Articles
Tom Alberg et al., 2013 State of Entrepreneurship Address: 'Financing Entrepreneurial Growth,' (Ewing Marion Kauffman Foundation, Research Paper, 2013), available at http://ssrn.com/abstract=2212743.
Abstract (by authors): Despite recent innovations in entrepreneurial finance, particularly at the early stage of business creation, many new and young companies continue to face hurdles to acquire capital. The Kauffman Foundation addressed current challenges and opportunities in financing entrepreneurial growth, a key driver of job creation and economic expansion, at its fourth annual State of Entrepreneurship Address on February 5, 2013. The event featured remarks from Small Business Administrator Karen Mills, U.S. Senator Jerry Moran and Kauffman President and CEO Tom McDonnell. In his address at the National Press Club in Washington, McDonnell offered policy recommendations to increase financing of entrepreneurial ventures that are featured in a paper on the same topic. Key recommendations include: Crowdfunding: the Securities and Exchange Commission should approve rules under the JOBS Act that encourage experimentation without excessive regulation; IPOs: greater use of auctions, such as the Dutch auction used by Google, rather than the more common practice of setting a specific price for new stock offerings; Bank Debt: introduce more flexibility into the regulatory process – such as providing the Federal Reserve, Comptroller of the Currency and Federal Deposit Insurance Corporation the authority to make judgment calls at the local level; Regulation: allow shareholders of companies the right to vote whether Sarbanes-Oxley accounting rules are necessary; Venture Capital: create longer-term venture funds that include significant "skin-in-the-game" investment from General Partners, so their interests are aligned with Limited Partner investors over a reasonable time horizon.
Guillaume Andrieu, Optimal Allocation of Control Rights in Venture Capital Contracts (International Conference of the French Finance Association (AFFI), 2011), available at http://ssrn.com/abstract=1833417.
Abstract (adapted from author): This article questions the allocation of control rights to venture capitalists with particular focus on liquidation decisions. The literature has shown that the venture capitalist acts as the principal to prevent the agent (i.e., the entrepreneur) from pursuing private objectives and destroying value. The author develops a two-staged model in which an entrepreneur asks a venture capitalist to finance her project. The VC (venture capital) firm immediately makes a first investment but may not make the second investment, depending on its horizon preference (e.g., short-term or long-term). The results show that the investor makes optimal decisions only if he is able to remain throughout the lifetime of the project. If this is not possible, he will opportunistically decide to sell the project, whatever its quality, thereby generating inefficient continuation of bad projects. If the entrepreneur holds control rights, she will follow the same strategy. However, under certain conditions (especially projects with higher liquidation proceeds), she will make the correct decisions, unlike the investor. This proves that the short-term constraints of VC investors create inefficiencies and that allocating control rights to entrepreneurs may reduce them. An empirical study on the portfolio of two venture capitalists illustrates this result.
Amitrajeet A. Batabyal & Hamid Beladi , The Effects of Collateralizable Income and Debt Overhang on Entrepreneurial Investment in an Open Regional Economy, 51 J. Reg. Sci. 768 (2011), also available athttp://ssrn.com/abstract=1934635.
Abstract (adapted from authors): The authors use a two ‐period model to analyze the contractual relationship between entrepreneurs and venture capitalists in an open regional economy. First, they describe the first best investment contract, the authors study the second best investment contract in the presence of private information, and then examine the impact of an exogenous second period income endowment (collateralizable income) on investment by entrepreneurs. Next, they analyze the interaction between entrepreneurs and venture capitalists when the regional government (RG) must pay off a per capita debt (debt overhang) which it finances by taxing successful second period entrepreneurs. The authors show that a rise in the per capita debt has an effect on investment that is analogous to a fall in the second period income endowment. In addition, the overhang of the RG's debt discourages entrepreneurial investment.
John R. Becker-Blease & Jeffrey E. Sohl, The Effect of Gender Diversity on Angel Group Investment, 35 Entrepren. Theory & Prac. 709 (2011).
Abstract (adapted from journal): The authors examine the impact that gender diversity has on angel group investment behavior for a sample of 183 group-years between 2000 and 2006. The evidence suggests that gender diversity is a significant predictor of group investment behavior, and that the proportion of women angels in the group has a negative though nonlinear effect on investment likelihood. These data are most consistent with a situational interpretation that women invest differently when they are in the small minority compared with other situations. These results have important implications for the availability of funds for women entrepreneurs and call for greater participation of women investors in the angel marketplace.
Ola Bengtsson & Frederick Wang, What Matters in Venture Capital? Evidence from Entrepreneurs’ Stated Preferences, 39 Fin. Mgmt. 1367 (2010).
Abstract (from author): We study how entrepreneurs evaluate the ability of different US venture capitalists (VCs) to add value to start-up companies. Analyzing a large data set of entrepreneurs’ stated preferences regarding VCs, we demonstrate that entrepreneurs view independent partnership VCs more favorably than other VC types (e.g., corporate, financial, and government sponsored VCs). Although entrepreneurs are able to correctly identify VCs with better track records, they do not believe them to be more desirable investors. We also find that an entrepreneur’s rankings are affected by their overall exposure to VCs, emphasizing the role of experiential learning in the venture capital market.
Allen N. Berger & Klaus Schaeck, Small and Medium-Sized Enterprises, Bank Relationship Strength, and the Use of Venture Capital, 43 J. Money, Credit & Banking 461 (2011).
