Cross‐Border Investments and Venture Capital Exits in Europe

• Date: 01 March 2014
• Author: Fabio Bertoni,Alexander Peter Groh
• DOI: http://doi.org/10.1111/corg.12056
• Published date: 01 March 2014

Cross-Border Investments and Venture Capital

Exits in Europe

Fabio Bertoni* and Alexander Peter Groh

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: We examine the way in which the exit mode (i.e., initial public offering – IPO, trade sale, or

write-off) of venture capital (VC) investments is inf‌luenced by the additional exit opportunities brought by cross-borderVC

investors.

Research Findings/Insights: We perform our analysis on a sample of 1,062 VC investments in 462 young high-tech

companies in seven European countries. Our f‌indings indicate that, controlling for f‌irm performance, investor characteris-

tics, and local exit conditions, the probability of exiting via trade sale is positively correlated to the additional set of mergers

and acquisitions (M&A) opportunities brought by cross-border investors. A similar effect, but with weaker statistical

signif‌icance, is also identif‌ied for exits by IPO, which are positively affected by IPO volumes in the countries of cross-border

investors.

Theoretical/Academic Implications: Cross-border VC investment may, at least partially, compensate for inadequate local

exit conditions. Cross-border investors can spillover the capital market activity of their home country and enhance exit

options for young ventures. International syndicates are also quicker to write off their non-performing investments.

Practitioner/Policy Implications: Not all exit modes are equally affected by international syndication. The impact of

cross-border investors on the exit mode also depends on their country of origin and, more specif‌ically, on the exit

opportunities available there. The mechanism is stronger for trade sales than for IPOs.

Keywords: Corporate Governance, Cross-Border Ownership, Venture Capital, Initial Public Offering, Mergers &

Acquisitions

INTRODUCTION

Venture capital (VC) investors are increasingly investing

across their national borders (Bottazzi, Da Rin, &

Hellmann, 2004). This trend is particularly surprising given

that VC investors, like all cross-border investors, not only

have to overcome the liability of foreignness, but also have

to cope with the liability of distance (Bruton, Fried, &

Manigart, 2005), which derives from the fact that physically

proximate companies can be more easily monitored and

more effectively supported in their development (Cumming

& Dai, 2010). The liabilities of both foreignness and distance

can be reduced by syndicating with local partners, which is

very common in cross-border VC investments (Meuleman &

Wright, 2011). However, local partners will be willing to do

so only to the extent to which they perceive some additional

value in the international dimension of the syndicate.

The literature has proposed several reasons why interna-

tionality in VC syndicates may be an advantage. Cross-

border VC investors may complement the value-adding

activities of local VC investors by providing knowledge of

foreign markets and contacts with customers, suppliers and

key executives abroad (Mäkelä & Maula, 2005). Moreover,

international governance may be a signal of a venture’s

ability to become a global player. Empirical evidence sup-

ports the notion that international syndicates boost the

growth of their portfolio companies (Devigne, Vanacker,

Manigart, & Paeleman, 2013) and are more likely to success-

fully exit their investment (Chemmanur, Hull, & Krishnan,

2013).

In this paper, we argue that there is an additional dimen-

sion that may make international VC governance desirable:

the fact that international investors enhance the set of exit

opportunities. Exit is a fundamental step of the VC cycle

*Address for correspondence: Fabio Bertoni, EMLYON Business School, Research

Center on Entrepreneurial Finance (ReCEntFin), 23 AvenueGuy de Collongue, 69134

Ecully,France. Tel: +33 (0)4-78-33-70-03; E-mail: bertoni@em-lyon.com

84

Corporate Governance: An International Review, 2014, 22(2): 84–99

© 2014 John Wiley & Sons Ltd

doi:10.1111/corg.12056

(Gompers & Lerner, 1999): whether an investment is suc-

cessful or not for a VC investor depends crucially on the

timing and proceeds of the exit. Exit is so important that it is

already planned prior to closing the f‌irst f‌inancing round

(Cumming & Johan, 2008). As a result, the availability of exit

alternatives determines the attractiveness of an investment

opportunity. Divesting is more diff‌icult, and less likely to be

successful, in countries with illiquid capital markets, which

hinder the development of a vibrant local venture capital

industry in the f‌irst place (Jeng & Wells, 2000). In this paper,

we argue that the presence of cross-border investors in a VC

syndicate may open up additional non-local exit options,

thus facilitating divestment. This benef‌its all shareholders

of the venture: the entrepreneur, local, and foreign VC

investors.

We empirically verify this hypothesis using a sample of

1,062 VC investments in 462 European young high-tech

companies, which received their f‌irst round of f‌inancing

between 1994 and 2004. Of these investments, 872 were con-

ducted by local VC f‌irms and 190 were cross-border. We

apply continuous and discrete-time competing-risks regres-

sions, controlling for f‌irm- and investor-specif‌ic characteris-

tics, which reveal several important insights.

