How Does Policy Uncertainty Affect Venture Capital?

Abstract

How does policy uncertainty affect venture capital (VC) investment and exit outcomes? Using a newly developed policy uncertainty index, we find that increased policy uncertainty is associated with lower VC propensity to investment. VCs, however, adjust their investment strategy quickly in response to policy uncertainty changes. The relation is more pronounced when startups are riskier, i.e., when they are less mature, have fewer tangible assets, are more dependent on government spending, and are exposed to more severe entrepreneur holdup. We further show that policy uncertainty adversely affects VCs’ investment outcomes. VCs rely on stage financing, syndication with other VCs, and reduced investment amount to mitigate the negative effect of policy uncertainty. Our paper sheds new light on how policy uncertainty affects a previously ignored but important market – the venture capital market.

Keywords: Venture Capital, Policy Uncertainty, Investment, Exit Outcomes