Venture Capital Funding and Entrepreneurs’ Performance

Abstract

Venture Capital financing is structured to suit environments of high uncertainty and asymmetry of information. The presence of agency costs in the capital market is likely to impose financial constraints on some firms, especially small companies operating in risky industries. It is therefore expected that if such firms receive venture capital they would suffer less agency costs and finance constraints than those who do not. This thesis tries to answer three research questions: 1) Whether venture funds financial contracts deal with adverse selection and moral hazard adequately and sufficiently? 2) How these contracts affect the firm’s performance (Principle-Agent problem)?, and 3) What is its impact on Performance of firms funded by VC? This thesis compares 13 firms, funded, subsequently fully divested and backed by a Venture Capital Company: Gujarat Venture Finance Limited. Some hypotheses are developed to test the theory of capital market imperfection and agency theory based on the structure of venture capital contracts. The results show that venture capital backed firms achieve their objectives, with minimum risk and efforts for the maximum returns. Even if the financial constraints exist, VC protects them from optionally accumulating capital stock and assets over time and their economic performance is less affected. GVFL’s contract with the entrepreneur imposes/includes all the standard clauses/provisions that help in decision making in VC appraisal, self-selection, monitoring, incentivizing and legal remedies. These are the activities where the role of the VC comes into picture more regularly and the outcome is in the form of divestment of shares, initial public offering or acquisition/merger/takeover by third party.