1. © Cumming & Johan (2013) Portfolio Size Cumming and Johan (2013 Chapter 17) 1

2. © Cumming & Johan (2013) Portfolio Size Chapter Objectives Consider 4 main factors that influence the determinants of portfolio size in terms of the number of entrepreneurial firms in the venture capital fund portfolio, as well as portfolio size per fund manager per year of investment: – The fund’s characteristics, such as type of fund, fund size and fund management firms that operate more than one fund; – The characteristics of the entrepreneurial firms in the venture capitalist fund managers’ portfolio, including entrepreneurial firm development stage, technology and location; – The structure and characteristics of the financing transactions, including staging, syndication and forms of finance; and – Market conditions. 2

3. © Cumming & Johan (2013) Portfolio Size Issues How many entrepreneurial firms do VCs have in their portfolios? Is efficient portfolio size affected by:  Venture capital fund characteristics?  Entrepreneurial firm characteristics?  The nature of the financing transaction?  Market Conditions? Nonlinearities in the predicted relationships? Are returns to scale increasing or decreasing? Theory Data Regressions Conclusion/Summary 3

4. © Cumming & Johan (2013) Portfolio Size Basic Conjecture Expansion of portfolio size eventually becomes unprofitable as active VC investing and managerial advice gets diluted (Kannianen and Keuschnigg, 2003,2004) Add another entrepreneurial firm to the VC portfolio where the projected marginal benefits (PMB) outweigh the projected marginal costs (PMC) Marginal benefits and marginal costs vary according to  Type of entrepreneurial firm  Type of venture capital firm  Nature of the deal ($ amount, forms of finance, syndication, etc.) Theory Data Regressions Conclusion/Summary 4

5. © Cumming & Johan (2013) Portfolio Size Number of Entrepreneurial Firms in VC ’ s Portfolio Benefits / Costs per Firm in Portfolio EF 0 1 PMB 0 1 PMC 0 1 Figure17.1. Efficient Venture Capital Portfolio Size and Comparative Statics Increase in staging frequency, proportion of early stage And high - tech firms; etc. Increase in fundraising, improvement in market conditions; etc. 5

6. © Cumming & Johan (2013) Portfolio Size Hypotheses: Venture Capital Fund Characteristics 6 Venture Capital Fund Characteristics Hypothesized Effect on PMC Hypothesized Effect on PMB Predicted Effect # of Portfolio Firms Government Funds, LSVCCs Low cost of capital  Low PMC ---Increase Private Independent Limited Partner Funds High value added  High PMC Dilution VC Effort  Low PMB Decrease VC Fund in VC Firm with Many VC Funds Effort Sharing Across Funds  Low PMC Complementarities, Co-investment  High PMB Increase VC Fundraising (Drawdowns) --- More funds  High PMB Increase VC Fund Duration Lower Opportunity Cost of Effort  Low PMC Less Dilution of Effort, etc.  High PMB Increase # VC Managers---High PMBIncrease Theory Data Regressions Conclusion/Summary

7. © Cumming & Johan (2013) Portfolio Size Hypotheses: Entrepreneurial Firm Characteristics and Market Conditions 7 Entrepreneurial Firm Characteristics Hypothesized Effect on PMC Hypothesized Effect on PMB Predicted Effect # of Portfolio Firms Early Stages of Development Higher Effort  High PMC Specialization  High PMB Ambiguous High-Tech Intangible Assets, Higher Effort  High PMC Economies of Specialization  High PMC Ambiguous Strong Market Conditions Ease in Fundraising  Low PMC Improved chances of exit  High PMB Increase Theory Data Regressions Conclusion/Summary

8. © Cumming & Johan (2013) Portfolio Size Hypotheses: Financing Characteristics 8 Financing Characteristics Hypothesized Effect on PMC Hypothesized Effect on PMB Predicted Effect # of Portfolio Firms Staging FrequencyIntensive Monitoring  High PMC Dilution of VC Effort  Low PMB Decrease Syndication FrequencyRisk Sharing  Low PMC Value Added  High PMB Increase $ Invested / Total Entrepreneurial Capital High Control Rights  Low PMC High Control Rights  High PMB Increase Convertible SecuritiesHigh Opportunity Costs  High PMC Dilution of VC Effort  Low PMB Decrease Theory Data Regressions Conclusion/Summary

