Performance differentiation: cutting losses and maximizing profits of private equity and venture capital investments

Abstract

Recent research has pointed out the need to differentiate between good versus poor performance of venture capital and private equity investments and to analyze the factors that determine the ‘winners’ and ‘losers’ of a fund. This study examines the different contractual and behavioral characteristics and their influence on the positive and negative performances of private equity investments. Specifically, we analyze how fund managers apply tools and investment behavior to mitigate risks and maximize returns. The empirical investigation of these questions is based on a merged dataset, which combines the Venture Economics and CEPRES databases. It includes a total of 1,011 investments made by 137 different funds that belong to 54 private equity and venture capital firms worldwide over the period from 1979 to 2003. Our results confirm that the reduction of losses and the maximization of investment profits have different antecedents. Although losses are minimized by the use of convertibles and by increasing the venture capital firms’ accumulated experience, profits are increased by the potential of the fund’s management to allocate resources to portfolio companies. Our findings contribute to the understanding of the determinants of venture capital and private equity returns by differentiating between the mitigation of risks and the maximization of profits. Copyright Swiss Society for Financial Market Research 2007Private equity, Venture capital, Staging, Risk, Return, Performance, Profit, Losses, G24, E51,

Advice and monitoring in venture finance

“…The interaction between effort and years is indirect, via exit conditions and contract decisions. That is, our instruments are based on the premise that investment contract decisions and exits are more closely related to market conditions and year effects, consistent with Gompers andLerner (1999, 2001), Lerner andSchoar (2004, 2005), Bessler and Kurth (2006), Lauterbach et al (2006), Tykvova (2006), Tykvova and Walz (2006), Witt and Brachtendorf (2006), and others. Our instruments in this context were not selected on the basis of prior work directly on topic of advice, as such papers (e.g., Kaplan and Strömberg 2004) did not control for endogeneity.…”