Venture capital partners that are distracted by IPOs tend to make investment decisions that lead to underperformance, new research shows.
Taking a portfolio company public involves everything from searching for underwriters to ensuring that the final close runs smoothly. These tasks pull executives’ attention away from other investments, which in turn suffer, according to Rustam Abuzov, a Ph.D. candidate at the University of Lausanne in Switzerland.
Abuzov said via email Friday that he wants to address a fundamental question about venture capital that remains unanswered: whether venture capitalists are able to pick winners.
“We know little about VCs’ abilities to identify young companies, which are poised to thrive ex-ante,” he said via email. “It could be the case that the success of renowned venture capital firms is built on better post-investment monitoring, networks, and reputation, combined with initial luck in the company selection. In my paper, I approach the question of skill in the company selection using the concept of limited attention.”
Abuzov’s research found that companies selected by those distracted partners were seven percent less likely to go public or to be acquired than portfolio companies of focused VCs. “These results reveal that investments made concurrently with the distraction events seem to create less value for their investors,” according to Abuzov.
Companies selected by distracted partners also sold for 16 percent lower multiples, the research showed. The dampening effect on exit multiples was only true for the 90 days following the IPO, though. In other words, distraction doesn’t appear to have a long-term impact on investments.
Abuzov, published his paper March 19, used several sources including Thomson Reuters’ VentureXpert, BoardEx, and SDC Platinum to compile data on 5,355 individual partners, 3,168 venture capital funds, and 1,372 venture capital firms.
“An active engagement in the IPO process is likely to significantly reduce the amount of time and effort that VCs can exert on screening, which in turn impairs their ability to choose promising companies with high growth potential,” according to the paper.
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The negative effects of distraction impact VCs working solo more than those on teams, the research showed.
Abuzov said via email that he will present his findings at the University of Oxford’s spring Private Equity Research Symposium, which takes place at the end of May.