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The different roles played by venture capital and private equity investors on the investment activity of their portfolio firms

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Abstract

Venture capital (VC) and private equity (PE) investors play different roles in their portfolio companies. We argue that this will translate in a recognizable difference in the investment sensitivity to cash flows of portfolio companies and its evolution after the first investment round. We hypothesise that VC, thanks to its ability in overcoming asymmetries in information, will entail a reduction in the financial constraints which hampered the growth of investee firms. We predict, instead, a greater dependency of investments to cash flow for PE-backed companies, driven by the renewed interest for growth of their management combined with higher leverage. We find evidence confirming our hypotheses on a large panel of Spanish unlisted firms in low and medium technology sectors, where both VC and PE firms are active.

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Notes

  1. The distinction between PE and VC is, however, ambiguous. PE should, generally speaking, be a broader conceptual category than VC, including all professional investors focusing on unlisted firms (i.e. comprising VC as a special case). This is, for instance, the definition given by the EVCA in its glossary: ‘Private Equity provides equity capital to enterprises not quoted on a stock market. Private equity can be used to develop new products and technologies (also called venture capital), to expand working capital, to make acquisitions, or to strengthen a company’s balance sheet’. However, often, a narrower definition of PE is used, which includes only non-VC (i.e. only late stage) deals. Incidentally this ambiguity is also present in the full name of the EVCA, which is ‘European Private Equity and Venture Capital Association’, suggesting that the latter does not include the former as a special case.

  2. Wright et al. (2009) also identify secondary buyouts (SBOs) as acquisitions in which both the vendor and the acquirer are PE firms. Even though firm’s investment-cash flow sensitivity may undergo significant changes across an SBO, this latter category of deals is clearly distinct from all other buyouts, because companies going through an SBO are PE-backed both before and after the investment event. Accordingly, these deals are excluded from our analysis.

  3. Except secondary buyouts.

  4. Only firms in receivership could be an exception to that, since external providers of financing would be reluctant to provide funding to distressed firms.

  5. In this regard, even if major innovation opportunities exist, managers with more traditional managerial cognition orientations might be unable to take advantage of them (Wright et al. 2000).

  6. Even though leverage is frequently reduced by selling non-core assets (Easterwood 1998).

  7. Which represent the least frequent type of buyout in the US and the UK, and even more in continental Europe (see Cumming et al. 2007; Meuleman et al. 2009).

  8. For a more detailed description of the Spanish VC/PE market, see Martí (2002).

  9. This technique is usual in this field of analysis. See Cleary (1999) and Bertoni et al. (2010a), among others. We replicate all the regressions using 1 and 5% winsorising thresholds and obtain fairly similar results.

  10. In a few firms data about 2008 are also included.

  11. It is interesting to point out that this is consistent with the work by Da Rin et al. (2006), who show that the innovation ratio (defined as the ratio of early stage investments to total VC/PE investments) is a crucial element in the ability of the VC and PE industry to boost R&D and innovation.

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Acknowledgments

This paper is part of the output of the EU VII Framework Programme ‘Financing Entrepreneurial Ventures in Europe: Impact on innovation, employment growth, and competitiveness—VICO’ (Contract 217485). We thank Álvaro Tresierra Tanaka (Universidad de Piura) for his help in processing data. We wish to express our gratitude for the comments from the discussant and other participants in the Workshop ‘Reassessing the Relationships between Private Equity Investors and Their Portfolio Companies’, Vlerick Leuven Gent Management School, Gent (Belgium), September 30–October 1, 2010. We also thank the valuable comments and suggestions from two anonymous referees.

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  1. DIG Dipartimento di Ingeneria Gestionale, Politecnico di Milano, Piazza Leonardo da Vinci, 32, 20133, Milan, Italy

    Fabio Bertoni

  2. Facultad de CC. Económicas y Sociales, Núcleo Humanístico, Ciudad Universitaria, Universidad del Zulia, Maracaibo, 4005, Estado Zulia, Venezuela

    María Alejandra Ferrer

  3. Departamento de Ec. Financiera y Contabilidad III, Facultad de CC. EE. y EE, Universidad Complutense de Madrid, Pozuelo de Alarcón, 28223, Madrid, Spain

    José Martí

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  1. Fabio Bertoni
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  2. María Alejandra Ferrer
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  3. José Martí
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Correspondence to José Martí.

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Bertoni, F., Ferrer, M.A. & Martí, J. The different roles played by venture capital and private equity investors on the investment activity of their portfolio firms. Small Bus Econ 40, 607–633 (2013). https://doi.org/10.1007/s11187-011-9384-x

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  • DOI: https://doi.org/10.1007/s11187-011-9384-x

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