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The influence of capital market laws and initial public offering (IPO) process on venture capital

https://doi.org/10.1016/j.ejor.2007.09.007Get rights and content

Abstract

This paper is concerned with the influence of capital market laws and initial public offering (IPO) process on venture capital. It discusses the impact of US federal state laws and Securities and Exchange Commission (SEC) regulations to the venture capital markets, arguing if the rules and regulatories are burdensome to entrepreneurs and new-growth businesses. The impact of Sarbanes-Oxley Act and the future Investment Act on venture capital funds and entrepreneurial companies going public are also discussed. The paper proposes the model of venture capital financing describing the process from fund raising to investment exits, the linkages of the venture capital market to the financial/capital markets and the related capital market laws. The policy implications on SEC regulations essential to the development of venture capital industry are suggested.

Introduction

Given that the capital market is essential for the venture capitalists to exit through an initial public offering (IPO) within the venture capital (VC) industry, this paper explores the influence of capital market laws and IPO process on venture capital. Given the scarcity of empirical research on the inter-relationships of capital market laws and the venture capital industry, this paper makes a contribution to a body of knowledge on VC-backed IPOs (entrepreneurial ventures).

The paper is structured as follows. Section 2 reviews the theoretical framework on the relation of venture capital funding and the capital market, legal structures and regulatories concerning the venture capital fund. Section 3 explores how the push for regulatory compliance (the capital market laws) can be burdensome for venture capital funds. This section discusses the influence of federal state laws and Securities and Exchange Commission (SEC) legislative initiatives/regulations and IPO process in the development of venture capital industry. Section 4 offers a model of venture capital financing from fund raising to management of investment exits. The model illustrates the linkages between the venture capital market and the financial/capital markets and the related capital market laws. Policy implications with regard to the development of venture capital industry as well as conclusions are drawn in Section 5.

Section snippets

The relation of venture capital funding and the capital market

Venture capital (VC) is a high-risk, potentially high-return investment to support business creation and growth. It is a source of funds that typically finance new and rapidly growing companies through equity participation (Bygrave and Timmons, 1992, Gompers and Lerner, 2001). In other words, VC is pre-IPO equity capital provided by professional investors. The concept of modern venture capital is defined by Megginson (2002) as a professionally managed pool of money raised for the purpose of

The capital market laws – the burden for VC-backed companies going public?

To understand the influence of capital market laws and IPO process on venture capital, the empirical analysis is based on 70 interviews with a range of individuals including SEC examiners, lawyers, venture capitalists, governmental officials, entrepreneurs, faculties, and policy analysts. The interviews were conducted in the US, using the semi-structured questionnaires with open-ended questions. The interview questionnaire is unique, in that it focusses on the perspective of entrepreneurial

Venture capital industry and SEC’s role in regulating the capital market

In the venture capital industry, the entrepreneur is the owner of the VC share. Venture capitalists liquidate their portfolio company investments by bringing venture-backed companies to public. Fig. 5 presents the model of venture capital financing describing the process from fund raising to investment exits. The model also describes the linkages of venture capital market to the financial/capital markets and the related capital market laws.

For the young companies entering the over-the-counter

Policy implications and conclusions

Given that the stock market is essential for the venture capitalists to exit through an initial public offering (IPO), this study explores the influence of capital market laws and IPO process on venture capital. The analysis suggests that the government should take action to improve the environment for small business capital formation, consistent with other public policy goals since entrepreneurial businesses are important to the economy. Policymakers wishing to develop venture capital market

Acknowledgements

The author is grateful for professional advice and supports of Mr. Edward A. Ryan, Jr.; Mr. Joseph B. Mick, Esq., Mr. Luis M. Barros, Mr. Daniel A. Mazzaferro and SEC staffs while working on the research at the United States Securities and Exchange Commission (SEC).

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