THE HIGH RISK AND HIGH REWARD GAME - PERFORMANCE OF VENTURE CAPITAL BACKED IPOS - DIVA

Master Thesis

The High Risk and High
Reward Game
Performance of Venture Capital Backed IPOs

 Authors: Didrik Brinkestam Persson & Johanna
 Karlsson
 Supervisor: Elias Bengtsson
 Examiner: Håkan Locking
 Term: Spring 2021
 Subject: Master thesis
 Course code: 4FE17E

Abstract
For start-up businesses, the source of outside capital can be retrieved from
the venture capital industry. The venture capital industry has grown
substantially over the past 50 years, reaching its pinnacle during the internet
bubble in the 1990s and serves as an important contributor to the economy.
After some time, and optimally when the start-up has matured into a
successful business, venture capitalists want to receive money in return for
their investments. Most commonly, the exiting of venture capital investments
is retrieved through an IPO. An IPO refers to the transition from a private
corporation to a public corporation and occurs when a private corporation
offers its shares to the public for the first time. The existing literature of IPOs
is commonly associated with the depiction of abnormal returns. More
precisely, the offer price is often underpriced in comparison to the closing
price on the first day of trading. In addition, the returns 1 to 5 years after
going public are often subject to subsequent declines (Miller & Riley, 1987;
Ritter, 1998). A part of the underperformance of IPOs is anchored in the type
of capital structure, venture capital. Thus, this study examines the
relationship between venture capital backed IPOs and IPO performance.
Furthermore, the relationship between the degree of venture capital, the
amount of capital held by the venture capital firm in the IPO, and IPO
performance are examined in order to discover eventual correlations.
Concerning the performed analysis, the study concludes that there is no clear
positive relationship between venture capital backing and IPO performance
in the short run. However, one could interpret that being a VC-backed IPO
can be prosperous for long-term performance since VC has a positive impact
on ROA. Regarding the degree of venture capital, it had a negative impact on
the ROA, i.e., the level of degree of venture capital does not have a positive
impact on the IPO performance

Key words
Initial public offerings, venture capital, venture capital backed IPOs, non-
venture capital backed IPOs, underpricing, initial first day return, abnormal
return.

Acknowledgments
We would like to express our very great appreciation to our supervisor Elias
Bengtsson and our examinator Håkan Locking for their valuable guidance,
enthusiastic support, and useful critique throughout this study. Our grateful
thanks are also extended to our opponents, who with valuable and
constructive suggestions on the seminars have supported the development of
this study.

Thank you,

Didrik Brinkestam Persson & Johanna Karlsson
May 2020

Table of Contents
1 INTRODUCTION ......................................................................................................................................... 3
 1.1 BACKGROUND.......................................................................................................................................... 3
 1.2 PROBLEMATIZATION ................................................................................................................................ 5
 1.3 PURPOSE .................................................................................................................................................. 6
 1.4 DISPOSITION ............................................................................................................................................ 7
2 SCIENTIFIC METHODOLOGY ................................................................................................................ 8
 2.1 RESEARCH APPROACH.............................................................................................................................. 8
 2.2 RESEARCH STRATEGY ............................................................................................................................. 8
 2.3 RESEARCH DESIGN .................................................................................................................................. 9
3 THEORY ...................................................................................................................................................... 10
 3.1 UNDERPRICING ...................................................................................................................................... 10
 3.1.1 The underpricing of IPOs ................................................................................................................. 10
 3.1.2 The underpricing of VC backed IPOs............................................................................................... 12
 3.2 LONG-TERM PERFORMANCE ................................................................................................................... 14
 3.2.1 Long-term performance of IPOs....................................................................................................... 14
 3.2.2 Long-term performance of VC-backed IPOs .................................................................................... 15
4 EMPIRICAL METHODOLOGY .............................................................................................................. 17
 4.1 MEASUREMENTS .................................................................................................................................... 17
 4.1.1 Venture Capital Measures ................................................................................................................ 17
 4.1.2 Short-Term Performance Measures ................................................................................................. 18
 4.1.3 Long-Term Performance Measures .................................................................................................. 18
 4.2 DATA COLLECTION ................................................................................................................................ 20
 4.3 SAMPLE .................................................................................................................................................. 21
 4.4 REGRESSION SPECIFICATION ................................................................................................................. 23
 4.4.1 OLS regression model ...................................................................................................................... 23
 4.4.2 Variables ........................................................................................................................................... 25
5 EMPIRICAL RESULTS ............................................................................................................................. 29
 5.1 DESCRIPTIVE STATISTICS ....................................................................................................................... 29
 5.2 HYPOTHESIS TESTING ............................................................................................................................ 34
 5.2.1 Correlation Analysis ......................................................................................................................... 35
 5.2.2 T-Test ................................................................................................................................................ 36
 5.2.3 Regression Analysis .......................................................................................................................... 37
 5.2.4 Multicollinearity ............................................................................................................................... 42
6 ANALYSIS AND DISCUSSION ................................................................................................................ 44
 6.1 ARE VC BACKED IPOS ENTAILED WITH HIGHER INITIAL FIRST DAY RETURNS? ..................................... 44
 6.2 DOES VC BACKED IPOS UNDERPERFORM NON-VC BACKED IPOS IN THE LONG RUN? .......................... 46
7 CONCLUSION ............................................................................................................................................ 52
8 APPENDIX ................................................................................................................................................... 54
9 REFERENCES............................................................................................................................................. 60

