Moderating effects of investor experience on the signaling value of private equity placements

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. (c) 2005 Elsevier Inc. All rights reserved.