1. Venture Capital Incubation Period, Underpricing, and Firm Performance
NTU International Conference on Finance
December 2006
Scott Hsu

2. The findings on the effect of the VC incubation period:
Overview
Definition:
The findings on the effect of the VC incubation period:
Firms with a longer incubation period are less underpriced at the IPO stage
Firms with a longer incubation period are more likely to survive three years after the IPOs
Firms with a longer incubation period exhibit better post-IPO operating performance
VC incubation period
Founding date
First VC investment date
IPO date

3. Also important to study the determinants of the VC incubation period because..
VCs play a dual role of “incubators” and “short-term investors”
Incubators: Hellmann and Puri (2002)
Short-term investors:
“Google’s founders would have preferred to wait longer to do their IPOs, but had to rush it because venture capitalists,…, wanted to cash in”
-The Economists, November 27, 2004
It is thus important to find a measure to examine whether and under what circumstance VCs behave as “incubators” versus “investors”, and consequences that follow

4. The significance of studying the determinants of the VC incubation period and its impact
The conflicting role of VCs in incubating startups
- Screening and monitoring: Jain and Kini (1995); Hellman and Puri (2002); Wang et al. (2003)
Certification in the IPO market: Megginson and Weiss (1991); Lee and Wahal (2004); Ljungqvist and Wilhelm (2003)
Most studies in this vein focus on the “binary comparison” between VC-backed and non-VC-backed firms. However, the “magnitude” of the VC effect could matter for firm success
A large proportion of IPOs were backed by VCs in recent years
50.33% of IPOs were backed by VCs in 2000; 34.58% in 2001
Thus, the investment strategy of VCs could have a profound impact marketwise

5. Data and methodology Data Methodology
1502 venture-backed IPOs that went public from 1980 to 2003
SDC Venture Xpert database
Supplemented by SDC New Issues database, CRSP, Compustat, and Jay Ritter’s firm founding dates and underwriter ranking data
Methodology
OLS to study both the determinants and effects of VC incubation period
Robustness check: Heckman’s two step procedures and survival analysis

6. VC incubation period and investments over time
Number of firms
Number of firms (percentage)
Mean incubation period (years)
Median incubation period(years)
Mean of VC investments (thous.)
Median of VC investments (thous.)
342
22.77%
3.37
2.72
18,574.02
8,484.85
697
46.40%
4.58
3.82
26,860.45
16,722.93
381
25.37%
3.38
2.95
59,416.11
41,687.29 82
5.46%
5.03
3.97
77,888.46
49,098.20
Total
1502
100.00%
4.02
3.28
35,951.32
20,199.43

7. High incubation period
Univariate result: VC incubation period and IPO underpricing
High incubation period
Mean (Median)
Low incubation period
Non-bubble period
11.79% (5.71%)
15.10% (8.54%)
Bubble period
( )
57.68% (21.61%)
82.97% (38.71%)
High (Low) incubation period group: Firms whose incubation periods are ranked in the top (bottom) quarter of the whole sample

8. Determinants of the VC incubation period
Hypothesis
Literature
Prediction
Market timing
(VCs as short-term investors)
Lerner(1994)
Pagano et al.(1998)
Michelacci and Suarez(2004)
Market-to-book ratio (-)
Information asymmetry and need of monitoring
(VCs as incubators)
Gompers (1995);Cumming and McIntosh(2001)
Research intensity (+)
Hightech dummy (+)
Early stage dummy(+)

9. Determinants of the VC incubation period
 Dependent variable: VC incubation period (year)
(1)
(2)
(3)
(4)
(5)
(6)
Coefficient
S.E
Intercept
4.43**
1.97
4.72**
4.39**
1.96
5.28***
1.98
4.92**
5.21***
Industry market-to-book ratio
-0.31***
0.06
-0.33***
-0.32***
Industry research intensity
0.34*
0.20
0.23
0.35*
0.24
Industry tangibility ratio
-1.32
2.01
-0.68
-1.50
2.00
-0.82
-0.90
Herfindahl Index
-1.07**
0.51
-1.22**
-0.92*
0.52
Industry capital intensity
-10.25***
3.35
-11.23***
3.36
-10.04***
3.42
Lead VC age > 4
-0.44**
0.18
-0.45**
-0.48***
Industry fit
-0.20
0.21
-0.23
Hightech dummy
0.61***
0.17
0.55***
0.57***
0.54***
0.563***
0.51***
Early stage dummy
1.95***
0.26
1.94***
1.91***
1.97***
1.930***
1.93***
Middle stage dummy
0.74***
0.29
0.75***
0.73**
0.76***
0.28
Adj R-Sq
0.0713
0.0735
0.0766
0.0764
0.08
0.0812 N
1474

