the impact of venture capital investments on industry performance
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DESCRIPTIONThe Impact of Venture Capital Investments on Industry Performance. Tim Loughran Sophie Shive University of Notre Dame. Venture Capital – Background. From 1980-2005, VC funding totaled $394.2 billion. 500 VC funds concentrated in CA, MA and a few other states. - PowerPoint PPT Presentation
The Impact of Venture Capital Investments on Industry PerformanceTim LoughranSophie ShiveUniversity of Notre Dame
Venture Capital BackgroundFrom 1980-2005, VC funding totaled $394.2 billion. 500 VC funds concentrated in CA, MA and a few other states. Raise funds from wealthy individuals, pension funds and endowments and invest it in new companies. Began just after WW II, but took off in 1979 when prudent man rule allowed pensions to invest.
Venture Capital - BackgroundVCs provide both cash and expertise to young firms, and then plan their exit20-35% of VC-funded firms are taken public bulk of VCs returns are here (Gompers and Lerner, 2002).
Brau, Francis, and Kohers (2003) find that IPOs get a 22% premium over the average price paid for privately-held firms. Apple Computer, Sun Microsystems, Yahoo, eBay, and Google were all VC funded firms.
Research: Venture Capital Some evidence that VCs are smart: When public market prices are high, VCs take more firms public (Lerner, 1994)VC funded IPOs have higher subsequent returns than non-VC funded IPOs (Brav and Gompers, 1997)The most experienced ones make the most money (Gompers, Kovner, Lerner and Scharfstein, 2007).
Research: Industry ReturnsLess competitive industries earn lower returns (Hou and Robinson, 2006)The market reacts slowly to information contained in some industries (Hong, Torous and Valkanov, 2007)
QuestionWhat is the effect on public companies of VC funding in their industry? We explore the relation between public market returns and VC funding activity3 possibilities: It decreases the value of existing companies due to competition It does nothingIt encourages other investors, increasing the value of existing public companies
Summary of FindingsIn an panel of 3,502 quarterly industry observations, more VC funding is related to lower subsequent industry returnsVC funding is negatively related to industry ROA in the subsequent year. Our results are generally significant for both the EW and VW returns. Also true for both the bubble and non-bubble periods.
Merck ExampleDecember 1999, Merck employed 62,300 workers and had mkt value of $157 billion.Yet, Merck was dependent on only a few successful drugs related to elevated cholesterol (Zocor and Mevacor) or hypertension/heart failure (Vasotec). A young bio-tech needs only a single successful product to hurt the giant Merck.
Yahoo/Google ExampleIn our dataset, Google received two rounds of VC money: June 4, 1999 other early stage infusion of $25 million and September 1, 2000 expansion infusion of $15.175 million.Yahoo was more established than Google, and it also had older technology.
Market ValuesYahoo had mkt value of $67 billion when Google received expansion money.In August of 2004 (Googles IPO date), Yahoo had $42 billion value.By September 2007, Yahoo had $30 billion market value (Google is now $164 billion).
Outline of talkDataMethodologyMain resultsRobustnessIndustry Return on AssetsConclusion
DataVenture capital (VC) data is from Thomsons VentureXpert database: Data is self-reported by the VCs or the companies they invest inall VC disbursements between 1980 and 2005. Re-code industries into Fama-French 48: 34 industries have at least one round of funding.Other sources: Ken Frenchs website, CRSP, Compustat
Fig 1: Quarterly level of Nasdaq and VC disbursements
Fig 2: Quarterly level of Nasdaq and VC disbursements scaled by assets
Types of VC FundingEarly StageSeed (1.9% of total funding)Startup (17.2%)Other Early Stage (6.9%)Expansion (57.3%)Later Stage (16.8%)We exclude Other Stage (Acquisitions, Special Situation, VC Partnership)
DataOver 83% of total VC funding goes to five industries: Business Services: 37.3%Telecommunications: 24.4%Pharmaceutical Products: 9.2%Computers: 6.6%Chips and Electronic Equipment: 5.7%
Fig. 3. VC Disbursements for the Five Most-Funded Industries, 1980-2005
DataOther variables: Value and equal weighted industry returns and book/market from Ken Frenchs websiteLog (Number of IPOs + 1) from SDCHerfindahl Index of sales from Compustat: Sum of squares of firm sales (Total industry sales)2 A high value means low competitionHou and Robinson (2006) show H is related to returnsH =
Table 2: Summary Statistics by Industry and Quarter
MethodologyRegression with quarterly and industry fixed effects and errors clustered by quarter and industry (Petersen, 2007, Thompson, 2006).
