Venture capital and entrepreneurial firms: A review of recent academic literature and suggestion for future studies in Vietnam

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VENTURE CAPITAL AND ENTREPRENEURIAL FIRMS: A REVIEW OF RECENT ACADEMIC

LITERATURE AND SUGGESTION FOR FUTURE STUDIES IN VIETNAM

Dao Hong Nhung , Tran Thanh Thu*, Nguyen Bao Hien Thi

ABSTRACT: The objective of this study is to conduct a comprehensive review of recent literature on

venture capital and its eﬀects on entrepreneurial ﬁrms from a corporate ﬁnance perspective. Previous

literature emphasizes the role of venture capital of entrepreneurs, ﬁnanciers, governors, and information

intermediaries. Moreover, the recent literature makes great eﬀorts to explain vital factors inﬂuencing the

survival and success of venture capital on entrepreneurs. Some factors worth mentioning are the venture

capital’s ﬁnancing stages, the syndication of various kinds of venture capitalists, the intervention of various

types of ﬁnanciers such as banks and government involvement as venture capitalists and public decision

makers. This study not only reviews the very scant academic literature on venture capital in Vietnam but also

identiﬁes previous research gaps and provides recommendations for future studies.

Keywords: venture capital; entrepreneurial ﬁrms; corporate ﬁnance; agency problem; syndication.

1. MAIN TEXT

1.1. Introduction

Venture capital (VC) is deﬁned as “the independent, professionally managed, dedicated pools of capital

that focus on equity or equity- linked investments in privately held, high growth companies.” (Gompers

and Lerner, 2001). Venture capital has increasingly emerged as a key ﬁnancial intermediary, providing

capital for entrepreneurial ventures that have numerous obstacles to accessing ﬁnancing from other capital

providers, like banks or ﬁnancial institutions. This is due to the fact that entrepreneurial ventures, especially

those in the seed or early stage, are normally those with high growth opportunities but correspondingly high

risk, few tangible assets, and operating in rapidly changing markets. Since the inception in 1946 of a true

venture capital ﬁrm for startups born from technology development in World War II by MIT President Karl

Compton, the global venture capital industry brokers 13,900 deals of 158 billion USD in 2017 (National

Venture Capital Association, 2018). According to the Topica Founder Institute, Vietnam was given 92

investment deals for entrepreneurship, innovation, and creation with a total investment amount of 291

million USD in 2017. This is double the number of deals in 2016 with a 50% increase in total deal size.

The emergence of venture capital and the ambitious “startup nation” plan of the Vietnamese government

will better succeed by considering the valuable lessons from the success of other nations, Vietnam’s own

previous experiences in operating venture capital and careful consideration of all future ventures. The ﬁrst

objective of this study is to conduct a comprehensive review of recent literature on venture capital and its

effects on entrepreneurial ventures in the context of corporate ﬁnance. The previous studies emphasize the

* Department of Corporate Finance, Academy of Finance, Hanoi, Vietnam, corresponding author. Tel.: +84989191960, E-mail

address: [email protected], [email protected].

HỘI THẢO KHOA HỌC QUỐC TẾ KHỞI NGHIỆP ĐỔI MỚI SÁNG TẠO QUỐC GIA

role of venture capital of entrepreneurs, ﬁnanciers, governors, and ﬁnancial intermediaries. Moreover, the

recent literature makes great efforts to explain vital factors inﬂuencing the survival and success of venture

capital on entrepreneurs. Some factors worth mentioning are the venture capital’s ﬁnancing stages, the

syndication of various kinds of venture capitalists, the intervention of various types of ﬁnanciers such

as banks and government involvement as venture capitalists and public decision makers. This study not

only reviews the very scant academic literature on venture capital in Vietnam but also identiﬁes previous

research gaps and provides recommendations for future studies.

The remainder of our paper is organized as follows. Section 1.2 reviews the recent literature to discuss

the roles of venture capital in entrepreneurial ventures’ performance. Section 1.3 presents the determinants

of venture capital’s success on entrepreneurs. Section 1.4 summarizes the recent literature on venture capital

in Vietnam and provides suggestions for future studies.

