Investor Horizon and the Life Cycle of Innovative Firms: Evidence from Venture Capital

Abstract

This paper studies whether and how the contractual horizon of venture capital funds affects their investments in innovative firms. I find that funds with a longer remaining horizon select younger companies at an earlier stage of their development, which grow their patent stock significantly more than companies financed by funds with a shorter horizon. The sensitivity of investment decisions to horizon is stronger among experienced venture capital firms, who allocate investments across a larger number of fund vintages. Finally, I find that the interaction of funds’ fixed horizon with their option-like compensation structure affects their investment decisions: when early performance has been high, fund managers target less innovative companies. These findings shed light on the drivers of venture capital investment decisions and on their implications for the type of companies that receive venture capital financing. This paper was accepted by Gustavo Manso, finance.

Venturing beyond the IPO: Financing of Newly Public Firms by Venture Capitalists

“…Gompers (1996) concludes that younger VC firms have greater needs to establish a strong record quickly, so as to increase their ability to raise follow‐on funds. Lee and Wahal (2004), Tian and Wang (2014), and Barrot (2017) provide additional support for such dynamics.…”

“…We also include the number of pre‐IPO VC firms that are young, which we define as six years old or less at the IPO. Gompers (1996), Barrot (2017), Tian and Wang (2014), and Lee and Wahal (2004) show that young VCs are more sensitive to agency issues, as they are driven to establish their reputations quickly to raise follow‐on funds.…”

“…The Agency Hypothesis, in contrast, is based on the idea that VCs are motivated by factors other than just the NPV of underlying investments. As shown by Carpenter (2000) and discussed by Barrot (2017) and Nanda and Rhodes‐Kropf (2018), the convexity of VC compensation contracts incentivizes managers to condition investment decisions on prior performance. VCs typically earn a 2% management fee that is based on the total capital raised from limited partners (LPs), plus 20% of cumulative fund profits (commonly referred to as carried interest).…”

Ranking Range Based Approach to Madm Under Incomplete Context and Its Application in Venture Investment Evaluation

“…Venture investment evaluation method is often adopted to help the venture capitalists to rank or select the best venture project(s) according to the performances of the projects associated with multiple criteria (or attributes). A lot of methods have been reported in literature for venture investment evaluation problems (Barrot, 2016;Nanda & Rhodes-Kropf, 2016;Townsend, 2015). For example, Barrot (2016) studied whether and how the contractual horizon of venture capital funds affects investors' investments in innovative firms.…”

“…Venture investment evaluation involving multiple projects (can be seen as the alternatives in the MADM) and multiple evaluation indices (can be seen as the evaluation attribute in the MADM) can be regarded as a MADM problem. The MADM approaches have been widely used in venture investment evaluation system (Aggarwal, Kryscynski, & Singh, 2015;Barrot, 2016;Hall & Hofer, 1993;Tyebjee & Bruno, 1984). In this paper, the proposed ranking range based MADM approach can be used to help the investors select the best investment project(s).…”