exit announcements in this period. The data was retrieved on April 16th 2015, and consists of venture capital sample on portfolio company’s
aggregated and unique round level data.2 The models were to be tested by the use of the data
representing the venture capital portfolio companies headquartered in the US and in Europe.
11,670 VC-backed companies’ exit announcements were collected including the information of pre-exited VC-backed company’s name, location of company’s headquarter, exit type, exit date completed, individual investment duration, investment’s valuation or deal value at exit date, investment’s stage, round number, number of VC funds at investment date, number of VC firms in total participating in investment.
After the removal of 204 observations due to the missing values of the dependent variable (duration), the sample was left with 11,466 VC-backed exits of which the US observations represent 9,543 data points and Europe 1,923 data points.
2 The search criteria was defined as following: a) Companies involved in: Types of deals prior to the exit - only
VC rounds: VC investments including startup/seed, early, expansion, and later stage deals regardless of the investor type (bridge loan, acquisition for expansion, recap/turnaround, mezzanine or secondary purchase investment stages were also included as long as there was at least one traditionally venture focused investor and all other stages were either startup/seed, early, expansion or later stages); b) Exit Types: IPO, Secondary Sale, Trade Sale, Reverse Takeover, Buyback, Write Off; c) Company location: the US / Europe (no country specific information was collected in Europe – the region was analyzed as a homogenous region); d) Industry: The Venture Economics Industry Codes (VEIC codes) codes developed by Thomson Reuters were used (these were Information Technology, Medical/Health/Life Science, and Non-High Technology).
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Table 3 provides the descriptive statistics of the main variables used in the regression for the whole sample and for the regional sub-samples of the US and Europe.
The mean value of duration is 5.2 years and the median value is 4.5 years which is in line with previous research3. The range varies from 0.1 years to 40.2 years. The average number of rounds
over the entire investment is 3.9 with the median of 3.0. The range varies from 1 to 27 rounds (the cumulative frequency of 90% of number of rounds vary between 1 and 7 rounds). Taking both regions separately, the European VC-backed companies overall have a smaller average number of rounds – the mean value of 2.7 in Europe versus 4.2 in the US. Given that the duration is longer by 0.5 years and there are fewer rounds in Europe compared to the US, this indicates that European VC-backed companies have longer periods between each investment round with the longer average duration over the entire investment period.
The number of VC firms in VC companies is 5.5 on average in which the number of VCs in the first round is 2.2. The average number of investors in first round is somewhat higher for the US, 2.3 VC firms on average, versus 1.7 in the European sample. The European VC-backed companies overall have a smaller average number of VC-firms investing in one VC-backed company – the mean value of 5.9 in the US versus 3.2 in Europe. The difference might be the result of the more established VC environment in the US in which the VC firms are more often approached as syndication partners (Manigart, Lockett et al., 2002; Wright, Robbie et al., 2000).
In the total sample, 82% of investments by VC firms are syndicated. The average number of syndicated stages in total (number of VC firms participating in at least one investment round is
3 The average investment duration for venture capital funds in the United States is 5.07 years and for the European
funds is 5.56 years (Cumming, MacIntosh 2001).
Variable Name All US Europe Me dian STD Min Max
Duration (in years) 5.2 5.1 5.6 4.5 3.6 0.1 40.2
Number of Rounds in Total 3.9 4.2 2.7 3.0 3.0 1.0 27.0
Number of VC Firms in Total 5.5 5.9 3.2 4.0 4.4 1.0 33.0
Number of Syndicated Rounds in Total 2.7 2.9 1.2 2.0 2.5 0.0 21.0
1st Round Syndicated 0.6 0.6 0.4 1.0 0.5 0.0 1.0
Number of VCs in 1st Round 2.2 2.3 1.7 2.0 1.5 1.0 16.0
Number of VC Firms in Total to Number of Rounds in Total 1.6 1.6 1.3 1.3 1.0 0.1 10.5 Number of Syndicated Rounds in Total to Number of Rounds in Total 0.6 0.7 0.4 0.7 0.4 0.0 1.0 Note: Total observations 11,466, of which the US represents 9,543 and Europe 1,923.