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Table of Tables
TABLE 1. SAMPLE SELECTION.................................................................................................................................. 23
TABLE 2. SUMMARY OF REGRESSION VARIABLES .................................................................................................... 25
TABLE 3. TOTAL SAMPLE OF VC BACKED AND NON-VC BACKED IPOS BY YEAR ................................................... 29
TABLE 4. TOTAL SAMPLE OF VC BACKED AND NON-VC BACKED IPOS BY INDUSTRY ............................................ 30
TABLE 5. DESCRIPTIVE STATISTICS ......................................................................................................................... 30
TABLE 6. TEST OF DIFFERENCES IN DESCRIPTIVE STATISTICS .................................................................................. 32
TABLE 7. TOTAL SAMPLE OF IPOS SUBJECT TO LOCK-UP AGREEMENT BY YEAR ..................................................... 33
TABLE 8. TOTAL SAMPLE OF VC BACKED AND NON-VC BACKED IPOS SUBJECT TO LOCK-UP AGREEMENT ........... 33
TABLE 9. CORRELATION ANALYSIS ......................................................................................................................... 35
TABLE 10. TWO-SAMPLE T-TEST ............................................................................................................................. 36
TABLE 11. OLS REGRESSION ANALYSIS INCLUDING THE DEGREE OF VENTURE CAPITAL ........................................ 37
TABLE 12. OLS REGRESSION ANALYSIS EXCLUDING THE DEGREE OF VENTURE CAPITAL ....................................... 40
TABLE 13. MULTICOLLINEARITY STATISTICS .......................................................................................................... 42
TABLE 14. SUMMARY OF MAIN FINDINGS ................................................................................................................ 44
TABLE 15. FULL LIST OF IPOS AND VENTURE CAPITAL FIRM OR FUND .................................................................... 59

Table of Equations
EQUATION 1. FIRST DAY RETURN ............................................................................................................................ 18
EQUATION 2. BUY-AND-HOLD ABNORMAL RETURN ................................................................................................ 19
EQUATION 3. RETURN ON ASSETS............................................................................................................................ 20
EQUATION 4. OLS REGRESSION............................................................................................................................... 24
EQUATION 5. REGRESSION MODELS INCLUDING DEGREE OF VENTURE CAPITAL ..................................................... 38
EQUATION 6. REGRESSION MODELS EXCLUDING DEGREE OF VENTURE CAPITAL..................................................... 41

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1 Introduction

1.1 Background
The entrepreneur along with its family members and friends is usually capable of funding the
initial capital that a start-up business requires. However, as the business grows, it becomes
necessary to raise outside capital and diversify the risk that a sole proprietorship may infer
(Berk & DeMerzo, 2013). Among these outside capital sources are angel investors, venture
capitalists, institutional investors, and corporate investors. The first round of outside funding
is usually retrieved from angel investors. These angels are individual investors, often with
close ties to the entrepreneur, who receive a considerable number of shares and influence in
return for their investments (Berk & DeMerzo, 2013; Gompers & Lerner, 2001).

The difficulty of finding angels as well as the need for additional capital usually requires that
firms find another capital source (Berk & DeMerzo, 2013; Gompers & Lerner, 2001). For
start-up businesses, the source of outside capital can be retrieved from the venture capital
industry. The venture capital industry has grown substantially over the past 50 years, reaching
its pinnacle during the internet bubble in the 1990s and serves as an important contributor to
the economy (Berk & DeMerzo, 2013). By actively managing the portfolio companies,
venture capital investments support innovation and digitalization in highly productive sectors
and strengthen the GDP through spillover effects (Invest Europe, 2021; SVCA, 2021).

A venture capital firm is a limited partnership that invests in young promising businesses that
show high growth potential. The first stage that a venture capital firm must complete is
fundraising. Fundraising involves the creation of venture capital funds by collecting capital
from interested investors. Further, the venture capital firm must select suitable start-up
businesses to invest the venture capital fund in. When the venture investment is made, the
venture capital firm actively manages the portfolio companies. Thus, venture capital firms
contribute with their capital and expertise in order to increase the chances of growth and
success for young businesses (Gompers & Lerner, 2001; SVCA, 2019).

The final task for a venture capital firm is exiting. After some time, and optimally when the
start-up has matured into a successful business, venture capitalists want to receive money in
return for their investments. To do so, the venture capitalists seek for potential buyers so that
their shares in the start-up businesses can be liquidated into realized returns. This stage can

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occur at different times depending on the start-up business's maturity pace and the venture
capital firm’s desire. Most commonly, the exiting of venture capital investments is retrieved
through an Initial Public Offering, hereafter IPO (Gompers & Lerner, 2001; Jain & Kini,
1995; SVCA, 2019).

An IPO refers to the transition from a private corporation to a public corporation and occurs
when a private corporation offers its shares to the public for the first time (Berk & DeMerzo,
2013). According to Ritter & Welch (2002), the primary reason firms choose to go public is to
raise capital and extend their access to capital. Prior to an IPO, a firm usually raises capital
through a small number of private investors who gain shareholding in return. These investors
can either be entrepreneurs, family members, and friends or be of a more professional nature
such as venture capitalists and angel investors, as depicted above. In order for the firm to raise
additional capital, the firm must offer its shares to the public (Gompers & Lerner, 2001).

