Ebook Strategic Investing and Financial Contracting in Start-ups: Evidence from Corporate Venture Capital
Corporations have pumped in billions of dollars in funding young entrepreneurial companies (start-ups) in the past decade alone. At the height of their investment activity in the late nineties, corporate venture capital (CVC) accounted for nearly 15% of the total venture investment in the US economy. Corporations can be thought of as natural candidates to engage in venture investing activity given that they are often active players in technology and/or product space that start-ups are positioned in. Since many start-up companies innovate in existing markets, established firms in these markets may be particularly keen to obtain participating stakes in these start-ups. These start-ups can appear to be attractive investment opportunities for such corporations, both for financial and strategic reasons.
However, CVCs’ strategic objectives, which can often be at the expense of start-ups’ well-being, are likely to be in conflict with the interests of both the entrepreneurs and traditional venture capitalists (TVC) investing in these start-ups. This study empirically analyzes the effects of CVC strategic objectives on the venture capital process, particularly the nature of strategic relationship between the start-ups and their CVCs and its impact on CVC participation and contracting in venture syndicates.
Hellmann (2002) provides a theoretical foundation for analyzing the competitive advantages and disadvantages of strategic venture investors. A central insight of this analysis is that a strategic investor’s quest for synergies can turn into a competitive disadvantage for start-ups because the wealth gains for the strategic investor are not always aligned with the economic benefits to the start-up and as a consequence can be economically damaging to the start-up.
Hellmann also discusses conditions under which entrepreneurs prefer CVC investors whose parent corporations operate in related segments (thus having strategic objectives), and contrasts them with circumstances when they prefer independent venture capitalists. In addition to their strategic objectives, CVCs have less experience investing in start-up companies than TVCs; furthermore, CVC managers have weaker performance incentives compared to TVCs.
Given these issues, a number of important empirical questions arise. Does the type of venture capitalist matter to a start-up? In particular, under what circumstances will a start-up accept funding from strategic CVC investors? Is there evidence that the allocation of shareholdings and control rights among VC syndicate members reflects concerns of unwanted interference by strategic CVC investors in the operating decisions of start-ups? Given the strategic objectives of CVCs’ parent corporations (‘CVC parents’ hereafter), it is important to allocate the start-ups’ control and shareholding rights in ways that motivate all start-up constituents including the CVCs, TVCs and entrepreneurs to provide strong financial, technical and managerial support to the venture.
Finally, how different are the prices paid by strategic investors when buying start-up shares and does the pricing depend on the nature of CVC start-up relationship? In this study, we empirically relate the nature of CVCs’ strategic objectives to CVC participation in venture syndicates, the allocation of start-up shareholdings and control rights among entrepreneurs and various classes of venture investors, and differences in pricing of CVC investments.
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