Abstract (from author): We investigate the nexus between small and medium-sized enterprises’ (SMEs’) use of venture capital and bank financing relationships using a unique data set with detailed information on SME finance in Italy, Germany, and the UK. The empirical regularities we uncover show that that entrepreneurial firms substitute venture capital for multiple banking relationships. This substitution effect is primarily driven by expertise substitution, and there is also some suggestive, yet inconclusive, indication in the data that SMEs turn to providers of venture capital to avoid rent-extracting behavior by the firm’s main bank. Our results do not support the view that firms obtain venture capital in instances when bank financing is difficult to obtain. Instead, venture capital funds are used if bank funding is deemed not appropriate, and firms do seem to be aware of which type of financing is more appropriate for them.
Shai Bernstein, Arthur G. Korteweg & Kevin Laws, Attracting Early Stage Investors: Evidence From a Randomized Field Experiment (Rock Center for Corporate Governance at Stanford University, Working Paper No. 185, 2014), available athttp://ssrn.com/abstract=2432044.
Abstract (by author): This paper uses a randomized field experiment to identify which start-up characteristics are most important to investors in early stage firms. The experiment randomizes investors’ information sets using nearly 17,000 emails to 4,500 active, early stage investors on AngelList, an online platform that matches investors with capital-raising start-ups. The average investor responds strongly to information about the founding team, but not to firm traction or existing lead investors. However, inexperienced investors respond to all information categories. Our results suggest that information about human assets is causally important for the funding of early stage firms, and hence, for entrepreneurial success.
Brian Broughman & Jesse M. Fried, Carrots and Sticks: How VCs Induce Entrepreneurial Teams to Sell Startups, 98 Cornell L. Rev. 1319 (2013).
Abstract (adapted from authors): Venture capitalists (VCs) usually exit from their investments in a startup via a trade sale. But the startup’s entrepreneurial team—the startup’s founder, other executives, and common shareholders—may resist a trade sale. Such resistance is likely to be particularly intense when the sale price is low relative to the VCs’ liquidation preferences. Using a hand-collected dataset of Silicon Valley firms, the authors investigate how VCs overcome such resistance. The authors find, in their sample, that VCs give bribes (carrots) to the entrepreneurial team in 45% of trade sales; in these sales, carrots total an average of 9% of deal value. The overt use of coercive tools (sticks) occurs, but only rarely. This study sheds light on important but underexplored aspects of corporate governance in VC-backed startups and the venture capital ecosystem.
Lowell W. Busenitz & James O. Fiet,The Effects of Early-Stage Venture Capitalists Actions on Eventual Venture Disposition,5 Entrepreneurial & Small Bus. Fin. 97-114 (1996).
Abstract: Presents information on a study which examines the relationship between venture capitalist actions, and the eventual disposition of a venture through an Initial Public Offerings (IPO). Actions included in the study; Relationship between IPO exit and the amount of their investment.
Abraham J. B. Cable, Incubator Cities: Tomorrow's Economy, Yesterday's Start-Ups, 2 Mich. J. Private Equity & Venture Capital L. 195 (2013), available athttp://ssrn.com/abstract=2294084.
Abstract (by author): Venture development funds ("VDFs") are products of state and local government law that use public funds to invest in local start-ups, in the hope that these companies will then attract venture capital investment. Existing analysis by legal scholars largely assumes that establishing a private venture capital market is essential to encouraging entrepreneurship. This article challenges that assumption. It argues that VDFs and other policies focused on encouraging venture capital are outmoded and inconsistent with the ultimate economic development goals of state and local governments. In many industries, entrepreneurs can now get by with less capitnal because the cost of developing a product is rapidly declining due to technological advances (e.g., cloud computing) and other developments (e.g., the ability to market an app through Apple’s App Store). But venture capital funds continue to seek out investments in a small number of industries that still require a great deal of capital, such as biotech firms trying to develop new drugs. This narrow focus is inconsistent with the advice of economic development experts to pursue industry-neutral policies that broadly encourage entrepreneurial activity in all of its forms. Also, policies oriented towards venture capital may undermine goals of employment diversity and stability because companies seeking venture capital pursue particularly high-risk business strategies that often fail. This article recommends that state and local governments shift their policies to encourage, or at least not hinder, alternatives to venture capital.
Annamaria Conti et al., Show Me the Right Stuff: Signals for High Tech Startups, (NBER Working Paper Series, Vol. w17050, 2011), available athttp://ssrn.com/abstract=1841287.
Abstract (from author): We examine the potential for technology startups to use patents and founders, friends and family money (FFF money) as signals to attract business angel and venture capital funds, patents reflect technology quality and FFF money reflects founder commitment. We find that if investors value technology quality more (less) than founder commitment, the optimal mix of signals is a relatively higher (lower) use of patents than FFF money. Regardless of investor preferences, high quality founders should invest more in both signals than in the absence of private information. This investment is inversely related to the opportunity cost of investing in the signals. We test these predictions empirically and find evidence in support of this proposition. When we distinguish between venture capitalist and business angel investment, we find that patents serve as a signal for venture capitalists and FFF money is a signal for business angels (but not vice versa).John Freear, Jeffrey E. Sohl & William Wetzel, Jr., Angels: Personal Investors in the Investment Capital Market, 7(1) Entrepreneurship & Reg’l Dev. 85-94 (1995).
Douglas Cumming & April M. Knill, Disclosure, Venture Capital and Entrepreneurial Spawning (2012), available athttp://ssrn.com/abstract=2016540.