9. © Cumming & Johan (2013) Portfolio Size 9 Number of Entrepreneurial Firms in VC ’ s Portfolio Benefits / Costs per Firm in Portfolio Figure17.2a. Comparative Statics and Nonlinearities EF 1 3 0 2 4 PMB (Linear) PMB (Concave) PMC 0 1 2

10. © Cumming & Johan (2013) Portfolio Size 10 Number of Entrepreneurial Firms in VC ’ s Portfolio Benefits / Costs per Firm in Portfolio Figure17.2b. Comparative Statics and Nonlinearities EF 1 3 0 2 4 PMB 0 PMC (Convex) PMB 1 2 PMC (Linear)

11. © Cumming & Johan (2013) Portfolio Size 11 Number of Entrepreneurial Firms in VC ’ s Portfolio Figure17.3. Nonlinearities in Hypothesis Tests Fundraising, Proportion of Early Stage Entrepreneurial Firms, etc. The concave shape follows from the convex shape of the PMB curve and the convex shapeof the PMC curve (see Figures 18.2a and 18.2, r espectively). The econometric tests consider nonlinearities (both concave and convex) in the effect of the hypothesized effects on venture capital por tfolio size. The curvature of the slope is determined by grid search methods on various Box - Cox transformations.

12. © Cumming & Johan (2013) Portfolio Size Canadian VC Data 1991-2000 214 venture capital funds  Corporate (18)  Government (15)  LSVCC (29)  Other (Institutional) Investors (48)  Private independent Limited Partnerships (104) Source: Macdonald & Associates, Ltd. Exclude funds with (possibly) unobserved investments Theory Data Regressions Conclusion/Summary 12

13. © Cumming & Johan (2013) Portfolio Size 13 Table 17.2a. Summary of the Data by Type of Venture Capital Fund Variable Names Corporate Venture Capital Government Venture Capital LSVCC Private Limited Partnership Other Institutional Venture Capital Total Venture Capital Fund Characteristics Total Number of Funds18152910448214 2 or more Venture Capital Funds managed by the Venture Capital Management Firm 033141232 Venture Capital Funds Raised (Drawdowns) ('000)$70,650$48,343$117,273$24,307$110,071$61,724 # Years Fund Investments Tracked by CVCA4.2225.5334.5864.6634.7504.696 Investment Duration Period (Quarters)3.6254.8504.0433.9594.0734.030 # Venture Capital Fund Managers6.0008.5336.3795.6738.0837.075 Entrepreneurial Firm Characteristics Average # Portfolio Firms17.05632.46737.9668.22130.50019.692 Average # Portfolio Firms / # Venture Capital Managers 2.7937.4606.3792.5894.9394.003 Average # Portfolio Firms / # Venture Capital Managers / # Years 0.8631.6951.6740.8431.6321.194 Early Stage0.8190.9000.8970.8570.7760.844 Life Sciences0.0660.2000.2290.1980.0880.167 Other High-Tech0.5970.3930.4270.5100.4280.479 Entrepreneur / Venture Capital Different Provinces0.2970.0830.0520.1610.2860.180 Financing Transactions Characteristics Staging Frequency0.5600.4710.4970.5440.4890.521 Syndication Frequency0.6240.4560.5190.4900.5360.513 Venture Capital Investments / Ent. Capital0.5260.5090.4090.4810.6300.511 Convertible Securities0.2370.2010.2720.2620.2000.243 Market Conditions MSCI Return0.2960.2680.3600.2680.3340.297 Note: Data over the period 1991 - 2000. Venture capital funds that invested for 1 year only in the data are excluded. Canadian Venture capitalists only. Source: Macdonald and Associates, Ltd.,.