Table 3: Industry Fixed Effects RegressionsN ranges from 3,468 to 3,502, R-Square ranges from 0.52 to 0.65VC/A is the VC funding for each industry-quarter divided by total industry assetsMkt-Rf, SMB, HML, MOM are contemporaneous; remaining variables are lagged. Ind and Time are industry and quarter dummy variables. T-statistics in parentheses; Standard errors clustered by quarter and industry.
CommentsVC/Assets consistently significantIPOs and Herfindahl are generally not significantAre our results due to a certain time period, like the internet bubble period of 1998-2001?
Table 4: Time-period Break-downVC/A is the VC funding for each industry-quarter divided by total industry assetsIndustry and quarterly dummies are includedT-statistics in parentheses; Standard errors clustered by quarter and industry.
Table 5: Funding Stage Break-down
Table 6: Industry Break-down
Some Robustness ChecksIncluding industries with zero fundingIncluding other stagesOther control variables: industry size, dividend yield, IPO initial returns, additional lags of the number of IPOs, equity share in new issues (Baker & Wurgler, 2000)
More Robustness: Redefining IndustriesSame analysis for Tech industry as defined by Loughran and Ritter (2004). Consistent significance at 1% level for EW and VW returns
Industry Operating PerformanceDoes VC funding affect the subsequent years ROA for firms that are already public?Poor stock returns and poor operating performance for the same industry should be expected to go together.
We compute ROA as Industry net income before extraordinary items from Compustat divided by total assets. We include Capex to assets and R&D to assets ratios. Also include industry and yearly dummies, and errors are clustered by both industry and year.
Table 7: Return on AssetsDependent variable is industry-level return on assets: Net Income Before Extraordinary Items/Assets. Independent variables lagged one year.I and Y are industry and annual dummiesT-statistics are in parentheses; standard errors are clustered by industry and year
ConclusionFindingsHigher VC funding is associated with lower industry returns in the subsequent quarter during 1980-2005.True for equal and value weighted returnsRemains true in or out of the bubble. True for most funding types and most of the 5 main industries. VC funding is negatively related to industry ROA in the subsequent year.
ConclusionOur empirical results are consistent with the capital market myopia work of Sahlman and Stevenson (1985). Overoptimism on the part of venture capitalists leads directly to overfunding of a few key industries which precedes a decline in both industry stock returns and operating performance.
VCs are good at creating firmsThey also like to move into industries where firms are highly valuedThey are influenced by commitmentsLerner 1994: This paper examines the timing of initial public offerings and private financings by venture capitalists. Using a sample of 350 privately held venture-backed biotechnology firms between 1978 and 1992, I show that these companies go public when equity valuations are high and employ private financings when values are lower. Seasoned venture capitalists appear to be particularly proficient at taking companies public near market peaks. The results are robust to a variety of controls and alternative explanations. Brav and Gompers 1997: VC backed IPOS have higher returns after the offering than non vc-backed. Gompers-Lerner2000We show that inflows of capital into venture funds increase the valuation of thesefunds' new investments. This effect is robust to (i) controlling for firm characteristics andpublic market valuations, (ii) examining first differences, and (iii) using inflows intoleveraged buyout funds as an instrumental variable. Interaction terms suggest that theimpact of venture capital in#ows on prices is greatest in states with the most venturecapital activity. Changes in valuations do not appear related to the ultimate success ofthese "rms. The "ndings are consistent with competition for a limited number ofattractive investments being responsible for rising prices.
GKLS 2005: It is well documented that the venture capital industry is highly volatile and that much of thisvolatility is associated with shifting valuations and activity in public equity markets. This paperexamines how changes in public market signals affected venture capital investing between 1975 and1998. We find that venture capitalists with the most industry experience increase their investmentsthe most when public market signals become more favorable. Their reaction to an increase is greaterthan the reaction of venture capital organizations with relatively little industry experience and thosewith considerable experience but in other industries. The increase in investment rates does not affectthe success of these transactions adversely to a significant extent. These findings are consistent withthe view that venture capitalists rationally respond to attractive investment opportunities signaledby pub