First, we replicate prior research results and conf‌irm the

importance of local conditions. In general, the chances of

any exit (successful or unsuccessful) and timing to exit are

determined by the liquidity of the IPO and M&A markets,

and by the quality of legal rights in the venture’s home

country.

Second, we show that international syndication provides

access to foreign M&A markets. The likelihood of a trade

sale and the time to exit not only depend on the state of the

local M&A market in the country of the investee, but also on

the M&A market liquidity in the countries of the cross-

border investors. Essentially, the presence of foreign inves-

tors increases the size of the exitable market.

Third, we provide evidence, albeit with limited statistical

robustness, that international syndication also has a positive

impact on IPO prospects. The results are not as strong as for

trade sales, but suggest that international investors can

improve IPO chances by granting access to their home

capital market. We interpret the limited signif‌icance of our

f‌indings on IPOs as a consequence of the fact that, despite

their growing importance, foreign IPOs remain such a rare

phenomenon (Hursti & Maula, 2007) thatthe impact of inter-

national VC syndicates on the likelihood of going public is

diff‌icult to detect.

Fourth, the likelihood of exiting an unsuccessful venture

by means of a write-off or share buy-back1increases, and the

time until this event decreases, with the presence of foreign

investors. This result, in line with evidence by Devigne,

Manigart, and Wright (2012), supports the idea that interna-

tional syndication puts more emphasis on professionalism

and that unsuccessful transactions are abandoned more

quickly. Legal rights in the investee’s country are important

for winding up start-ups, and we f‌ind that the process is

quicker in countries with higher quality legal systems.

We control for a number of determinants of exit mode

which could act as confounding factors, such as the size of

the syndicate, or the size and the commercial and techno-

logical success of the company. The results, controlling for

these characteristics, are consistent with our expectations.

The likelihood and speed of an exit by IPO increase with the

size of the investee and the syndicate, while the likelihood

of a write-off decreases. Similarly, commercial success

increases the chance and speed of going public and lowers

the likelihood of write-off. Technological success also

reduces the probability of liquidating the investment.

Overall, this conf‌irms the notion that IPOs are the exit

channel for the most successful ventures. More importantly,

by including syndicate size and f‌irm operating performance

in our analyses, we are able to control for potential

endogeneity. Syndicate size is typically a signal of f‌irm

quality (Meuleman, Wright, Manigart, & Lockett, 2009), and

thus by controlling for it, we partially correct for unobserved

heterogeneity. Furthermore, international syndicates may

indirectly affect the exit mode by affecting f‌irm performance

(Devigne et al., 2013). Controlling for the commercial and

technological performance of investee f‌irms allows us to

rule out this alternative explanation.

Finally, to verify that our results are robust to potentially

endogenous selection, we replicate our analysis on a sample

constructed via propensity score matching (see, e.g., Dai, Jo,

& Kassicieh, 2012). We match each cross-border VC deal

with the f‌ive local investments that have the closest propen-

sity score, and estimate the competing risks model on the

restricted sample. We arrive at the same results, indicating

that they are not driven by endogenous selection.

Our paper reveals that international VC governance

improves the exit perspectives and accelerates the abandon-

ment of unsuccessful ventures. This increases the eff‌iciency

of resource allocation to start-up f‌irms. Entrepreneurs can

directly benef‌it from international syndication because it

increases the likelihood of cashing out their individual share

of the returns. Moreover, since international syndicates are

less likely to escalate commitment in unsuccessful ventures,

they direct entrepreneurial effort away from projects thatare

unlikely to be successful.

The rest of our paper is organized as follows. In the next

section we present the literature related to our study, illus-

trate the contribution of our paper,and develop our research

hypotheses. In the following section, we describe the data

and methodology. We then report the results of our econo-

metric analysis. Finally, we summarize and conclude.

LITERATURE REVIEW AND

DEVELOPMENT OF HYPOTHESES

A number of seminal papers have dealt with the socio-

economic frameworks that facilitate VC investment. Black

and Gilson (1998) elaborate on the impact of stock market-

centered versus bank-centered capital markets on VC activ-

ity. They note that only well-developed stock markets allow

venture capitalists to exit via IPOs. IPOs are crucial for them

because only successful divestments compensate for the

risks of early-stage f‌inancing. Bank-centered capital markets

also show less ability to produce an eff‌icient deal-

supporting infrastructure. Jeng and Wells (2000) f‌ind that

IPO cycles are one of the major driving forces of VC activity,

because they directly determine the returns of VC funds.

However, it is not only stock market conditions that affect

MODE OF EXIT AND CROSS-BORDER VC INVESTMENTS 85

Volume 22 Number 2 March 2014© 2014 John Wiley & Sons Ltd