Ritter & Welch (2002) presents two theories in order to explain why firms choose to go
public. The market-timing theory implies that the choice of going public confides in the
issuing activity cycles and is considered to be the most important theory. An asymmetric
information perspective assumes that the public market provides entrepreneurs with valuable
information. If a bear market is present, the share price is most likely low and the firm will
therefore postpone its IPO until a bull market. A non-asymmetric information perspective
would assume that the entrepreneurs are provided with valuable information from their
internal activities rather than the public market. The changes in value are therefore not as
quickly absorbed by the entrepreneurs and their value adjustments are somewhat delayed.
However, regardless of the driving factors of the public market price or the entrepreneur's
price, an entrepreneur is more likely to sell its shares post an increase in market valuation
(Ritter & Welch, 2002).

The life cycle theory is considered the second most important theory and suggests that firms
go public due to the state of the firm rather than the state of the market. After reaching a
certain size, it will be optimal for a firm to go public. This is due to the fact that the
entrepreneurs will attain a higher value of the firm if they go public compared to an outright
sale. Moreover, since venture capitalists and angel investors possess undiversified portfolios,
the diversified public investors are more likely to pay a higher price. The high public price

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will facilitate market competition and put faith into investors, customers, creditors, and
suppliers (Ritter & Welch, 2002).

1.2 Problematization
The existing literature of IPOs is commonly associated with the depiction of abnormal
returns. More precisely, the offer price is often underpriced in comparison to the closing price
on the first day of trading. In addition, the returns 1 to 5 years after going public are often
subject to subsequent declines (Miller & Riley, 1987; Ritter, 1998).

In a review of existing literature, Ritter, J.R. and Welch, I. (2002) summarizes the explanatory
factors of these abnormal returns. One of the explanatory research fields derives from
behavioral finance and the occurrence of overconfidence. For instance, Teoh et al. (1998)
conclude that the post-IPO underperformance partly is connected to optimistic accounting in
the early life cycle due to the desire to be interpreted as prosperous when going public.
Purnanandam and Swaminathan (2004) confirm this with findings that IPOs priced higher
compared to similar public market corporations show approaches to perform weakly in the
long run, despite the higher returns of the first day.

A different field of the research explains the underpricing issue with the presence of
asymmetric information. Miller (1977) argues that the long-run underperformance confides in
the limited ability to short IPOs and the investors’ contradicted expectations on firm
valuation. A while after an IPO occurs, the variance of the investor's opinions will converge
towards the mean and the price will drop. This statement is further developed by Bradley et
al. (2001) who explain that the long-run underperformance is due to lock-up agreements. The
lock-up agreements entail that there is a restriction regarding selling the IPO for a certain
period of time. Once the lock-up agreement expires, many investors immediately sell their
holdings which results in notable negative returns and high volumes.

Further, Bradley et al. (2001) found that the underperformance due to the lock-up agreements
was concentrated to venture capital backed IPOs. In fact, a great part of the research in post
IPO performance examines the possible differences that VC backed and non-VC backed IPOs
entail. However, the findings of its impact are contrasting. For instance, Jain, B.A. and Kini,
O. (1995), find that VC backed IPOs in the U.S. exhibit superior post-performance relative to

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non-VC backed IPOs. Meanwhile, Ber et al.’s (2007) evidence from Israel entails that the
post-listing performance of VC backed IPOs are not statistically different from non-VC
backed IPOs.

Apart from contrary findings across countries, the literature within VC backed IPOs also
varies when it comes to the choice of measurement. For instance, Ritter, J.R. and Welch, I.
(2002) criticize the results of previous studies for being sensitive to the chosen method and
time period. Krishnan et al. (2011) nuances the research of VC backed IPOs by measuring the
impact of venture capital reputation. VC reputation, in terms of VC backed IPOs prior market
share, turned out to be positively related to the long-run performance of IPOs where the better
reputation led to the better post IPO performance. Although its variations, some recurrent
attributes in the literature are noteworthy as well. Coakley, J. et al. (2007) points out how a
superior number is based on a U.S. sample, and Jain, B.A. and Kini, O. (1995) continue with
the observation that most samples are dominated by high-tech firms.

Given the existing literature's concentration on the U.S. but also its contrasting findings of VC
backed IPO's impact on post-IPO performance across countries, it is of interest to further
study the impact of venture capital. Therefore, this study will provide the existing research
with a study in another context, the nation of Sweden. Additionally, as a variation of methods
and time periods are used in previous studies, investors nor scholars can’t conclude any
absolute determining factors of the matter. An interesting aspect that is rarely discussed in the
literature is to what extent the degree of venture capital has any implications for the IPOs
performance, both in the long and short run. Hence, this thesis will contribute to the existing
literature by examining the impact different degrees of venture capital have on IPO
performance in Sweden. Moreover, as the area of matter covers young corporations over a
short time period, it is difficult to adjust for risk. This thesis will therefore not include any risk
adjustments in the empirical method.

1.3 Purpose
This thesis aims to find whether venture capital and different degrees of it has an impact on
post IPO performance or not.

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1.4 Disposition
The remainder of this thesis will proceed as follows; Section 2 will cover the scientific
methodology including the approach, strategy, and design of the research. Section 3 will
survey the existing literature of the research area. Section 4 will cover the empirical
methodology of the study and section 5 the empirical results. Section 6 will analyze and
discuss the empirical results with support in previous literature. Section 7 will conclude.

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2 Scientific Methodology

2.1 Research approach
Before presenting the approach of the study, it can be necessary to clarify the essence of the
methodology. Taylor, Bogdan & Devault (2015) refers to methodology as the specific
strategy to approach a dilemma in order to find answers. However, it might seem diffuse why
one should examine research methodology. On the other hand, Bryman & Bell (2017)
underlines that the understanding of research methodology is important due to the fact that it
improves the ability of the writer to avoid entanglements. Moreover, Bryman & Bell adverts
that research methods are central in order for the writer to fulfill the purpose of the study, i.e.
finding answers to the problem that is the target of the study.

