Do Venture Capitalists Add Value to Small Manufacturing Firms? an Empirical Analysis of Venture and Nonventure Capital-Backed Initial Public Offerings
Brau, James C., Brown, Richard A., Osteryoung, Jerome S., Journal of Small Business Management
We examine a set of small, venture capital (VC)-backed manufacturing firms and compare it to a control sample of non VC-backed manufacturing firms going public between 1990 and 1996. We use the degree of underpricing, three-year sales growth, three-year cumulative stock return, and three-year survivability as measures of success. First, we test if the presence of VC backing results in significant differences in success between the two samples. Next, we test if certain VC and deal characteristics are discriminators within the VC-backed sample of firms. Despite previous literature, which argues for either inferior or superior VC post-initial public offering (IPO) performance, these tests indicate no significant differences between VC- and nonVC-backed firms. Additionally, it is found that VC and deal characteristics are not discriminating factors within the VC sample.
In his 1994 survey of the venture capital literature, Barry (1994) suggests a potential future research question: "Do venture capitalists add value within the portfolio firm?" Since the asking of this question, several articles have examined the performance of venture capital (VC)-backed firms versus the performance on nonventure-backed firms (for example, see Brav and Gompers (1997)). In this paper, we extend the literature by further examining Barry's question. Specifically, the authors' extension is on three fronts.
First, efforts are concentrated on small businesses that conduct an initial public offering (IPO) between 1990 and 1996. A small business is defined in accordance with the Small Business Administration standard--a firm with less than 500 employees. Examination of small businesses provides an extreme setting of potential asymmetric information and should represent a setting in which differences between VC-backed and nonVC-backed firms are detectible (if they exist). Megginson and Weiss (1991) argue that VCs provide a certification role to mitigate information asymmetries. By examining only small firms, firms with large degrees of asymmetric information, VC certification should be even more valuable. The analysis of small firms is not trivial, as the preponderance of the empirical evidence used to test VC-related hypotheses is based upon samples that consist mainly of large firms. Ang (1991) argues that small firms are inherently different than larger firms. As such, whether the empirical findings of the large firm empirical tests are robust to small firms is a matter worthy of study.
Second, the focus here is only on manufacturing firms that conduct an IPO. Creating a fairly homogeneous data sample permits the further refinement of comparison between VC- and nonVC-backed firms. Similar to the work of Lerner (1994), who chooses to analyze a particular industry (biotechnology), the authors argue that focusing on a certain subset of firms allows for a cleaner comparison of VC performance.
Third, four dimensions are used to measure success: initial underpricing, stock performance, sales growth, and survivability. Many of the existing studies consider only one of the measures of success in isolation. Using an array of success metrics allows for the addition of completeness to this study of small, manufacturing firms.
The remainder of the paper flows as follows. Next, theories are presented that speak to the expected impact of VC presence in firms going public. One stream of literature suggests that VC-backed firms should have superior performance relative to a control sample, whereas a second line of literature suggests the opposite. The literature that supports both views is discussed. Following the discussion, the data sample and empirical tests are presented. The final section includes a discussion of the empirical results and interpretations of the findings.
Literature Review and Theoretical Camps
Tyebjee and Bruno (1984) outline five specific functions of venture capitalists. …