Journal of Business Venturing 21 (2006) 27 – 44

Moderating effects of investor experience on the

signaling value of private equity placements
Jay J. Janneya,*, Timothy B. Foltab,1
a
School of Business Administration, University of Dayton, 300 College Park, Dayton,
OH 45469-2271, United States
b
Krannert Graduate School of Management, Purdue University, West Lafayette, IN 47907-1310, United States
Received 1 July 2002; received in revised form 1 January 2005; accepted 1 February 2005

Abstract

We contend that young start-up firms requiring external capital are able to differentiate themselves
from competitors through their choices of investors and financing mechanisms. Private placements of
equity convey efficient signals to markets for several reasons. They are (short-term) irreversible, occur
after a more rigorous analysis than public offerings provide, contain governance mechanisms, and are
generally observable by outsiders. The disclosure that investors possess a superior reputation for
evaluative ability conveys an additional, endorsing signal of the firm’s prospects. This proves
especially valuable for younger firms, less capitalized firms, and firms that have more recently received
private equity from an experienced investor. Using an event history analysis on a sample of 329
publicly held biotechnology firms, we find firms that are perceived to be more uncertain and that
disclose the presence of more prominent investors are better able to attract subsequent financing.
D 2005 Elsevier Inc. All rights reserved.

Keywords: Private equity; Signaling; Reputation

1. Executive summary

Because knowledge-intensive firms increasingly go public earlier in their life, the Initial
Public Offering (IPO) resolves a relatively smaller amount of information asymmetry

* Corresponding author. Tel.: +1 937 229 2975; fax: +1 937 229 3788.
E-mail addresses: janney@notes.udayton.edu (J.J. Janney)8 foltat@mgmt.purdue.edu (T.B. Folta).
1
Tel.: +1 765 494 9252; fax: +1 765 494 9658.

0883-9026/$ - see front matter D 2005 Elsevier Inc. All rights reserved.
doi:10.1016/j.jbusvent.2005.02.008
28 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44

present in the firm. At the same time, increases in technological uncertainty add to the
amount of information asymmetry needing to be resolved. Combined, these two elements
make it more difficult to differentiate between firms. This leaves a given firm appearing
similar to other firms, which in turns creates obstacles to obtaining future financing.
While capital is a commodity, the ability for young firms to attract it on favorable terms
can enable them to differentiate themselves from similar-appearing peers. Consistent with
Peteraf (1993), this type of differentiation can provide for a relative competitive advantage,
especially when levels are uncertainty are greater. As such, we argue that a firm’s choice of
financing is a key strategic decision to be managed, and conveys a credible signal.
Specifically, how firms accept money, and whom they accept them from can convey
credible signals.
In this work we examine how the choice of investors conveys additional information
to investors. Our main thesis is that the experience levels of investors may moderate the
effectiveness of the private equity signal. We suggest that the choice of investor not only
provides the funding required, but also conveys endorsements that enable firms to
differentiate themselves from their peers. Other studies have examined similar issues,
(e.g. Deeds et al., 1997; Stuart et al., 1999), focusing on privately-held firms as well as
access to unique resources. This study differs in two ways that we believe advances our
understanding of signaling: first, we examine only publicly-held firms, where the effects
of information asymmetry should prove smaller. Second, we examine the reputation
effects on providing a commodity product (capital), as opposed to providing a unique
resource (e.g., an alliance agreement). We also examine the moderating effect
uncertainty has on the value of investor endorsements, both technological uncertainty,
as well as time-based.
We examined the financing history of 329 publicly-held biotechnology firms (from
1973–1998). We identified a total of 1152 equity financing events subsequent to IPOs-806
private equity placements and 346 seasoned public offerings. Employing an event history
analysis, where the dependent variable is the rate of subsequent financing events, we
examine the effect investor experience has on a firm’s ability to attract subsequent
financing to the current round. Different from many studies, we include not only venture
capitalists in our study, but also industry-based investors, such as pharmaceutical firms and
other biotechnology firms. We find that attracting capital from more experienced investors
enhances a firm’s ability to attract subsequent capital, both from existing investors as well
as from new ones. This effect is stronger when uncertainty about the firm is greater (e.g.
when the firm is young, relative to peers). In addition, we find that reputation effects
dissipate over time, suggesting that information asymmetry about a firm is dynamic, and
must be actively managed. The timing effect suggests affiliation with a reputable investor
can be a two-edged sword, rewarding a firm when it does well managing news about itself,
but punishing the firm when it fails to do so.

2. Introduction

Sustained profitability is no longer the Rubicon young firms must cross in order to go
public. Over the past 10 years young firms have begun to go public when markets are
 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44 29

favorably inclined towards investment, not necessarily when those firms have demon-
strated viable profitability (Stuart et al., 1999; Fenn et al., 1997; Lerner, 1994). As a result,
an Initial Public Offering (IPO) no longer provides the level of legitimizing differentiation
that it did in the past. By going public prior to producing profits, or even providing
evidence of viability, levels of post-IPO information asymmetry have risen. This increase
in information asymmetry makes it more difficult for young firms when competing with
similar-appearing peers to acquire capital. For such firms, success rests with their ability to
acquire necessary resources, at fair prices (Pfeffer and Salancik, 1978). To do so, firms
may convey critical information to investors through signaling mechanisms that outsiders
perceive to be credible (Spence, 1974).
This paper investigates how one type of signal-the post-IPO choice of issuing private
equity placements, enhances a firm’s ability to acquire future capital. In doing so, we
follow a line of research that advocates how issuing private equity may provide a signal of
quality for issuing firms (e.g. Hertzel and Smith, 1993). Nearly all private equity securities
are unregistered with the Securities Exchange Commission, and as a result may only be
purchased by investors bcertifiedQ by the SEC (Gompers and Lerner, 1999). Our main
thesis is that the experience levels of these certified investors moderates the effectiveness
of the private equity signal.
Our interest in the effect of private equity investor experience is complementary to
the work of Stuart et al. (1999), who examined the experience of a firm’s alliance
partners in generating endorsements for the firm. We extend their research in several
important ways. First, we examine the value of endorsements emanating from an
entirely different type of signal-post-IPO private placements. Publicly-held firms
generally enjoy several financing alternatives, the choice of which creates a credible
signal (Janney and Folta, 2003). Next, the key resource involved is a commodity-
capital, whereas with alliances the key resource involves a unique, intangible resource
associated with the partnering firm. Third, while Stuart et al. (1999) only explored how
endorsements benefit privately-held firms, we examine how signals benefit publicly-
held firms. Fourth, we consider that the recency of a firm’s endorsement may moderate
signal effectiveness. Whether endorsements effects are temporal or enduring is an
important, yet underdeveloped aspect of signaling theory. Finally, while Stuart et al.
(1999) characterized uncertainty with firm age, we examine whether additional firm
and industry measures of uncertainty may moderate the endorsement effect of investor
experience.
The remainder of the paper is divided into four sections, and proceeds as follows: The
next section discusses the role of signaling in acquiring capital. We explain how private
equity placements generate a credible signal, observable by non-investors. We hypothesize
about the effect that disclosing an investor’s experience has on a firm’s ability to attract
subsequent capital, as well as factors that may moderate the benefits from signaling. We
then address our research methods. Conducting an event history analysis, we test our
hypotheses with a sample of 329 publicly-held US biotechnology firms. The
biotechnology industry exemplifies the financial challenges for young firms because they
must raise large amounts of capital prior to demonstrating any commercial success. The
final two sections discuss our findings and conclusions, as well as proposed directions for
future research.
30 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44

