Berk A. Sensoy

Should Investors Bet on the Jockey or the Horse? Evidence from the Evolution of Firms from Early Business Plans to Public Companies

We study how firm characteristics evolve from early business plan to initial public offering (IPO) to public company for 50 venture capital (VC)-financed companies. Firm business lines remain remarkably stable while management turnover is substantial. Management turnover is positively related to alienable asset formation. We obtain similar results using all 2004 IPOs, suggesting that our main results are not specific to VC-backed firms or the time period. The results suggest that, at the margin, investors in start-ups should place more weight on the business (“the horse”) than on the management team (“the jockey”). The results also inform theories of the firm.

Club Deals in Leveraged Buyouts

We analyze the pricing and characteristics of club deal leveraged buyouts (LBOs)--those in which two or more private equity partnerships jointly conduct an LBO. Using a comprehensive sample of completed LBOs of U.S. publicly traded targets conducted by prominent private equity firms, we find that target shareholders receive approximately 10% less of pre-bid firm equity value, or roughly 40% lower premiums, in club deals compared to sole-sponsored LBOs. This result is concentrated before 2006 and in target firms with low institutional ownership. These results are robust to controls for target and deal characteristics, including size, Q, measures of risk, and time and industry fixed effects. We find little support for benign motivations for club deals based on capital constraints, diversification motives, or the ability of clubs to obtain favorable debt amounts or prices, but it is possible that the lower pricing of club deals is an inadvertent byproduct of an unobserved benign motivation for club formation.

Do Private Equity Fund Managers Earn Their Fees? Compensation, Ownership, and Cash Flow Performance

We study the relations between management contract terms and performance in private equity using new data for 837 funds from 1984--2010. We find no evidence that higher fees or lower managerial ownership are associated with lower net-of-fee performance. Nevertheless, compensation rises and shifts to performance-insensitive components during fundraising booms. Further, the behavior of distributions around contractual fee triggers is consistent with an underlying agency conflict between investors and fund managers. Our evidence suggests that managers with higher fees deliver higher gross performance, and highlights that agency costs are an inevitable consequence of the information frictions endemic to agency relationships. The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Changing the Nexus: The Evolution and Renegotiation of Venture Capital Contracts

We study empirically how financial contracts evolve and are renegotiated as venture capital (VC)-backed companies secure new rounds of financing. Because VC contract designs vary considerably between companies according to their economic circumstances, it is plausible to expect that the contracts governing successive financing rounds of a quickly-evolving company should often be dissimilar. The data offer little support for this intuitive hypothesis. In fact, the majority of cash flow provisions in a new round contract are recycled from the previous round contract, even when the company has evolved substantially. Such recycling may be beneficial in typical situations because it alleviates information problems in negotiations and reduces the complexity of the company’s nexus of financial contracts (Fama, 1980). However, in some situations restructuring contract design may be necessary to entice investors to provide new capital. Consistent with debt overhang arguments (Myers, 1977), we show that venture capital contracts evolve to include more investor-friendly cash flow provisions when the valuation of the company has not increased since the previous round, when new investors join the new round, or when new round investors hold larger debt-like claims. Although major renegotiations of previous round contracts are rare, minor renegotiations appear to be more common and almost uniformly result in making the previous round contract more similar to the new round contract. Overall, our findings suggest that the tradeoff relevant for changing a company’s nexus of financial contracts is different from the tradeoffs relevant for the initial structuring of this nexus.

What are Firms? Evolution from Early Business Plans to Public Companies

We study how firm characteristics evolve from early business plan to initial public offering (IPO) to public company for 50 venture capital (VC) financed companies. We describe the financial performance, line of business, point(s) of differentiation, non-human capital assets, growth strategy, top management, and ownership structure. The most striking finding is that firm business lines or ideas remain remarkably stable from business plan through public company. Within those business lines, non-human capital aspects of the businesses are more stable than human capital aspects. In the cross-section, firms with more alienable assets experience more managerial turnover suggesting that specific people becomes less critical as firms establish non-human assets. We obtain qualitatively similar results to those in our primary sample for all non-financial start-up IPOs in 2004 - both VC- and non-VC backed. This suggests that our main results are not specific to the presence of a VC or to the time period. We discuss how our results relate to theories of the firm and to VC investment decisions.

How Much for a Haircut? Illiquidity, Secondary Markets, and the Value of Private Equity

Limited partners (LPs) of private equity funds commit to invest with significant uncertainty regarding the timing of capital calls and payoffs and extreme restrictions on liquidity. Secondary markets have emerged which alleviate some of the associated cost. This paper develops a subjective valuation model incorporating these institutional features. Private equity values are sensitive to the discount in secondary market transactions, especially for more risk averse LPs. Model-implied breakeven returns generally exceed empirically observed returns. However, highly risk tolerant LPs may find private equity attractive at portfolio allocations observed in practice, especially if they can access above-average funds and an efficient secondary market.

Measuring Institutional Investors' Skill from Their Investments in Private Equity

Using a large sample of institutional investors’ investments in private equity funds raised between 1991 and 2011, we estimate the extent to which investors’ skill affects their returns. Bootstrap analyses show that the variance of actual performance is higher than would be expected by chance, suggesting that some investors consistently outperform. Extending the Bayesian approach of Korteweg and Sorensen (2017), we estimate that a one standard deviation increase in skill leads to an increase in annual returns of between one and two percentage points. These results are stronger in the earlier part of the sample period and for venture funds.Using a large sample of institutional investors’ private equity investments in venture and buyout funds, we estimate the extent to which investors’ skill affects returns from private equity investments. We first consider whether investors have differential skill by comparing the distribution of investors’ returns relative to the bootstrapped distribution that would occur if funds were randomly distributed across investors. We find that the variance of actual performance is higher than the bootstrapped distribution, suggesting that higher and lower skilled investors consistently outperform and underperform. We then use a Bayesian approach developed by Korteweg and Sorensen (2015) to estimate the incremental effect of skill on performance. The results imply that a one standard deviation increase in skill leads to about a three percentage point increase in returns, suggesting that variation in institutional investors’ skill is an important driver of their returns.