10. Firm Survival and the VC incubation period
Definition of non-survivors: Firms that are delisted within 3 years after the IPO for reasons other than mergers and acquisitions
Survivors
Non-survivors
T-test
Number of observations
1168
288
Mean (Median) VC incubation period
(Years)
4.15 (3.36)
3.63 (2.82)
2.53**

11. Firm survival probability and the VC incubation period

12. IPO underpricing and the VC incubation period
The IPO underpricing decreases with the length of the VC incubation period
The effect of firm age at IPO on the underpricing mainly come from the incubation period, not from the period before the VCs’ investment

13. IPO underpricing and firm age at IPO
(1)
(2)
(3)
(4)
(5)
(6)
coefficient
S.E
Intercept
-1.64
13.96
0.53
14.76
-4.39
14.24
2.17
16.18
3.80
16.75
-1.44
14.67
Log of firm age at IPO
-8.17**
3.17
-9.60***
3.43
-7.97**
-8.33**
3.32
-9.12**
3.56
-7.41**
2.94
Underwriter ranking
2.91**
1.43
2.69*
1.44
2.89**
3.04**
1.46
2.99**
1.49
2.61**
1.21
Share overhang
1.58***
0.29
1.54***
1.62***
1.57***
0.28
Ln(firm assets)
-0.34
1.66
-0.19
1.77
Ln(firm sales)
0.65
1.26
0.23
1.38
Lead VC age >4
-1.10
4.42
0.21
4.19
Industry fit
12.94***
4.99
13.25***
4.67
Hightech dummy
10.09***
3.82
9.91**
3.93
10.39***
3.81
9.88**
4.10
9.70**
4.21
9.06**
Bubble dummy
66.59***
4.37
67.65***
4.52
65.38***
4.39
68.11***
69.01***
67.60***
4.30
Number of IPOs
0.00
0.01
Market-to-book
-1.40
1.79
-1.38
1.84
-1.01
1.64
Research intensity
-7.93*
4.71
-7.93
5.43
-8.38*
4.45
Herfindahl Index
13.65
13.56
7.71
13.75
13.82
12.07
Early stage dummy
-0.55
6.55
-0.29
6.65
5.98
Middle stage dummy
-7.00
7.06
-7.40
7.11
-6.22
6.47
Adj R-Sq
0.2800
0.2871
0.2837
0.2877
0.2911 N
932
878
915
862
994

14. IPO underpricing and VC incubation period
(1)
(2)
(3)
(4)
(5)
(6)
coefficient
S.E
Intercept
-2.49
13.7
-1.52
14.43
-5.17
14.02
-0.30
15.70
1.11
16.23
-4.15
14.27
Log of VC incubation period
-8.32**
3.49
-8.80**
3.59
-8.05**
3.48
-9.82***
3.77
-10.19***
3.90
-8.93***
3.39
Log of firm age at first VC investment date
-3.27
2.05
-4.03*
2.21
-3.21
2.25
-2.84
2.36
-2.18
2.10
Underwriter ranking
3.11**
1.42
2.89**
1.44
3.10**
3.15**
1.45
1.48
2.68**
1.21
Share overhang
1.58***
0.29
1.55***
0.289
1.62***
1.53***
1.60***
0.28
Ln(firm assets)
-0.67
1.65
-0.52
1.64
-0.53
1.76
Ln(firm sales)
0.25
1.25
-0.10
1.36
Lead VC age >4
-1.19
4.41
-0.14
4.18
Industry fit
12.56**
4.97
13.20***
4.67
Hightech dummy
9.77**
3.80
9.68**
3.92
9.72**
9.44**
4.08
9.36**
4.19
8.91**
3.79
Bubble dummy
67.30***
4.34
68.33***
4.50
66.14***
4.36
68.80***
4.49
69.64***
4.64
67.80***
4.29
Number of IPOs
0.00
0.01
Market-to-book
-1.93
1.79
-1.97
1.84
-1.32
1.66
Research intensity
-7.48
4.65
-7.72
5.34
-7.97*
4.46
Herfindahl Index
10.80
13.53
13.71
12.22
12.09
Early stage dummy
5.05
7.09
5.28
7.24
5.21
6.53
Middle stage dummy
-3.87
7.14
-4.11
7.20
-3.48
6.59
Adj R-Sq
0.2817
0.2884
0.2851
0.2842
0.2905
0.2914 N
938
884
921
868
995

