Factors Affecting Capital Structure of Indian Venture Capital-Backed Growth Firms

EntrepreneurshipEntrepreneurship is considered as an engine for bringing about positive changes in the form of socioeconomic welfare (Kortum[AUT]Kraus, A. and Lerner[AUT]Lerner, J. 2000). However, it is a well-established fact that, one of the major constraints faced by entrepreneurs is access to finance. Self-financing is usually not sufficient and collateral-based debt funding is not always available. Information asymmetries prevailing between investors and entrepreneurs, uncertainty related to the future of the product, and bleak exit prospects of the investor severely curtail a new venture’s prospects of receiving finance (Chan[AUT]Chan, Y. , 1983; Amit[AUT]Amit, R. et al. 1990). In recent years, equity financing in terms of venture capital has emerged as one of the alternative sources of financing for new ventures. The most accepted form of definition for venture capital includes investment in young firms which are very risky but promise a great return. (Gompers[AUT]Gompers,.[AUT]M.M. & Hellman, T. et al.P.A. 1998[AUT]Blair M.M. ). Recent research in venture capital indicates a trend toward venture capitalists’ preference toward late stage deals (e.g., Gompers[AUT]Gompers, P.A. and Lerner 2001). Since a large volume of venture capital is flowing into growth stage firms, it becomes essential to understand the various factors that venture capitalists consider before investing in a particular firm which is in its growth stage. Earlier research has focused mostly on analyzing the criteria used by venture capitalists to select a new venture based on human capital, attractiveness of markets, uniqueness of products etc. However, this chapter seeks to identify the various financial indicators that venture capitalists consider before funding growth firmsGrowth Firms . One way to do this is to analyze the capital structure of firms which receive venture financing later. The basic objective of this chapter is to understand whether the determinants of capital structure of a firm has a major role to play in the access of venture capital later in its life cycle. The finance literature comprises of numerous studies that focus on the determinants of capital structureCapital Structure of firms. However, there do not exist many studies which talk about the determinants of capital structure of a firm which is financed by venture capital. This chapter is based on the Indian context. It uses the static trade-off theory, pecking order theory, and agency theory to explain the financial structure of firms which receive venture capital subsequently. This chapter draws from the capital structure literature to carve out the variables, i.e., tangible assets, profitability, size, volatility, growth opportunities etc. that affect the capital structure of firms which receive venture financing later. Propositions are drawn on the basis of this reasoning and a conceptual framework is put forth that tries to identify an optimal capital structure strategy for Indian growth firmsGrowth Firms that seek venture capital.