3. Theory background and hypothesis development

When firms lack resources necessary to exploit growth opportunities, their unique,
proprietary knowledge (which creates the opportunity) may also hinder their ability to
attract funding at reasonable prices. This problem is known as adverse selection, and is
characterized by Akerlof’s (1970) blaw of lemonsQ, i.e. investors cannot adequately
distinguish between high quality firms and low quality ones, because both types of firms
look similar. Overcoming problems of adverse selection requires firms to either
demonstrate accomplishments unmatched by peers (e.g. patent activity), or signaling
their high quality via transactions that low quality peers cannot match, for either risk or
cost reasons (Spence, 1974; Leland and Pyle, 1977).
Signaling in the strategy literature primarily focuses on information exchanges between
firms of an industry, their suppliers and customers (e.g. Heil and Robertson, 1991). Firms
may seek to influence competitive behavior by peers (Heil and Robertson, 1991), by
signaling their level of competitive aggressiveness (e.g. Lumpkin and Dess, 1996), or their
propensity to respond to attacks by competitors (Ferrier et al., 1999). In contrast, signaling
in the economics literature typically examines how best to discern performance differences
between firms. Such studies seek to separate high and low quality firms. Well-noted
signals include the amount of personal equity entrepreneurs place at risk in their venture
(Leland and Pyle, 1977), the issuance of debt (Harris and Raviv, 1990), or the choice of
issuing private over public equity (Hertzel and Smith, 1993). Signaling benefits young
firms if, subsequent to a credible signal, they are able to acquire resources more easily and
at a better price than their lower quality peers. Signals are credible if they produce a
separating equilibrium, whereby low quality firms find it more costly (or risky) to signal
than high quality firms. In the next section we discuss the attributes of private equity that
generate a credible signal.

3.1. Private placements of equity

Private equity placements are privately negotiated financial instruments sold outside of
public exchanges. They occur via specific exemptions of the Securities Act of 1933
registration requirements (e.g. Rule 144, 144a). Unless re-registered with the SEC, they
are illiquid (except in rare and limited circumstances) for 2 years. The majority of private
placements in biotechnology transact common stock; because these transactions are
negotiated, roughly a fourth of the time they include additional provisions (e.g. warrants,
convertible features, etc.). At least three characteristics suggest that high quality firms
should be able to attract private equity, while low quality firms should not. These private
placement characteristics involve (1) investment irreversibility, (2) knowledgeable
investors who conduct thorough due diligence before investing, and (3) post-investment
monitoring provisions (Hertzel and Smith, 1993).
Private equity is often illiquid, bearing significant re-sale restrictions, typically 2 years.
These restrictions create a significant illiquidity risk because a firm’s performance and
competitive position may plummet during the investor’s block-inQ period. It is this
illiquidity that primarily distinguishes public and private equity. An investor making an
illiquid investment is demonstrating greater confidence in the investment’s outcome.
 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44 31

Because of the greater risk involved, the SEC permits investment only by bcertified
investorsQ, or bQualified Institutional BuyersQ i.e., high net worth parties who demonstrate
they possess sufficient knowledge to make informed decisions.
Having assumed a substantial illiquidity risk, private investors demand, and are
granted, in-depth access to firm data prior to committing their funds. As the private
placements are unregistered, there is no formal disclosure format to follow, and due
diligence even more the responsibility of the private investors. This process approaches the
level offered in mergers and acquisitions, a much higher standard than typically found in
public equity offerings (Lerner, 1994). It is frequently performed by the investors
themselves (or someone they contract with). Due diligence reviews may last as long as six
weeks, and frequently include the following: a review of the disclosure provided by the
issuing firm; visits to the firm; as well as meetings and telephone conversations with key
employees, customers, suppliers, and creditors (Lerner, 1994). Problems with low quality
firms are likely to be discovered under such rigorous search processes, both raising their
costs of acquiring private equity, and decreasing their incentive to do so.
Finally, the credibility of signaling through private equity is enhanced by the inclusion
of key governance and reporting provisions. Investors demand monitoring provisions that
reduce moral hazard problems, such as covenants to inspect facilities, books, and records.
They also require timely financial reports and operating statements (Lerner, 1994). Major
investors typically demand board representation, providing an avenue to intervene at signs
of trouble.
These three reasons make it much more difficult for relatively low quality firms to
attract private equity investors; when firms do attract a private placement investment, it
should generate a positive signal. Thus, attracting private equity may be viewed as
winning a certification race for legitimacy (Rao, 1994), and signals that investors have
confidence in the firm’s viability.

