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Venture Capital

Fund Certification, Performance Prediction and Learnings from the Past

Series:

Armin Höll-Steiner

This book contains three studies. The first study investigates the relationship between private equity investors and fund managers and how intermediaries can mitigate their agency problems. The incentive structure of three intermediary types and their behavior in signaling fund qualities to investors are studied theoretically. A recommendation which intermediary to consult is given. The second study presents a new statistical method to predict the performance distribution of venture capital direct investments. The accuracy of this method is investigated and compared to existing approaches. The third study is about the European venture capital market’s historic development before and after the internet bubble and reasons for the bad development especially after the bubble.

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3 Study 2: A New Approach to Predict the Performance ofVenture Capital Direct Investments 79

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3 Study 2: A New Approach to Predict the Performance of Venture Capital Direct Investments 3.1 Introduction Since the 1980’s the asset class PE gained more and more attention world- wide. PE is generally split into VC that focuses on financing start-ups and young companies and Buyout (BO) capital mainly used in leveraged buy- outs (LBO) and management buy-outs (MBO) or buy-ins (MBI). This study focuses on VC deals. Venture Capital bares great chances but also high risks which became especially evident during the end of the last century when massive returns from Internet investments were followed by dramatic losses after the burst of the new economy bubble. In consequence, one may hardly speak of evenly distributed investment returns like in stock or bond markets. In fact, the distribution pattern of the commonly used return measure IRR of private equity investments is highly skewed: A small share (approx. 10%) of in- vestments performs exceptionally well with returns of more than 100% p.a., about 60% have a performance between −99% and +100% and about 30% of investments fall out completely (−100% IRR). The small share of excep- tionally high returns has to compensate the significant amount of write-offs for investors to earn a positive return, on average. Some studies, e.g., Ick 80 3 New Approach to Predict Performance of VC Direct Investments (2005) and Phalippou and Gottschalg (2009), even raise doubts that this was achieved in the past on a risk adjusted basis. Thus, finding the right moment in...

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