How do Venture Capitalists Handle Risk in High-Technology Ventures? - some preliminary results
AbstractThis paper presents new empirical evidence, obtained by fieldwork methods, on investor risk-handling practice in the UK venture capital industry. Its focus is on high-technology firms and the techniques their venture capital backers use for risk management. The active areas of risk management are explored under the headings of risk premia, investment time horizons, and sensitivity analysis. As an organising framework, risk is divided into ‘agency risk’, ‘business risk’ and ‘innovation risk’. Data were gathered by working through a semi-structured interview agenda in face-to-face meetings with the top venture capital deal-makers in the UK. They were questioned specifically on how they handled risks in high-technology ventures. The interview agenda covered: risk premia, investment time horizon, sensitivity analysis, expected values, cash flow prediction, financial objectives, decision making, and qualitative appraisal. The paper draws on evidence from all eight agenda items, but focuses on the first three. This paper finds that the three categories of risk identified as important, innovation, agency and business risk, have pervasive influences on investor conduct in the UK. Their form of influence was traced under the agenda headings of risk premia, investment time horizon, and sensitivity analysis. It was found that the riskiness of investment types (e.g. seed, MBO etc) could be clearly ranked by investors. These rankings were found to be generally consistent with principles of financial economics. Investors were also asked what factors were most important to their risk appraisals, for given high technology investments. Of a wide range of factors, it was found that the most important to risk appraisal could be directly related to our categories of ‘agency risk’ and ‘business risk’. It was found too that the time profiles of investments and their sensitivity to changed assumptions could be approached using our three risk categories. Of these, ‘innovation risk’ was thought to be particularly high, implying various forms of adaptation by investors, including setting very high hurdle rates of return and deploying radical stress tests of investment models.
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Bibliographic InfoPaper provided by Centre for Research into Industry, Enterprise, Finance and the Firm in its series CRIEFF Discussion Papers with number 0107.
Date of creation: Feb 2001
Date of revision:
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Venture Capital; Risk Management; High-Technology; Fieldwork;
Find related papers by JEL classification:
- G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- L84 - Industrial Organization - - Industry Studies: Services - - - Personal, Professional, and Business Services
- M21 - Business Administration and Business Economics; Marketing; Accounting - - Business Economics - - - Business Economics
- L21 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Business Objectives of the Firm
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-06-14 (All new papers)
- NEP-ENT-2005-06-14 (Entrepreneurship)
- NEP-FIN-2005-06-14 (Finance)
- NEP-FMK-2005-06-14 (Financial Markets)
- NEP-INO-2005-06-14 (Innovation)
- NEP-RMG-2005-06-14 (Risk Management)
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