Abstract (adapted from authors): Venture capital funds have been facing increasing regulatory scrutiny since the 2007 financial crisis, particularly with respect to calls for increased disclosure requirements. In this paper the authors examine the effect of more stringent securities regulation on the supply and performance of venture capital as well as new business creation (i.e., entrepreneurial spawning). Using country- and investment-level data from 34 countries over the years 2000-2008, they find that more stringent securities regulation is positively associated with the supply and performance of venture capital around the world. More stringent securities regulation is also positively associated with entrepreneurial spawning induced by venture capital. Among different forms of securities regulation, disclosure stands out as having the most economically meaningful impact, which casts doubt on the oft repeated objections to disclosure in VC – that it would stifle the VC industry because secrets would have to be revealed to competitors and the public. These findings are robust to numerous robustness checks for endogeneity. The policy implications are clear regardless of endogeneity concerns, however: VC and entrepreneurship markets are enabled, not curtailed, in countries with better disclosure standards when one compares the existing differences in disclosure around the world and changes thereto over the 2000-2008 period.
Jerome S. Engel, Accelerating Corporate Innovation: Lessons from the Venture Capital Model: What Can Corporate Innovators Learn from the Innovation Practices of Agile Start-Ups? 54 Research-Technology Mgmt. 36 (2011).
Abstract (from author): The last half century has seen the emergence of a new model of business innovation featuring the convergence ofentrepreneurs , rapid technological change, and venture capital. This combination has proven an effective force at realizing disruptive innovation that has often left incumbents shattered in their wake. What can the mature enterprise learn from this venture capital model of innovation management? What is the role of the CTO in identifying and adopting these approaches? This article investigates the ten leading strategies employed by venture capitalists and entrepreneurs to test new ideas and commercialize innovations quickly. The most disruptive innovations are seen to be those that go beyond technical discovery to embrace business model innovations that disrupt supply chains, disintermediate incumbents, and create new markets. This article presents the tools the modern CTO needs to participate in this dynamic process.
Richard Fairchild, An Entrepreneur’s Choice of Venture Capitalist or Angel-Financing: A Behavioral Game-Theoretic Approach, 26 J. Bus. Venturing 359 (2011).
Abstract: This article examines the consequences of an entrepreneur choosing between venture capital and angel financing, taking into account economic factors and behavioral factors, and the trade-offs they entail.
Victor Fleischer, Symposium, We Are What We Tax: Job Creationism, 84 Fordham L. Rev. 2477 (2016).
Abstract (adapted from author): Consider the ease with which many politicians claim that tax cuts for entrepreneurs and investors spur useful investment, create jobs, and drive economic growth. More recent studies have confirmed what most tax academics now believe: there is little evidence to support a claim that U.S. tax policy materially affects the rate of entrepreneurial entry or the growth rate of new firms. An entrepreneur rationally should assess the odds of success, assess the risk-adjusted after-tax payoff, and make a decision. In the range of tax rates one can observe and reasonably discuss as a policy matter, tax is rarely a first order consideration for most entrepreneurs. We should not be so surprised that there is little empirical evidence to support a claim that taxes have a significant effect on entrepreneurship. As for investors, tax often is irrelevant for a different reason: most of the capital for entrepreneurial ventures comes from tax-exempt investors like pension funds and university endowments. Taxable investors, even the most sophisticated ones, are sometimes unaware of how their investments will be taxed. Venture capitalists do pay taxes, occasionally, and the tax rate on carried interest is common knowledge.
This article considers four ways of interpreting the phenomenon of job creationism: (1) as a cynical ploy to shovel tax benefits to the rich; (2) as an exercise in hero worship; (3) as an ideological claim properly beyond the scope of scientific inquiry; or (4) as a legitimate comparison of our system of entrepreneurial capitalism to other capitalist systems.
Garry A. Gabison, Spotting Software Innovation in a Patent Assertion Entity World, 8 Hastings Sci. & Tech. L.J. 99 (2016).
Abstract (adapted from author): Entrepreneurs wish to secure some financial backing in order to grow their business; but, while they know their business inside-out, potential investors must be convinced to invest. To defeat information asymmetries, entrepreneurs and potential investors must rely on observable characteristics or other manufactured signals to make investment decisions. Fund seeking companies and investors rely on selection criteria that address information asymmetries and separate companies according to their potential. In the software industry, entrepreneurs and investors have arguably used patent portfolios to separate companies according to their potential. The software industry moves too fast for the patent system and for the innovator to profit on her monopoly power. This is because a patent takes on average of almost three years to be granted, while most software users would have changed software at least once during that time period.
Software patents are often used as innovation-potential signals. Software startups rarely hold patents. This scarcity makes them good signals. This paper analyzes whether patents have been used as innovation-potential signals as well as how they help investors select which projects to finance. This paper argues that VC funds have indirectly encouraged the proliferation of software patents. By using patents in an unexpected way, Patent Assertion Entities (PAEs) have complicated VCs' company valuation. Indirectly, VCs have fed into the patent assertion entity problem. This paper presents empirical evidence that PAEs have impacted the behavior of VCs. Finally, this paper discusses how VCs have been impacted by PAEs and the role that VCs play to hinder the PAE phenomenon. This paper argues that VCs can do more to hinder the impact of PAEs.
Luis Armando Garcia, Teaching Private Equity Investment in Higher Education: An Entrepreneurship Approach (2011), available athttp://ssrn.com/abstract=1944809.