3.2. The effect of an investor’s experience on signal strength

A key assumption of our reasoning is that investor reputation is a key attribute of the
private placement signal. In turn, we suggest that investor reputation accrues over time as a
function of observed experience. This is largely consistent with a broader literature,
consistent with the legitimacy literature, that examines the benefits of affiliation with
reputable partners, such as underwriters (Carter and Manaster, 1990), venture capitalists
(Lerner, 1994), and alliance partners (Powell et al., 1996). Certifications and endorsements
confer legitimacy to recipient firms to the extent that their partners possess a legitimized
reputation. Baum and Oliver (1991) note that organizations that ally themselves with
prominent actors glean some portion of the legitimacy associated with the prominent
actors. Credible signals are enhanced when they are transacted with partners who possess
substantial incentive to maintain exchange exclusivity (Podolny, 1994). When these
transactions are observable, potential investors may view them as third party endorsements
or certifications (Booth and Smith, 1986).
In general, these studies have demonstrated that firms affiliating with prestigious
service providers enjoy higher share prices when issuing securities. External observers can
rely on the partner’s reputation for evaluative ability to refine their own perspectives of the
32 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44

young firm’s present value and growth prospects. Since these partners compete in a market
for reputation, it is assumed that they will affiliate only with higher quality firms,
otherwise they risk dissipating the economic and social rents generated by a good
reputation (Shapiro, 1983; Podolny, 1994). Because prominent investors are seen as due
diligence experts, their investments convey a valuable, legitimizing endorsement (Stuart et
al., 1999).
We argue that disclosing investor identity benefits issuing firms by providing new
(potential) investors additional information about firm quality. This helps differentiate
issuing firms from similar appearing peers. When potential investors can identify existing
investors, it serves to filter the entire body of potential investments into a much smaller
bselection poolQ. Issuing firms benefit by an improved likelihood of attracting subsequent
capital because investors will be more likely to invest alongside more experienced
investors. Because endorsements reduce search costs for potential investors, it expands the
number of potential investors young firms can turn to for future funds. Accordingly, we
propose the following hypothesis:
Hypothesis 1. A firm’s ability to attract subsequent capital will be positively related to the
private equity investor’s prior experience.

3.3. The moderating effect of timing on the strength of a firm’s signal

Signals are static in time-relevant when they occur, but less so as conditions change.
The btaken for grantednessQ element of legitimacy (Carroll and Hannan, 1989) that
emerges from the signal must be questioned if the assumptions under which it was made
have changed. Although investors may not be able to directly observe changes in real and
perceived information about the firm, managers can. This leads to information asymmetry.
As it grows over time, signals should be particularly strong and reliable for more recent
private equity placements. Inversely, endorsements erode in value over time because
potential investors assume they are no longer timely. An absence of private equity funding
over an extended period may signal negative information to potential investors,
particularly when experienced investors do not reinvest in the firm. Thus, we propose
that while the endorsement effect of investor experience will be particularly strong
immediately subsequent to an investment, it will dissipate over time. Furthermore, signal
dissipation will be greater for signals from more experienced investors.

Hypothesis 2. The more recent the last private equity placement, the more positive is the
effect of a private equity investor’s prior experience on the firm’s ability to attract capital.

3.4. The moderating effect of uncertainty on the strength of a firm’s signal

Benefits of signaling should hinge on the degree to which exchange partners lack
sufficient information about the firm. As a result, signals should have a particularly strong
effect on assessments of value when there is considerable information asymmetry about
the young company’s quality. Consequently, the overall benefit from endorsements should
also vary inversely with existing perceptions of firm quality (Stuart et al., 1999). Signals
 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44 33

reinforce the reputations of high quality firms, maintaining their separation from lower
quality firms. Firms able to signal remain the most desirable partners for both existing and
potential investors. However, like Stuart et al. (1999), we expect that the marginal benefit
from signaling is small for firms already perceived as being high quality. For such firms
there is less uncertainty about the firm’s underlying value and viability, and hence the need
to signal is attenuated. Signaling then should have a greater marginal impact for unproven
firms. The signal’s endorsement substitutes for a lack of existing reputation, and increases
perceptions of firm quality. This more potent signal, in turn, attracts the attention of
potential investors, increasing the firm’s ability to raise capital. While we do not believe
that unproven firms will attract more capital than strong, proven firms, we believe that
private equity signals with experienced investors convey an endorsement that is more
valuable when there is greater uncertainty about firm prospects.

Hypothesis 3. The more uncertainty about firm prospects, the more positive is the effect of
a private equity investor’s prior experience on the firm’s ability to attract capital.

4. Research methods

4.1. Sample

Our sample is comprised from US biotechnology firms founded between 1973–the year
of Cohen and Boyer’s recombinant DNA breakthrough–and 1998. Since our theoretical
focus is on financing events of publicly traded firms, we used Bioscan (1997) and the North
Carolina Biotechnology Center (NCBC) Actions Database (1996) to identify the 329 US
biotechnology firms that had issued an initial public offering by 1998. We supplemented
these sources with data from the Recombinant Capital and S&P NetAdvantage websites, and
by searching Lexus/Nexis by matching the terms bprivateQ and bpublicQ with the following
words: bequityQ, bfinancingQ, and bofferingQ. We uncovered a total of 1461 equity financing
events subsequent to IPOs for 329 firms. Of these 1461 events, 1111 were private equity
placements and 350 were seasoned public offerings. For each company we constructed an
event history, information on the number, timing (month, day, year), and sequence of the
events of interest, including private equity placements, public equity financing events,
strategic alliances, patent approvals, founding dates, and exits. Firm events were recorded
until either the firm exited (through liquidation or acquisition) or until December 1998, the
end of the observation period, in which case spells were coded as bright censoredQ. We also
gathered performance data from Compustat for each of the events noted. Since several of the
firms in our sample lacked Compustat data, our sample was reduced to 1152 equity financing
events. Models using full and reduced samples produced substantially similar results,
suggesting the absence of the missing data had no meaningful effect.

