The value of Venture Capital and Private Equity investors to shareholders in listed firms
Wei-Huei Hsua , Sian Owenb and Jo-Ann Suchardc
We examine how shareholders in listed firms with prior Venture Capital (VC) and Private Equity (PE) investment, value the ongoing involvement of these investors in the firm after listing. Unlike the U.S market, Australian VC/PE funds sell their holdings in listed firms in the market rather than distributing shares directly to their investors and have much longer lockup periods. Most Australian VC/PE funds retain a stake in their portfolio firm after listing and many VC/PE managers hold a seat on the board of directors. We examine the market reaction to the announcement of changes in the shareholdings of VC/PE funds and the resignation of VC/PE managers from the board. We find that buy transactions have a positive market reaction and sell and exit transactions, a negative market response. In addition, the market reacts negatively to the resignation of directors that represent the VC/PE investor, from the board. The results suggest that VC/PE funds are believed to have a positive influence and create value in their portfolio companies, from which the funds themselves and other shareholders benefit. The market reaction varies according to the shareholding of the VC/PE fund, fund reputation and director tenure.
Keywords : Venture capital, private equity
JEL: G32, G24.
a School of Economics and Finance, Massey University, E-mail address :
b School of Banking and Finance, Australian School of Business, UNSW, Sydney NSW 2052 Australia, Tel.: +612 9385 4412; fax: +612 9385 6347. E-mail address:
c School of Banking and Finance, Australian School of Business, UNSW, Sydney NSW 2052 Australia, Tel.: +612 9385 5876; fax: +612 9385 6347. E-mail address: .
1. Introduction
Both theoretical and empirical research in the US and Europe is consistent with the proposition that Venture Capital and Private Equity (VC/PE) funds add value to their portfolio companies (Gompers and Lerner, 1999, 2001; Lerner, 1999, 2002a, 2002b; Kortum and Lerner, 2000; Hege et al., 2003; Gompers et al., 2005). In contrast to other financial intermediaries, the VC/PE fund takes an active role in the development of the investee firm. In addition to providing funding, VC/PE managers serve their investee firms through coaching and guidance, networking for strategic alliances, and attracting further capital (Bygrave and Timmons, 1992; Hellmann and Puri, 2002).
VC/PE funds are frequent participants in the capital markets as a method of exiting from their investments (Lerner, 1994). Empirical observations suggest that they choose the exit channel strategically and build up reputation primarily through successful initial public offerings (IPOs) (Gompers, 1996). VC/PE funds tend to hold significant ownership and board positions (Barry et al., 1990), and continue to be involved in the firm after going public (Megginson and Weiss, 1991) and thus may provide access to capital even in the post initial public offering (IPO) period. Finally, VC/PE funds tend to put effective management structures in place, which assist in superior long run performance (Brav and Gompers, 1997).
One way to assess the value of VC/PE investor involvement in the firm after listing (post IPO) is to examine how the market reacts when the VC/PE investor changes their shareholdings in the firm or resigns from the board of directors. VC/PE funds closely monitor their portfolio companies’ performance, are actively involved in the management of these firms before listing[1] and can remain involved in the firm post IPO. Thus, they potentially have an informational advantage compared to other investors such as institutional investors, who are not actively involved in the management of the firm. We argue that as VC/PE managers are actively involved in the firm, the market should react negatively to each exit event following the IPO, as the positive influence and value creating mechanisms of the VC/PE fund leave the portfolio company with each share sale and director resignation.
However, the ability to assess the impact of continuing VC/PE ownership in the firm after listing is restricted by the limited disclosure requirements for these types of investors. In the U.S, only insiders (directors, officers) and owners of at least 10 percent of a class of equity securities have to disclose transactions no later than the second business day (or no later than the tenth day of the month after the transaction, pre 2002). Further, rather than selling their shares in the market, many VC firms in the U.S distribute these shares to their investors (limited partners). Such distributions, and the subsequent open-market sale of the distributed shares, need not be reported to the SEC. (Gompers and Lerner, 1998) and thus it is not possible to examine directly the trading behaviour of VC firms (Bradley et al., 2012).
