Exit Timing of Venture Capitalists in the Course of an Initial Public Offering

Abstract

The exit process in venture capital (VC) financing is important to understand since many venture capital firms provide funding to initial public offerings (IPOs) for only a limited amount of time.The decision to disinvest is based on a variety of factors, which are explored here.An explanation is provided for the underpricing of young firms, citing this strategy as a means of creating credible commitment to building up a reputation for accurate pricing. The basic model of this study is discussed, and several propositions are presented related to reputation, pricing and timing of divestitures.The underpricing of a firm aids in building a firm's reputation, based on the presented model.The findings of this study provide explanations for several of the propositions:the characteristics of "hot issue" markets are explained; a combination of high market share, high credibility, and low price uncertainty aids in building a firm's reputation; careful venture selection and late-stage investment through intense management support represent clear substitutes; high-risk ventures tend to establish a reputation for selling high-quality ventures at their true value rather than falsely reporting their value; and unlike experienced VCs, inexperienced VCs have an incentive to underprice. (AKP)

Keywords: Equilibrium strategies, Investment portfolios, Divestitures, Exit strategies, Firm image, Late stage financing, Underpricing, Venture capital, Initial public offerings (IPO), Startups