Me an
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more than one) in Europe is 1.2 versus 2.9 for the US, indicating that the US has a greater emphasis on stage financing. With regard to first round syndication, it is more popular in the US with 64% of venture-backed companies syndicating in the first investment round, versus 40% of the entire European sample. The median number of investors in the first round provides an insight into whether or not the median portfolio company has first round syndicated or not. The median in the US is 1, which forms a syndicate in the first round. The median in Europe is 0, which does not form a syndicate.
Table 4 provides with the information for the number of exit types analyzed in the dataset.
A trade sale is the most popular exit method in both regions, being chosen in 70% of all exits. However, the method of IPO is more popular exit option for the US VCs, with 19% of companies having gone public, versus only 11% going public in the European sample. Lerner (1994) argues that the VC environment for young companies in Europe is less established and therefore VC firms are left with a primary exit vehicle chosen as a trade sale rather than an IPO. Individual European countries are considered to be too small and fragmented for the active IPO markets compared to the US, and therefore other exit strategies (such as trade sale) seem to provide better exiting options (Boquist and Dawson, 2004).
Table 5 gives the correlation between variables.
IPO 2003 17% 1782 19% 221 11%
Trade Sale 8065 70% 6650 70% 1415 74%
Other Exit Type* 1398 12% 1111 12% 287 15%
Total Observations 11466 100% 9543 100% 1923 100%
Note: Other exit types include: Secondary Sale, Reverse Takeover, Buyback, Write Off.
Table 4. Number of Exit Types
Total US Europe
(1) (2) (3) (4) (5) (6) (7) (8)
(1) Duration 1
(2) Number of Rounds in Total 0.4508 1 (3) Number of VC Firms in Total 0.3057 0.6671 1 (4) Number of Syndicated Rounds in Total 0.3875 0.8627 0.7492 1 (5) 1st Round Syndicated (1 or else 0) -0.0435 0.0804 0.2317 0.3216 1 (6) Number of VCs in 1st Round -0.0404 0.0904 0.3195 0.2659 0.6799 1 (7) Number of VC Firms in Total / # of Rounds in Total -0.1795 -0.243 0.3785 -0.0223 0.3614 0.4976 1 (8) Number of Syndicated Rounds in Total / # of Rounds in Total 0.0093 0.169 0.4166 0.5149 0.7192 0.5072 0.5142 1
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The correlations depicted in Table 5 aid in determining a preliminary association between the variables. The relationships between dependent variable Duration and independent variables Number of VC Firms in Total, and Number of Syndicated Rounds in Total show the expected positive relation, given that more rounds extend the lifespan of VC involvement in portfolio companies. The variables related to 1st round syndication – 1st Round Syndicated and Number of VCs in 1st Round – have a negative relationship to Duration, indicating that in case of syndication taking place in the first round, the total number of investors is smaller over the entire life cycle of investment, resulting in shorter duration.
The relationships between dependent variable Number of Rounds in Total and the variables Number of VC Firms in Total, Number of Syndicated Rounds in Total, 1st Round Syndicated and Number of VCs in 1st Round are all positive to Number of Rounds in Total. Variables related to the first round have an opposite impact on Number of Rounds in Total compared to Duration and should be further investigated in regressions given that Number of Rounds in Total was considered as a proxy to Duration and should therefore not have controversial signs.
Correlation matrix exhibits a multicollinearity in which independent variables are highly correlated with each other. Even though the reliability of the model as a whole is not affected, this results in biased coefficients and standard errors. In order to test for multicollinearity, Variance Inflation Factors (VIF) were consulted. VIF measures the severity of multicollinearity in an ordinary least squares regression analysis with quantifying the increase of variance in an estimated regression coefficient due to multicollinearity. The general rule of thumb is that a VIF exceeding 10 indicates serious multicollinearity, while a VIF exceeding 5 requires further investigation (O’brien, 2007).