4.2. Independent variables

Investor experience. Investor experience is the time (number of days/365.25) since the
investor’s first private equity investment in a biotechnology company that has gone public
34 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44

by the end of our sample.2 Where there are multiple investors, like Lerner (1994), we use
the bleadQ investor’s experience. When the lead is formally specified, they are always
listed first in press releases. When no lead is explicitly mentioned, we assume the first
investor is the bleadQ. Our measure differs slightly from Lerner’s who captured experience
by the investor’s age. While Lerner included only venture capital investors, we also
include investors such as pharmaceutical and other research firms, institutional investors,
and government agencies, several of whom are over 100 years old. As an example, Eli
Lilly is over 100 years old, but has been making biotechnology investments for roughly 20
years. We believe that the time since an investor’s first investment in a biotechnology firm
better approximates their perceived evaluative ability among the investment community.
We were surprised, however, by how many private placement announcements did not to
disclose investor identity. In our sample investor identity is not disclosed for 55.2% (698)
of private equity placements. We retained only the events with previously disclosed
investors, leaving us with 567 financing events by public firms subsequent to a private
equity placement.3

4.3. Firm-level variables that moderate investor experience

Like Stuart et al. (1999), we believe that firm-level uncertainty is higher for firms that
have raised less capital. They reasoned that such firms were more likely to suffer from the
liability of newness (Stinchcombe, 1965) because many of the accomplishments that build
firm reputation (e.g., patents, new product development, commercial success, private
equity, alliances, etc.) take time to develop. Two measures approximate the amount of
capital raised for biotechnology firms. Private placement count is the square root of the
firm’s cumulative number of private placements prior to the current transaction. Firms
having executed rounds of private equity will have gone through the due diligence process
multiple times, which should reduce uncertainty about a firm’s legitimacy and enhance
perceptions of firm quality over time. Capitalization is the square root of the cumulative
amount of equity raised ($MM) in capital markets prior to the current transaction. Firms
with fewer private placements and lower capitalization should thus benefit more from the
endorsement effect of the investor.
Uncertainty about firm prospects may also be related to the timing of previous
financing events. The longer it has been since a firm received private equity financing, the
more uncertainty and information asymmetry there is about a firm’s growth opportunities
(Janney and Folta, 2003), all else equal. Thus, the longer it has been that a firm received
private financing, the more a firm should benefit from the endorsement of a known
investor. Private placement clock is the number of days since the firm initiated its last
private equity placement, divided by 365.25. Because this variable was skewed, we
transformed it via a log transformation.

2
We also measure investor experience by counting the number of prior private equity investments for each
investor. The two measures generated nearly identical results; therefore we present only the results using investors
experience measured by time.
3
We also run models including a dummy variable for disclosed/undisclosed investors and find similar results to
the ones reported in this paper.
 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44 35

4.4. Industry-level variables that moderate investor experience

Firm prospects may be uncertain due to industry conditions. For example, Ritter (1984)
has documented the presence of bhotQ and bcoldQ financing windows. Industry Funding is
measured as the total amount of private and public equity raised in the biotechnology
industry in the 3 months prior to the financing event. In young industries, assessing firm
performance proves problematic because the measures which distinguish high and low
quality firms are still evolving (Rao, 1994). The age of the industry equals b1Q at the
beginning of the industry’s life in 1973, and proceeds toward b26Q by 1998. Industry age is
a log transformed variable for this measure. We expect endorsements to prove especially
beneficial to unproven firms during cold financing windows and in young industries.

4.5. Control variables

We have implemented a full range of variables to control for industry-level and firm-
level effects which may influence a firm’s ability to get financing. Biotech Index is a stock
market index of biotechnology firms, and is used as a control for the market receptivity to
the industry and its growth prospects. To control for growth and the development in the
infrastructure in the industry, density is the cumulative count of all existing firms in the
industry.
At the firm level, Therapeutic is equal to b1Q if the firm is in the therapeutic segment,
b0Q otherwise. To measure firm scope, we sum the number of product markets the firm is
in. This variable ranges from one to six. Firm size, Revenue, and Operating Income are all
taken from Compustat and are measured in the year prior to the transaction.4 Survival ratio
is measured as the prior year’s cash plus operating income, all divided by R&D expense.
This is a common measure of performance in the biotechnology industry. Other measures
of firm performance are patent count and alliance count, which are the logarithmic
transformation of the cumulative number of patents held by a firm and the cumulative
number of alliances initiated by a firm, respectively. Firms with more patents or alliances
should be able to raise more capital. Firm age is the number of days since firm founding,
divided by 365.25, IPO age is the number of days since the firm’s IPO, divided by 365.25.
The size of prior financings may also influence a firm’s ability to raise capital. Amount of
last private placement is the dollar amount ($000) invested in the prior private placement,
and IPO amount is the amount of capital raised at initial public offering. If a firm’s prior
private equity placement involved restricted stock it was coded b1Q, b0Q otherwise. Finally,
the endorsement effect from investors should hold if the investor maintains its stake in the
issuing firm. However, if investors liquidate their holdings, then the endorsement effect
may disappear. While we do not observe whether an investor liquidates its holdings, one
common way for private equity investors to liquidate their holdings is through public
equity offerings. To control for the potential for liquidation to occur we code liquidation
b1Q if a public offering occurred subsequent to a private equity placement. Table 1 provides
descriptive statistics and Pearson correlation coefficients for all variables.

4
We divide these values by 1000 to revise their scales.
 36
Table 1
Descriptive statistics and Pearson correlations (n = 1152)
Variable Mean S.D. Min Max 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
Industry Age 2.97 0.021 2.2 3.26
Biotech 3.51 0.98 1.68 5.86 0.37
Index

J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44

Equity Finance
Window 0.75 0.51 0 1.92 0.61 0.64
Density 492.38 62.87 117 540 0.89 0.19 0.44
Scope 2.58 1.36 1 6
0.39
0.19
0.17
0.32
Therapeutic 0.78 0.42 0 1
0.13
0.06
0.01
0.15 0.34
Firm Size 3.71 1.32 0.09 7.43 0.14
0.01 0.11 0.17 0.27 0.08
Restricted 0 0.05 0 1 0.04 0.04 0 0.02
0.03 0.03
0.04
Stock
Survival 2.09 2.37 0 52.19
0.13 0.07
0.04
0.11
0.02 0.06 0.09
0.02
Ratio
Revenue 0.03 0.11 0 1.21 0.12 0.02 0.07 0.09 0.31 0.02 0.52
0.01
0.14
Operating
0.01 0.02
0.11 0.1
0.14
0.05 0.01
0.12
0.03
0.07
0.02 0.01 0.39
Income

