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Indulgent angels or stingy venture capitalists? The entrepreneurs' choice

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  • LESHCHINSKII, Dima

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    Abstract

    This paper studies entrepreneurs' choice of investors, who must provide financial capital and effort for projects with externalities. Venture capitalists (VCs) and individual investors (angels) compete to finance the projects. VCs seek to invest into a portfolio of projects, while angels have more slack in how much they invest into one project. In the presence of externalities between projects, VCs can potentially increase the total value of their investment portfolio through better coordination of investment, while some angels behave indulgently and give more financial investment than necessary, earning zero profits in equilibrium. Surprisingly, externalities do not give VCs as much of an advantage as one would expect. Quite often VCs lose out to angels even when this means that some projects will not receive an optimal amount of effort. In the projects they invest in, VCs always make strictly positive profits despite the competition.

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    Bibliographic Info

    Paper provided by HEC Paris in its series Les Cahiers de Recherche with number 769.

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    Length: 36 pages
    Date of creation: 01 Nov 2002
    Date of revision:
    Handle: RePEc:ebg:heccah:0769

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    Keywords: investment choice; venture capitalist; angel; project financing;

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    1. Ueda, Masako, 2002. "Banks versus Venture Capital," CEPR Discussion Papers 3411, C.E.P.R. Discussion Papers.
    2. Ilya Segal, 1999. "Contracting With Externalities," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 337-388, May.
    3. Kanniainen, Vesa & Keuschnigg, Christian, 2003. "The optimal portfolio of start-up firms in venture capital finance," Journal of Corporate Finance, Elsevier, vol. 9(5), pages 521-534, November.
    4. Ehrlich, Sanford B. & De Noble, Alex F. & Moore, Tracy & Weaver, Richard R., 1994. "After the cash arrives: A comparative study of venture capital and private investor involvement in entrepreneurial firms," Journal of Business Venturing, Elsevier, vol. 9(1), pages 67-82, January.
    5. Steven N. Kaplan & Per Stromberg, 2001. "Venture Capitalists As Principals: Contracting, Screening, and Monitoring," NBER Working Papers 8202, National Bureau of Economic Research, Inc.
    6. Repullo, R. & Suarez, J., 1998. "Venture Capital Finance: a Security Design Approach," Papers 9804, Centro de Estudios Monetarios Y Financieros-.
    7. Gorman, Michael & Sahlman, William A., 1989. "What do venture capitalists do?," Journal of Business Venturing, Elsevier, vol. 4(4), pages 231-248, July.
    8. Bhattacharya Sudipto & Chiesa Gabriella, 1995. "Proprietary Information, Financial Intermediation, and Research Incentives," Journal of Financial Intermediation, Elsevier, vol. 4(4), pages 328-357, October.
    9. Catherine Casamatta, 2003. "Financing and Advising: Optimal Financial Contracts with Venture Capitalists," Journal of Finance, American Finance Association, vol. 58(5), pages 2059-2086, October.
    10. Cabral, Luis M. B., 2000. "R&D cooperation and product market competition," International Journal of Industrial Organization, Elsevier, vol. 18(7), pages 1033-1047, October.
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    Cited by:
    1. Heukamp, Franz & Liechtenstein, Heinrich & Wakeling, Nick, 2006. "Do business angels alter the risk-return equation in early stage investments? Business angels as seen by venture capitalists in the German speaking countries," IESE Research Papers D/655, IESE Business School.

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