Further, in the literature of Bryman & Bell, it is noticeable that the most common strategy
when performing empirical studies is a deductive approach. The deductive approach implies
that the study consists of theoretical inputs and hypotheses, which is suitable for this type of
study. The hypotheses are then tested on the basis of the data collected for the study in order
to provide the research with results. The hypotheses are a central matter of the research, as for
this study. The hypotheses contain the main points of the study, and they are then converted
into relevant components in the form of data. Furthermore, the deductive approach will be
used in order to examine the relationship between the degree of venture capital and the IPO
performance of Swedish corporations. This will benefit the study by granting it to culminate
into applicable findings. Moreover, since the research field with existing theories and
literature related to the matter of IPOs is broad, it will be used as a basis for this study.
Therefore, the deductive approach is beneficial since it allows the study to formulate
hypotheses with regard to the existing research in order to further develop it.

2.2 Research Strategy
In the literature of Bryman & Bell (2017), it is further explained that there are different
strategies available when performing research. One strategy is quantitative research which
implies a quantitative focus regarding both collection and analysis. The quantitative approach
will be a part of this study, due to its quantitative nature and also since a quantitative focus
will be necessary in order to give answers to the questions of the study. The other strategy
when performing research, described by Bryman & Bell, is qualitative research. This strategy

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is entailed with verbal aspects instead of quantitative matters as for the other strategy. Hence,
words are the pervading factor when performing qualitative research, both when collecting
data as well as performing an analysis. It is therefore clearer why the quantitative approach is
more appropriate for the purpose of this study where an examination of quantitative aspects
regarding IPOs and venture capital will be performed.

2.3 Research Design
Bryman & Bell (2017) extends the research approach by describing different research designs
that are necessary in order to perform a study. The design that will be used for this study is the
longitudinal design. The longitudinal design is explained as research in which one collects
data for several time periods where change over time is measured and analyzed. Since the
study will be based on the development of IPOs over time, it is thereby appropriate to use the
longitudinal design in order to fulfill the target of the study. However, the longitudinal design
can be of a panel study type or a cohort study type. The two types are similar but they do
correspond to some dissimilarities that are important. Both of the study types have the ability
to understand causal connections over time, but the panel study is regarded to be more
efficient when it comes to longer time periods. Panel studies, unlike cohort studies, have a
combination of both change over time and cross-sectional aspects in their approach (Bryman
& Bell, 2017). Thus, since this study will focus on change over time as well as being of a
cross-sectional nature, the longitudinal panel study approach is convenient.

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3 Theory
The performance of IPOs has been given great attention by researchers in recent years. What
is recurring in the existing research are the findings that IPOs are to a large extent associated
with abnormal returns. Moreover, first day returns are identified with underpricing whereas
returns 1 to 5 years after going public often are subject to subsequent declines (Miller &
Riley, 1987; Ritter, 1998). In order to get an understandable overview of the matter, this
section will present the findings of underpricing and long-term performance separately. Each
subsection will first involve a theoretical explanation regarding the abnormal returns of IPOs.
Thereafter, the findings in the existing literature that are concentrated on the venture capital
aspect will be presented.

3.1 Underpricing

3.1.1 The underpricing of IPOs
A great part of the existing literature of IPOs entails the findings of the dominated
performance indicator underpricing (e.g., Miller & Riley, 1987; Ritter, 1984). Underpricing
refers to the difference between the IPOs offering price and the closing price on the first day
of trading. More precisely, underpricing occurs when the IPO closes above the offered price
on its first day of trading (Ibbotson, Sindelar & Ritter, 1988). Researchers refer to
underpricing and initial first day return interchangeably.

A range of theories has been presented in order to explain the underpricing issue of IPOs.
Although the classification of the theories tends to vary by authorship, existing literature
contains more or less the same explanations. In order to summarize existing literature's
explanatory theories of underpricing, we will regard Ritter (1998) and Ljungqvist (2007)
explanatory hypotheses as well Jenkinson & Ljungqvist (2001) and Ritter & Welch (2002)
exclusive literature reviews of the matter.

The winner’s curse hypothesis derives from the assumption of asymmetric information.
Moreover, a certain group of investors has superior information compared to the issuer and
other investors. Since the offered shares of an IPO are roughly issued at a fixed rate and
volume, a strong demand will result in rationing. The investors with superior information
have the ability to recognize if an IPO is over- or underpriced whereas the investors with

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informational disadvantage cannot. The IPOs identified as overpriced will therefore face a
decreased demand from the informed investors. However, the uninformed investors, unaware
of the overprice, will be able to purchase a larger number of shares and thus face the winner’s
curse. Moreover, the uninformed investors will obtain a full allocation of the overpriced
shares while they will only be allocated a fraction of the underpriced shares. Thus, in order for
these investors to be compensated for the unevenly distributed allocation of shares and to
break even, they will only purchase reasonably underpriced IPOs (Rock, 1986; Ritter, 1998;
Ritter & Welch, 2002). Evidence from Singapore implies that a strategy with informational
disadvantage merely broke even (Koh & Walter, 1989).

The market feedback hypothesis assumes that if book building is present, underwriters can
receive information from investors. With the presence of book building, the offered shares of
the IPO are fixed within a preliminary price range. This facilitates the underwriters' possibility
to seize the potential demand of investors during the pre-IPO period and set an accurate
offering price as possible. Thus, if a large demand is found, the underwriters can determine a
higher price within the fixed range. However, if investors are aware that revealing indications
of willingness to pay a higher price will lead to a higher offer price, they will require
something in return. In order to compensate the investors for giving valuable information, the
underwriters must offer them underpricing to an extent where the investors would not reveal
inaccurate information (Ritter, 1998; Ritter & Welch, 2002). A study of book building around
the world reveals that investors who give up valuable information are awarded with desirable
allocations (Cornelli & Goldreich, 2001).

