Venture capital and risk management: evidence from initial public offerings

Abstract

In this study we analyze a sample of initial public offerings (IPOs) to infer the sources of firm-specific risk associated with investment by venture capitalists. The results indicate that IPO backing by venture capitalists is associated with risk factors related to operating profit margins and ongoing sales generation, but not operational financing. The results also indicate that venture-backed IPOs are associated with greater reductions in firm-specific risk over the course of a year that includes the date of the IPO. In sum, the findings suggest venture capitalists are willing to accept higher levels of uncertainty in those instances where they have an advantage in terms of managerial skill, and are able to reduce firm-specific risk subsequent to investment in order to maximize returns when they cash out. Our study also makes use of proxies that are representative of the ex-ante nature of firm-specific risk at the time of a new issue.