Amt of Last Priv

Place 0.01 0.05 0 0.44
0.09
0.11
0.01
0.04 0.12 0.1 0.29 0
0.05 0.2 0.27
Alliance 2.71 0.9 0 4.84 0.11
0.05 0.13 0.19 0.45 0.11 0.57
0.03
0.13 0.36 0 0.21
Count
Patent Count 1.73 1.35 0 4.49 0.15
0.04 0.08 0.27 0.18
0.02 0.44
0.03
0.11 0.3
0.06
0.07 0.52

Private Placement
Count 1.28 0.48 0.69 3.09 0.19 0.09 0.18 0.15 0.23 0.18 0.4 0
0.08 0.28
0.04 0.31 0.46 0.13
Firm Age 9.05 3.51 1.03 23.23 0.35 0.03 0.26 0.36 0.09 0.23 0.35 0
0.28 0.35 0.08 0.08 0.49 0.55 0.27
IPO Age 4.85 3.35 0 17.15 0.26 0.02 0.23 0.27 0.22 0 0.4 0.03
0.23 0.43 0.09 0.09 0.56 0.56 0.29 0.78
IPO Amount 4.16 2.15 0 9.61 0.1 0.02 0.06 0.07
0.25
0.05 0.29
0.03 0.01
0.01 0.04 0.14 0.09
0.01 0.1 0.01
0.2
Capitalization 3.47 1.28 0 5.91 0.31 0.12 0.23 0.28
0.05 0.03 0.61
0.02
0.02 0.23
0.15 0.14 0.4 0.34 0.25 0.37 0.28 0.62
Liquidity 0.82 0.39 0 1 0.11 0.01 0.19 0.14 0.07 0.04 0.28 0.01 0.01 0.13
0.03 0.06 0.31 0.31 0.27 0.36 0.49
0.04 0.25

Private Placement
Clock 1.08 0.64 0 2.89 0
0.06 0.05 0.05 0.08
0.04 0.2
0.02
0.02 0.1 0.02
0.11 0.14 0.26
0.28 0.27 0.21 0.07 0.23
0.18
Investor 0.01 0.01 0 0.06 0.25 0.09 0.13 0.2
0.11 0.02 0.1 0
0.05 0
0.01 0.1 0.04 0.05 0.1 0.18 0.08 0.12 0.14
0.09 0.3
 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44 37

4.6. Dependent variable

We model the dependent variable as the rate of financing through (a) private equity
placements or (b) seasoned public offerings subsequent to the firm’s initial public offering,
where the rate is defined as
kðt Þ ¼ lim½qðt; t þ Dt Þ=Dt ; Dt0;
and q is the discrete probability of the firm initiating subsequent financing events
between t and (t + Dt), conditional on the history of the process up to time t. This rate

