Policy makers and practitioners can play an important role in advancing the contributions of academic studies by providing access to relevant data and by examining the validity of analytical models and research findings. During the Financial Markets Conference 2002, co-hosted by the Federal Reserve Bank of Atlanta and the Berkley Center for Entrepreneurial Studies last May, academic researchers presented their observations on a wide range of important issues confronting the venture industry. What made this event particularly valuable was that these academics were not just talking to other academics, but to an audience of policy makers and practitioners who probed and challenged their conclusions and greatly enriched the discourse that ensued.

Drawing from the presentations delivered at the conference, we provide a sampling of the issues confronting policy makers, academics, and practitioners as they assess the evolving role of venture capital as a source for funding radical innovation and economic growth

How Can We Get Clean Data?

Chief among the challenges facing both academics and practitioners is how to obtain good data. Many of the academic presenters at the conference lamented that good data is extremely difficult to find and that the lack of it has hampered their efforts to discover what, exactly, venture capitalists do.

Susan Woodward, founder of Sand Hill Econometrics, located in Menlo Park, Calif., and former chief economist for the U.S. Securities and Exchange Commission (SEC), believes that better data is critical for revitalizing private equity investment. Betting that investors will pay top dollar for reliable information, Sand Hill Econometrics, which was launched in 2001,has developed a proprietary system for evaluating private equity performance. Woodward’s motive is simple: Investment in pre-public companies is no longer experimental or exploratory, but is a permanent feature of the U.S. financial landscape. Private equity, the domain of venture capital, is here to stay.

Unfortunately, in the absence of disclosure requirements, the world of private equity investments in pre-public companies is quite opaque. There are no SEC rules for enhancing transparency, as is the case with public entities. Rather, data has been collected primarily through commercial venues, such as VentureOne (in partnership with PricewaterhouseCoopers) and Venture Economics (owned by Thomson Financial), and through trade organizations, such as the National Venture Capital Association (NVCA). Late last year, all three of these data trackers formed a strategic alliance to pool their research and jointly publish quarterly information regarding the venture capital industry.

The data, however, is incomplete. It is not always clear, for instance, how much each investor contributed to a particular round of financing. In spite of the trend over the past few years of publishing a press release announcing an investment (a tactic intended to boost a young company’s value), valuations are rarely disclosed. Woodward noted that pricing events for private companies are intermittent and infrequent. Prices are set only when a company raises money (private or public), when it is acquired, or when it ceases operations.

Using existing resources as a starting point, Woodward and her team have set about cleaning up the data and designing a database that can be used for analysis. To this end, she borrowed from her experience working as a deputy assistant secretary at the Department of Housing and Urban Development, where she helped to construct price indices for residential real estate. As Woodward summarized her approach, “The novelties in our application lie in the extension of the repeat sales approach to private companies and the correction for selection bias made necessary by the non- random nature of the reporting of transactions.” The end result is the creation of the “Sand Hill Index," which measures the market-wide valuation for private equity much as the S&P 500 Index does for publicly traded equity.

By facilitating securitization of venture investments, price indices may prove particularly useful in making fundraising for start-ups more efficient. If VCs can raise much more money from financial intermediaries than before, they will become less dependent on the time-consuming process of courting limited partners for money and also be able to spend more time on building the businesses in their charge. Limited partners, who have recently come to distrust VCs because of their outrageous management fees and disastrous performance, are also likely to prefer the benefits of liquidity and transparency that securitization can provide.

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by Ari Ginsberg