1.2. Roles of venture capital on entrepreneurial ﬁrms’ performance

Figure 1, adapted from National Venture Capital Association (2018), provides an overview of where

venture capital plays on the development of entrepreneurial ventures. While the stage of idea generation

and product development, which are suitable only for high-risk takers - angel investors, the development

and growth of a startup are highly attractive to venture capitalists who prefer sponsoring for operational

growth and expansion. In these stages, the previous literature highlights the three main roles that venture

capital play for entrepreneurs, including (i) ﬁnancial intermediary; (ii) governance and (iii) quality signal

and information intermediary (Dutta and Folta, 2016).

Fig. 1. Entrepreneurs’ development and investment stages

1.2.1. Financial intermediary

Entrepreneurial ﬁrms face difﬁculties in ﬁnancing projects through debts and equity since these ﬁrms

suffer high uncertainties and high information asymmetries. These characteristics allow for overinvestment

by managers without the consent of creditors and equity investors. Gompers and Lerner (2001) identiﬁed

the high volatile investment strategies as an example of the overinvestment problem in young biotechnology

ﬁrms. These kinds of ﬁrms have a high proportion of intangible assets that are difﬁcult to assess and

often invest in recognized scientiﬁc research, which builds personal reputation for entrepreneurs but at the

expense of investors.

INTERNATIONAL CONFERENCE STARTUP AND INNOVATION NATION

In these circumstances, venture capital functions as a specialized ﬁnancial intermediary that not only

provides ﬁnancial resources but also alleviates the information gaps through screening and monitoring of

entrepreneurs. Gompers and Lerner (2001) stated that the pre-investment screening could help venture

capitalists to gain private information of entrepreneurs, and thereby solve the information asymmetries.

Bertoni and Martí (2013) justiﬁed the dominant role of venture capitalists by studying Spanish low and

medium technology ﬁrms utilizing venture capital investments from 1995 to 2004. The sample witnessed

high dependency on internally generated cash ﬂow for previous investment before the ﬁrst venture capital

round as evidence of information asymmetries. However, after collaborating with venture capitalists, the

investment-cash ﬂow sensitivity dramatically decreased.

1.2.2. Governance role

Previous literature focused on different ﬁnancial contract theories to deal with various types of conﬂicts

arising from contractual parties, including the principal- agent theory, the control theory (the incomplete

contract theory), the “stealing” theory and the hold-up theory (Harris and Raviv, 1979; Dewatripont and

Tirole, 1994; Hart and Moore, 1998). Based on these theories, Kaplan and Stromberg (2003) studied 200

venture capital investments in 118 portfolio companies and found that venture capitalists in a governance role

had the authority to separately allocate rights to entrepreneurs such as cash ﬂow, voting, board, liquidation

and other control rights. The rationale for this allocation rests in the entrepreneurial ﬁrm performance. The

better ﬁrm performance, the more control rights allocated to entrepreneurs. By doing this, venture capital

can govern, circumvent the agency conﬂicts among contractual parties, and create strong motivation for

entrepreneurs to operate at the best efforts to enhance ﬁrm performance and protect stakeholders.

Venture capital also provides coaching and monitoring for operating activities of entrepreneurial ﬁrms.

Lerner (1995) conducted a study of 271 biotechnology ﬁrms that indicated that an average of 1.75 venture

capitalists were added to replace and reshape the top management team. Chemmanur et al. 2011 listed

the coaching and monitoring functions of venture capital, including investigating and professionalizing

management team, and setting the compensation schemes as incentives for managers. Using the

Longitudinal Research Database of the U.S, they explored that VC-backed ﬁrms’¹overall productivity

(efﬁciency) is improved when compared to non-VC-backed ﬁrms. Relative to monitoring function, venture

capital can help professionalize entrepreneurs by assisting in strategic business planning, product market

support, human resources and internal organization. Hellmann and Puri (2002) conducted a study on

170 young technology ﬁrms in Silicon Valley and conﬁrmed the involvement of venture capitalists in

entrepreneurial ﬁrms’ corporate governance through replacing existing CEOs with outsiders, employing

marketing and sales team and adopting stock option plans. Additionally, venture capitalists that possess

strong business ﬂexibility can participate in various business functions, understand business threats and

opportunities of entrepreneurs, and consult them to make a right decision such as the timing and the mode

of commercialization such as IPO and acquisition.

