The Management of Risk by Taiwanese Venture Capital Firms Operating in China: A Process Perspective

By Liu, Chung-Chu; Chen, Shiou-Yu | International Journal of Management, September 2006 | Go to article overview

The Management of Risk by Taiwanese Venture Capital Firms Operating in China: A Process Perspective


Liu, Chung-Chu, Chen, Shiou-Yu, International Journal of Management


This article adopts a process perspective to identify the risks faced by Taiwanese venture capitals operating in China and offers workable suggestions and solutions for every stake uncovered. Qualitative and open-ended responses to questions were collected from 13 venture capital principals, agents, and third-parties. Content analysis was then used to examine the data. The result shows different venture capital investment processes have or use different management methods to reduce risks; for example, setting clear goals, establishing close relationship, continuous communication, effective monitoring and exit capabilities.

Introduction

Venture capital firms are frequently given management support to close the funding gap for start-up, innovative companies (Engel, 2004). The venture capital function of a capital market provides investment funding for higher risk, but often groundbreaking and innovative that cause the development of start-up companies (Moore & Wustenhagen, 2004). New businesses are subject to more market risk than established businesses because they are often exploring markets where competitive stability among buyers, suppliers, potential entrants, current competitors, and product/service substitutes have not been established (Porter, 1980). Venture capital is a financial service that emerged in the United States during the 1960s, appeared in the United Kingdom during the 1970s and expanded over to Continental Europe in the 1980s. Venture capital funds are managed by small teams of highly qualified venture managers, general partners who will generally receive a part of the raised capital as an incentive. Its main objective is long-term capital gains to remunerate risks (Tyebjee & Bruno, 1984; Fassin, 1998).

Illiquidity, volatile returns and lack of information are sources of the high risk that characterize the investments made by venture capitalists (Promise & Wright, 2005). Prior research identified two types of risks relevant to venture capital investments: The first is agency risk, which relates to a risk caused by divergent interests between venture capital firms and their portfolio firms. The second is market risk, which pertains to risk associated to unforeseen competitive conditions affecting a market Fiet, 1995). Clercq, Goulet, Kumpulatinen, and Makela (2001) proposed that Fiet's concept of market risk covers two dimensions: business risk and systematic risk. Business risk pertains to a lack of knowledge about the competitive conditions in a specific market, whereas systematic risk pertains to dimensions: business risk and systematic risk. Business risk pertains to a lack of knowledge about the competitive conditions in a specific market, whereas systematic risk pertains to risks stemming from external factors not under the control of the venture capitalist (e.g. technological obsolescence). Both dimensions of market risk may have a detrimental effect on a given industry, the company's stage of growth, or geographic region. Based on these concepts of risk, Clercq, Goulet, Kumpulatinen, and Makela (2001) hypothesized that in order to achieve superior returns on portfolio company investments, venture capitalists choose either a specialization strategy in order to manage agency risks and directly control business risk, or a diversification strategy to manage systematic risks and indirectly control business risks. Because venture capital financing involves making decisions under conditions of high uncertainty, previous research has used several criteria to determine whether or not to invest in a particular company. These criteria include the venture's expected risk and return profile, the attractiveness of the product or market, the quality of the venture's top management, and the fit between the team's kills and the venture's apparent needs (Tyebjee & Bruno, 1984; Hisrich & Jankowicz, 1990). Rational decision-making models following a step-by-step and logical sequence were used to describe the venture capital decision-making process (Tyebjee & Bruno, 1984). …

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