The bandwagon hypothesis derives from the assumption that investors pay attention to other
investors' actions. Despite access to prosperous information of an IPO, an investor may refuse
to submit purchases if other investors show no interest in purchasing the same shares. In order
to prevent this bandwagon effect or negative information cascade, the issuer must at an early
stage create a perception of demand. Through underpricing, a small number of investors will
submit purchases and thus encourage other investors to purchase shares. Optimally, the other
investors will ignore the available information and instead imitate the early investors (Ritter,
1998; Welch, 1992). A paper contends that informational cascades are a reflection of the
issuer's choice of pricing and that the investors confide in the actions of the early investors
rather than their own information (Welch, 1992).

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The signaling hypothesis assumes that the issuer is more informed than the investor. More
specifically, the issuer has access to private information about the firm that is unavailable to
the investor. In such cases, the issuer wants to signal its high quality, at a cost, in order to
distinguish itself from low-quality issuers. By using IPO underpricing as a signal, the issuer
can expect favorable market responses to seasoned equity offerings and dividend
announcements. In these signaling theories, researchers often refer to the issuing of the costly
signal as leaving money at the table (Allen & Faulhaber, 1989; Ljungqvist, 2007; Ritter &
Welch, 2002; Welch, 1989). Evidence reveals that there is a positive relationship between
IPO underpricing and seasoned equity offerings stock price reactions, considering that
underpricing is viewed as a signal of quality (Jagadeesh et al., 1993; Welch, 1989).

The lawsuit avoidance hypothesis derives from symmetric information instead of asymmetric
information. In the U.S., the Securities Act of 1993 ensures that those who sign the IPOs
prospectus are held liable for any possible defaults in the future. An issuer pricing a share too
high is more likely to suffer a lawsuit than an issuer who underprices the share, considering
that the share, later on, will drop below the offer price. Thus, the issuer uses underpricing as a
way to reduce its litigation risk and avoid future lawsuits (Ritter, 1998; Ritter & Welch,
2002). Although theoretical evidence implies that IPO underpricing is associated with
litigation risk, it cannot be viewed as a solely explanatory factor of underpricing (Hughes &
Thaker, 1992)

The ownership dispersion hypothesis assumes that the issuer uses underpricing as a means to
create a demand among investors which in turn will generate a diverse number of
shareholders. A dispersed ownership structure would improve the management's control over
the shareholders and the IPO's overall liquidity on the market (Ritter, 1998).

3.1.2 The underpricing of VC backed IPOs
The findings of venture capitalist's involvement in the IPOs underpricing issue are to a large
extent concentrated in the U.S. market. Megginson and Weiss (1991) found that VC backed
IPOs between the years of 1983-1987 are identified with lower underpricing than non-VC
backed IPOs. The reason presented was that VC involvement indicates a high quality of the
issue. Further, the venture capitalists reduce the information asymmetry between the issue and
the investors. Likewise, Barry, Muscarella, Peavy, & Vetsuypens (1990) revealed that VC

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backed IPOs between the years 1978-1987 entail less underpricing than non-VC backed IPOs.
By possessing a considerable number of shares, maintaining the board and other top executive
positions, the venture capitalists have an important monitoring role in the issuing firm. In
order to provide the firm with a high level of monitoring skills, the venture capitalists usually
concentrate their investments on certain industries. Thus, the indications of reputational
capital and high expertise that VC involvement entails, reduces investor's uncertainty which
in turn decreases the underpricing of an IPO (Barry, Muscarella, Peavy, & Vetsuypens, 1990).
This is in line with the documenting of Megginson and Weiss (1991) where it is presented
that the VC involvement reduces the information asymmetry in the offering process.
Similarly, Jain and Kini (1995) suggest that the VC monitoring services are subject to
favorable market responses in the early stages. However, these differences dissolve in the
long run. Thus, the services of venture capitalists are of a higher necessity before and at the
beginning of an issuance.

Inconsistent with prior research, Gompers's (1996) grandstanding hypothesis suggests that VC
involvement indicates a higher level of underpricing. The funds that venture capitalists raise
from investors are liquidated at a certain expiration date in order for the original investors to
be rewarded. The most common way to realize these returns are through IPOs. In order for
venture capital firms to receive fundraising in the future, it is essential that they show a
capability of taking firms public. The cost of underpricing is thus considered irrelevant in
comparison to going through with an IPO. This is considered especially true for young VC
firms since they yet lack an established reputation (Gompers, 1996). Similarly, Lee & Wahal
(2004) finds support in the grandstanding hypothesis and reveals that VC backed IPOs are
entailed with greater underpricing than non-VC backed IPOs between the years 1980-2000.

Bessler & Seim (2012) studied a sample of VC backed IPOs and non-VC backed IPOs in
Europe between the years of 1996-2010 and found that the VC-backed IPOs were subject to a
high level of underpricing.