1.2.3. Quality signal and information intermediary

Venture capital can help entrepreneurs to participate in its extended network of investors, suppliers,

and customers. Hsu (2006) identiﬁed four major constraints that hinder the abilities of entrepreneurs to

expand boundaries for commercialization. These constraints consisted of high search costs in ﬁnding

cooperation partners, fear of expropriation, unrecognized quality, and insufﬁcient development. Hsu (2006)

VC-backed ﬁrms: Venture capital-backed ﬁrms

HỘI THẢO KHOA HỌC QUỐC TẾ KHỞI NGHIỆP ĐỔI MỚI SÁNG TẠO QUỐC GIA

analyzed 696 startups in the US and justiﬁed that venture capital could mitigate these four hurdles by its

network, its role as information intermediary and quality endorsement. For example, since startups can be

seen as poor quality by partners, venture capital can play an important role in legitimizing the existence of

startups. Megginson and Weiss (1991) found that 320 VC-backed ﬁrms from 1983 to 1987 exhibited lower

underpricing and lower underwriter spreads compared to non-VC-backed ﬁrms matched by industry and

offering size. More importantly, involvement in the capital venture network helps startups to reduce the

search cost and enhance an opportunity to ﬁnd cooperation partners. Additionally, the ability of venture

capital to professionalize startups may work well in dealing with the issue of insufﬁcient development and

attracting more cooperation partners (Hellmann and Puri, 2002). The study of 701 startups in the U.S.

by Hsu (2006) conﬁrmed that VC-backed startups engaged in cooperative commercialization strategies

resulting in post-funding R&D alliances, achieving an IPO or a reputable IPO underwriter.

1.3. Determinants of venture capital’s success on entrepreneurial ﬁrm performance

1.3.1. Venture capital syndication

Syndication is one of the highlight features of venture capital ﬁnancing when at least two venture

capitalists cooperate in ﬁnancing a given entrepreneurial ﬁrm, especially when the capital needed is quite

modest compared to that of each separate venture capitalist’s contribution. There has been a continuing

debate on which is more prominent in explaining motives for venture capital, the selection or the value-added

hypothesis. The selection hypothesis supports the idea that two or more venture capitalists participating in

choosing projects improves the effectiveness of the screening process when one partner can learn from the

others’ evaluation (Lerner, 1994). The value-added hypothesis, on the other hand, is justiﬁed by a study

of Brander et al. (2002) who conducted research on the removal of 584 Canadian venture capitalists from

startups. The study showed that on average, the syndicated venture investments had higher rates of return

than those in standalone investments. These rates are the results of venture capitalists’ likelihood to engage

in managerial activities of an entrepreneur to enhance investment performance, thus, supporting the value-

added hypothesis. Likewise, Tian (2011a) argued that syndicate-backed entrepreneurial ﬁrms can enhance

both product and ﬁnancial market value through support from various venture capitalists. Regarding

the product market value, syndicated venture capitalists have a broad range of skills, industry expertise,

information advantages, and networks. Therefore, entrepreneurs can beneﬁt from one venture capitalist’s

network to employ staff, maintain relationships with suppliers and customers while taking another venture

capitalist’s advantages of fundraising and obtaining sufﬁcient ﬁnancial resources. Consequently, venture

capital syndicates can intensify innovation and operating performance of entrepreneurial ﬁrms. According

to Tian (2011a), venture capital syndicates can bridge the information gap by guaranteeing and conveying

favorable information about entrepreneurs to the public. Hence, syndicate-backed entrepreneurs can achieve

higher exit outcome via lower underpricing and higher market stock return.