Abstract (from author): A determining factor in entrepreneurship is the level of education of the entrepreneur. Universities and institutions of higher learning are called to design courses and support to potential entrepreneurs. European universities taking part in the European Higher ducation Area (EHEA) should exploit the potential business network that students have at their reach inside the EU area. Entrepreneurship education warrants an improvement of financial literacy, for studies have shown that in many developed nations consumers are poorly informed about financial products and practices. Venture Capitalists consider universities as sources of truly exceptional innovations and inventions, which can develop into successful companies within a short period of time. The Private Equity Investment industry has acquired enormous popularity as an alternative investment asset class over the past two decades. Its backers claim that its extensive economic benefits come from a model that aligns the interest of both owners and management. Perhaps it has never been easier than right now for companies and start-ups to locate, contact and engage potential sources of Private Equity Investment and/or Venture Capital Funds. Entrepreneurship and financial Literacy should be taught openly in Business Schools around the world. The entrepreneurship industry is ready to join forces with academics and students in order to confront the unharmonious aspects of the current curriculum of entrepreneurship education.
Suting Hong, Konstantinos Serfes & Veikko Thiele, The Market for Venture Capital: Entry, Competition, and the Survival of Start-Up Companies (2012),available at http://ssrn.com/abstract=2163723.
Abstract (adapted from authors): Over the last two decades the number of venture capital (VC) firms actively investing in start-up companies in the US has more than tripled. This paper examines (i) the response of incumbent VC firms to increased competitive pressure from less experienced entrants, and (ii) the implications for the funding and survival of start-up companies. The authors first develop an equilibrium model of the VC market with heterogenous entrepreneurs and VC firms. Each VC firm matches endogenously with an entrepreneur, offering capital in exchange for an equity stake. Their theoretical model predicts that entry of new VC firms has a ripple effect throughout the entire market: all start-ups then receive more capital in exchange for less equity (implying higher pre-money valuations), and become more likely to survive. The authors then test these predictions using VC data from Thomson One, and find strong empirical support.
Darian M. Ibrahim, Equity Crowdfunding: A Market for Lemons? 100 Minn. L. Rev. 561 (2015).
Abstract (adapted from author): Venture capitalists (VCs) and angel investors have long valued close networks and personal relationships when selecting which entrepreneurs to fund, and they closely monitor their investments in person after they fund. These practices lead to intense locality in funding. But with everything else in society moving online, why not entrepreneurial finance? Can online platforms successfully match entrepreneurs and investors from different communities? And on the flip side, the Internet democratizes investing by allowing the majority of those without connections to angels or VCs the possibility of getting rich funding the next Facebook or Twitter.
This article examines the progression in entrepreneurial finance from: (1) traditional angel/VC operations through personal networks; to (2) online soliciting of accredited investors (JOBS Act Title II); to (3) full-blown crowdfunding to anyone who wishes to invest in a startup (JOBS Act Title III). This article's first main contribution is to show that Title II sites are succeeding, and to explain why. Its second main contribution is to theorize about how Title III might play out when implemented, and to suggest legal reforms to increase its chances for success. This article asks the normative question of whether this trend toward online fundraising is desirable, completing our progression from traditional investing to online investing by examining Titles II and III of the JOBS Act in turn. Do these laws adequately balance the SEC's twin goals of raising capital and investor protection, or do they skew too heavily toward the former? More pointedly, will Title III crowdfunding - the end goal of the legislation - turn into a market for "lemons," existing only for low-quality startups and foolish investors?
Martin Kenney, How Venture Capital Became a Component of the U.S. National System of Innovation (2011), available at http://ssrn.com/abstract=1847203.
Abstract (from author): Venture capital (VC) is a relatively recent addition to the U.S. national system of innovation (NSI). Tracing the history of the VC industry in the U.S. provides an interesting example of how NSIs can add new institutions and in the process be transformed. The history encompasses important exogenous events, endogenous developments, and actions by individual actors. The story of the development of VC is set in the technological trajectories where it has experienced its greatest success, the ICT and biomedical industries. The emergence of VC is intimately related to various government actions, and yet the paper does not attribute a ach ex achine role to government actors. While NSI theory provides the framework, it is also recognized that VC is geographically localized in a few regions, and a regional innovation system perspective is also valuable.
Arthur G. Korteweg & Morten Sorensen, Risk and Return Characteristics of Venture Capital-Backed Entrepreneurial Companies, 23 Rev. Fin. Stud. 3738 (2011), also available at http://ssrn.com/abstract=1949366.
Abstract (from authors): Valuations of entrepreneurial companies are only observed occasionally, albeit more frequently for well-performing companies. Consequently, estimators of risk and return must correct for sample selection to obtain consistent estimates. The authors develop a general model of dynamic sample selection and estimate it using data from venture capital investments in entrepreneurial companies. This selection correction leads to markedly lower intercepts and higher estimates of risks compared to previous studies. The methodology is generally applicable to estimating risk and return in illiquid markets with endogenous trading.
Oskari Lehtonen & Tom Lahti, The Role of Advisors in the Venture Capital Investment Process, 11(3) Venture Cap. 229 (2009).
Abstract (from authors): Despite the extensive research on venture capitalists and entrepreneurs, there is at least one group of actors whose role has been overlooked, namely advisors that specialise in helping entrepreneurs raise venture capital funding. This explorative study aims to fill this gap. Based on qualitative case study data, this paper shows that the activities of advisors have several benefits for entrepreneurs seeking funding. Advisors appear to accelerate the process of acquiring funding and improve the terms and conditions of the funding. By participating in the preparation of written documents that are required when approaching investors advisors can contribute to increasing the investment readiness of an entrepreneurial venture. They also typically participate in investment negotiations. This may reduce the possibility that negotiations between the venture capitalist and the entrepreneur become confrontational which could, in turn, adversely affect the venture capital-entrepreneur post-investment relationship. The findings in this study strongly suggest that using advisors increases the likelihood that entrepreneurs will successfully obtain venture capital funding. This paper recommends that inexperienced entrepreneurs in particular should seek support from advisors when seeking to raise venture capital.