Table 2
Maximum likelihood estimates for the hazard of attracting capital, main effects modelsa,b
Variable name Model 1 Model 2
Industry Age 1.05 (0.55) 0.06 0.93 (0.56) 0.10
Biotech Index 0.05 (0.05) 0.31 0.06 (0.05) 0.25
Equity Finance Window 0.04 (0.10) 0.73 0.02 (0.10) 0.84
Density 0.00 (0.00) 0.04* 0.00 (0.00) 0.05
Scope
0.05 (0.04) 0.15
0.06 (0.04) 0.15
Therapeutic 0.10 (0.11) 0.34 0.10 (0.11) 0.36
Firm Size
0.07 (0.05) 0.16
0.08 (0.05) 0.11
Restrickted Stock 1.27 (0.28) 0.00*** 1.24 (0.30) 0.00***
Survival Ratio
0.04 (0.02) 0.03*
0.04 (0.02) 0.03*
Revenue
0.62 (1.18) 0.60
0.49 (1.12) 0.66
Operating Income 0.35 (4.34) 0.94 0.35 (4.30) 0.94
Amt Of Last Priv Place
0.71 (1.07) 0.51
1.00 (1.13) 0.38
Alliance Count 0.12 (0.06) 0.05* 0.13 (0.06) 0.03*
Patent Count 0.05 (0.04) 0.14 0.05 (0.03) 0.16
Private Placement Count 0.10 (0.10) 0.34 0.04 (0.11) 0.72
Firm Age
0.15 (0.05) 0.00***
0.15 (0.05) 0.00***
IPO Age 0.01 (0.02) 0.67
0.01 (0.02) 0.74
IPO Amount 0.09 (0.05) 0.06 0.05 (0.02) 0.02*
Capitalization 0.5 (0.04) 0.26 0.05 (0.04) 0.23
Liquidity 0.30 (0.12) 0.01* 0.32 (0.13) 0.01*
Private Placement Clock 0.80 (0.09) 0.00***
0.83 (0.09) 0.00***
Investor Exp. 0.02 (0.01) 0.04*
Priv. Placement Count  0.00
Inv. Exp.
Capitalization 
Investor Exp.
Priv. Placement Clock 
Inv. Exp.
Industry Age  Investor exp.
Equity Fin. Window 
Investor Exp.
Constant
13.83 (2.39) 0.00***
13.67 (2.41) 0.00***
Log-likehood 323.38 *** 325.43 ***
Likelihood Ratio Test-Model 410 *
vs. Model 1
t, p b 0.1, *, p b 0.05; **, p b 0.01; ***, p b 0.001.
a
Adjusted standard errors in parentheses.
b
Year fixed effects are not reported.
 38
J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44
Table 3
Maximum likelihood estimates for the hazard of attracting capital, interaction modelsa,b
Variable name Model 3 Model 4 Model 5 Model 6 Model 7
Industry Age 0.86 (0.55) 0.12 0.91 (0.56) 0.10 0.87 (0.56) 0.12 1.68 (0.64) 0.01** 0.90 (0.55) 0.10
Biotech Index 0.07 (0.55) 0.15 0.06 (0.05) 0.25 0.06 (0.05) 0.26 0.06 (0.05) 0.24 0.05 (0.05) 0.33
Equity Finance 0.02 (0.10) 0.81 0.02 (0.10) 0.83 0.01 (0.10) 0.94 0.02 (0.10) 0.82 0.25 (0.14) 0.08
window
Density 0.00 (0.00) 0.05* 0.00 (0.00) 0.05 0.00 (0.00) 0.07 0.00 (0.00) 0.01** 0.00 (0.00) 0.03*
Scope
0.06 (0.04) 0.12
0.06 (0.04) 0.14
0.06 (0.04) 0.13
0.06 (0.04) 0.15
0.06 (0.04) 0.15
Therapeutic 0.10 (0.10) 0.34 0.10 (0.11) 0.35 0.09 (0.11) 0.41 0.11 (0.11) 0.29 0.11 (0.11) 0.31
Firm Size
0.10 (0.05) 0.06
0.09 (0.05) 0.11
0.09 (0.05) 0.08
0.09 (0.05) 0.10
0.08 (0.05) 0.11
Restricted Stock 1.23 (0.29) 0.00*** 1.24 (0.30) 0.00*** 1.25 (0.28) 0.00*** 1.24 (0.29) 0.00*** 1.24 (0.30) 0.00***
Survival ratio
0.03 (0.02) 0.07
0.04 (0.02) 0.03*
0.03 (0.02) 0.05*
0.04 (0.02) 0.03*
0.04 (0.02) 0.03*
Revenue
0.37 (1.14) 0.74
0.47 (1.12) 0.68
0.47 (1.18) 0.69
0.44 (1.03) 0.67
0.52 (1.08) 0.63
Operating Income 0.59 (4.38) 0.89 0.25 (4.26) 0.95 0.18 (4.32) 0.97 0.89 (4.39) 0.84 0.97 (4.33) 0.82
Amt of last Priv
0.78 (1.51) 0.61
1.00 (1.15) 0.39
0.97 (1.17) 0.41
1.30 (1.10) 0.24
1.23 (1.11) 0.27
place
Alliance count 0.13 (0.06) 0.03* 0.13 (0.06) 0.03* 0.13 (0.06) 0.03* 0.13 (0.06) 0.03* 0.14 (0.06) 0.02*
Patent count 0.05 (0.04) 0.13 0.05 (0.03) 0.17 0.05 (0.04) 0.16 0.05 (0.03) 0.18 0.04 (0.03) 0.19
Private placement 0.34 (0.13) 0.01* 0.04 (0.11) 0.75 0.08 (0.11) 0.49 0.01 (0.11) 0.92 0.03 (0.11) 0.79
count
Firm age
0.15 (0.05) 0.00***
0.15 (0.05) 0.00***
0.15 (0.05) 0.00*** 0.15 (0.05) 0.00*** 0.15 (0.05) 0.00***
IPO age
0.01 (0.02) 0.64
0.01 (0.02) 0.76
0.01 (0.02) 0.74
0.01 (0.02) 0.76
0.01 (0.02) 0.75
IPO Amount 0.05 (0.02) 0.02* 0.05 (0.02) 0.02* 0.05 (0.02) 0.04* 0.05 (0.02) 0.02* 0.05 (0.02) 0.02*
Capitalization 0.05 (0.04) 0.25 0.06 (0.05) 0.24 0.05 (0.04) 0.25 0.05 (0.04) 0.25 0.05 (0.04) 0.25
Liquidity 0.33 (0.12) 0.01** 0.32 (0.12) 0.01** 0.30 (0.13) 0.02* 0.33 (0.12) 0.01** 0.32 (0.12) 0.01**
Private Placement
0.88 (0.09) 0.00***
0.83 (0.09) 0.00***
1.23 (0.12) 0.00***
0.86 (0.09) 0.00***
0.84 (0.09) 0.00***
clock
Investor Exp.
0.12 (0.03) 0.00*** 0.02 (0.02) 0.15
0.03 (0.02) 0.05 0.42 (0.18) 0.02* 0.05 (0.02) 0.00***
Priv. Placement
0.08 (0.02) 0.00***

J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44

count  Inv. Exp.
Capitalization  0.00 (0.00) 0.73
Investor Exp.
Priv. Placement 0.06 (0.01) 0.00***
clock  Inv. Exp.
Industry age 
0.13 (0.06) 0.02*
Investor Exp.
Equity fin. window 
0.04 (0.01) 0.01*
Investor exp.
Constant
14.37 (2.49) 0.00***
13.68 (2.42) 0.00***
13.53 (2.40) 0.00***
15.55 (2.68) 0.00***
13.75 (2.36) 0.00***
Log-likehood 331.42 *** 325.48 *** 332.39 *** 327.64 *** 327.66 ***
Likelihood ratio 16.08 *** 4.20 18.02 *** 8.52 * 8.56 *
testmodel vs.
model 1
t, p b 0.1, *, p b 0.05; **, p b 0.01; ***, p b 0.001.
a
Adjusted standard errors in parentheses.
b
Year fixed effects are not reported.

39
40 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44

summarizes the information on the intervals of time between successive events, with
higher values of the rate corresponding to shorter times between events and vice versa.
To test the suitability of different parametric forms for k, we used the Akaike
information criterion (1974) and found a Weibull distribution provided the best model fit.
The Weibull distribution is appropriate for modeling data with monotone hazard rates that
increase exponentially with time, as is the case with our data. Thus, k was specified as an
exponential function of the independent variables and a set of parameters capturing the
effects of the variables on the rate of subsequent financing such that:

kðt Þi ¼ kðt Þ4expðaCit þ bVEit þ dVMit þ /Xit Mit Þ:

where k(t) represents the baseline hazard rate; C it is the matrix of time-varying control
variables, E it is the investor experience variable, M it is the matrix of firm and industry
variables expected to moderate the effect of investor experience, and X it M it is the
interaction effect capturing the moderating relationships; and a, b, d, / are parameters to
be estimated by the method of maximum likelihood using STATA. A key assumption for
maximum likelihood estimation of a is the independence of event times. However, when
firms have repeated financing events, assuming event independence is questionable. The
covariance matrix does not incorporate the additional correlation in the data, so
conventional estimates of variance are not appropriate. We use STATA’s bclusterQ option
to adjust for this concern (Lin and Wei, 1989), reporting adjusted standard errors for each
coefficient.