1.3.2. Venture capital stage ﬁnancing

Venture capitalists can allocate the capital under many ﬁnancing rounds as a mechanism to intervene

in entrepreneurial ﬁrm performance. Existing literature illustrates three main motives for venture capital

staging, monitoring, preventing hold-up problem and learning opportunities. The underlying view behind

these three motives is the ability to mitigate the agency problem. By setting targets for each ﬁnancing

round, venture capitalists can monitor entrepreneurs following these targets, reduce investment amount

in any stage or even abandon those ﬁrms, which do not fulﬁll the stage targets (Kaplan and Stromberg,

2003: Tian, 2011b). This not only prevents entrepreneurs from overinvesting capital, originally generated

INTERNATIONAL CONFERENCE STARTUP AND INNOVATION NATION

from agency conﬂicts between managers and investors, but also avoids entrepreneurs from leaving ﬁrms

for better careers as seen in the hold-up problem. Additionally, what venture capitalists learn from the

investees through each stage of capital infusion will inﬂuence the level of commitment to entrepreneurs.

Tian (2011b) studied 27,460 entrepreneurial ﬁrms in the US from 1980 to 2016 and found evidence that

supports the monitoring hypothesis through the causes and consequences of venture capital staging.

Accordingly, venture capitalists that are located far away from entrepreneurial ﬁrms experience higher

numbers of ﬁnancing stages, smaller amounts of capital invested as well as shorter duration between each

round. This is aligned with the monitoring hypothesis, caused by increased geographic distance. Venture

capitalists of this nature need to keep investees under stricter discipline. Subsequently, according to Tian

(2011b) the number of venture capital stages also positively affects an entrepreneurial ﬁrm’s performance

regarding the probability to go public, operating performance, and survival in the post-IPO period.

1.3.3. Governmental or independent or bank-aﬃliated venture capital

Previous literature on governmental venture capital (GVC, hereafter) argues that GVC entrepreneurial ﬁrms

perform worse than those of independent venture capital (IVC). GVC is determined by regulators; therefore,

venture capitalists may have to deal with more political pressure than IVC. GVC pursues politically related

and non-ﬁnancial goals such as social welfare maximization whose beneﬁts are not substantial enough to offset

costs generated. According to Cumming et al. (2017), the limitations of GVC compared with IVC are covenants,

decision-making process or compensation plans, which are highly dependent on regulators and may be constant

across managers, funds, operation, and performance. These issues may even increase the possibility for agency

conﬂict between political forces in _GVC and managers of VC-backed ﬁrms regarding appropriate manager

compensation. Cumming et al. (2017) also suggest the solution for the problem of GVC is IVC-GVC syndicated

partnerships when independent venture capitalists can join in and mitigate the agency problem called by political

pressure or inefﬁcient compensation terms. In exchange, GVC can give entrepreneurial ﬁrms more opportunities

to access government contacts that widen a ﬁrm’s network to government-related suppliers or customers and

circumvent the political risks such as regulatory hurdles in business plan approvals.

Another type of venture capital worth mentioning is an afﬁliated VC ﬁrm. Different from an

independent VC in which a close-end fund is established and provides capital from investors (normally

institutional investors called limited partners), the afﬁliated VC ﬁrms refer to those, which are subsidies

of larger ﬁrms, parent banks or insurance companies. While the independent VC seeks investment for

corresponding investment return, the purpose of afﬁliated VC is to also fulﬁll long-term strategic interests of

an afﬁliated company. Therefore, afﬁliated VC tends to focus more on ﬁnding potential entrepreneurs who

are complementary to the parent ﬁrms’ activities than on raising capital, which can be easily accessed from

a large pool of afﬁliates (Hellmann et al., 2007). Andrieu and Groh (2012) explore how the afﬁliation of

VC inﬂuences entrepreneurial ﬁrms compared to those ﬁnanced by independent VC. The authors indicated

that independent VC provides better support for entrepreneurs regarding business and operation strategies

and monitoring and management, while bank-afﬁliated VC is suitable for entrepreneurs who are seeking

funds for an expansion stage. This is because of a bank-afﬁliated VC’s advantage of available capital and

the ability to discard any moral hazard raised from outside investors.

