Last Exit Before Toll: Venture Capital and Liquidity Pressure

Abstract

We study the impact of independent limited partnership venture capital funds’ (VC) limited lifespan on the timing and outcome of their portfolio firms’ exit events. We find that portfolio firms backed by funds approaching maturity experience quicker initial public offerings and selloffs, consistent with the idea that the liquidity pressure faced by older funds influences the venture capital exit cycle. VCs under liquidity pressure are more likely to favor quick trade sales over initial public offerings and are more likely to exit during cold markets. Focusing on initial public offerings, we document that firms backed by VCs that are under liquidity pressure raise less capital at the IPO, issue more secondary shares, and have shorter lockup periods. Moreover, IPO firms experience significantly larger trading volume and lower stock returns around the expiration of their lockup periods if they are backed by older funds, suggesting a larger selling pressure by these VCs, and this lockup effect is amplified if there are multiple VC firms facing liquidity pressure. Our results indicate that VC funds’ limited lifespan — a standard contractual feature intended to alleviate agency problems between general partners and limited partners — influences the venture capital exit cycle and imposes externalities on their portfolio firms.

Keywords: Venture Capital, Initial Public Offerings, Exit Strategy, Lock-up Expiration, Agency Problems, Contracting

JEL Classification: G24, G14