Academic journal article South Asian Journal of Management

Factors Affecting Capital Structure of Indian Venture Capital Backed Growth Firms[dagger]

Academic journal article South Asian Journal of Management

Factors Affecting Capital Structure of Indian Venture Capital Backed Growth Firms[dagger]

Article excerpt

Entrepreneurship is an engine for bringing about positive changes in the form of socioeconomic welfare (Kortum and Lerner, 2000). One of the major constraints faced by entrepreneurs is access to finance. Recently, venture capital has emerged as one of the alternative sources of financing for new ventures. Studies indicate a trend towards venture capitalists' preference towards late stage deals (e.g. Gompers and Lerner, 2001). Therefore, it becomes essential to understand the various factors that venture capitalists consider before investing in growth firms. This paper seeks to identify the various financial indicators that venture capitalists consider before funding growth firms by analyzing their capital structure. This paper draws from the capital structure literature to carve out the variables, i.e., tangible assets, profitability, size, volatility, growth opportunities, etc., that affect the capital structure of firms which receive venture financing later. Propositions are drawn on the basis of this reasoning and a conceptual framework is put forth that tries to identify an optimal capital structure strategy for Indian growth firms that seek venture capital.

INTRODUCTION

Entrepreneurship is considered as an engine for bringing about positive changes in the form of socioeconomic welfare (Kortum and Lerner, 2000) . However, it is a well established fact that, one of the major constraints faced by entrepreneurs is access to finance. Self-financing is usually not sufficient and collateral based debt funding is not always available. Information asymmetries prevailing between investors and entrepreneurs, uncertainty related to the future of the product and bleak exit prospects of the investor severely curtail a new venture's prospects of receiving finance (Chan, 1983; and Amit et al., 1990). In recent years, equity financing in terms of venture capital has emerged as one of the alternative sources of financing for new ventures. The most accepted form of definition for venture capital includes investment in young firms which are very risky but promise a great return. (Gompers et al, 1998).

Recent research in venture capital indicates a trend towards venture capitalists' (VCs) preference towards late stage deals (e.g., Gompers and Lerner, 2001). Since a large volume of venture capital is flowing into growth stage firms, it becomes essential to understand the various factors that VCs consider before investing in a particular firm which is in its growth stage. Earlier research has focused mostly on analyzing the criteria used by VCs to select a new venture based on human capital, attractiveness of markets, uniqueness of products, etc.

However, this paper seeks to identify the various financial indicators that VCs consider before funding growth firms. One way to do this is to analyze the capital structure of firms which receive venture financing later. The basic objective of this paper is to understand whether the determinants of capital structure of a firm have a major role to play in the access of venture capital later in its life cycle. Finance literature comprises of numerous studies that focus on the determinants of capital structure of firms. However, there do not exist many studies which talk about the determinants of capital structure of a firm which is financed by venture capital. This paper is based in the Indian context. It uses the static trade-off theory, pecking order theory and agency theory to explain the financial structure of firms which receive venture capital subsequently. This paper draws from the capital structure literature to carve out the variables, i.e., tangible assets, profitability, size, volatility, growth opportunities, etc., that affect the capital structure of firms which receive venture financing later. Propositions are drawn on the basis of this reasoning and a conceptual framework is put forth that tries to identify an optimal capital structure strategy for Indian growth firms that seek venture capital. …

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