The Effect of Venture Capital Financing on the Sensitivity to Cash Flow of Firm's Investments


  • Support from the Venture Fun project promoted by the PRIME Network of Excellence is gratefully acknowledged. The authors are grateful to an anonymous referee, Gil Avnimelech, Marina Balboa, Terttu Luukkonen, Pascal Petit, Michel Querè, Alessandro Rosiello, Morris Teubal and participants in the 2006 EFMA Conference, 2006 EARIE Conference and XX RENT Conference for helpful comments. The usual disclaimer applies.


This work studies the effect of venture capital (VC) financing on firms' investments in a longitudinal sample of 379 Italian unlisted new-technology-based firms (NTBFs) observed over the 10-year period from 1994 to 2003. We distinguish the effects of VC financing according to the type of investor: independent VC (IVC) funds and corporate VC (CVC) investors. Previous studies argue that NTBFs are the firms most likely to be financially constrained. The technology-intensive nature of their activity and their lack of a track record increase adverse selection and moral hazard problems. Moreover, most of their assets are firm-specific or intangible and hence cannot be pledged as collateral. In accordance with this view, we show that the investment rate of NTBFs is strongly positively correlated with their current cash flows. We also find that after receiving VC financing, NTBFs increase their investment rate independently of the type of VC investor. However, the investments of CVC-backed firms remain sensitive to shocks in cash flows, whereas IVC-backed firms exhibit a low and statistically not significant investment–cash flow sensitivity that we interpret as a signal of the removal of financial constraints.