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Legal Conditions and Venture Capital Governance. Cumming & Johan (2013, Chapter 13). 1. Introduction Evidence Conclusion. Issues Addressed in this Chapter. What drives corporate governance structures in VC finance? - PowerPoint PPT Presentation
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© Cumming & Johan (2013) Forms of VC Finance
Legal Conditions and Venture Capital Governance
Cumming & Johan (2013, Chapter 13)
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© Cumming & Johan (2013) Forms of VC Finance
Issues Addressed in this Chapter
Introduction
Evidence
Conclusion
• What drives corporate governance structures in VC finance?
• How do different legal and institutional frameworks in different countries affect international differences in corporate governance structures?
• Three dimensions:– time from fundraising to deal origination – syndication and co-investment– board seats and security choice
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© Cumming & Johan (2013) Forms of VC Finance
Prior work
Introduction
Evidence
Conclusion
• Law and Finance– La Porta et al. (1997; 1998); Berkowitz et al. (2003)
• Venture Capital meets Law and Finance– VC Contracts:
• Gilson and Schizer (2003); Kapland Stromberg (203,2005); Lerner and Schoar (2005); Cumming and Johan (2006);
– VC Exits:• Black and Gilson (1998); Schleifer /Wolfenzon (2002); Cumming et al. (2006 );
Bienz/Walz (2007)– Size of VC Markets
• Jeng and Wells (2000); Armour and Cumming (2006 )– Public policy
• Keuchnigg/Nielsen (2001, 2003, 2004)
– Datasets not large (200 or so observations) due to private nature of VC data
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© Cumming & Johan (2013) Forms of VC Finance
New Insights in this Chapter
Introduction
Evidence
Conclusion
• Complementary Elements of Legal Conditions and VC Governance Worldwide:– Screening– Syndication– Co-investment– Board Seats– Functional Definition of Security
• Data– 3838 VC - backed companies– 39 countries, developed and developing, worldwide– Extensive confidential details not previously studied
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© Cumming & Johan (2013) Forms of VC Finance
Law and Venture Capital Governance
Introduction
Evidence
Conclusion
• Law quality facilitates– Deal screening time– Syndication– Effectiveness of boards
• Law quality mitigates– Co-investment– Securities requiring periodic cash flows pre-exit
• How to measure law quality– Legality (Berkowitz et al.’s weighted average of La Porta et al.’s
indices)– Legal Origin versus Country Dummy Variables
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© Cumming & Johan (2013) Forms of VC Finance
Data
Introduction
Evidence
Conclusion
• 3838 VC - backed companies• 39 countries, developed and developing, worldwide
• Source: CEPRES, Germany• Partnership among practitioners worldwide to improve data quality for
decision making in private equity
• Extensive confidential details not previously studied
• Little expected sample bias– Good and poor performing investments– Exited and un-exited investments– Matches profile of VC investments across countries and across time
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© Cumming & Johan (2013) Forms of VC Finance
Time to Deal Origination
Introduction
Evidence
Conclusion
• Time from starting the VC fund until the first-round lead investment
• Not previously studied in any single or multiple country study
• Hazard models
• Legality index from 20 to 21 (e.g. France versus US) lowers the time until lead first investment by 12%
• Legality index from 10 to 11 (e.g. Philippines versus Indonesia) lowers the time until lead first investment by 24%
• Faster time to deal origination in common law countries by approx. 30%
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1. Deal Origination2. Syndication and Co-Investment3. Board Seats and Functional Definition of Security
© Cumming & Johan (2013) Forms of VC Finance
Time to Deal Origination
Introduction
Evidence
Conclusion
1. Deal Origination2. Syndication and Co-Investment3. Board Seats and Functional Definition of Security
# Ent Firms
Average Duration (Holding Period in
Days) until First
Investment
Difference Test
(means)