1.3.4. Public policy and institutional factors

The study of Lerner (2009)- one of the most comprehensive studies on public policy, venture capital,

and entrepreneurships tries to explain why, what, and how public efforts are implemented to boost the

entrepreneurships and venture capital. The main purpose for public policy focused on entrepreneurships

HỘI THẢO KHOA HỌC QUỐC TẾ KHỞI NGHIỆP ĐỔI MỚI SÁNG TẠO QUỐC GIA

and venture capital are to encourage investments that beneﬁt both individuals and the society as a whole

and to provide entrepreneurs with legitimacy (stamp of approval) to overcome capital constraints (Lerner

2009). _While knowledge spillovers hinder venture capital and entrepreneurs from investing in innovation

due to fewer beneﬁts compared to society. Information asymmetries also create obstacles for raising capital

from external providers like banks. Hence, the government improves entrepreneurial climate and venture

capital market attractiveness in order to enhance investment and overcome ﬁnancial constraints.

Regarding entrepreneurial climate, the ﬁrst focus of public policy is improving the legal system to boost

entrepreneurial activities, such as well-deﬁned legal frameworks and enforcement on complex contracts

between venture capital and entrepreneurial ﬁrms. An example for such rules in the US is the allocation

of control of entrepreneurial ﬁrms depending on how the investment performs and correspondingly, the

issuance of convertible securities for investors. Lerner (2009) estimated that those venture capital funds

active in the US legal system can experience 19% higher return than other typical funds. The second

focus is how public policy creates cutting-edge technologies by commercializing technologies invented by

universities or academic-based institutions. The ﬁnal and more common focus is the tax policy for capital

gain tax. Decreasing capital gain tax, increasing the difference between tax rates on capital gains and

ordinary income, or offering special tax rates for investments in entrepreneurial ﬁrms are all underlying

policies that boost entrepreneurs’ demand on capital, which in turn increases venture fundraising. Lerner

(2009) gives outstanding examples of how the tax policy motivates entrepreneurial activities. In the US,

venture capital operating under limited partnerships can exclude 50 percent of any capital gains from small

businesses such as entrepreneurs, which means that the marginal tax rate is 14 percent compared with 28

percent in normal tax rate. Similarly, in the UK, the tax policy allows a decrease from 40 % to 10% of

the effective tax rate for disposal of assets for those ﬁrms operating for two years or less, which boosts

entrepreneurial activities (Lerner, 2009).

For the venture capital market, the public policy aims at increasing the attractiveness of this market by

allowing true limited partnerships. Such limited partnerships attempt to limit the level of risks for investors,

improve the local market aligned with IPO opportunities and utilize overseas labor force via pools of

expatriates who can serve as angle investors, mentors, venture capitalists or consultants for policy markers

(Lerner, 2009).

For institutional factors, Cumming and Johan (2013) identiﬁed various factors inﬂuencing the

development of the venture capital market. For example, the legal origin which follows the common law

tradition as in La Porta et al. (1997) usually provides better protection for private properties and offer more

ﬂexibility to new developments and governance; therefore, that legal origin is more suitable for venture

capital development compared with those in civil law. Other levels of institutional quality according to La

Porta et al. (1997), such as the rule of law, the efﬁciency of legal environments or the level of corruption,

risk of expropriation or contract modiﬁcation offer a better environment for venture capital. For example,

higher legal quality offers well-deﬁned contracts that are easily enforced faster implemented corporate

governance in venture capital (Cumming and Johan, 2013). Likewise, other studies, such as Bruton et al.

(2009), explore how institutional differences inﬂuence the development of entrepreneurial ventures. The

authors explored the strong impacts of the institutions with concentrated economic power on how venture

capital chooses funded ﬁrms, how difﬁcult it is for venture capital to monitor entrepreneurs compared with

those in more diverse ownership structures, and how strategic sales of funds become the dominant exit

strategy of venture capital.

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1.4. Research on the relationship between venture capital and entrepreneurs in Vietnam and suggestion for future

studies

1.4.1. Previous literature in Vietnam

For the development of venture capital, Klingler (2014) studied the venture capital industry in Vietnam

and discovered that it is underdeveloped with a total of only 150 million USD from four venture capitalists

in 2014, including IDG Ventures Vietnam, DFJ Vina Ventures, Dragon Capital, and Mekong Capital. The

venture capital policy focuses much more on credit-based ﬁnancing than regulation, tax, and policies for

equity ﬁnancing. According to Klingler (2014), Vietnam has not adopted Limited Partnerships for venture

capital management, and the appearance of venture capital fund in Vietnam is often negotiated under one-

off deals with the government rather than industry-wide public offerings. For example, the establishment

of IDG Ventures Vietnam is a single agreement between the Ministry of Science and Technology and IDG

venture capitalist in which IDG license is approved in exchange for the support to promote Hoa Lac Hi-

