The role of venture capitalists in the acquisition of private companies

Paul A. Gompers and Yuhai Xuan* 28.1 INTRODUCTION The motivation for and the performance implications of acquisitions have been important areas for corporate finance researchers. We explore the characteristics of one particular type of acquisition, the acquisition of venture capital-backed private companies. Unlike other companies, young, private venture capital-backed companies have values that are primarily based upon real options, that is, future investment opportunities. For most companies, their values may be determined more by assets in place. Venture capital-backed companies, on the other hand, are generally small with relatively minor sales, but substantial technology and intellectual property. Large public companies may be motivated to purchase these companies because they represent potential future investment opportunities for them or because the young start-up may be a future competitor of the firm. As such, we expect that the characteristics of acquirers of venture capital-backed private companies as well as the market’s reaction to their announcement and long-run performance may differ from other types of public or private acquisitions. Prior research on acquisitions (Jensen and Ruback, 1983) has shown that announcement period event returns for acquiring firm shareholders tend to be insignificant or slightly negative. Cash mergers have consistently higher announcement period abnormal returns than those financed with stock. Moeller et al. (2004) find that shareholders of small acquirers gain from acquisition announcements and those of large acquirers suffer losses. In addition, acquirer announcement period returns for private targets are typically higher than those for public targets. Within the sample of acquisitions for private….