With support in existing literature’s contrasting findings of venture capital involvement in
IPOs, the first hypothesis is outlined as follows:

H1: Venture capital backed IPOs are entailed with higher initial first day returns than non-
venture capital backed IPOs

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3.2 Long-term performance

3.2.1 Long-term performance of IPOs
In addition to the underpricing issue, IPOs are commonly associated with poor long-term
performance in existing literature (Ritter, 1998). Ritter (1991) found that the following three
to five years after an IPO are identified with relatively poor performances. Moreover, Brav,
Geczy & Gompers (2000) revealed findings that over a five-year period, IPOs
underperformed the S&P 500 by an average of 44 %. Coherent, Ritter & Welch (2002) found
that IPOs underperformed by an average of 23.4 % relative to the market over a three-year
period.

A popular explanation for the underperformance is the appearance of overoptimism among
investors. Miller (1977) assumes that investors have heterogeneous opinions of valuation. The
disparity between the investors' opinions will decrease over time and thus result in a price
decline. Ritter (1998) evaluates this by presenting the divergence of opinion hypothesis. If the
value of an IPO is uncertain, the optimistic investors will value it extremely high compared to
the valuations among pessimistic investors. Along with time, the information asymmetry is
reduced, the gap between the two types of investors is eliminated, thus the price will decrease.

Another proposed explanation involves the market timing aspect from the issuer's perspective.
Ritter (1998) classifies this as the windows of opportunity hypothesis. If there are certain
periods where the investing public tends to act in an optimistic manner regarding potential
growth for IPOs, issuers might attempt to time the public offering in order to float the wave of
optimism. The basis for the hypothesis is that corporations turning into IPOs in periods with a
high volume of IPOs tend to be overvalued. In other words, high-volume periods of IPOs
would imply that they should be depicted by low long-term returns. This is further evaluated
by Schultz (2003) who presents the Pseudo market timing hypothesis and implies that firms
are more likely to go public when the market provides a high share price. This means that
more IPOs tend to follow fortunate IPOs. Consequently, the volume of IPOs will be higher in
times of higher share prices than in times of lower share prices. Naturally, this process will
continue until the prices finally drop and the number of IPOs decline. This means that the last
sample of IPOs are not only subject to underperformance, but also constitute a large fraction
of the total IPO sample. Thus, if the IPO performance is measured by equal-weighted returns,
the periods of high volume will be given greater influence and generate underperformance for

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the entire sample. This is supported by Loughran, Ritter, and Rydqvist (1994) who reveal
findings that the volume of IPOs increases in time with the market in 14 countries.

Additional explanations regard the underwriters of the issuance. Ritter (1998) refers to this as
the impresario hypothesis. The impresario hypothesis implies that the underwriters have the
ability to manipulate IPOs. In order for the underwriters to generate high demand and
favorable initial first day returns, they will underprice the IPOs. Hence, the basis for the
hypothesis is that the corporations with the highest initial first day returns have the worst post-
IPO performance.

3.2.2 Long-term performance of VC-backed IPOs
As with underpricing, the findings of VC backed IPO's long-term performance in existing
literature are contrasting. Brav and Gompers (1997) examine 934 VC backed IPOs in relation
to 3 407 non-VC backed IPOs over a five-year period in the U.S., in order to compare the IPO
performance. The results provided by Brav and Gompers indicate that VC backed IPOs do
outperform non-VC backed IPOs. However, the authors point out that the result is consistent
only when the returns are weighted equally. The outperformance is due to the added value and
reduction of information asymmetry that venture capitalists entail.

Jain & Kini (1995) find that both VC backed IPOs and non-VC backed IPOs are subject to a
decline when comparing the pre IPO performances with post-issue performances years 1 to 3.
However, the VC backed IPOs exhibited superior post-issue performances relative to the non-
VC backed IPOs. Thus, since the differences between VC backed and non-VC backed IPOs
tend to dissolve over time, they suggest that the monitoring services of venture capitalists are
most appreciated in the early years. Similarly, Bessler & Seim (2012) found that European
VC backed IPOs exhibit positive returns the first three years after going public. Noteworthy,
the first year after going public was subject to an acceleration whereas the following two
years exhibited marginally declining returns. The findings are supported by the expiration of
lock-up periods that usually occur during the first year after going public and which enables
investors to exit their investments.

The impact of lock-up periods on IPO's long-term performance has received considerable
attention from several researchers. Bradley et al. (2001) suggest that the underperformance of

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IPOs is due to lock-up agreements which entails a restriction regarding selling the IPO for a
certain period of time. Once the lock-up agreement expires, many investors immediately sell
their holdings which results in notable negative returns and high volumes. Bradley et al.
(2001) found that the underperformance due to lock-up agreements was concentrated to
venture capital backed IPOs. This is supported by Field & Hanka (2001) who finds that the
abnormal returns and abnormal volumes at the lock-up expiration date, usually 180 days after
an IPO, are greater for VC backed IPOs. This indicates that venture capitalists sell their
holdings more aggressively in comparison to other investors who also are subject to the lock-
up agreement.

Considering existing literature’s results of VC backed IPO’s long-term performance, our
second hypothesis is outlined as follows:

H2: Venture capital backed IPOs underperform non-venture capital backed IPOs in the long
run

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4 Empirical Methodology

4.1 Measurements

4.1.1 Venture Capital Measures
To serve the purpose of this thesis, it is necessary to define the measurement of venture
capital. Several different measures of venture capital have been identified in previous studies.
Krishnan et al. (2011) choose to focus on the reputation of the venture capital firm backing
the initial public offering in order to examine the relationship between the reputation and the
long-term performance of the IPO. Krishnan motivates the relevance of the VC reputation
since it is regarded as an impacting factor regarding the IPO performance due to the fact that
it provides the IPO with competitive advantages and that it improves the IPO reputation as
well. In other words, reputation is an important asset and was thereby a relevant object for
testing concerning IPO performance. Another aspect regarding venture capital measures is
more standardized and is focused on the basic presence of VC in initial public offerings and
the effects of it. Further, Brav and Gompers (1997) examine the difference between IPO
performance for IPOs with no venture capital and IPOs backed with venture capital. Thus,
this type of VC measure is based on the existence of venture capital and no specific type of
venture capital nor the reputation of it.

