Entrepreneurs, Investors, and Equity Financing

Abstract

We develop a theoretical model of the interaction between investors and entrepreneurs in a stylized private-equity market. Analysis of the entrepreneur's and the investor's optimization problems leads to the derivation of the equilibrium ownership share accruing to the investor; comparative-static analysis of variation in this share then motivates four central hypotheses. We test these using unique data from a professionally-conducted survey of high-technology managers of start-up firms. Empirical analysis confirms the model's prediction of an inverse relationship between the ownership share yielded to the investor and the level of entrepreneurial profitability, productivity, and resources. Results also confirm a predicted positive association between ownership share and investor costs.

Keywords: Private equity, ownership, corporate governance

JEL Classification: G24