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Syndication of Venture Capital Investments - Lerner (1994)

Syndication of Venture Capital Investments - Lerner (1994). Why do Venture Capitalists Syndicate? 1. Syndication (in the first round) may lead to a superior selection of investments.

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Syndication of Venture Capital Investments - Lerner (1994)

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  1. Syndication of Venture Capital Investments - Lerner (1994) • Why do Venture Capitalists Syndicate? • 1. Syndication (in the first round) may lead to a superior selection of investments. • Another venture capitalist’s willingness to invest in the new firm may be an important factor in the lead venture investor’s decision to invest. • George Middlemas (a practitioner): “If two or three funds whose thinking you respect agree to go along, that is a double check to your own thinking.”

  2. Syndication of Venture Capital Investments - Lerner (1994) • Why do Venture Capitalists Syndicate? • 2. Syndication (in later rounds) resolves information asymmetries between the initial venture investors and other potential investors in later rounds. • Initial venture investor is very closely involved with the day-to-day running of the firm. Will have a more precise estimate of the value of the firm than outside investors. • Initial venture capitalist has an incentive to understate/overstate the proper price for the securities in the next financing round. • The only way to avoid this opportunistic behavior is if the lead venture capitalist maintains a constant share of the firm’s equity. => Later-round financing must be syndicated.

  3. Syndication of Venture Capital Investments - Lerner (1994) • Why do Venture Capitalists Syndicate? • 3. Syndication is a mechanism through which venture capitalists collude to overstate their past-performance to potential investors. • It is difficult to evaluate the performance of a pension fund by considering its quarterly or annual return. • Pension funds “window dress.” Pension fund managers adjust their portfolios at the end of quarter by buying firms whose shares have appreciated and selling “mistakes.” • Initial-stage venture capitalists may generate goodwill with their colleagues by permitting them to invest in later-round financings in promising companies. Quid pro quo: The syndication partners will in turn offer such opportunities to invest in the later rounds of their promising companies.

  4. Syndication of Venture Capital Investments - Lerner (1994) • Practical Implications • 1. Syndication (in the first round) may lead to a superior selection of investments. • Experienced venture capitalists will primarily syndicate first-round investments with other experienced venture investors. • 2. Syndication (in later rounds) resolves information asymmetries between the initial venture investors and other potential investors in later rounds. • Established venture capitalists will syndicate to peers and less well-experienced venture investors. • 3. Syndication is a mechanism through which venture capitalists collude to overstate their past-performance to potential investors. • When experienced venture capitalists invest for the first time in later rounds, the firm is usually doing well.

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