14. © Cumming & Johan (2013) Portfolio Size 14 Table 17.2b. Summary Statistics for All Types of Venture Capital Funds in the Data (214 Funds) Variable NamesMeanStandard DeviationSkewnessKurtosisMinimumMaximum Venture Capital Firm Characteristics Venture Capital Funds Raised (Drawdowns) ('000)$61,7241383135.08934.636150$1,219,360 # Years Fund Investments Tracked by CVCA4.6962.4640.8222.538210 Investment Duration Period (Quarters)4.0302.3760.7602.5380.59.25 # Venture Capital Fund Managers7.0757.5052.80413.965148 Entrepreneurial Firm Characteristics Average # Portfolio Firms19.69242.2205.69843.4031408 Average # Portfolio Firms / # Venture Capital Managers4.0036.6263.96622.6860.09148.4 Average # Portfolio Firms / # Venture Capital Managers / # Years1.1941.9365.65147.9290.02620 Early Stage0.8440.207-1.7315.80101 Life Sciences0.1670.2712.1046.46001 Other High-Tech0.4790.3380.0631.73401 Entrepreneur / Venture Capital Different Provinces0.1800.2771.7495.11201 Financing Transactions Characteristics Staging Frequency0.5210.211-0.4342.78900.933 Syndication Frequency0.5130.3130.0281.82701 Venture Capital Investments / Ent. Capital0.5110.2750.2931.9480.0471 Convertible Securities0.2430.1940.8283.50001 Market Conditions MSCI Return0.2970.1981.6287.315-0.0671.192 Note: Data over the period 1991 - 2000. Venture capital funds that invested for 1 year only in the data are excluded. Canadian Venture capitalists only. Source: Macdonald and Associates, Ltd.,.

15. © Cumming & Johan (2013) Portfolio Size 15 Table 17.2c. Summary Statistics for Private Limited Partnership Funds Only (104 Funds) Variable NamesMeanStandard DeviationSkewnessKurtosisMinimumMaximum Venture Capital Firm Characteristics Venture Capital Funds Raised (Drawdowns) ('000)24306.529385.71.9696.645600149316 # Years Fund Investments Tracked by CVCA4.6632.4000.8082.489210 Investment Duration Period (Quarters)3.9592.2970.7582.5640.759.25 # Venture Capital Fund Managers5.6734.7881.2613.840119 Entrepreneurial Firm Characteristics Average # Portfolio Firms8.2216.9872.1529.167142 Average # Portfolio Firms / # Venture Capital Managers2.5893.3853.24416.1870.20023 Average # Portfolio Firms / # Venture Capital Managers / # Years0.8430.8771.6805.5190.0484 Early Stage0.8570.213-1.8435.9480.0711 Life Sciences0.1980.3211.6264.22401 Other High-Tech0.5100.364-0.0741.58201 Entrepreneur / Venture Capital Different Provinces0.1610.2361.6385.15201 Financing Transactions Characteristics Staging Frequency0.5440.236-0.6862.81900.933 Syndication Frequency0.4900.293-0.0411.99801 Venture Capital Investments / Ent. Capital0.4810.2830.4852.0320.0471 Convertible Securities0.2620.1920.7503.07200.875 Market Conditions MSCI Return0.2680.1801.2185.000-0.0670.944 Note: Data over the period 1991 - 2000. Venture capital funds that invested for 1 year only in the data are excluded. Canadian Venture capitalists only. Source: Macdonald and Associates, Ltd.,.