Median Duration (Holding Period in
Days) until First
InvestmentDifference Test
(medians)
Legality Index > 20.5 2052 718.762
-8.479***
469
p <= 1.21e-08***
Legality Index < 20.5 1140 1042.399 660
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© Cumming & Johan (2013) Forms of VC Finance
Time to 1st Lead Investment Model (1): All Model (3): All Model (7): Early Model (9): Early
Market and Legal Factors
Log (1+ MSCI Return at Inv Date) 2.193*** 2.407*** 2.312** 0.494***Log (Committed Capital Overall Market at Inv Date)
-0.538*** -0.648*** -0.454*** -0.047
Log (Legality Index) 2.298** 2.728***
Log (GNP Per Capita) 0.714*** 0.705***
French Legal Origin Dummy -0.252*** -0.360***
Germany Legal Origin Dummy -0.080 -0.280**
Scandinavian Legal Origin Dummy -0.702** -0.611**
VC Fund Characteristics
Log (Fund Manager Experience) -0.044 -0.053 -0.115** -0.188***
Log (Fund Vintage Date) -1.604*** -1.671*** -1.635***
log (Fund Capital / General Partner) -0.083* -0.018
Entrepreneurial Firm Characteristics
Seed Stage 0.475*** 0.669*** 0.439*** 0.837***
Start-up Stage 0.148 0.282* 0.195 0.282*
Early Stage -0.055 -0.025
Expansion Stage -0.063 0.081
Log (Industry Market / Book) 0.428*** 0.342*** 0.403*** 0.535***
Model Diagnostics
Total Number of Observations 2284 3159 1091 1298
Pseudo R2 0.053 0.060 0.051 0.020
Industry, Year, Country, VC firm dummies includedTable 13.4
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© Cumming & Johan (2013) Forms of VC Finance
Syndication and Co-Investment
Introduction
Evidence
Conclusion
1. Deal Origination2. Syndication and Co-Investment3. Board Seats and Functional Definition of Security
• Syndication– Typically ‘Good’– Decision making, value-added, 2 heads better than 1– Legality 20 to 21: increases the probability of syndication by 3.8%– Legality 10 to 11: increases the probability of syndication by 5.5%– Legal origin ambiguous effect
• Co-Investment– Typically ‘Bad’– One VC fund bails out bad investments of prior VC fund from the same VC
organization– Legality 20 to 21: reduces probability of co-investment by 1.8%– Legality 10 to 11: reduces the probability of co-investment by 3.5%– Legal origin ambiguous effect
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© Cumming & Johan (2013) Forms of VC Finance
Syndication and Co-Investment
Introduction
Evidence
Conclusion
1. Deal Origination2. Syndication and Co-Investment3. Board Seats and Functional Definition of Security
# Ent Firms
Proportion of Syndicated Investments
Difference Test
# Ent Firms
Proportion of Co-
InvestmentsDifference
Test
Legality Index > 20.5 1303 0.413
-0.848
1875 0.167
-4.650***
Legality Index < 20.5 848 0.432 930 0.270
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© Cumming & Johan (2013) Forms of VC Finance
Syndication and Co-Investment Model (13): Syndication
Model (15): Syndication
Model (19):Co-Investment
Model (21):Co-Investment
Constant -2.239*** -1.847*** -0.873* -1.012**
Market and Legal Factors
Log (1+ MSCI Return at Inv Date) 0.028 -0.007 -0.104** -0.069
Log (Committed Capital Overall Market at Inv Date) 0.118*** 0.124*** 0.085*** 0.081***
Log (Legality Index) 0.577** -0.369***
Log (GNP Per Capita) 0.115** -0.093***
French Legal Origin Dummy 0.218*** -0.005
Germany Legal Origin Dummy 0.021 0.105*
Scandinavian Legal Origin Dummy 0.069 -0.056
VC Fund Characteristics
Log (Fund Manager Experience) -0.129*** -0.125*** 0.028*** 0.028***
Log (Fund Age at First Investment since Fundraising) -0.012** -0.013** -0.016*** -0.016***
Log (Fund Vintage Date) -0.100*** -0.086*** 0.120*** 0.115***
Log (VC Firm Age)
Entrepreneurial Firm Characteristics
Seed Stage 0.174*** 0.190***
Start-up Stage
Early Stage 0.140*** 0.147*** 0.002 -0.005
Expansion Stage -0.065** -0.062* 0.017 0.008
Log (Industry Market / Book) 0.125*** 0.118*** 0.047*** 0.056***
Investment Characteristics
Log (Amount Invested) -0.006 -0.005 -0.002 -0.002
Sample Selectivity Correction
Model Diagnostics
Total Number of Observations 3176 3159 3176 3159
Pseudo R2 0.212 0.214 0.266 0.271
Industry, Year, Country, VC firm dummies includedTable 13.5
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© Cumming & Johan (2013) Forms of VC Finance
Board Seats and Functional Security
Introduction
Evidence
Conclusion
