The Performance of Venture Capital Investments : Do Investors Overreact?

Using a unique proprietary data set of over 5,400 realized and unrealized venture capital investments between 1980 and 2005, we examine the impact of supply-related factors, i.e. money provided by VC investors, as well as demand-related factors, e.g. entrepreneurial activity, on the return of individual VC investments. This way, we are able to shed more light on the question whether volatile VC investment returns are rather driven by fundamental changes with regard to the number of attractive investment opportunities or by overreaction by investors. We find that rising demand for VC, i.e. an increase in entrepreneurial activity, results initially in higher returns. However, our results also indicate that overreaction on the supply side can be observed, destroying deal-level results. Over-funding, specifically over-investing seems to be a recurring characteristic of the VC industry. In fact, contra-cyclical investment strategies yield highest deal-level returns