15. The level of post-issue ROA and VC incubation period
Dependent variable
Mean ROA (year0 to year3)
ROA(year0)
ROA(year1)
ROA(year2)
ROA3(year3)
Coefficient
S.E
Intercept
-37.40***
7.87
-21.57***
6.60
-40.61***
10.60
-55.07***
9.81
-41.86***
10.10
Log of VC incubation period
5.65***
1.82
6.67***
1.52
6.10**
2.44
6.03***
2.25
4.80**
2.33
Log of firm age at first VC investment date
4.65***
1.21
5.15***
0.98
5.00***
1.60
3.82**
5.62***
1.57
Ownership retention
15.19***
4.85
2.30
4.35
15.477**
6.93
24.71***
6.28
14.39**
6.29
Natural log of IPO offer size
8.09***
1.44
6.89***
1.18
9.40***
1.92
9.35***
1.80
7.60***
1.85
Hightech dummy
3.32*
2.00
5.96***
1.67
4.44
2.71
3.60
2.51
0.28
2.60
Bubble dummy
-20.04***
2.83
-22.86***
2.24
-25.42***
3.71
-28.48***
3.51
-10.96***
3.65
Industry median market-to-book ratio
-3.54***
0.86
-4.40***
0.71
-4.46**
1.15
-2.54**
1.07
-2.78**
1.11
Industry median research intensity
-13.17***
-9.77***
1.96
-17.08***
3.14
-11.57***
2.97
-14.65***
2.95
Herfindahl Index
6.46
-8.01
5.27
-6.87
8.52
10.52
8.11
8.63
8.35
Early stage dummy
-9.85***
3.67
-8.35***
-9.90**
4.80
-11.72***
4.53
-8.15*
4.76
Middle stage dummy
-0.74
3.64
-0.70
-1.20
4.79
-1.00
4.50
0.68
4.72
Adj R-Sq
0.1945
0.2187
0.1287
0.1391
0.1034 N
953
1300
1207
1086
963

16. Robustness Check
1. The effect of VC participation or merely natural maturation? A further investigation
2. Does there exist a potential selection bias of venture financing?
-Heckman’s two-step procedure
3. A survival analysis of the determinants of the VC incubation period

17. “Age” effect is more pronounced for venture-backed firms
 Dependent Variable
ROA (year0)
ROA(year1)
ROA(year2)
ROA(year3)
Ind. Variables
coefficient
S.E
Intercept
-9.38
***
1.50
-33.59
4.83
-35.18
5.50
-25.62
4.05
Ln(IPOAGE)
2.91
0.41
3.48
1.31
3.10 **
1.49
3.54
1.08
VC dummy
-22.06
1.84
-21.75
6.01
-31.49
6.86
-24.36
5.05
VC*Ln(IPOAGE)
5.94
0.80
6.56
2.59
9.25
2.93
6.83
2.16
Underwriter ranking
2.84
0.22
3.45
0.70
4.29
0.79
3.36
0.58
Ln(proceeds)
0.27
0.43
2.33 *
1.40
1.05
1.60
-0.26
1.17
Hightech Dummy
-1.14
0.76
-1.83
2.48
-2.11
2.80
-3.11
2.05
Bubble Dummy
-21.90
1.06
-28.11
3.50
-27.73
4.02
-13.30
2.95
Adjusted R-Square
0.2327
0.0430
0.0453
0.0513
Number of observations
4222
3963
3525
3074