Yong Lia & Shaker A. Zahra, Formal Institutions, Culture, and Venture Capital Activity: A Cross-Country Analysis, 27 J. Bus. Venturing 95 (2012).
Abstract (from journal): Why does the level of venture capital activity vary across countries? This study suggests that the variation can be attributed to the different levels of formal institutional development. Further, this study proposes that venture capitalists respond differently to the incentives provided by formal institutions depending on different cultural settings. Analysis of VC activity for 68 countries during the 1996–2006 period shows that formal institutions have a positive effect on the level of venture capital activity, but this effect is weaker in more uncertainty-avoiding societies and in more collectivist societies. This study has useful theory and policy implications for venture capital and entrepreneurship development.
Tatiana S. Manolova, Candida G. Brush & Linda F. Edelman, Touched by an Angel: Entrepreneurs Seeking and Obtaining Private Equity Financing, 31 W. New Eng. L. Rev. 745 (2009).
Abstract (from authors): The purpose of this exploratory study is to fill this gap by investigating the characteristics of entrepreneurs who seek and secure angel financing. More specifically, we ask two questions: (1) what are the characteristics of entrepreneurial new ventures that seek informal equity financing? and (2) what are the characteristics of entrepreneurial new ventures that obtain informal equity financing? To address the two research questions, we examined all investment proposals submitted to an angel financing network based in the Northeast over a two-year period. Following the multi-stage selection process implemented by informal equity providers, we focused on the characteristics of the entrepreneur and his new venture that are associated with increased likelihood of being funded. Our preliminary findings indicate that entrepreneurs who seek angel financing tend to be male and well educated, and their new ventures have predominantly business-to-business models that boast a variety of sources of competitive advantage. While the median investment sought is around $ 1.5 million, angel investors funded new ventures seeking lower amounts of investment, coupled with higher revenue and profit projections. The rest of our paper is organized as follows: after a brief review of the literature on angel financing and the relationship between entrepreneurs seeking informal equity financing and the capital providers, we present our methodology and research design. We next report and discuss our findings. The study concludes with some implications for future research and managerial practice.
Colin M. Mason & Richard T. Harrison, Closing the Regional Equity Capital Gap: The Role of Informal Venture Capital, 9(4) Small Bus. Econ. 153-172 (1995).
Ashish Mathur & Meeta Nihalani, Promotion of Ventures by the Entrepreneurs in the Modern Era (2011), available at http://ssrn.com/abstract=1968237.
Abstract (from authors): The concept of entrepreneurship has a wide range of meanings. On one extreme end, the entrepreneur is a person with high aptitude to take changes and on the other hand, entrepreneur is a person who takes economic activities for himself. The concept of entrepreneur venture differs from the small scale business in this the amount of wealth created is more and the speed of wealth created is high. The risk associated with the venture is high and is designed by the innovative abilities of the entrepreneurs. The entrepreneur is a person with high aptitude for changes and he works for himself. The venture capital has significant benefits and the venture back companies generally grow at a faster and accelerated pace. With venture capital in place, customer, supplier’s staff and even the banks have higher confidence. The basic aim of the paper is to analyse the potential opportunities to build the ventures by the entrepreneurs so to design the world of creativity by his innovative abilities.
Ethan R. Mollik, Swept Away by the Crowd? Crowdfunding, Venture Capital, and the Selection of Entrepreneurs (2013), available athttp://ssrn.com/abstract=2239204.
Abstract (by author): Venture Capitalists (VCs) are experts in assessing the quality of entrepreneurial ventures. A long tradition of research has examined the signals of quality that VCs look for in new ventures, and the biases that result from the VC selection process. Recently, an alternative form of new venture funding has arisen in the form of crowdfunding, which relies on the judgment of millions of amateurs about which entrepreneurial projects are worth funding. Little is known about the degree to which amateurs respond to the same signals of quality as VCs, and whether they are subject to the same biases. To address this gap, the author examined 2,101 crowdfunded projects that match characteristics of more traditional VC-backed seed ventures. Despite the radical differences in selection environments, the author found that entrepreneurial quality is assessed in similar ways by both VCs and crowdfunders, but that crowdfunding alleviates some of geographic and gender biases associated with the way that VCs look for signals of quality.
Andrew Metrick & Ayako Yasuda, Venture Capital and Other Private Equity: A Survey (2010), available at http://ssrn.com/abstract=1723882.
Abstract (from author): We review the theory and evidence on venture capital (VC) and other private equity: why professional private equity exists, what private equity managers do with their portfolio companies, what returns they earn, who earns more and why, what determines the design of contracts signed between (i) private equity managers and their portfolio companies and (ii) private equity managers and their investors (limited partners), and how/whether these contractual designs affect outcomes. Findings highlight the importance of private ownership, and information asymmetry and illiquidity associated with it, as a key explanatory factor of what makes private equity different from other asset classes.
Charles Murnieks et al., ‘I Like How You Think': Similarity as an Interaction Bias in the Investor–Entrepreneur Dyad, 48 J. Mgmt. Stud. 1533 (2011), also available at http://ssrn.com/abstract=1932523.
