The Role of Venture Capitalists in Bankruptcy

Abstract

The role of venture capitalists to distress and bankruptcy in their publicly traded portfolio firms between 1990-2004 is the focus of this paper. A LOGIT analysis on the full sample of 180 VC-backed firms that declared bankruptcy and 180 VC-backed and non-bankrupt healthy matching firms examines the probability of success/failure of public VC-backed companies. An OLS analysis on the VC-backed firms that declared bankruptcy examines the duration of life of these firms before they declare bankruptcy. Most striking is that financial leverage is not, unlike in other studies, a significant factor in predicting bankruptcy for VC-backed companies, or in the duration of life of VC-backed companies that eventually declared bankruptcy. These firms are mostly financed through equity, insulating debt as a factor in bankruptcy. While the extent to which the VC monitors its companies is not a significant factor in prolonging the life of VC-backed companies that eventually declare bankruptcy, these firms have a higher probability of success than firms that are less often monitored. Monitoring pays off in reducing the probability of bankruptcy and hence its frequency. The reputation of the VC measured by its recent successes in publicly placing its companies facilitates a quicker declaration of bankruptcy when a company is distressed, but the experience of the VC prolongs the life of its companies that ultimately go bankrupt. The results are robust even after imposing more strict definition of success for the matched sample and controlling for the ability of VCs to influence managerial decisions in their portfolio firms.

Keywords: Venture Capital, Bankruptcy, IPOs

JEL Classification: G24, G32, G33, G34