Table 6 gives the VIF values for independent variables.
VIF 1/VIF
Number of VC Firms in Total 4.72 0.211766
Number of Syndicated Rounds in Total 6.19 0.161612
1st Round Syndicated 3.17 0.315107
Number of VCs in 1st Round 2.35 0.425776
Number of VC Firms in Total / # of Rounds in Total 3.84 0.260545 Number of Syndicated Rounds in Total / # of Rounds in Total 4.36 0.229121
Mean VIF 4.11 Table 6. VIF Value s
26
Based on a rule of thumb for VIFs and the correlation matrix, it can be seen that the Number of Syndicated Rounds in Total has the VIF value of 6.19 which means that the standard error of the coefficient is 2.5 times as large as it would be if the variable was uncorrelated with the other variables. With the mean VIF 4.11 and the majority of VIFs lying between 2 and 5, the multicollinearity might be problematic, however the VIFs are not large enough to be overly concerned about.
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5.
RESULTS AND DISCUSSION
5.1.
Results
Table 7 shows the results of the OLS regressions on duration using the whole dataset in regressing models (1) and (2) outlined in Methodology section and their various specifications.
The highest adjusted R2 results with model (1) and its 6 specifications. The adjusted R2 varies
between 20% and 29% (except the specification in column 4 when only ratios Number of VC Firms in Total to Number of Rounds in Total and Number of Syndicated Rounds in Total to Number of Rounds in Total are included). The adjusted R2 is rather high indicating that
syndication is an important determinant in explaining duration. One additional VC firm over
Duration (1) Duration (1) Duration (1) Duration (1) Duration (1) Duration (1) Duration (2) Duration (2) Duration (2) Number of VC Firms in Total 0.22*** 0.36*** 0.28***
(0.03) (0.03) (0.01) Number of VC Firms in Total_sq 0.00 -0.01***
(0.00) (0.00)
Number of Syndicated Rounds in Total 0.45*** 0.30*** 1.06*** 0.56*** (0.07) (0.07) (0.04) (0.01) Number of Syndicated Rounds in Total_sq 0.00 0.00 -0.03***
(0.00) (0.00) (0.00) Number of VC Firms in Total to Number of
Rounds in Total -0.66*** -0.74*** 0.00 -0.77*** (0.06) (0.06) (0.03) (0.03) Number of Syndicated Rounds in Total to
Number of Rounds in Total -1.48*** -1.15*** -2.72*** 1.15*** (0.17) (0.17) (0.13) (0.10) 1st Round Syndicated -0.38** -0.36*** (0.12) (0.07) Number of VCs in 1st Round 0.08 -0.10*** (0.08) (0.02) Number of VCs in 1st Round_sq -0.01 (0.01) Constant 4.90*** 3.96*** 3.98*** 4.39*** 2.85*** 3.45*** 3.69*** 3.77*** 3.82*** (0.08) (0.17) (0.17) (0.18) (0.17) (0.17) (0.19) (0.18) (0.18) Year Fixed Effects No Yes Yes Yes Yes Yes Yes Yes Yes Regional Fixed Effects No Yes Yes Yes Yes Yes Yes Yes Yes Company Fixed Effects No Yes Yes Yes Yes Yes Yes Yes Yes N 11466 11466 11466 11466 11466 11466 11466 11466 11466 R-sq 0.21 0.29 0.28 0.12 0.20 0.23 0.10 0.10 0.10 adj. R-sq 0.21 0.29 0.28 0.12 0.20 0.23 0.09 0.09 0.09 F 538.29 209.91 209.67 98.8 139.39 166.89 62.53 67.86 67.22
Table 7. OLS cross-sectional regression on Duration
28
the entire investment life cycle adds 0.28 years to the duration, all other variables kept constant. The number of syndicated rounds increases the duration by more than half a year, with other variables kept constant. The quadratic variable of Number of VC Firms in Total indicates that an additional VC firm has a positive effect on duration until 18 VC firms are participating in the investment, after which it has a negative impact.
