Financing With Venture Capital: Advances in Knowledge Over the Last Ten Years and Research Avenues

3.5 The impact and rate of survival of businesses financed by VC after divestiture

The intervention of the venture capital investor occurs at three levels. First, at the time of injection of funds for the purpose for which they were requested (increase production capacity, develop new markets, market an innovation, etc.), then by the implementation of more formal management procedures (referred to above as 'professionalization'), which usually enhances the SME and, finally, at the time of divestiture. This last impact is sometimes dramatic for a certain number of businesses as the choice of exit strategy can change the organization and its financial health in a major way.

Figure 8: Summary of Topic 5 Studies

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3.5.1 Exit strategies

A divestiture through an initial public offering significantly changes the management structure, objectives and financial situation of the SME. This is because of the new regulations to which the company must conform, the disclosure policies, etc. A buyback of the shares held by the venture capital company also has significant impact as much on the financial health of the SME as on that of the entrepreneur (especially if the latter must borrow to make this purchase). The literature tells us of these various strategies and the costs that they can generate for the business, but we know less about the economic impact and the rate of survival of the businesses that are financed once the investor has withdrawn. The subjects that are dealt with are:

• the initial public offering (IPO): synchronization with the evolution of stock markets, influence of the stage of development of the business at the time of the initial financing, influence of the industrial sector, international comparisons where structural differences between countries explain different financial behaviour, etc.;
• the entrepreneurs: cultural differences between countries which explain the various attitudes of the entrepreneurs, the financing contract and anticipated exit, etc.;
• the organization: use of convertible securities, size of the markets and type of exit, cultural differences between countries, rights to cash flow and to the control and type of exit, etc.

A number of authors have studied the IPO, which is the most cost-effective exit means for VCC, but the studies do not seem conclusive. The size of the capital market and its liquidity, as well as regulations, influence the probability of using the IPO and partial exits. It would be interesting to look at exit strategies according to type of business. Are IPO appropriate exits for certain types of investment (technological sectors, very rapid potential growth,…)? The more the VCC has invested, the more the IPO will be the optimum form of exit given the advanced stage of development of the SME and its size. What about smaller businesses? What are the best types of exits when the stock market is not receptive? And what are the post-investment consequences on the financed businesses after the exit, depending on the different strategies?

3.5.2 The Initial Public Offering

What are the effects of an IPO on the financed businesses? What is the rate of success of this strategy but, especially, what are the variables that influence its failure? How does the SME survive such a situation and how much time does it need to regain a certain balance? The literature reports many success stories but we know little of the failures. Analysing these failures would allow us to help identify possible improvements in this market. The subjects dealt with are:

• the synchronization of going public: experience of VCC, etc.;
• the type of business: industrial sector, etc.;
• comparisons: performance, independence from the VCC and from underwriters, total or partial exit, influence of the type of financial market, management of the business, etc.

Several authors have demonstrated the positive effect that VCC could have on businesses that proceed with an IPO. The reputation effect is mentioned by some authors but, beyond that, does the VCC contribute significantly to "preparing" the private business to going public? How many businesses financed by VC go on to an IPO? What of the rate of failure, which is studied very little, and what are the medium- and long-term consequences on the businesses that are financed? What proportion of small businesses remain listed on the stock exchange after the VCC has withdrawn? The post-IPO period has not been studied much, while the stock market collapse of the last few years should worry VCC as well as SME, which need substantial funds that they could not get anywhere but in the public market. Could financing consortia between VCC, government or financial institutions be substitutes for the stock market to meet the substantial needs of certain businesses? There is also talk about the influence of structural factors, such as the size and liquidity of the capital market, in terms of improving the public financing of small companies. The case of the United States is more of an exception than a rule because of the size of available capital and of the volume of transactions. Is it reasonable to assume that the IPO would be a solution for the financing of Canadian SME?

3.5.3 The performance of financed companies

The influence of venture capital on the companies that are financed can take various forms depending on the quality of the intervention and the potential of the business. A small number of works have dealt with the following points:

• growth: volume of activity and influence of VCC, etc.;
• performance: financial performance, evolution of stock market prices, monitoring, relations between underwriters and VCC, reputation of VCC, etc.;
• entrepreneurs: skills and expertise, etc.

Much remains to be done to better understand the effects of an intervention by VCC on the businesses that are financed. Comparative studies are necessary. Longitudinal studies and event studies should afford a better understanding of the effectiveness of VC in helping businesses move ahead. Beyond the simple aspects of performance, we must see how VCC have managed the risk associated with their investments. Did it diminish after their entry into the business? If yes, under what conditions? And at what cost? – major sacrifices on the part of the business including the withdrawal of the senior executive? On the other hand, none of these studies alludes to the behaviour of the entrepreneurs or to their satisfaction as to the financing that they obtained, the conditions under which they worked with this particular partner, the concessions they had to make, etc. Is VC complementary to other sources of financing that we find on the market, as it should be, or does it take the place of other moneylenders with fewer resources? Is good performance not simply attributable to the fact that VCC have very restrictive criteria for selection and that businesses that are financed would have had a good performance with or without the VCC?