The Burden of the Nondiversifiable Risk of Entrepreneurship
Entrepreneurship is risky. We study the risk facing a well-documented and important class of entrepreneurs, those backed by venture capital. Using a dynamic program, we calculate the certainty-equivalent of the difference between the cash rewards that entrepreneurs actually received over the past 20 years and the cash that entrepreneurs would have received from a risk-free salaried job. The payoff to a venture-backed entrepreneur comprises a below-market salary and a share of the equity value of the company when it goes public or is acquired. We find that the typical venture-backed entrepreneur received an average of $5.8 million in exit cash. Almost three-quarters of entrepreneurs receive nothing at exit and a few receive over a billion dollars. Because of the extreme dispersion of payoffs, an entrepreneur with a coefficient of relative risk aversion of two places a certainty equivalent value only slightly greater than zero on the distribution of outcomes she faces at the time of her company's launch. (JEL G24, G32, L26, M13)
Volume (Year): 100 (2010)
Issue (Month): 3 (June)
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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Klaus M. Schmidt, 2003.
"Convertible Securities and Venture Capital Finance,"
Journal of Finance,
American Finance Association, vol. 58(3), pages 1139-1166, June.
- Schmidt, Klaus M., 1999. "Convertible Securities and Venture Capital Finance," CEPR Discussion Papers 2317, C.E.P.R. Discussion Papers.
- Schmidt, Klaus M., 2003. "Convertible Securities and Venture Capital Finance," Munich Reprints in Economics 19769, University of Munich, Department of Economics.
- Klaus Schmidt, 1999. "Convertible Securities and Venture Capital Finance," CESifo Working Paper Series 217, CESifo Group Munich.
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- Repullo, Rafael & Suarez, Javier, 1999. "Venture Capital Finance: A Security Design Approach," CEPR Discussion Papers 2097, C.E.P.R. Discussion Papers.
- 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.
- Casamatta, Catherine, 2002. "Financing and Advising: Optimal Financial Contracts with Venture Capitalists," CEPR Discussion Papers 3475, C.E.P.R. Discussion Papers.
- Admati, Anat R & Pfleiderer, Paul, 1994. " Robust Financial Contracting and the Role of Venture Capitalists," Journal of Finance, American Finance Association, vol. 49(2), pages 371-402, June.
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- Robert E. Hall & Susan E. Woodward, 2007. "The Incentives to Start New Companies: Evidence from Venture Capital," NBER Working Papers 13056, National Bureau of Economic Research, Inc. Full references (including those not matched with items on IDEAS)
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