Specifications in the first and second column show the impact of controlling for the annual, regional and company fixed effects. The adjusted R2 increases the most when yearly effects are
included, indicating that there are yearly factors that influence the whole VC industry that must be considered, regardless of the regional or company differences. The specification without any control variables has the explanatory power of 21% that results from syndication, indicating that given the significant coefficients of Number of VC Firms in Total and Number of Syndicated Rounds in Total at the 1% level, syndication represents a significant determinant in explaining duration. Mentioned variables contribute to longer duration in model (1), supporting the theory of reduced information asymmetry as outlined in the Literature section in paragraph 2.
Model (1) includes two calculated ratios – Number of VC Firms in Total to Number of Rounds in Total and Number of Syndicated Rounds in Total to Number of Rounds in Total – by implying that with an increase of VC firms and syndicated rounds per total number of rounds, the duration decreases. However, given the high correlation between Number of Rounds in Total (in denominator) to both variables in nominators, it does raise concerns that the ratios exhibit simply correlation with the duration, as an increased number of rounds can only take place over an increased number of years, which results in negative relationship in ratios to duration. Furthermore, Number of Syndicated Rounds in Total to Number of Rounds in Total changes the sign in specification 4, exhibiting non-robustness. Also, when running the regressions with the mentioned two variables in other sub-samples (for example, the sub-sample for the US and the European VC markets), the results are not significant, indicating that the specifications including mentioned ratios are not robust.
Model (2) relates specifically to 1st round syndication (1st Round Syndicated and Number of
VCs in 1st Round). While the 1st Round Syndicated shows negative relationship to duration as expected based on the correlation matrix, the variable Number of VCs in 1st Round in first specification of model (2) is not significant even at a level of 10% and becomes significant only
29
when regressed alone. The model (2) implies that in case of syndication taking place in the first round, the total length of an investment is shorter. This result seems to support the theory of diminishing marginal benefit that argued in favor of shorter duration, given the decreasing marginal value added over time by the VC firm to the portfolio company as the expected marginal benefits are considered to be larger at the beginning of an investment period compared to at the end of the investment period. Furthermore, the impact of being syndicated on the duration is almost 4 times larger compared to the impact of how many VC firms syndicate in the 1st round at the time. In case syndication does take place, the total duration of an investment
is approximately 0.4 year shorter compared to not syndicating in the first round, with other variables held constant. In contrast, every additional VC firm shortens duration only by 0.1 years compared to the 0.4 years the 1st Round Syndicated does.
In the next step, the total data set were separated into sub-samples representing IPOs and trade sales. The results are presented in Table 8.
In Table 8, interaction terms are added to test whether the relationships between the Number of VC Firms in Total and Number of Syndicated Rounds in Total on Duration are different in the
Duration All Duration IPO Duration Trade Sale Duration All Duration IPO Duration Trade Sale Duration IPO Duration Trade Sale Duration IPO Duration Trade Sale
Number of VC Firms in Total 0.32*** 0.17*** 0.33***
(0.01) (0.02) (0.01)
Number of VC Firms in Total * IPO -0.13***
(0.02)
Number of Syndicated Rounds in Total 0.59*** 0.42*** 0.61***
(0.01) (0.04) (0.02)
Number of Syndicated Rounds in Total * IPO -0.11**
(0.04)
1st Round Syndicated -0.45* -0.32***
(0.18) (0.08)
Number of VCs in 1st Round -0.14** -0.08**
(0.05) (0.03)
IPO (IPO=1, or else 0) 0.57*** 0.19
(0.17) (0.17)
Constant 2.39*** 1.93*** 2.44*** 3.01*** 2.38*** 2.99*** 2.81*** 3.33*** 2.88*** 3.36***
(0.15) (0.30) (0.18) (0.14) (0.29) (0.17) (0.33) (0.19) (0.33) (0.19)
Year Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Regional Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Company Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
N 11466 2003 8065 11466 2003 8065 2003 8065 2003 8065
R-sq 0.20 0.20 0.22 0.23 0.22 0.25 0.15 0.08 0.15 0.08
adj. R-sq 0.20 0.19 0.22 0.23 0.21 0.25 0.14 0.08 0.14 0.08
F 141.5 37.34 116.67 167.64 40.24 135.68 28.06 44.67 28.18 43.62
Table 8. OLS cross-sectional regression on Duration, sample All with sub-samples IPO and Trade Sales
30
exit through IPO compared to other exit vehicles. For VC-backed companies exiting through IPO, duration with one additional VC firm participating in syndication and similarly one additional syndicated round is 0.19 and 0.48 years longer, respectively, compared to duration for VC-backed companies exiting through other exit vehicles with one additional VC firm participating in syndication and similarly one additional syndicated round (0.32 and 0.59 years longer, respectively). Therefore, an exit through IPO results in shorter duration compared to other exit vehicles conducted under similar conditions. This result can be considered very novel in empirical research given that the prior studies of syndication have mainly focused on IPO exits only (Giot and Schwienbacher, 2007; Gompers, 1995).
