In defense of Venture Capitalism

February 28, 2009
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Critics of private equity claim that compensation is greatly exaggerated for them, that they are risk averse, and invest only in sure shot companies , and exploit almost like  a cartel the need of the entrepreneur for capital ( http://bits.blogs.nytimes.com/2009/01/28/maybe-we-should-call-them-venture-pessimists/ )
Well here is some data for this type of financing.Here is a paper in […]

Critics of private equity claim that compensation is greatly exaggerated for them, that they are risk averse, and invest only in sure shot companies , and exploit almost like  a cartel the need of the entrepreneur for capital ( http://bits.blogs.nytimes.com/2009/01/28/maybe-we-should-call-them-venture-pessimists/ )

Well here is some data for this type of financing.Here is a paper in the National Bureau of Economic Research (http://www.nber.org/papers/w14331.pdf)

The following extract sums it all.-

 

Leslie and Oyer examine 233 U.S. companies that either underwent a leveraged buyout (LBO) between 1996 and 2004 and then completed an initial public offering (IPO) before the end of 2005 or went private between 1998 and October 2007 (and about which there is compensation data available). They supplement that data with interviews of half a dozen experienced executives at private equity firms. They find that since 1996 the highest paid executive in a privately owned firm earned about 12 percent less salary, but got 3.3 percentage points more company equity and 12.6 percent more of his cash compensation through bonuses and other variable pay, than the CEO of a public corporation. And, they claim that it’s not just the CEO who got this treatment: the 20 to 80 top managers typically also got significant equity in the company.

"A very important aspect of the equity programs is that managers are required to contribute capital — managers purchase the equity with their own personal funds," they write. They say that their study is the first to document the changes in management incentives in private buyouts since 1990, when the PE landscape was far different. The impact of these incentives is less clear, however. "While the incentives given to PE-owned firms’ managers keep their companies operating at average levels of profitability and efficiency, we do not find evidence that they create significant excess profits," the authors conclude. In only one category they measured – sales per employee – did private-equity ownership have a significant positive effect. 

It does seem clear the VC or PE funded companies get more productivity because it is their money on the line not some anonymous share holder or pension fund. The current scenario is a great time to buy for Venture funds– and for us to wait and anticipate for the next Google to emerge.

Ajay-

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