Funding liquidity risk, syndication behavior and the risk culture of the Australian venture capital industry

Abstract

Venture capital (VC) is usually invested in high risk technology companies at their early stages of development. In response to the industry risk environment, the VC fund managers have developed a set of risk management practices appropriate for the industry which include investment syndication. Furthermore, the VC funds are supplied by individual and institutional investors with different risk profiles and investment focus, usually in finite amounts and for a limited period of time. The funding agreement between the VC firms and the fund investors combined with the limited amount and time can lead to additional funding liquidity risks as the VC funds are invested in the portfolio companies. In this paper, we develop a simple two period model from a VC firm’s perspective with funding liquidity constraints to demonstrate how funding liquidity risk can influence syndication decisions. We subsequently analyze the implication of the model, derive a set of predictions and validate them with VC investment data from Australia. The analysis shows that syndication has both instrumental function in risk management and behavioral implications on risk culture essential for addressing the emerging frontiers of sustainability risks.