In sub-samples of IPO and trade sales exits, the variable Number of Syndicated Rounds in Total has a notably larger coefficient for trade sales than for IPOs – the positive impact on duration is 0.61 and 0.42, respectively. However, for the variables 1st Round Syndicated and Number of VCs in 1st Round duration shortens by 0.45 and 0.14 years for IPOs, compared to 0.32 and 0.08 years for trade sales, respectively. However, in absolute terms, the actual time differences are rather small.
With regard to the possible regional differences in syndication, Table 9 presents the comparison between the US and European regions.
In Table 9, interaction terms are added to test whether the relationships between the Number of VC Firms in Total and Number of Syndicated Rounds in Total on Duration are different in the US compared to the European region. For VC-backed companies located in the US, one additional VC firm participating in syndication results in 0.28 years longer duration than in Europe where the duration is 0.25 years longer with one additional VC firm participating in syndication. For VC-backed companies located in the US, one additional syndicated round is associated with 0.58 years increase in duration, compared to Europe, where one additional syndicated round increases duration by 0.41 years.
The results indicate that R2 is notably lower for the sub-sample companies operating in the
European region compared to the US. Furthermore, the results do not differ that much from one another between regions. The coefficients for the variables related to the first round syndication are significant only in the US. For the European area, the variables 1st Round Syndicated and
31
Number of VCs in 1st Round are not significant across regressions performed indicating non-robustness.
Table 10 presents the results with regard to dependent variable Number of Rounds in Total that replaces dependent variable Duration in models (1) and (2). Specifications show positive and highly significant relationship between Number of Syndicated Rounds in Total and Number of Rounds in Total which was expected as both variables relate to rounds. Furthermore, the correlation between the two variables is 0.8627 and all specifications have R2 and adjusted R2
at least 75%. With regard to syndication in the first round, the variables 1st Round Syndicated and Number of VCs in 1st Round are indicating non-robustness across specifications. Although the paper focuses on syndication and its relationship to duration, overall number of rounds the VC-backed company has is an important variable to examine. The effect of having multiple rounds over the entire life cycle of investment may increase the expected value of the VC-backed company since it may act as an incentive for the VC company to work harder to achieve its milestones (Schwienbacher, 2008a).