Abstract (adapted from authors): Investigating the factors that influence venture capital decision-making has a long tradition in the management and entrepreneurship literature. However, few studies have considered the factors that might bias an investment decision in a way that is idiosyncratic to a given investor–entrepreneur dyad. The authors do so in this study. Specifically, they build from the literature on the ‘similarity effect’ to investigate the extent to which decision-making process similarity (shared between the investor and the entrepreneur) might bias or otherwise impact the investor's evaluation of a new venture investment opportunity. The findings suggest venture capitalists evaluate more favourably opportunities represented by entrepreneurs who ‘think’ in ways similar to their own. Moreover, in the presence of decision-making process similarity, the impacts of other factors that inform the investment decision actually change in counter-intuitive ways.
Alma Pekmezovic & Gordon Walker, The Global Significance of Crowdfunding: Solving the SME Funding Problem and Democratizing Access to Capital, 7 Wm. & Mary Bus. L. Rev. 347 (2016).
Abstract (from authors): This article provides a comprehensive review of the crowdfunding phenomenon. It argues that equity crowdfunding ("ECF") and, to a lesser extent, peer-to-peer lending ("P2PL") offer the possibility of a global solution to the small and medium-sized enterprise ("SME") funding problem. In the United States, the SME funding problem is exacerbated by the markedly diminishing rate of startup formation, a factor that injects a degree of urgency into resolving the optimal means to implement ECF. Here, as with the "fin-tech" revolution, the law lags behind technological developments. The second main argument is that ECF enhances access to capital for SMEs globally while simultaneously democratizing access to investments for ordinary citizens. The article begins by providing definitions, business models, and historical background before outlining the SME funding problem and new constraints on SME lending since the global financial crisis. ECF is placed within the so-called "financing escalator" and is distinguished from venture capital and angel financing. The global market for crowdfunding is reviewed in order to indicate growth trends in the sector. Some common legal issues associated with crowdfunding are presented before a review of crowdfunding globally. Dominant models in some Organization for Economic Co-operation and Development (OECD) countries and the potential for crowdfunding to assist SMEs in the undeveloped world are explored. The conclusion outlines key considerations and choices for legislators considering the regulatory puzzles presented by crowdfunding.
Alvaro Pina-Stranger & Emmanuel Lazega, Bringing Personalized Ties Back In: Their Added Value for Biotech Entrepreneurs and Venture Capitalists Interorganizational Networks, 52 Soc. Q. 268 (2011).
Abstract: This article studies the value of personal relationships between entrepreneurs and VCs at different organizations, confirming their importance.
Jean-Michel Sahut & Jean-Sebastien Lantz, Corporate Venture Capital and Financing Innovation (2011), available at http://ssrn.com/abstract=1762247.
Abstract (from author): Corporate venture capital (CVC) is a real driving force behind the development of technology-based innovation. It is an entrepreneurial strategy used by big corporations who go outside the company because they can no longer depend solely on creating innovations in-house. CVC enables them to reduce the risk of innovation whilst keeping some control over the target firm or a purchase option on the innovation once it has passed the early stage. This type of operation offers technology-based start-ups both an input of equity capital and technical and strategic expertise and experience. In spite of economic downturns, CVC continues to develop in the high-tech sectors which have been least affected; in particular in biotechnologies. The advantages which it brings to each stage of the project (launching, refinancing and exiting) compared to financing by traditional venture capital funds make its future development secure.
Yochanan Shachmurove, First-Round Entrepreneurial Investments: Where, When and Why? (PIER Working Paper No. 11-017, 2011), available athttp://ssrn.com/abstract=1873356.
Abstract (from author): This paper examines the where, when and why of first round entrepreneurial investment activity in the United States from the first quarter of 1995 until the second quarter of 2010. The paper analyzes these venture capital investments taking into consideration the role of macroeconomic variables, region, and industry. Additionally, trends in regional and industrial investments are evaluated using statistical and graphical analyses. By studying these findings, the authors are able to understand the impact of different periods of economic growth on venture capital investments. Lastly, the shock of the dot.com bubble and recent financial crisis are integrated into the findings.
Jeffrey E. Sohl, The Early-Stage Equity Market in the USA, 1(2) Venture Capital 101-120 (1999).
Abstract (from author): As recently as 20 years ago the USA began a transition from a declining industrial and manufacturing economy to an emerging entrepreneurial/innovation-driven economy. With this transition, the early-stage equity market has also evolved. As the institutional venture capital industry continues to focus on later stage and larger investments, the private investor market now provides the major source of seed and start-up capital. However, imperfections in the seed and start-up market have led to market inefficiencies for the high-growth firm. Two funding gaps appear to exist in the US equity market, both largely as a result of these market inefficiencies. This paper provides a broad overview of the early-stage equity market for high-growth ventures in the USA. In light of the critical role of business angels in the early-stage market, special attention will be given to this population. Also included is a discussion of angel markets and recent trends in the early-stage equity financing of entrepreneurial ventures.
Krishnamurthy Subramanian, The Color of Money: A Start-Up’s Choice Among Venture Capitalists (2011), available at http://ssrn.com/abstract=1785097.