Another measure of venture capital is the fraction of venture capital of the IPOs capital in
order to examine whether there is a positive relationship between venture capital and IPO
performance. This measure is used by Jain and Kini (1995) where they use the variable alpha
as a symbol for the fraction of the firm owned by the original owners, i.e. entrepreneurs and
venture capitalists. By doing this, Jain and Kini made it possible to delve deeper into the
relationship between different degrees of venture capital and IPO performance.

This thesis will measure venture capital similar to Brav and Gompers (1997), where venture
capital simply refers to if the IPO was venture capital backed at the time of the IPO.
Moreover, this implies if the IPO had an owning firm or fund that corresponds to our
definition of venture capital at the time of the offer (For further description of our venture
capital definition, see 4.4 Sample). To further be able to nuance the impact of venture capital,
an alternative of Jain and Kini’s (1995) measure is implemented. The venture capital measure
will be developed by solely focusing on the fraction of venture capital. More precisely, the

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amount of capital held by the venture capital firm(s) or fund(s) at the time of the IPO will be
controlled for.

4.1.2 Short-Term Performance Measures
In order to measure the short-term performance of the IPOs, we have reviewed the general
formula of the initial first day return as presented in previous studies. For instance,
Megginson and Weiss (1991) reviewed the closing price on the first day of trading and the
offer price when calculating the initial first day return for a sample of venture capital backed
IPOs and non-venture capital backed IPOs. Likewise, this thesis has adopted the following
formula when calculating each IPO’s initial first day return:

 − 
 =
 
Equation 1. First day return

The closing price on the first day of trading for each IPO corresponds to the stock price from
the first available date displayed in DataStream. The offer price refers to the price offered in
each IPOs prospectus or listing memorandum. In order to avoid exchange rate fluctuations, all
prices were collected in SEK. The initial first day return was then calculated by subtracting
the closing price on the first trading day with the offer price. To obtain each IPOs initial
return, the sum was then divided by the offer price. This gives rise to review whether the IPO
is underpriced or not at the time of the IPO.

4.1.3 Long-Term Performance Measures
When widening the measurements of the IPO performance to the longer perspective, several
factors can be used in order to retrieve some sort of indication of the result. In a study
performed by Krishnan et al. (2011) where the post-IPO performance is examined, various
indicators of the post-IPO performance are described. The presented performance
measurements are the rate of return on assets (ROA), market-to-book ratio, long-run exchange
listing survival rate, and buy-and-hold abnormal stock return. Further, Walters, Kroll, and
Wright (2010) used similar measurements except they also included firm sales growth. As
there are numerous amounts of performance measurements to adopt, it is important to regard
those that suit the purpose of this thesis the most.

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4.1.3.1 Buy-and-Hold Abnormal Return
In order to retrieve an indicator of the eventual abnormal returns, previous studies with similar
purposes have been reviewed. In a study by Chahine (2004), the Buy-and-Hold Abnormal
Return (BHAR) is used. Further, Krishnan (2011) and Brav & Gompers (1997) used BHAR
when they studied the differential impact of venture capital backed and non-venture capital
backed IPOs on post IPO performance. As this thesis serves a similar purpose as the previous
studies, we will adopt the following formula to calculate the Buy-and-Hold Abnormal Return:

 = ∏(1 + ) − ∏(1 + )
 =1 =1

Where,
 = ℎ ö 
 = 
 = 
Equation 2. Buy-and-hold abnormal return

In order to calculate the BHAR, we have collected each IPO’s daily closing stock prices,
starting the first day of trading until fifteen months post the IPO date. Further, to relate the
stock price data with a benchmark, we have collected daily stock prices for a market index
over the same time period as each individual IPO’s stock price data. A market index
corresponds to the overall performance of the listed corporations and is, therefore, necessary
to include in the formula since it is a proper indicator to compare the IPO performance with.
Of the total IPO sample, 78 of the IPOs were listed on the OMX Stockholm, 76 on the First
North Stockholm, and 34 on Aktietorget (Spotlight Stock Market). Thus, in order to include
an index that matches the IPOs by size and industry as much as possible, daily stock price
data between 2010 and 2019 for OMX Stockholm PI (OMXSPI) have been collected. To
calculate and , the holding period return on a daily basis was computed. More
precisely, the following day’s stock price was subtracted from the previous day’s stock price.
The sum was then divided by the previous day’s stock price. To obtain daily BHAR for each
IPO, each IPOs daily holding period return was subtracted from the corresponding daily
holding period return of the market index during the same time period ( - ). Lastly, the
sum of the IPO’s BHAR was computed for the first, third, sixth, ninth, twelfth, and fifteenth
months post the individual IPO dates.

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4.1.3.2 ROA
In order to widen the perspective and improve the indication of the results, an additional long-
term performance measure will be reviewed. As Krishnan (2011) refers to the rate of return
on assets (ROA) as one of the most common performance standards, ROA will be adopted in
this study. The following formula will be used in order to calculate ROA:

 =
 
Equation 3. Return on assets

The components to calculate ROA were gathered from the year-end financial statements of
the IPOs the year after they went public. Thus, the time period that each IPO's ROA is based
upon varies depending on what time of the year it was issued. However, the variations that the
time differences may infer are considered minor and not causing any major implications for
the study. The financial statements data was obtained from DataStream in SEK. In order to
compute each IPO's ROA, the operating income was divided by the total assets.

