It may seem like an innocuous question. On the one hand, why would venture capital companies add value to an IPO? Perhaps the presence of venture capital companies could drag down the value of a company’s IPO because the market could view such presence as venture capitalists attempting to exit from a “peaking” investment. On the other hand, the presence of venture capitalists could signal to would be investors that the soon-to-be public company is a company with a bright future – after all, the venture capitalists are putting their reputation (and money) on the line.
In a recent draft publication from professors out of Boston College and Northeastern University, the authors find that the presence of venture capital firms at an IPO offering may actually add value to the IPO.
A Review of What the Authors Did
The authors gathered a dataset of pre-IPO media covereage as a proxy for investor attention. They then statistically tested whether IPOs of venture capital-backed companies garnered greater or less attention. They also tested the effect of venture capitalists on the absolute value of price revisions.
The Theory Before Going Into Their Findings
The authors argued that venture capital-backed firms (and thus venture capitalists themselves) may add value to the private firms in which they invest through two main mechanisms related to information dissemination.
The first is that venture capitalists may provide a valuable backdrop to IPO underwriters by garnering “investor attention.” Essentially, venture capitalists assist the IPO underwriters by helping with the book-building and road-show process, in that the presence of venture capitalists is desirable from the perspective of potential institutional investors when institutional investors are evaluating noisy information and other aspects of the pending IPO.
Second, venture capitalists help with information extraction in that venture capitalists provide the lead underwriter valuable information in pricing the pending IPO (for the moment, one can disregard the perverse incentive venture capitalists have in pricing the IPO).
What They Found
Interestingly, the authors found that the presence of venture capitalists before and during the IPO process does, in fact, add value to the soon-to-be public company. The value-add comes in the form of increased investor interest in the pending IPO, as well as the pricing trend of the soon-to-be public company both before and after the IPO. A summary of their results follows. In blue are venture capital-backed companies. In red are non-venture capital-backed companies. The top chart is the valuation of the private company based on a price to sales multiple. This clearly shows the “theoretical” positive effects a venture capital company has (the blue line is greater than the red line). Interestingly, and not surprisingly, the effect diminishes as time goes by.
Source: Chemmanur, Krishnan, and Yu (2016), Venture Capital Backing, Investor Attention, and Initial Public Offerings
Conclusion
In a recently draft publication by professors Chemmanur , Krishnan, and Yu, the authors find that the presence of venture capital firms when a company goes public may add value to the IPO. The authors speculate that the somewhat surprising result might stem from increased investor curiosity.
In any event, the next time you evaluate the potential near-term price trend of a soon-to-be public company, you might want to consider whether venture capital firms were involved. This could be affecting the offering price and the near term pricing trend of the soon-to-be public company.
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