16. © Cumming & Johan (2013) Portfolio Size 16 Table 17.3. Difference Tests All 214 Funds104 Limited Partnerships Only Average # Portfolio FirmsDifference Test Average # Portfolio Firms / # Venture Capital Managers / YearsDifference Test Average # Portfolio FirmsDifference Test Average # Portfolio Firms / # Venture Capital Managers / YearsDifference Test Limited Partnership Venture Capital Fund8.221 -7.483*** 0.843 -0.102 --- Corporate Venture Capital Fund17.0560.863--- Limited Partnership Venture Capital Fund8.221 -19.515*** 0.843 -2.805*** --- LSVCC Fund37.9661.674--- Limited Partnership Venture Capital Fund8.221 -14.247*** 0.843 -2.566** --- Government Venture Capital Fund32.4671.695--- Venture Capital Mgmt. Firm with 1 Fund17.790 -5.044*** 1.214 0.242 6.956 -6.313*** 1.059 -0.517 Venture Capital Mgmt. Firm with 2 or More Funds22.3111.16610.6111.166 Venture Capital Fund with More than $50,000,000 Drawdowns50.155 36.749*** 1.428 1.446 16.400 11.085*** 0.574 -1.598 Venture Capital Fund with Less than $50,000,000 Drawdowns8.3651.1076.8430.889 Investment duration period > 4 years24.730 14.880*** 0.985 -2.780*** 10.333 13.136*** 0.623 -3.100*** Investment duration period < 4 Years10.7271.5654.5531.226 # Managers >735.246 22.060*** 0.530 -5.915*** 12.185 8.469*** 0.275 -5.330*** # Managers <712.2901.5106.8311.043 Early Stage >.7520.067 1.465 1.211 0.331 8.265 0.308 0.895 1.265 Early Stage <.7518.4291.1368.0480.638 Life Sciences >.510.045 -12.790*** 1.318 0.485 9.250 1.413 0.858 0.061 Life Sciences <.520.7971.1808.0340.841 Other High-Tech >.515.626 -8.938*** 1.063 -1.268 7.154 -4.268*** 0.794 -0.541 Other High-Tech <.523.1911.3069.2880.893 Venture Capital / Entrepreneur Different Province >.1510.452 -19.352*** 0.688 -4.701*** 7.474 -2.336** 0.633 -1.956* Venture Capital / Entrepreneur Different Province <.1524.4751.4568.6520.964 Staging Frequency >.521.575 4.470*** 0.862 -3.758*** 9.164 4.406*** 0.609 -3.046*** Staging Frequency <.517.5841.5656.8841.176 Syndication Frequency >.515.783 -9.065*** 0.700 -5.588*** 7.833 -1.406 0.588 -2.706*** Syndication Frequency <.523.5281.6798.5541.062 Venture Capital Investments / Entrepreneurial Capital >.521.970 4.740*** 1.514 3.127*** 7.390 -2.590*** 1.099 2.212** Venture Capital Investments / Entrepreneurial Capital <.517.7300.9198.7620.676 Convertible Securities >.59.333 -13.839*** 1.277 0.314 8.700 0.568 1.083 0.753 Convertible Securities <.520.6431.1868.1700.818 MSCI >.2519.775 0.216 1.335 1.795* 6.980 -4.816*** 0.761 -0.879 MSCI <.2519.5851.0149.4150.922

17. © Cumming & Johan (2013) Portfolio Size Variables Dependent Variable:  Number of firms in VC fund portfolio Independent Variables:  VC Fund Characteristics Fund type, # funds in VC firm, duration, # VC Managers, fundraising (drawdowns)  Entrepreneurial Firm Characteristics Development stages, life sciences, other high-tech  Financing Characteristics Frequency of use of Convertible Pref Equity, Staging, Syndication, $ Invested / Firm Capital  Market Conditions TSX Index Theory Data Regressions Conclusion/Summary 17

18. © Cumming & Johan (2013) Portfolio Size Regressions (1) All funds together  with dummy variables for the type of fund) (2) Private Independent Funds Only  Different types of funds face different restrictive covenants; different objectives (3) For Portfolio Size and Portfolio Size / Manager / Year Theory Data Regressions Conclusion/Summary 18

19. © Cumming & Johan (2013) Portfolio Size Box-Cox Transformation Grid search over various values of to allow for both concavity and convexity Transformation applies to independent variables, not the dependent variable Theory Data Regressions Conclusion/Summary 19

20. © Cumming & Johan (2013) Portfolio Size Heteroscedastic Box-Cox Box – Cox grid-search specification as per last slide Also consider where w=fund duration possibility of truncated observations in the data Likelihood dominance tests  superior High Adjusted R 2 (>.88) Theory Data Regressions Conclusion/Summary 20