Thus, while there is a substantial literature on the IPO exit decisions of VC/PE funds (see Da Rin et al., 2011 for a survey), there is limited evidence on the post IPO transactions of VC/PE funds. The empirical evidence has focused on abnormal returns around the expiration date of lockup periods for VC/PE funds rather than on the market response to actual share transactions (Bradley et al., 2001; Field and Hanka, 2001; Brav and Gompers, 2003; Bradley et al., 2012).[2]
However, the Australian market has a number of features that allow an examination of the impact of VC/PE funds on the firm post IPO. Firstly, unlike the U.S, Australian VC/PE funds can completely divest their holdings at IPO (although only approximately a third do so). Secondly, Australian VC/PE funds sell their share holdings in their listed portfolio firms and distribute the proceeds to their investors (limited partners). In comparison in the U.S, many VC firms distribute shares in the listed portfolio firms to their investors (limited partners). Such distributions, and the subsequent open-market sale of the distributed shares, need not be reported to the SEC. Further, Australian VC/PE funds are subject to a much longer lockup period than US markets. US markets typically have lockup periods of 180 days for VC funds (Bradley et al., 2001; Field and Hanka, 2001; Bradley et al., 2012) compared to one year for Australia (the lockup period was two years before 2002). Thus, Australian VC/PE funds remain invested for much longer periods post IPO than U.S VC funds and are often substantial shareholders in the listed firm. In addition, there is a requirement for substantial shareholders (who hold more than 5% of the outstanding shares) in listed firms to disclose any changes in their shareholdings to the stock exchange within two days of the transaction. This requirement provides a unique opportunity to analyse the direct impact of a change in an investor’s holding (such as a VC fund) around the time that the transaction occurs.
We use a sample of Australian listed firms that VC/PE funds have taken public and not fully divested their holdings at the IPO. We examine the market reaction to the change in shareholdings of VC/PE funds in their portfolio firms after they have listed on the stock exchange. That is, we analyze the market reaction to buy and sell transactions of VC/PE funds in the firms that they have previously taken public. Owen and Suchard (2012) find that most Australian VC/PE funds retain a stake in the firm (only 28.75% of VC/PE funds divest their holdings at the time of the IPO), and the average ownership after listing is 12.68% of the firm. This allows us to analyze the value that shareholders place on VC/PE funds in the firm. In addition, many VC/PE managers hold a seat on the board of directors of their investee firm after the IPO. The decision of the VC/PE manager to resign from the board allows us to evaluate the value that shareholders place on the ongoing role and influence of VC/PE managers on the board of directors. The analysis also provides an alternative means of examining the value of Australian VC/PE funds to their investee firms. Research on the impact and value-add of Australian VC/PE funds to their portfolio firms has been hampered by the lack of publically available data for private firms.
The Australian VC/PE market has received little attention in the academic literature. It has a legal and institutional structure similar to most common law countries where VC/PE markets have been the subject of much study (including Canada, the UK and the U.S), but is a relatively younger market. Investment in Australia VC/PE funds has increased 348% in the last decade (Australian Bureau of Statistics), yet accounts for only 0.58% of GDP compared to 1.8% of GDP in more mature markets such as the U.S (Probitas Partners, 2009). Australia only accounts for 1% of the global VC/PE market but is a significant part of the fastest growing region, representing around 14% of regional funds (Probitas Partners, 2009).
A significant difference between the Australian and U.S venture market is in the overall level of pension commitments. Australia’s pension fund investment has been more conservative in nature and the proportion of investments in VC/PE has been below that of pension funds in the U.S. The Australian pension industry in total invests approximately 2-3% of their assets in VC/PE, compared with U.S evidence that suggests that 5–10% is the norm (Gompers and Lerner, 1998). The comparative dearth of pension fund investment in VC/PE in Australia is comparable to other developing VC/PE markets around the world (Jeng and Wells, 2000).
