Venture Cycles: Theory and Evidence

Abstract

U.S. venture capital (VC) firms have provided the startup funding needed by many technology firms. However, bank-funded VC in Europe has been less successful with innovative new firms.Project evaluation is cited as a basis for VC funding decisions, but few studies have analyzed project evaluation.Theory suggests that screening cycles emerge endogenously as a result of uncoordinated searches for the best projects. It is predicted that a stationary inflow of new ideas would result in a negative serial correlation of the number of projects actually funded.The potential policy implications of structural regulation, information sharing, and screening subsidies are discussed.The empirical evidence about venture cycles within specific industries is presented, with the data collected from PriceWaterhouse, VentureOne, and the National Venture Capital Association (NVCA) from January 1995 to February 2002.A model of the screening activity of venture capitalists is presented, building on the framework of Gehrig and Stenbacka (2003). Venture financiers are categorized because they fund without screening, only fund with screening, or remain completely inactive.The relationship between the data and the theory are discussed, as are policy implications regarding market regulation, information sharing, and subsidies/tax incentives.The theory concurs with observed U.S. VC behavior. Areas for future research are presented. (AKP)

Keywords: VentureOne database, National Venture Capital Association, Market regulation, Tax incentives, Price Waterhouse, Startups, Public policies, Debt financing, Subsidies, Initial public offerings (IPO), Banks, Venture capital