21. © Cumming & Johan (2013) Portfolio Size 21 Table 17.5. Regressions with All Types of Venture Capital Funds in the Same Sample (continues on next slide) PANEL A. Dependent Variable: # of Entrepreneurial Firms in Venture Capital Fund Portfolio (continues on next slide) (1) Box-Cox(2) Linear(3) Box-Cox(4) Box-Cox(5) Box-Cox(6) Box-Cox Independent Variables Coefficientt-statisticSlopeElasticityCoefficientt-statisticCoefficientt-statisticCoefficientt-statisticCoefficientt-statisticCoefficientt-statistic Constant21.9974.415***21.9970.579147.6562.365**-10.119-2.891***-2.547-0.588-11.137-2.700***1.4420.510 Venture Capital Fund Characteristics Corporate Venture Capital -5.027-2.885***-5.027-0.0100.8470.094-7.521-3.694***-6.307-3.087***-7.016-3.429***-5.058-2.875*** Government Venture Capital 1.1410.6391.1410.0030.6100.0616.6143.203***5.5472.659***6.4613.120***5.8093.232*** LSVCC1.9101.1961.9100.0071.8870.2243.5042.056**4.7602.707***5.6993.238***7.8115.210*** Private Independent Venture Capital -10.757-8.669***-10.757-0.136-9.110-1.416-6.489-4.708***-7.870-5.593***-5.694-4.092***-6.469-5.355*** 2 or more Venture Capital Funds in the Venture Capital Mgmt.Firm -13.920-15.435***-13.920-0.163-6.379-1.351-15.670-15.114***-13.295-12.637***-15.406 - 14.731*** -14.615-15.997*** Venture Capital Funds Raised (Drawdowns) ('000) 0.1644.397***0.00020.48720.00027.698***0.3383.857***0.3463.697***0.3293.682***0.1454.050*** Venture Capital Fund Duration -2.482-3.985***-0.870-0.1370.2650.225-2.633-3.273***0.3700.466-1.698-2.037**-2.067-3.370*** # Venture Capital Fund Managers 7.95420.253***2.2100.5151.8185.748***8.29716.847***8.46816.346***8.44116.377***8.31319.372***

22. © Cumming & Johan (2013) Portfolio Size 22 Table 17.5. Regressions with All Types of Venture Capital Funds in the Same Sample (Continued) PANEL A. Dependent Variable: # of Entrepreneurial Firms in Venture Capital Fund Portfolio (Continued) (1) Box-Cox(2) Linear(3) Box-Cox(4) Box-Cox(5) Box-Cox(6) Box-Cox Independent Variables Coefficientt-statisticSlopeElasticityCoefficientt-statisticCoefficientt-statisticCoefficientt-statisticCoefficientt-statisticCoefficientt-statistic Entrepreneurial Firm Characteristics Early Stage17.8335.305***12.4380.60515.6131.344--- Life Sciences--- 0.4310.176--- 2.2711.089 Other High-Tech--- -19.152-9.454***--- -16.129-7.230***--- Entrepreneur / Venture Capital Different Provinces -23.242-11.909***-21.121-0.655-16.779-2.000**-26.509-11.432***-27.626-11.770***-27.880 - 11.940*** -23.206-11.756*** Financing Transactions Characteristics Staging Frequency-33.607-9.741***-25.932-1.062-26.072-2.093**--- -40.845-10.002***--- Syndication Frequency -32.113-11.494***-25.159-1.004-30.731-2.952***--- -25.178-12.816*** Venture Capital Investments / Ent. Capital -24.588-6.717***-19.441-0.764-22.264-1.706*--- 0.5020.1645.1651.783*--- Convertible Securities -13.253-4.556***-11.679-0.382-10.028-0.851--- -14.257-4.224***-12.909-4.443*** Market Conditions MSCI Return-10.956-2.632***-9.535-0.318-8.607-0.6973.3570.711-7.190-1.4971.2530.264-5.120-1.243 Returns to Scale λ0.41321.405***--- 0.34615.498***0.34014.543***0.34414.710***0.41419.778*** Adjusted R 2 0.8910.4430.8690.8700.8690.887 # Observations214

23. © Cumming & Johan (2013) Portfolio Size 23 Table 17.5. Regressions with All Types of Venture Capital Funds in the Same Sample (continues on next slide) PANEL B. Dependent Variable: # of Entrepreneurial Firms in Venture Capital Fund Portfolio / # Venture Capital Fund Managers / Investment Years (1) Box-Cox(2) Linear(3) Box-Cox(4) Box-Cox(5) Box-Cox(6) Box-Cox Independent Variables Coefficientt-statisticSlopeElasticityCoefficientt-statisticCoefficientt-statisticCoefficientt-statisticCoefficientt-statisticCoefficientt-statistic Constant2.9172.860***2.9172.2418.0992.502**0.6311.1601.0951.3640.3050.4601.4872.802*** Venture Capital Fund Characteristics Corporate Venture Capital -0.471-1.030-0.471-0.030-0.376-0.799-0.513-1.055-0.519-1.093-0.455-0.941-0.426-0.913 Government Venture Capital 0.0810.1580.0810.0040.0640.1200.3930.7380.3600.6830.4380.8260.2300.445 LSVCC-0.206-0.485-0.206-0.021-0.212-0.4800.0310.0720.1370.3170.2150.4940.0060.013 Private Independent Venture Capital -0.515-1.590-0.516-0.193-0.529-1.563-0.266-0.799-0.258-0.781-0.187-0.562-0.458-1.420 2 or more Venture Capital Funds in the Venture Capital Mgmt. Firm -0.160-0.667-0.160-0.052-0.194-0.787-0.357-1.436-0.223-0.894-0.278-1.104-0.172-0.709 Venture Capital Funds Raised (Drawdowns) ('000) 0.0060.5350.00030.4260.00024.628***0.0050.4880.0130.5310.0050.4350.0020.395

