Venture Capital Backing, Investor Attention, and Initial Public Offerings

Abstract

We propose and empirically analyze a new channel through which venture capitalists (VCs) may add value at IPO to the private firms that they invest in. We hypothesize that the IPOs of VC-backed firms garner greater “investor attention” (in the sense of Merton (1987)), allowing the IPO underwriters of such firms to perform two information-related roles more efficiently during the IPO book-building and road-show process: information dissemination, where the lead underwriter disseminates noisy information about various aspects of the IPO firm to institutional investors; and information extraction, where the lead underwriter extracts information useful in pricing the IPO firm equity from institutional investors. Based on this investor attention channel, we develop and test several implications for the IPO characteristics of VC-backed firms. We use a hand-collected dataset of pre-IPO media coverage as a proxy for investor attention in our empirical analysis. Our results are summarized as follows. First, IPOs of VC-backed firms attract greater investor attention than those of non-VC-backed firms; further, while the IPOs of both high- and low-reputation VC-backed firms attract greater investor attention than those of non-VC-backed firms, the IPOs of high-reputation VC-backed firms attract greater investor attention than those of low-reputation VC-backed firms. Second, VC-backed firms are associated with larger absolute values of IPO offer price revisions, greater IPO and after-market valuations, larger IPO initial returns, greater institutional investor equity holdings, and greater analyst coverage post-IPO. Our interaction tests reveal that, even after controlling for the direct effect of VC-backing, there is an incremental positive effect of higher investor attention received by VC-backed firms on various IPO characteristics. Our dynamic analysis of IPO firm valuation in the three years post-IPO shows that the valuation of VC-backed firms falls to a greater extent than those of non-VC-backed firms corresponding to investor attention fading with time, with the valuation of firms that received the greatest investor attention at IPO falling to the greatest extent. Our instrumental variable analysis shows that the positive relation we document between VC-backing, investor attention, and various IPO characteristics is causal.