We find that where VC/PE funds buy additional shares in their portfolio firms that have previously listed, there is a positive market reaction. In contrast, sell and exit transactions, are met with a negative market response. In addition, the market reacts negatively to the resignation from the board, of directors that represent the VC/PE investor. These results suggest that VC/PE funds are believed to create value in their portfolio companies, from which the funds themselves and other shareholders benefit. As soon as the VC/PE investor leaves the portfolio companies, this value creation process ends. Hence, investors discount the lack of future value creation by the funds from the portfolio companies’ share values as soon as they discover that fund managers are divesting from the portfolio company.
2. Methodology
We identify 94 VC/PE backed IPOs that listed between 1996 and 2009, from Venture Expert, Capital IQ and from shareholder information in prospectuses obtained from the Connect4 database and FinAnalysis.[3] We identify 70 IPOs where the VC/PE investor/s did not sell out at IPO. We use the IPO prospectus and post IPO disclosures to the Australian Stock Exchange (ASX) to identify 41 firms where the VC/PE investor retains a substantial shareholding in the firm post listing[4]. Substantial shareholders[5] are required to inform the ASX of changes to their shareholding within two business days. We use these Form 604 notifications to identify the buy and sell transactions of VC/PE funds post listing. VC/PE investor transactions are included in the sample only if the VC/PE fund originally invested in the firm before IPO. In addition, we use announcements to the ASX of the appointment or resignation of directors and their shareholdings at the time of appointment or resignation. The details of the transaction are hand collected from the announcements to the ASX accessed using the Finanlaysis database.
A change in shareholding notification or director appointment/resignation is included in the sample if there are no other significant announcements in the two day period around the notification. This allows us to identify the market reaction to the change of shareholding or director without being impacted by other firm specific information. The sample includes 90 buy and sell transactions by VC/PE funds in 41 firms and the resignations of 26 directors in 21 firms between 1998 and 2011.
The market model is used to estimate abnormal security returns associated with the announcement. The intercept and slope coefficients in the market model are estimated over a 150-day period, from day t-210 to t-61, relative to the announcement day (t=0). The announcement day is defined as the date of the change in shareholding notification to the ASX. If the notification is made after market close, the announcement day becomes the next trading day. An announcement is excluded from the sample if the firm is not traded in the 3 day window around the announcement. The final sample for the event study includes 78 transactions. As the Australian market suffers from thin or non synchronous trading, we use the Scholes-Williams beta estimation for the market model as well as ordinary least squares beta estimation. The market index is the value weighted index All Ordinaries index and we use a Rank test as well as a Generalised sign test due to a small sample size. Share price and the market index returns are accessed from Datastream.
As the sample size is small, we use a regularized regression model. We include a number of variables to analyze the market reaction to share transactions of VC/PE funds. These include VC/PE and deal transactions sourced from Venture Expert and Capital IQ, and firm and transaction characteristics from Finanalalysis. These variables are only available for 57 transactions. We control for the type of investor where PE is a dummy variable equal to one if the investor is classified as a PE manager or fund. We proxy for fund reputation using the size of the fund in USD, as larger funds are considered to be more experienced and reputable (Gompers, 1995; Gompers and Lerner, 2000; Krishnan et al., 2011 and Atanasov et al., 2012). We include a dummy variable for whether the VC/PE investment was syndicated (that is, there was more than one VC/PE fund investing in the firm), whether the VC/PE investor has a seat on the board of directors at listing and the number of rounds of financing that the firm received. In terms of firm characteristics, we control for the leverage of the firm (measured by the ratio of total liabilities to total assets at the year-end prior to the transaction) and the size of the firm (measured by the number of shares outstanding multiplied by the closing share price on the day before the transaction).