Tech Park. IDG, the ﬁrst true venture capital established in 2004 with 100 million USD under management

embraces the ﬁrst wave of startups in Vietnam. After that, there are some outstanding venture capital funds,

which contribute to the next wave of startups, such as Cyberagent Ventures, Vina Capital, 500 Startups

Vietnam (Dao, 2016).

There is very scant research on the link between venture capital and entrepreneurs in Vietnam.

Regarding the determinants of venture capital’s success on entrepreneurial ﬁrms, Scheela and Van Dinh

(2004), one of those few empirical studies on ﬁve venture capital ﬁrms in Vietnam, found that the venture

capitalists focus more on monitoring entrepreneurial ﬁrms in Vietnam compared with those in the US due

to the insufﬁcient institutions. More importantly, the connection with government ofﬁcials is proved to have

a statistically signiﬁcant and unique impact on how venture capitalists add value to entrepreneurial ﬁrms.

Likewise, Dao (2016) argues that the venture capital investment environment and the startup ecosystem in

Vietnam are lagging behind Singapore and Malaysia which is attributed to an incomplete legal framework,

bureaucracy, and an inefﬁcient ﬁnancial market for an effective exit strategy of venture funds.

Despite the emergence of venture capital and entrepreneurial ecosystem, the scarce studies on the

relationship between venture capital and entrepreneurs provoke potential future research in Vietnam.

1.4.2. Suggestion for future studies

First, with the surge of more than 3000 Vietnamese entrepreneurial ﬁrms according to the Echelon

Magazine, the research on the role of venture capital in entrepreneurial ﬁrms in Vietnam should focus

on conducting quantitative models to statistically examine what kinds of roles and subsequent value that

venture capital may add to entrepreneurial ﬁrms. Among those roles of capital provider, governance, and

quality signal, which one is more dominant in supporting entrepreneurs? More importantly, endogenous

tests need to be conducted to decide whether venture capital indeed creates value-added performance or

if this is just the consequence of the screening ability of venture capitalist to ﬁnd superior entrepreneurs

before investments.

Second, with the increasing appearance and database of more than 40 venture capital funds in Vietnam,

the next step is to explore what determines the success of venture capital on entrepreneurs. This can be

drawn from the way venture capital funds designs contract terms, stages of capital infusion, the syndication

of venture capitalists or funding sources from either individuals, governments or banks. Especially, with

the establishment of the project “Supporting the startup ecosystem until 2025”, the Vietnamese government

HỘI THẢO KHOA HỌC QUỐC TẾ KHỞI NGHIỆP ĐỔI MỚI SÁNG TẠO QUỐC GIA

commits to set up a national fund and use a considerable proportion of public budget to invest in

entrepreneurial ventures, innovation, and creative activities. Future research should study how effectively

the Vietnamese government inﬂuences startups through dual role as ﬁnancier and governor. Additionally,

whether government intervention can circumvent capital and managerial constraints or be detrimental to

venture capital and startups to fulﬁll political ambition is always a debatable topic for further research.

Last, there is indeed no venture capital established in Vietnam, all are established overseas and only

have representative ofﬁces in Vietnam due to incomplete legal framework and legal obstacles. With the

commitment of the Vietnamese government to promote a startup nation for Vietnam, new public policies

will be launched. For example, the decree on venture capital and the decree on investments in entrepreneurs

and innovation will be published by the Ministry of Planning and Investment. This creates a well-deﬁned

legal framework for any new establishments of venture capital in Vietnam. Further studies can enhance

understanding of the implications of public policies in the success of venture capital. Others can take the

disclosure of these policies as external political events to investigate the causal effects of venture capital on

entrepreneurial ﬁrms.

2. ACKNOWLEDGEMENT

We would like to show our gratitude to Mr. Butts for his editing on this manuscript. He also provided

insights and comments that are greatly assisted our research.

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