5. Results

5.1. Primary findings

Table 2 provides models that test our hypotheses about the main effects with disclosed
investor experience. With the exception of the investor experience variable, model 1
includes the full vector of firm and industry level variables. A likelihood ratio test
indicates that this model provides a significant ( p b 0.001) improvement over a model with
only a constant term.
Model 2 tests the effect that prior investor experience has on a firm’s ability to raise
capital (Hypothesis 1). A likelihood ratio test comparing model 2 to model 1 reveals a test
statistic above the critical value. This suggests that the investor experience variable
significantly improves ( p b 0.05) model fit. Interpretation of the individual coefficient
suggests that firms having more experienced investors are better able to attract subsequent
financing. This finding is consistent with expectations cited in Hypothesis 1.
Models 3–7 (shown in Table 3) incrementally introduce interaction terms involving
investor experience and variables that approximate uncertainty about a firm’s growth
prospects. In every case but model 4, likelihood ratio tests indicate that the interaction
terms significantly improve model fit relative to model 1, at two degrees of freedom. The
lack of significant improvement for model 4 suggests that model fit is not improved by
considering how firm capitalization moderates investor experience. The chi-square values
 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44 41

from these tests are available in Table 3. As a result of these findings, we can meaningfully
interpret the coefficients from the moderating effects exhibited in models 3, 5, 6, and 7.
In model 3, the negative interaction effect suggests prior investor experience has a more
important influence on attaining subsequent capital when firms have fewer private
placements. The positive interaction between investor experience and private placement
clock in model 5 suggests prior investor experience has a more important influence on
attracting subsequent capital when it has been a longer time since the last private
placement event. Since a firm’s potential is thought to be more uncertain when it has
initiated fewer private placement and it has been a longer time since the last private
placement, these findings are consistent with expectations cited in Hypothesis 2.
Since younger industries, and industries where firms are receiving less financing are
thought to exhibit greater uncertainty, we expect negative interaction effects in models 6
and 7. These models indicate that prior investor experience has a more important influence
on attaining subsequent capital when industries are younger and the financing environment
is less conducive to fundraising. This is consistent with expectations cited in Hypothesis 3.

5.2. Control variable effects

Several control variables affect the ability to attract capital subsequent to IPO. Firms
seeking capital when the industry is more mature are more likely to attract subsequent
capital. Younger firms and firms having lower survival ratios are more likely to attract
subsequent capital as well. Firms having larger IPOs and more alliance partners are also
more likely to attract subsequent capital, probably because these variables also represent
signals of high quality. Firms with restricted private equity are more likely to attract
capital. We expect that when investors are willing to accept such terms it represents a
strong signal that the firm is high quality. Finally, when a firm’s private investors
experience a liquidation event, the firm is better able to attract subsequent capital
immediately following this event.

6. Discussion

In this paper we have examined the effect of private equity investor experience on a
firm’s ability to attract subsequent capital, as well some factors that may moderate that
effect. We extend a literature that has found private equity placements to be important and
relevant signals of firm quality, by investigating how investor experience moderates the
signal, and when experience effects are most relevant as endorsements. We argue that
endorsements are most beneficial when there is greater uncertainty about firm quality, as
well as when endorsements are more recently initiated. Furthermore, this is the only study
that we know of which explicitly explores the investor endorsement effects that emerge
from the signals of private equity placements for publicly-held firms. Thus, our findings
are particularly important because publicly-held firms are generally perceived as being
better known than their privately-held peers, and because they should face less severe
problems from the effects of information asymmetry. This study suggests that while going
public helps to resolve information asymmetry, its value too is temporal, and additional
42 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44

signals are required to manage the emergence of additional information asymmetry. By

focusing on the ability to raise capital, our results suggest that publicly-held firms can also
obtain long-term benefits from signaling beyond acquiring capital.
We consistently found that endorsements are most important when there is greater
uncertainty about firm value. These findings directly complement the work of Stuart et al.
(1999), who use only firm age to measure uncertainty. Our findings are robust across a
number of different measures of uncertainty, including both industry and firm level. Firms
that have received less previous funding, or have conducted fewer previous rounds of
financing, benefit more from signals conveying the endorsements of experienced
investors. A good question for future exploration would be to examine the effects
experienced investors have on raising/(lowering) the cost of acquiring capital.
We also found that the endorsement effects of signals dissipate over time. This is a
unique contribution. The longer time since the private equity signal penalizes firms having
endorsements from more experienced investors. This finding is rather interesting. It
suggests that affiliation with a prominent investor is a two-edged sword; it not only
conveys quality, but also requires firms to maintain the prominent investor’s confidence.
Failing to do so may send a swift and detrimental signal to potential investors. It may be
specific to a context where repeated signaling is important to sustain firm viability. Further
research should examine the temporal nature of endorsing signals in other contexts.
In contrast to previous studies, we explicitly consider how the effect of signals is
influenced by the disclosure of investor identity. We argue that there should be no
endorsement effects for undisclosed private equity events. While the models presented
include only disclosed investors, our unreported models employing all investors do not
substantively change from the reported models. Furthermore, preliminary logit analyses
indicate that there are no significant differences between firms that disclose investors and
those who do not. We still do not know why so few firms disclose investor identity. Future
research should explore the decision to disclose investor identity in finer-grained detail.
There are at least three limitations of our work. First, similar to other studies on
biotechnology, we recognize how generalizability may be a concern. The biotechnology
industry is typical of many technology industries in having characteristics that may allow
information asymmetry to blossom. While our empirical work focused on a single
industry, our theory of signaling is applicable to any industry context where information
asymmetry is likely to persist. Future studies should explore how information asymmetry
differs across industries and examine the relative importance of signaling behavior.
Second, the importance of private equity as a signal may not hold outside of technology
industries. In technology industries, equity is the dominant form of financing, primarily
due to a lack of tangible assets. However, when competing in industries requiring a greater
percentage of tangible assets, debt becomes a viable alternative, and the reliance on private
equity to signal should be less. In such industries, firms may benefit to a greater extent
from other types of signals, such as debt. At the same time, due to the more observable
nature of assets in such industries, the need to signal is also likely to be less. There remain
ample opportunities to explore the enduring nature of signals. Our study provides evidence
of the enduring nature of signals for a specific type of signal in a specific type of industry.
We encourage future research to examine the moderating effects of investor experience
outside the context of biotechnology and private equity placements.
 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44 43

