Venture Capitalists as Benevolents Vultures: The Role of Network Externalities in Financing Choice
35 Pages Posted: 5 Jul 2001
Date Written: May 2000
Abstract
This paper studies how externalities between projects affect investment decisions and investor involvement with the companies they invest in. Entrepreneurs select investors for their projects, choosing between venture capitalists and individual "angel" investors. In industries with high externalities, venture capitalists can increase social welfare by coordinating their investments into portfolio companies and by intensively monitoring their progress to an endogenously determined higher degree. However, entrepreneurs are indifferent to the total effect of venture capital investment and simply choose venture capital finance only if it increases their project's NPV. When the network externalities are positive, coordinated investment by VCs guarantees profitable investment into some projects that would otherwise have ex-ante negative NPV and fail to attract funding When the network externalities are negative, coordinated investment allows early termination of some projects. Some positive NPV projects may even be sacrificed, to the total benefit of overall value of the VC portfolio. The entrepreneurs know that there is a probability that it is their project that will be terminated, yet they are willing to allow for this eventuality because, if their project continues the payoff will be much higher, than with non-coordinated individual investment.
JEL Classification: G24, G31, G34
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
By Steven N. Kaplan and Per Strömberg
-
By Steven N. Kaplan and Per Strömberg
-
Venture Capital and the Structure of Capital Markets: Banks Versus Stock Markets
By Ronald J. Gilson and Bernard S. Black
-
Money Chasing Deals?: The Impact of Fund Inflows on Private Equity Valuations
By Paul A. Gompers and Josh Lerner
-
Private Equity Performance: Returns, Persistence and Capital Flows
-
Private Equity Performance: Returns, Persistence and Capital
-
The Returns to Entrepreneurial Investment: A Private Equity Premium Puzzle?
-
Venture Capital and the Professionalization of Start-Up Firms: Empirical Evidence
By Thomas F. Hellmann and Manju Puri