18. Underpricing and VC incubation period: Heckman’s two-step procedure
(1)
(2)
Variables
coeff.
S.E
Intercept
9.99
12.04
17.43
14.57
Log of VC incubation period
-8.31***
3.18
-9.43***
3.41
Log of firm age at first VC investment date
-2.84
1.97
-2.16
2.13
Underwriter ranking
2.37**
1.19
2.43**
1.21
Share overhang
1.78***
0.29
1.75***
Hightech Dummy
8.36**
3.59
7.73**
3.84
Bubble Dummy
63.22***
4.38
63.64***
4.47
Market-to-book ratio
-1.77
1.64
Research intensity
-9.07**
4.57
Herfindahl Index
11.75
11.95
Early stage dummy
2.84
6.51
Middle stage dummy
-3.68
6.56
Lambda
-6.47
4.46
-9.37**
4.71
Selection Model
Industry dummies
included
State dummies
Firms were founded after 1980
0.66***
0.06
0.65***
0.07
IPO year dummies

19. Level of post-issue ROAs and VC incubation period: Heckman’s two-step procedure
ROA (year0)
ROA (year1)
ROA(year2)
ROA(year3)
Variables
coefficient
S.E
Intercept
-7.38
6.59
-26.92***
9.21
-43.33***
10.03
-33.87***
10.86
Log of VC incubation period
6.55***
1.44
6.56***
1.99
4.30**
2.17
2.77
2.37
Log of firm age at first VC investment date
4.76***
0.91
4.80***
1.29
3.65**
4.50***
1.58
Ownership retention
0.67
3.86
13.26**
5.32
19.73***
5.66
12.85**
5.99
Log of IPO size
3.08***
1.13
6.32***
1.61
6.04***
1.79
4.49**
1.94
Hightech Dummy
5.45***
1.59
3.33
2.23
5.28**
2.44
2.54
2.65
Bubble Dummy
-19.60***
2.10
-23.34***
2.99
-21.17***
3.31
-3.86
3.65
Market-to-book ratio
-4.50***
0.66
-5.84***
0.94
-3.64***
1.03
-4.17***
1.11
Research intensity
-8.90***
1.80
-10.99***
2.50
-8.85***
2.81
-13.33***
2.95
Herfindahl Index
-9.33*
4.92
-11.89*
6.94
11.61
7.79
13.67
8.55
Early stage dummy
-5.27*
2.71
-4.79
3.82
-5.36
4.24
-3.51
4.75
Middle stage dummy
1.15
2.32
1.72
4.21
4.25
4.68
Lambda
-1.29
1.78
-0.48
3.11
2.57
5.12*
2.75
Selection Model
Firm's industry dummies
included
Firm's state dummies
whether Firms were founded after 1980
0.70***
0.06
0.07
0.69***
0.65***
Firm's IPO year dummies

20. Determinants of VC incubation period-A survival analysis
Weibull distribution
Cox Proportional Model
(1)
(2)
(3)
(4)
(5)
(6)
(7)
coeff.
S.E
Intercept
1.73***
0.49
1.60***
1.92***
0.48
1.77*** -
Industry market-to-book ratio
-0.07***
0.01
-0.06***
0.09***
0.02
0.08***
Industry research intensity
0.07
0.05
-0.08
-0.05
-0.06
Industry tangibility ratio
-0.42
0.50
-0.25
0.51
-0.49
-0.32
0.53
0.71
0.34
0.72
Herfindahl Index
-0.21*
0.12
-0.26**
0.23
0.17
0.24
0.18
Industry capital intensity
-1.89***
0.69
-1.90***
0.68
2.19**
1.00
1.93*
1.02
Lead VC age > 4
-0.13***
0.04
-0.12***
0.18***
0.06
Industry fit
-0.07
0.09
Hightech dummy
0.13***
-0.16***
Early stage dummy
0.43***
0.44***
-0.48***
0.10
-0.47***
Middle stage dummy
0.16**
-0.13
0.11
-0.11 N
1473
1395

21. Conclusion
This paper finds that the strategic choice of VCs as “incubators” versus “short-term investors” determines the length of the VC incubation period, which has positive impacts on firms:
Less underpricing
Higher surviving probability
Better operating performance
This paper suggests that VCs play a positive role in incubating startups
This paper provides implications on the issues of corporate governance—the internal conflicts of large shareholders could affect the performance of firms