Duration All Duration US Duration Europe Duration All Duration US Duration Europe Duration US Duration Europe Duration US Duration Europe
Number of VC Firms in Total 0.25*** 0.28*** 0.27***
(0.02) (0.01) (0.02)
Number of VC Firms in Total * US 0.03
(0.02)
Number of Syndicated Rounds in Total 0.41*** 0.58*** 0.42***
(0.04) (0.01) (0.04)
Number of Syndicated Rounds in Total * US 0.17***
(0.04) 1st Round Syndicated -0.38*** -0.23 (0.08) (0.14) Number of VCs in 1st Round -0.10*** -0.12 (0.02) (0.06) US (US=1, Europe=0) -0.51*** -0.99*** (0.12) (0.11) Constant 2.94*** 2.44*** 5.49*** 3.65*** 2.64*** 5.97*** 4.21*** 6.72*** 4.22*** 6.85*** (0.19) (0.17) (0.36) (0.17) (0.17) (0.35) (0.18) (0.36) (0.18) (0.37)
Year Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Company Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
N 11466 9543 1923 11466 9543 1923 9543 1923 9543 1923
R-sq 0.20 0.22 0.09 0.23 0.26 0.08 0.10 0.04 0.10 0.04
adj. R-sq 0.20 0.21 0.08 0.23 0.26 0.08 0.10 0.03 0.10 0.03
F 133.61 134.45 16.97 160.49 164.65 17.3 66.5 6.37 65.7 6.52
Table 9. OLS cross-sectional regression on Duration, sample All with sub-samples the US and the European region
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5.2.
Discussion
An increase in the number of VC firms investing a portfolio company increases the duration, indicating that an exchange of information in syndication between VC firms increases the quality of an assessment of the portfolio company. This decreases the uncertainty related to investments by decreasing the possible information asymmetries. The same argument applies in relation to the increase in the number of financing rounds, where investing in several rounds allows the VC firm to assess and monitor the development of the portfolio company according to its milestones. This is also in line with Admati and Pfleiderer (1994), who argue that the motivation for the syndication stems from the resolution of uncertainty present over time instead of resolution present at one specific point in time. Therefore, the lead VC firm that invests in the portfolio company in the first round signals the value of the company to its subsequent VC firms that may participate in syndicates in future rounds. The lead VC firm is therefore interested in participating in all future financing rounds.
Number of Rounds in Total (1) Number of Rounds in Total (1) Number of Rounds in Total (1) Number of Rounds in Total (1) Number of Rounds in Total (2) Number of Rounds in Total (2) Number of Rounds in Total (2) Number of VC Firms in Total 0.03*** 0.08*** 0.45***
(0.01) (0.01) (0.01)
Number of Syndicated Rounds in Total 1.07*** 0.83*** 1.03*** (0.01) (0.02) (0.01) 1st Round Syndicated -1.20*** 0.09 0.25*** (0.04) (0.08) (0.06) Number of VCs in 1st Round -0.06*** 0.08** 0.10*** (0.01) (0.03) (0.02) Constant 2.29*** 1.82*** 1.02*** 1.91*** 2.12*** 2.19*** 2.12*** (0.08) (0.08) (0.11) (0.08) (0.15) (0.14) (0.15) Year Fixed Effects Yes Yes Yes Yes Yes Yes Yes Regional Fixed Effects Yes Yes Yes Yes Yes Yes Yes Company Fixed Effects Yes Yes Yes Yes Yes Yes Yes N 11466 11466 11466 11466 11466 11466 11466 R-sq 0.79 0.75 0.47 0.75 0.09 0.09 0.09 adj. R-sq 0.79 0.75 0.47 0.75 0.20 0.09 0.09 F 1426.84 1198.78 248.29 1373.48 55.59 57.9 57.12
Table 10. OLS cross-sectional regression on Number of Rounds in Total
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On the other hand, syndication in early stages results in providing the necessary financial capital and advice in larger scale at the time when the resources are the scarcest for the portfolio company, by allowing them to achieve their goals earlier, thereby resulting in shorter duration. Indeed, the diminishing marginal benefit prescribes an earlier exit given the reduced ambiguity of an investment return over time for the VC firm. Although presented implicitly in this paper, the results indicate that it seems likely that as VC company matures, uncertainty with respect to its future prospects is resolved suggesting that the probability of syndication declines as portfolio companies develop. Although only the first round was studied in this thesis, given that there is a negative relationship between duration and first round syndication, the impact should be reversed once the companies mature, with VC investments in later stage companies being more likely to be syndicated for being able to commit larger amounts of financial resources. An increase in the probability of later stage VC investments being syndicated then is a function of the effect driven by the increased investment of financial capital dominating the effect of a decrease in uncertainty.
