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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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    Postal: HEC Paris, 78351 Jouy-en-Josas cedex, France
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    Keywords: investment choice; venture capitalist; angel; project financing;

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    1. Prowse, Stephen, 1998. "Angel investors and the market for angel investments," Journal of Banking & Finance, Elsevier, Elsevier, vol. 22(6-8), pages 785-792, August.
    2. Steven N. Kaplan & Per Stromberg, 2001. "Venture Capitalists As Principals: Contracting, Screening, and Monitoring," NBER Working Papers 8202, National Bureau of Economic Research, Inc.
    3. Kanniainen, V. & Keuschnigg, C., 2000. "The Optimal Portfolio of Start-up Firms in Venture Capital Finance," University of Helsinki, Department of Economics, Department of Economics 486, Department of Economics.
    4. Ueda, Masako, 2002. "Banks versus Venture Capital," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3411, C.E.P.R. Discussion Papers.
    5. Casamatta, Catherine, 2002. "Financing and Advising: Optimal Financial Contracts with Venture Capitalists," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3475, C.E.P.R. Discussion Papers.
    6. Ilya Segal, 1999. "Contracting With Externalities," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 114(2), pages 337-388, May.
    7. Rafael Repullo & Javier Suarez, 2004. "Venture Capital Finance: A Security Design Approach," Review of Finance, Springer, Springer, vol. 8(1), pages 75-108.
    8. Bhattacharya Sudipto & Chiesa Gabriella, 1995. "Proprietary Information, Financial Intermediation, and Research Incentives," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 4(4), pages 328-357, October.
    9. Cabral, Luis M. B., 2000. "R&D cooperation and product market competition," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 18(7), pages 1033-1047, October.
    10. Gorman, Michael & Sahlman, William A., 1989. "What do venture capitalists do?," Journal of Business Venturing, Elsevier, vol. 4(4), pages 231-248, July.
    11. 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.
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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, IESE Business School D/655, IESE Business School.

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