Abstract (from author): Venture Capitalists (VCs) differ significantly from one another with respect to the non-financial resources — from business expertise to the network of contacts with potential suppliers, customers, employees and IPO underwriters — they offer their portfolio firms. In this paper, I develop a theoretical model incorporating such differences in resources to examine an entrepreneur’s choice among VCs. By relating the costs and benefits of associating with a VC ab initio to the resources offered by the VC, the model examines the conditions under which financing by a more resourceful VC is optimal. The results rationalize the empirical findings that: (1) Startups prefer more resourceful VCs even though they have to offer equity at a considerable discount to such VCs. (2) More resourceful VCs may not only create successful startups but are also able to appropriate the benefits from the same and thereby consistently outperform their less resourceful competitors. However, the model points out that these results may only hold locally depending upon the intensity of product market competition and the entrepreneur’s and VC’s ability to hold each other up. The model generates the following new predictions: (1) In contrast to the hold-up by an informed bank, hold-up by a VC does not necessarily dampen entrepreneurial incentives and can therefore be value-adding. (2) While hold-up involving physical assets is zero-sum, hold-up involving intangible assets is not necessarily so. (3) Financing from a more (less) resourceful VC is optimal when product market competition is low (high) and the likelihood of hold-up is low (high).
Gregory F. Udell et al., Disciplining Delegated Monitors: Evidence from Venture Capital (2011), available at http://ssrn.com/abstract=1782238.
Abstract (from author): Information-based theories of financial intermediation focus on delegated monitoring. However, there is little evidence on how markets discipline financial intermediaries who fail at this function. This paper uses the venture capital (VC) market to address this gap in the empirical literature by looking at how VC’s reputations are affected when they fail in their monitoring role to prevent fraud by their portfolio firms. We find that VCs who fail to prevent fraud experience greater difficulty in taking future portfolio firms public, and that the negative effect prevails over ten years after the fraud surfaces. In addition, reputation-damaged VCs interact differently in the future with their limited partners, other VCs in the community, and their IPO underwriters because they are perceived by these groups as inefficient monitors.
Manuel A. Utset, High-Powered (Mis)incentives and Venture-Capital Contracts, 7 Ohio St. Entrepren. Bus. L. J. 45 (2012).
Abstract (adapted from author): Venture capitalists are a major source of funding for start-up firms. As a general matter, entrepreneurs find it difficult to borrow money from banks or sell shares directly to the public until they have finished their innovation and acquired a sufficiently large market share. Venture capitalists bridge this gap by acting as financial intermediaries: they raise capital from investors, such as large institutions, and use it to identify, finance and monitor entrepreneurs with promising innovations. In return for its investment, a venture capitalist receives equity in the start-up and myriad other contractual rights. These contracts include a number of provisions meant to reduce the opportunistic behavior of entrepreneurs by exposing them to high-powered incentives and giving the venture capitalist control over the start-up, including the power to fire entrepreneurs and dilute their equity holdings. The venture-capital literature has explained these one-sided features of venture-capital contracts as rational, well-tailored reactions to informational asymmetries faced by venture capitalists. But shifting ex post bargaining power so drastically in favor of venture capitalists has an unfortunate side effect: it provides them with great leeway to act opportunistically at the entrepreneur's expense. Opportunistic behavior creates deadweight losses for society. From a social-welfare-maximizing perspective, the optimal contract would reduce the sum of the welfare losses from the opportunism of both venture capitalists and entrepreneurs. This Article examines the dynamics of this fundamental tradeoff between entrepreneurial and venture-capitalist opportunism. It shows that standard venture-capital contracts tip the scales in favor of venture-capitalist opportunism, but leave open the possibility for self-preserving strategic behavior by entrepreneurs that can reduce the joint welfare of both parties. It also identifies a number of factors that make it difficult for venture capitalists to modify the standard contracts in order to reduce these welfare losses. Part II provides an overview of entrepreneurial opportunism and the way that standard venture-capital contracts deal with the problem. Part III examines some of the unintended side effects of the high-powered incentives used by venture capitalists. Part IV identifies various roadblocks to the emergence of optimal venture-capital contracts. Part V discusses various ways in which legal rules can help reduce the misincentives created by standard venture capital contacts. Part VI concludes.
Manuel A. Utset, Time-Inconsistent Preferences and Venture Capital Contracting(Florida State University College of Law, Public Law Research Paper No. 498, Handbook of Venture Capital Finance, forthcoming 2011), available athttp://ssrn.com/abstract=1810147.
Abstract: Agency explanations of the venture capital process routinely assume that entrepreneurs and venture capitalists have time-consistent (“TC”) preferences, and thus perfect self-control. Given the growing evidence on self-control problems, from both experiments and field studies, it is natural to ask how our understanding of the venture capital process would change if one were to relax the TC assumption. This paper begins this process. It develops a model of venture capital contracts in which time-inconsistent (“TI”) parties may repeatedly procrastinate undertaking onerous tasks — e.g., innovators may procrastinate finishing the innovation, and venture capitalists may procrastinate monitoring and advising entrepreneurs. Similarly, TI entrepreneurs and venture capitalists may overindulge in self-dealing. The time-inconsistent contracting model developed in the paper helps explain why venture capital contracts include incentive and governance mechanisms that are much more high-powered than those used in innovation-intensive publicly traded companies, which not only have many of the same types of moral hazard problems, but are also more complex and less transparent. The model also helps explain some of the standard features of contracts between venture capitalists and their investors.
Howard E. Van Auken, A Model of Community-based Venture Capital Formation to Fund Early-stage Technology-based Firms, 40 J. Small Bus. Mgmt. (2002).