1. Deal Origination2. Syndication and Co-Investment3. Board Seats and Functional Definition of Security
• Board seats– VC board representation more important than that of other investors
(Gompers and Lerner 1999 MIT Press)– Legality 20 to 21: increases the probability of board seats by 4.2%– Legality 10 to 11: increases the probability of board seats by 8.1%
• Functional security– Security mandates periodic cash flows paid back to the investor prior to
an exit event– Not previously considered in any VC study for single and/or multiple
countries– Legality ambiguous effect– English legal origin approx 16% less likely to require periodic cash flows
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© Cumming & Johan (2013) Forms of VC Finance
Board Seats and Functional Security
Introduction
Evidence
Conclusion
1. Deal Origination2. Syndication and Co-Investment3. Board Seats and Functional Definition of Security
# Ent Firms
Proportion of
Investments with Board
SeatsDifference
Test# Ent Firms
Proportion of
Investments with
Periodic Cash Flows
Difference Test
Legality Index > 20.5 828 0.722
-0.240
2052 0.335
-5.072***
Legality Index < 20.5 378 0.728 1140 0.429
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© Cumming & Johan (2013) Forms of VC Finance
Control and Cash Flow Rights Model (25)Board Seats
Model (27)Board Seats
Model (31) Conv-ertible Security
Model (33) Conv-ertible Sectrity
Constant -1.798** -3.797*** -2.121*** -2.595***
Market and Legal Factors
Log (1+ MSCI Return at Inv Date) 0.096 0.074 0.257*** 0.079
Log (Committed Capital Overall Market at Inv Date) 0.050*** 0.049*** 0.018 0.043**
Log (Legality Index) 0.852*** -0.098
Log (GNP Per Capita) 0.446*** 0.022
French Legal Origin Dummy 0.133*** 0.160***
Germany Legal Origin Dummy -0.058* -0.023
Scandinavian Legal Origin Dummy -0.224** 0.188*
VC Fund Characteristics
Log (Fund Manager Experience) -0.119*** -0.113*** -0.046*** 0.024
Log (Fund Age at First Investment since Fundraising) -0.004 -0.005 -0.016*** -0.029***
Log (Fund Vintage Date) -0.140*** -0.127*** 0.224*** 0.184***
log (Fund Capital / General Partner) -0.043***
Entrepreneurial Firm Characteristics
Seed Stage 0.290*** 0.282*** -0.110*** -0.135***
Start-up Stage -0.263*** -0.252*** -0.236*** -0.142***
Early Stage 0.186*** 0.182*** -0.191*** -0.124***
Expansion Stage 0.091*** 0.090*** 0.009 0.024
Log (Industry Market / Book) 0.205*** 0.200*** -0.115*** -0.126***
Investment Characteristics
Lead Investor 0.296*** 0.280*** 0.125*** 0.093***
Log (Amount Invested) -0.055*** -0.053*** 0.042*** 0.055***
Sample Selectivity Correction
Model Diagnostics
Total Number of Observations 3176 3159 3176 2267
Pseudo R2 0.321 0.321 0.207 0.195
Industry, Year, Country, VC firm dummies includedTable 13.6
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© Cumming & Johan (2013) Forms of VC Finance
Robustness Checks
Introduction
Evidence
Conclusion
• Country dummy variables for English, US, France, German versus legal origin
• Alternative explanatory variables– Market conditions, e.g., MSCI, VC capital in market– VC fund characteristics– Entrepreneurial firm characteristics– Transaction characteristics
• Exclusion of certain countries – e.g., exclude developed countries
• Exclusion of different years – e.g., exclude all years prior to 1995
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© Cumming & Johan (2013) Forms of VC Finance
Related Evidence
Introduction
Evidence
Conclusion
• Chapter 22
• Better legal standards higher VC/PE returns
• Better legal and accounting standards less likely to observe inflated values of unexited investees reported to institutional investors prior to exit
• Based on data from 39 countries around the world• >5000 transactions
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© Cumming & Johan (2013) Forms of VC Finance
Concluding Remarks
Introduction
Evidence
Conclusion
• Law quality facilitates– Deal screening time– Syndication– Effectiveness of boards
• Law quality mitigates– Co-investment– Securities requiring periodic cash flows pre-exit (in conjunction with high-tech
investment)
• Legality has a more pronounced effect on emerging markets
• Effective VC investment will continue to lag behind in emerging countries whilst legal quality remains deficient
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