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Liquidity Risk and Venture Capital Finance

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  • Douglas Cumming
  • Grant Fleming
  • Armin Schwienbacher

Abstract

This article provides theory and evidence in support of the proposition that venture capitalists adjust their investment decisions according to liquidity conditions on IPO exit markets. We refer to technological risk as a choice variable in terms of the characteristics of the entrepreneurial firm in which the venture capitalist invests, and liquidity risk as the current and expected future external exit market conditions. We show that in times of expected illiquidity of exit markets (high liquidity risk), venture capitalists invest proportionately more in new high-tech and early-stage projects (high technology risk) in order to postpone exit requirements. When exit markets are liquid, venture capitalists rush to exit by investing more in later-stage projects. We further provide complementary evidence that shows that conditions of low liquidity risk give rise to less syndication. Our theory and supporting empirical results facilitate a unifying theme that links related research on illiquidity in private equity.

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Bibliographic Info

Article provided by Financial Management Association in its journal Financial Management.

Volume (Year): 34 (2005)
Issue (Month): 4 (Winter)
Pages:

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Handle: RePEc:fma:fmanag:cummingflemingschwienbacher05

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Cited by:
  1. Da Rin, M. & Hellmann, T. & Puri, M.L., 2011. "A Survey of Venture Capital Research," Discussion Paper 2011-111, Tilburg University, Center for Economic Research.
  2. Boulton, Thomas J., 2010. "Venture capital and the incorporation decisions of IPO firms," Journal of Economics and Business, Elsevier, vol. 62(6), pages 477-501, November.
  3. Pascal François & Georges Hübner, 2010. "A Portfolio Approach to Venture Capital Financing," Cahiers de recherche 1046, CIRPEE.
  4. Douglas Cumming, 2010. "Misinforming the public about public policy towards venture capital," Venture Capital, Taylor & Francis Journals, vol. 13(1), pages 99-102, October.
  5. Douglas Cumming, 2010. "Public policy and the creation of active venture capital markets," Venture Capital, Taylor & Francis Journals, vol. 13(1), pages 75-94, April.
  6. Poonam Puri, 2009. "A Matter of Voice: The Case for Abolishing the 30 percent Rule for Pension Fund Investments," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 283, February.
  7. Li, Yong & Mahoney, Joseph T., 2011. "When are venture capital projects initiated?," Journal of Business Venturing, Elsevier, vol. 26(2), pages 239-254, March.
  8. Achleitner, Ann-Kristin & Engel, Nico & Reiner, Uwe, 2013. "The performance of venture capital investments: Do investors overreact?," Review of Financial Economics, Elsevier, vol. 22(1), pages 20-35.
  9. Block, Joern & Sandner, Philipp & De Vries, Geertjan, 2010. "Venture capital and the financial crisis: an empirical study across industries and countries," MPRA Paper 20287, University Library of Munich, Germany.
  10. Ramana Nanda & Matthew Rhodes-Kropf, 2011. "Investment Cycles and Startup Innovation," Harvard Business School Working Papers 12-032, Harvard Business School, revised Dec 2012.

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