Underpricing of an initial public offering is less likely if a company is backed by angels compared with venture capital-backed firms, according to new research from the University of New Hampshire’s Centre for Venture Research.

Angel investors do not have the agency problems inherent in venture capital investments, according to the research authors, Professors William Johnson and Jeffrey Sohl.
 
“Angels invest their own money where venture capitalists are money managers and invest capital provided by their limited partners. This fundamentally changes the incentives of the venture capitalists.
 
“Where angels are concerned most about the return of their investment, venturecapitalists must also consider the incentives to raise additional funds, take other portfolio firms public, and ultimately, to maximize the management fees they can obtain from running their venture fund. The literature has shown, for instance, that venture investors will actually sell the shares of IPO firms at lower prices to enhance their ability to raise future funds, so-called grandstanding. In contrast, angel incentives are more closely aligned with pre-IPO shareholders who wish to maximize the proceeds of the firm.”

The researchers examined all companies that went public in the US from 2001 through 2007. They found underpricing – as represented by the difference between the offering and closing prices on the day of the IPO – averaged 12.1% and that average amount raised in an offering was $179.4 million. This means that the average IPO company left $21.7 million on the table.

Johnson and Sohl determined that of 665 companies for which they had sufficient data, 13.4% had only angel investors, 16.1% had both angel and venture investors, 32.8% had only venture investors and 37.7% had no venture or angel investors. Angels, whose investments tend to be less diversified than venture capitalists, are more likely to sell some of their shares as part of that IPO, thereby aligning their interests with the company, which seeks to raise as much as it can through the offering.
 
The study also noted that angel and/or venture capital backed firms go public at a younger age than non-backed firms implying that these investors have unique skills which enable a firm to go public sooner.
 
See the research here.
 

(Source: NZ Young Company Finance Newsletter - August 2009)