24. © Cumming & Johan (2013) Portfolio Size 24 Table 17.5. Regressions with All Types of Venture Capital Funds in the Same Sample (continued) PANEL B. Dependent Variable: # of Entrepreneurial Firms in Venture Capital Fund Portfolio / # Venture Capital Fund Managers / Investment Years (continued) (1) Box-Cox(2) Linear(3) Box-Cox(4) Box-Cox(5) Box-Cox(6) Box-Cox Independent Variables Coefficientt-statisticSlopeElasticityCoefficientt-statisticCoefficientt-statisticCoefficientt-statisticCoefficientt-statisticCoefficientt-statistic Entrepreneurial Firm Characteristics Early Stage0.6480.8950.5080.7200.4870.790--- Life Sciences--- 0.3790.723--- 0.5371.115 Other High-Tech--- -1.060-2.445**--- -0.727-1.574--- Entrepreneur / Venture Capital Different Provinces -0.739-1.517-0.692-0.627-0.646-1.459-0.791-1.554-0.817-1.565-0.861-1.691*-0.741-1.552 Financing Transactions Characteristics Staging Frequency-2.088-2.687***-1.769-2.068-1.616-2.495**--- -2.429-2.914***--- Syndication Frequency -2.476-3.927***-2.102-2.443-2.147-3.956***--- -1.952-4.130*** Venture Capital Investments / Ent. Capital -1.578-1.949*-1.340-1.556-1.267-1.810*--- 0.4410.6860.8441.419--- Convertible Securities -0.383-0.572-0.352-0.336-0.405-0.648--- -0.765-1.117-0.619-0.954 Market Conditions MSCI Return1.7642.494**1.5911.5861.8012.854***2.6623.574***1.6432.191**2.5133.349***2.2583.284*** Returns to Scale λ0.6052.549**--- 0.6242.408**0.4992.037**0.6242.147**0.7242.307** Adjusted R 2 0.3160.2570.2290.2590.2420.287 # Observations214

25. © Cumming & Johan (2013) Portfolio Size Summary of Some Key Results (refer also to Ch. 18) Empirical support for Kannianen and Keuschnigg (2003,2004):  expansion of portfolio size eventually becomes unprofitable as active VC investing and managerial advice gets diluted VCs have fewer firms in their portfolios when marginal costs are greater and monitoring and value added active assistance is more intensive  Greater frequency of staging and syndication  Private independent VCs VCs have more firms in their portfolios when marginal costs are lower and marginal benefits are greater  VC fund in VC firm with 2 or more VC funds  More VC managers  Convertible securities (for private independent funds) Theory Data Regressions Conclusion/Summary 25

26. © Cumming & Johan (2013) Portfolio Size Summary of Key Results (Con’t) Specialization and complementarities are important  Life Sciences, Other High-Tech, Early Stage Firms  Subsample of private independent funds only: different results Differences in the results across different types of VC funds  Private independent funds have smaller portfolios  Value added investors  Concave function for full sample (λ =0.4)  Less concave function for subsample of private independent funds  Less pronounced diminishing returns to scale (λ =0.8) Theory Data Regressions Conclusion/Summary 26

27. © Cumming & Johan (2013) Portfolio Size Conclusions Importance of context: type of entrepreneurial firm, type of venture capital firm, and nature of the financial contract Risk-taking and capital structure affect optimal portfolio size Future research  Differences across countries?  Impact on entrepreneurial firm innovation? Theory Data Regressions Conclusion/Summary 27