Venture Capital Reputation
Venture capital (VC) firms typically make early, high-risk, high-expected-return investments. VC reputation is the perception in the minds of investors that a VC firm will create value for investors. This entry discusses the beneficial effects of a good reputation for VC firms and ways to measure it.
The very presence of VC investment in a firm going public may have a certification effect, lowering costs for the issuing firm by attracting top underwriters and institutional investors. However, reports in the popular press indicate that all VC firms are not equal: the largest 20 percent of the firms manage about 80 percent of the industry’s capital, according to the Wall Street Journal. Some younger VC firms may take a firm public suboptimally early to earn a reputation, which is referred to as the grandstanding effect. Other VC firms are known for providing valuable advisory and monitoring services to their portfolio firms, sometimes even well after the initial public offering (IPO). Thus, for financial intermediaries such as the VC firms that operate in a fragmented industry (there were more than 2,300 VC firms operating as of 2014), a good reputation can result in better access to resources—both capital and skilled labor.
Investors recognize managers with superior skills and reward them by investing more capital, which results in the better funds earning higher aggregate fees. A good reputation can also enable cherry picking of target firms. Thus, when evaluating the effect of the performance of a reputed financial intermediary, it is important to control for self-selection bias in that the most reputed financial firms may get the pick of the litter. If reputed VC firms add value even after controlling for self-selection bias, then it is likely that such good performances could lead to higher market shares in the future. Previous research has found that investment bank advisory market shares in mergers are positively related to the percentage of deals completed in the past.
When a firm goes public, it usually results in large returns for the early investors, making an IPO the most successful way for a VC firm to exit its investment. Studies have examined a VC’s dollar market share of completed venture-backed IPOs in the past. Research has shown that a cumulative IPO market share reputation measure, determined by cumulating the dollar market value of all companies taken public by the VC firm until a given calendar year and normalizing it by the aggregate market value of all VC-backed companies that went public until the same calendar year, is positively related to the probability of a VC-backed firm going public in the future. Alternatively, a VC IPO market share measure that is based on the past three-year moving window is more current and avoids the bias against younger VC firms that is inherent in a cumulative IPO market share measure. This reputation measure consistently exhibits a significant positive relation with several issuer long-run performance measures.
More reputable VCs have a higher probability of retaining their shares and board seats for up to three years after an IPO. Moreover, continued VC shareholdings and directorships have significant positive associations with issuer long-run performance measures. This reputation measure has been compared against some others that are natural alternatives, including VC age and the amount of capital under management, and the studies have found that the VC IPO market share reputation measure does well compared with these alternative reputation measures.
Panel A of Table 1 shows the top 10 VC firms, according to the VC IPO market share reputation measure, for the past four years of the sample, while Panel B shows the top 10 VC firms following the same reputation measure in the most recent four years. Panels A and B show that certain firms, such as Kleiner Perkins, have maintained their reputation for making returns for their limited partners via the most favored exits—IPOs. Since its founding in 1972, Kleiner Perkins has been involved in a number of large IPOs, including America Online, Amazon, Compaq, Google, Netscape, and Sun Microsystems. Panel B shows that there are several new names in the top-10 list and market shares have somewhat consolidated more recently. For example, since its inception in 2009, Andreessen Horowitz, which appears at the second position in the more recent top-10 list, has invested in Skype, Facebook, Groupon, Twitter, Zynga, Airbnb, Jawbone, Belly, and Foursquare.
Table 1 Top 10 VC Firms Based on IPO Market Share
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