Exit Returns and Venture Capital Investment Opportunities

Abstract:     
This study is the first to empirically construct exit returns - the return accruing to venture capitalists (VCs) from investments in portfolio companies - for a large sample of U.S. venture-backed companies. Exit returns are used (1) to document the size and trends in returns for specific investments that exit via an M&A or IPO during 1985-2008, and (2) to develop an "Exit-to-Failure Ratio" (EXF) to assess the strength of VCs’ investment opportunities in an industry. EXF measures the coverage exits provide to make up for failures that pose high reputational and financial risk to VCs. Outside of the Dotcom period, new investments initiated under higher EXF levels result in significantly higher future returns. Higher values of EXF also increase VCs’ risk appetite and their willingness to fund early stage companies. Our results show sharply diminished returns to VC investments over the sample period, which has resulted in a significant downward trend in VCs’ inclination to fund early stage companies. The finding raises concerns about the industry’s role in funding young, innovative companies if the trend persists.

Number of Pages in PDF File: 42

Keywords: private equity, venture capital, investment performance, exits, IPOs

JEL Classification: G24

working papers series