4.2 Data Collection
The data for this study were retrieved from the private equity screener in Thomson Reuters
DataStream. Through DataStream’s private equity screener, we were able to collect daily
stock price data and yearly financial statement data of Swedish IPOs that were listed on the
following stock exchanges between the years of 2010 and 2019: OMX Stockholm, First North
Stockholm, and Aktietorget. Due to limitations regarding screening whether the IPO was
venture capital backed at the time of the IPO, secondary data was retrieved from SVCA (The
Swedish Private Equity & Venture Capital Association). Unfortunately, this data only
contained a combined filter of private equity and/or venture capital backed IPOs. To further
be able to filter if the IPOs were venture capital backed or not, a manual observation of each
IPO’s prospectus, or listing memorandum for those IPOs that are not subject to
Finansinspektionens prospectus obligation, was done. By doing this, it was also possible to
obtain the degree of venture capital. Since part of the data from DataStream was limited to
USD and in order to avoid exchange rate changes, offer price and offer size were also
obtained from each IPOs prospectus. In addition, the prospectus provided us with information
regarding if each IPO was entitled to any lock-up agreement. Each prospectus was accessed at

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either finansinspektionen.se, nyemissioner.se, Skatteverket.se, or the individual firm’s
website.

Once the data from DataStream and SVCA was obtained, it was exported into Microsoft
Excel where it was cleaned and timely sorted. After the exportation of the data to Excel, the
daily prices and financial statement data of all IPOs was easily observed. However, the offer
price, offer size, information regarding lock-up agreements along with the degree of venture
capital of the VC backed IPOs were manually obtained from the prospectus of each IPO.
After manually processing the data, it was structured and calculated together with the
previously obtained data in a proper way to be suited for exportation into STATA where the
statistical analyses were made.

Since the daily stock price data provide the study with a wider set of price data for the IPOs, it
is hoped to benefit the accuracy of the results. Further, by combining the two data sets from
DataStream and SVCA with a manual observation of each IPOs prospectus, the study was
provided with a more complete set of data that could better support the thesis’ purpose of
studying the venture capital aspect of IPOs.

4.3 Sample
In order to collect relevant data suitable for the purpose of this study, a number of criteria
were necessarily formulated. First of all, the time frame was of great importance. Due to the
financial crisis in 2008 and the pandemic in 2020, data from these periods could possibly
generate abnormal results. Therefore, the time frame had to be structured in a way that
provided the study with a wide data set that at the same time avoided periods where the result
could be affected by external, less relevant, factors. Therefore, the sample was set to an issue
date between the years 2010 and 2019.

In order to generate a sample of IPOs, the issue type filter in DataStream was set to “IPO”
which signifies that the common stock being offered is not traded publicly in any market at
the time of the offering. Further, to determine if the issuer’s stock is being offered for the first
time and exclude those that have formally been listed, the “Original IPO” filter was used.
Moreover, the stock exchanges OMX Stockholm, First North Stockholm, and Aktietorget
were chosen due to being the three exchanges that generated the largest fraction of IPOs going

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public in Sweden when the above filter was set in DataStream. In order to study the IPOs
performance over time, the transaction status of the IPOs was set to “Live” and thus excluded
those with any of the following transaction statuses: “In progress”, “Mandated”,
“Announced”, “Rumored”, “Unknown”, “Postponed” and “Cancelled”.

Furthermore, it was necessary to define venture capital backed IPOs in order to generate a
sample with a clear distinction between VC backed IPOs and non-VC backed IPOs. The data
retrieved from DataStream provides the user with a filter named Venture Capital Backed Issue
Flag that is set to true or false. In addition, DataStream also provides the user with the name
of the Venture Capital Firm/Fund. The data retrieved from SVCA included a filter titled
Private Equity/Venture Capital that was set to yes or no. Thus, the first sample of venture
capital-backed IPOs was based on the following criteria: if the Venture Capital Backed Issue
Flag was set to true and/or if a Venture Capital Firm/Fund existed, or the Private
Equity/Venture Capital was set to yes. Due to a small fraction of venture capital backed IPOs
and a poor distinction between private equity and venture capital, the final distribution of
venture capital backed IPOs and non-venture capital backed IPOs was obtained through a
manual observation of each IPOs prospectus or listing memorandum. By accessing the
prospectus, one could be certain of the ownership before the offer and the agreed ownership
after the offer. Each owner or indirect owner for each IPO was then manually observed
through their individual websites in order to examine if the purpose of these firms was similar
to the purpose of venture capital firms. The firms considered as venture capital firms either
mentioned being venture capital firms or having a focus on investments in start-ups or growth
companies. Those firms that mentioned being a private equity firm or having a focus on long-
term investments in both private and public companies were excluded. Finally, the IPOs
having an owning firm or fund at the time of the IPO that was defined as a venture capital
firm was then matched by our sample of venture capital backed IPOs from DataStream and
SVCA.

The total sample obtained from DataStream contained 201 IPOs between the years 2010 and
2019. Further, the data retrieved from SVCA included 81 of those IPOs that were retrieved
from DataStream. Due to the absence of prospectus, listing memorandums or financial
statements, early bankruptcies, or offer price unavailable in SEK, our final sample as
displayed in table 1 consisted of 188 IPOs. For a full list of the IPO sample and the venture
capital firm(s) or fund(s), see appendix 1.

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