A third limitation occurs in that by focusing on an investor’s industry experience, we

may be overlooking other resources provided by investors which strengthens the signal.
Future work should also seek to disentangle the signaling benefits created by affiliation
with experienced investors, beyond access to capital. Endorsements should aid the firm in
attracting other strategic resources, such as research partners and professional advisors.
Finally, our work sheds light on the strategic implications for firms seeking capital.
Although capital is a commodity, the ability to attract it is itself a valuable and
differentiating resource for firms to acquire. In addition, attracting it from more
experienced (e.g. more prominent) investors provides issuing firms an additional
separation from their similar appearing peers. In this sense, our work is consistent with
Peteraf’s (1993) view of relative advantage as a separating equilibrium; attracting capital
does not give any specific firm an advantage over all other firms, but rather separates high
and low quality firms into observably differentiated groups. A key finding from our study
is that young firms should seek capital first from prominent investors, to better prepare for
future financing needs. More established firms, however, may find they can afford a
tradeoff between better contractual terms and affiliation benefits (i.e. more established
firms might consider seeking lower financing costs from unknown investors). Inversely,
this suggests that undifferentiated firms may find it worthwhile to accept less generous
terms from more prominent investors, in order to enhance their future fund raising
abilities.

References

Akaike, A., 1974. A new look at the statistical model identification. IEEE Trans. Automat. Contr. AC 19 (6),
716 – 723.
Akerlof, G.A., 1970. The market for dlemonsT: qualitative uncertainty and the market mechanism. Q. J. Econ. 84,
488 – 500.
Baum, J.A., Oliver, C., 1991. Institutional linkages and organizational mortality. Adm. Sci. Q. 36 (20), 187 – 219.
Bioscan. Oryx Press, Phoenix, AZ.
Booth, J., Smith, R., 1986. Capital raising, underwriting, and the certification process. J. Financ. Econ. 15 (1–2),
261 – 281.
Carroll, G.R., Hannan, M.T., 1989. Density dependence in the evolution of populations of newspaper
organizations. Am. Soc. Rev. 54, 524 – 541.
Carter, R., Manaster, S., 1990. Initial public offerings and underwriter reputation. J. Fin. 45 (4), 1045 – 1067.
Deeds, D.L., DeCarolis, D., Coombs, J.E., 1997. The impact of firm-specific capabilities on the amount of capital
raised in an initial public offering: evidence from the biotechnology industry. J. Bus. Venturing 12, 31 – 46.
Fenn, G.W., Liang, N., Prowse, S., 1997. The private equity market: an overview. Financ. Mark. Inst. Instrum. 6,
1 – 105.
Ferrier, W., Smith, K., Grimm, C., 1999. The role of competitive action in market share erosion and industry
dethronement: a study of industry leaders and challengers. Acad. Manage. J. 42, 372 – 388.
Gompers, P., Lerner, J., 1999. The Venture Capital Cycle. MIT Press, Cambridge, MA.
Harris, M., Raviv, A., 1990. Capital structures and the informational role of debt. J. Fin. 45 (2), 321 – 349.
Heil, O., Robertson, T.S., 1991. Toward a theory of competitive market signaling—a research agenda. Strateg.
Manage. J. 12 (6), 403 – 418.
Hertzel, M., Smith, R.L., 1993. Market discounts and shareholder gains for placing equity privately. J. Fin. 58,
459 – 485.
Janney, J.J., Folta, T.B., 2003. Signaling through private equity placements and its impact on the valuation of
biotechnology firms. J. Bus. Venturing 18, 361 – 380.
44 J.J. Janney, T.B. Folta / Journal of Business Venturing 21 (2006) 27–44

Leland, H.E., Pyle, D.H., 1977. Informational asymmetries, financial structure, and financial intermediation.
J. Fin. 32 (2), 371 – 387.
Lerner, J., 1994. Venture capitalists and the decision to go public. J. Financ. Econ. 35, 293 – 316.
Lin, D.Y., Wei, L.J., 1989. The robust inference for the Cox proportional hazards model. J. Am. Stat. Assoc. 84,
1074 – 1078.
Lumpkin, G.T., Dess, G.G., 1996. Clarifying the entrepreneurial orientation construct and linking it to
performance. Acad. Manage. Rev. 21 (1), 135 – 172.
North Carolina Biotechnology Center Actions Database: North Carolina Biotechnology Center, Research Triangle
Park, 1996.
Peteraf, M.A., 1993. The cornerstones of competitive advantage: a resource-based view. Strateg. Manage. J. 14,
179 – 191.
Pfeffer, J., Salancik, G., 1978. The External Control of Organizations: A Resource Dependence Perspective.
Harper and Row, New York.
Podolny, J.M., 1994. Market uncertainty and the social character of economic exchange. Adm. Sci. Q. 39,
458 – 483.
Powell, W., Koput, K., Smith-Doerr, L., 1996. Interorganizational collaboration and the locus of innovation:
networks of learning in Biotechnology. Adm. Sci. Q. 41, 116 – 145.
Rao, H., 1994. The social construction of reputation: Certification contests, legitimization, and the survival of
organizations in the American automobile industry: 1895–1912. Strateg. Manage. J. 15, 29 – 44.
Ritter, J., 1984. The bhot issueQ market of 1980. J. Bus. 57, 215 – 240.
Shapiro, C., 1983. Premiums for high quality products as returns to reputations. Q. J. Econ. 98 (4), 659 – 679.
Spence, M., 1974. Job market signalling. J. Quant. Econ. 87, 355 – 379.
Stinchcombe, A.L., 1965. Social Structure and organizations. In: March, J.G. (Ed.), Handbook of Organizations.
Rand McNally, Chicago, IL.
Stuart, T.E., Hoang, H., Hybels, R.C., 1999. Interorganizational endorsements and the performance of
entrepreneurial ventures. Adm. Sci. Q. 44, 315 – 349.