Analyse the effectiveness of pre-deal screening and post-deal monitoring by venture capitalists

Seminar Paper 1998 8 Pages

Business economics - Investment and Finance


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"The venture capital process can be characterised as involving two sets of key relationships, those between venture capital firms and their fund providers and those between venture capital firms and the entrepreneurs in whom they invest." (Robbie et al., 1998, p. 1) The present work is concentrating upon the latter relationship. More specifically, it examines the effectiveness of pre-deal screening and post-deal monitoring by venture capitalists. Pre-deal screening and Adverse Selection

Once a venture capital investment is being considered, institutions are faced with a potential adverse selection problem in that they are unable to gauge the manager's performance in the enterprise prior to deal completion (Amit et al. , 1993). Adverse selection arises as venture capitalists have to rely on imperfect information about the state of affairs of the enterprise which is supplied by the entrepreneur. Whilst the entrepreneur possesses an accurate under-standing of the enterprise, "...there is no guarantee that this is conveyed in an unbiased and complete manner to the venture capitalist, given the entrepreneur an asymmetric information advantage." (Wright et al., 1997, p.157) To the extend that these problems lead investors to misjudge the situation, an inappropriate deal may be agreed and as a result, the control mechanism introduced may lead to suboptimal decisions. Although the entrepreneur's personal characteristics, track record, and familiarity with the industry can provide some insight for the venture capitalist, these criteria are at most partial predictors of future success. However, these problems may vary between types of investment. In the case of a management buy-out proposal, investing institutions may be guided by incumbent management's experience in post and their knowledge of the business, though management may have an incentive not to disclose full information in order to get the most favourable terms. In a management buy-ins, where the entrepreneur comes from outside, there are problems of asymmetric information, both in relation to their true skills and an inability to observe the manager in post ex ante (Wright and Robbie, 1998). Amit et al. (1993) show that where venture capitalists cannot access private information about an entrepreneur's capabilities, low-ability entrepreneurs will accept the venture capitalist's price offer while high-ability entrepreneurs will not.

Several empirical studies have been conducted to examine the relative importance of a wide range of factors taken into account by venture capitalists in the screening process for

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University of Nottingham




Title: Analyse the effectiveness of pre-deal screening and post-deal monitoring by venture capitalists