Abstract (from author): This paper suggests a model of capital formation that concurrently establishes a mechanism to fund early-stage technology-based firms and meets the economic development needs of rural communities. Investors in a community capital investment fund can gain high rates of return on investment while firms realize all of the benefits associated with the investment, community support, and expanded network. The model includes factors associated with the community environment (community-based factors that impact community members' participation) and external support environment (factors that facilitate the accumulation of investment capital within a community). The result of a community effort can be an environment in which members of the community contribute to an investment fund, cooperate in attracting firms, and provide networking assistance to new business owners. Communities benefit through job creation and economic stability. Community members benefit through wealth creation.
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Dana M. Warren, Venture Capital Investment: Status and Trends, 7 Ohio St. Entrepren. Bus. L.J. 1 (2012).
Abstract (from author): This article looks at the status of macro trends in venture capital investing in light of the Great Recession and then examines whether those trends have had an impact on the transaction terms presented to entrepreneurs by venture capital investors.
William Wetzel, Jr., Angels and Informal Risk Capital, 3 Sloan Mgmt. Rev. 23-34 (1983).
Abstract (from author): Raising risk capital is always a challenging and difficult task. "Business angels" play a key role in the risk capital market by providing seed capital for inventors, and start-up and growth capital for small, technology based firms. This article discusses the investment characteristics of a sample of angels active in New England, offers suggestions for entrepreneurs looking for angels, and recommends steps to improve the efficiency of the informal risk capital market.
Andrew L. Zacharakis, Truls Erikson & Bradley George, Conflict Between the VC and Entrepreneur: The Entrepreneur's Perspective, 12(2) Venture Cap. 109 (2010).
Abstract (from author): In this study, the effects of conflict on confidence in partner cooperation are explored. While the literature on VC-entrepreneur interactions is well developed, viewing the impact of conflict within the dyad is less developed. The data are based on a survey of 57 entrepreneurs who have received venture capital investments. Whereas past research finds that VCs view task conflict favorably, the current study finds that entrepreneurs do not, which leads to reduced confidence in partner cooperation. Furthermore, intragroup conflict within the entrepreneurial team increases conflict between the entrepreneurial team and VC. The implications of the findings suggest that it is important for the entrepreneurial team to build cohesion both within the team and with the VC so that if conflict arises, it doesn't lead to lower overall performance.
Andrew L. Zacharakis & Dean A. Shepherd, A Contingent Decision-Aid for Venture Capitalists’ Investment Decisions, Eur. J. Operational Res. (2003).
Andrew L. Zacharakis, Dean A. Shepherd & Robert A. Baron, Venture Capitalists’ Decision Processes: Evidence Suggesting More Experience May Not Always Be Better, J. Bus. Venturing (2003).
Abstract (from publisher): Decision-making processes employed by venture capitalists (VCs) varying in experience were compared. Results show that for relatively inexperienced VCs, increasing experience is associated with improvements in reliability and performance relative to a benchmark (a bootstrapping model). Beyond a specific point, however, further gains in experience are associated with actual reductions in reliability and performance. Thus, greater experience at the venture capital task may not always result in better decisions.
Andrew L. Zacharakis, Dean A. Shepherd & Joseph E. Coombs, The Development of Venture Capital-Backed Internet Companies: An Ecosystem Perspective, J. Bus. Venturing (2003).
Abstract (from publisher): The current paper uses an “environmental ecosystem” perspective to explore the development of the Internet sector. The findings suggest that different geographic regions possess different ecosystem qualities that benefit some Internet sectors and not others. For example, Internet hardware seems concentrated in northern California; Internet software in the Southwest; and some evidence that e-commerce and content is concentrated in the Rocky Mountains. We also found that the development of the Internet sector is iterative with Internet software companies developed first followed by Internet Infrastructure, Internet hardware, Internet service providers, and finally e-commerce companies.
Junfu Zhang, The Advantage of Experienced Start-up Founders in Venture Capital Acquisition: Evidence from Serial Entrepreneurs, 36 Small Bus. Econ. 187 (2011).
Abstract (from author): Entrepreneurs with prior firm-founding experience are expected to have more skills and social connections than novice entrepreneurs. Such skills and social connections could give experienced founders some advantage in the process of raising venture capital. This paper uses a large database of venture-backed companies and their founders to examine the advantage associated with prior founding experience. Compared with novice entrepreneurs, entrepreneurs with venture-backed founding experience tend to raise more venture capital at an early round of financing and tend to complete the early round much more quickly. In contrast, experienced founders whose earlier firms were not venture-backed do not show a similar advantage over novice entrepreneurs, suggesting the importance of connections with venture capitalists in the early stage of venture capital financing. However, when the analysis also takes into account later rounds of financing, all entrepreneurs with prior founding experience appear to raise more venture capital. This implies that skills acquired from any previous founding experience can make an entrepreneur perform better and in turn attract more venture capital.
Yanfeng Zheng, In Their Eyes: How Entrepreneurs Evaluate Venture Capital Firms, 14 J. Private Equity 72 (2011).
Abstract (from author): Although the literature on the venture capital industry is extensive, how entrepreneurs perceive their VC investors remains an under-researched topic. The dominant principal-agent model provides a crude picture based on rational assumptions. As such, we still lack accurate understanding of how exactly entrepreneurs view and why they evaluate their VC investors in certain ways. This study attempts to address this gap through a systematic content analysis on 4,653 online comments for 261 VC firms and statistical analyses on numerical ratings. Our results show that entrepreneurs are attentive to certain attitude and behaviors exhibited by VC firms such as late responses and ethical concerns. Statistical analyses also reveal that, surprisingly, VC firms with success records appear to have lower ratings and VC geographic density seems to boost ratings. The implications for practitioners and scholars are discussed.