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The entrepreneur's investor choice: The impact on later-stage firm development

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  • Schwienbacher, Armin

Abstract

This article analyzes how early-stage financing decisions may affect how entrepreneurial firms ultimately grow. This theoretical study considers an entrepreneur seeking early-stage financing from either a specialist or a generalist investor in the context of stage financing. It is assumed that an early-stage specialist is less efficient in assisting a venture beyond the early-stage round than a generalist. This leads to the following tradeoff: by initially selecting an early-stage specialist, the entrepreneur benefits from increased investor incentives in the first round. Such incentives generate additional value for the entrepreneurial venture, improving valuation in the interim round and thereby mitigating the risk of dilution against follow-up investors and potentially even of premature discontinuation of the project. However, early-stage specialists are more reluctant to finance later rounds. Conversely, using a generalist secures efficient follow-up funding but also leads to weaker investor incentives in the early stage. With this tradeoff, the presence of asymmetric information about the quality of entrepreneurial projects particularly affects generalists; entrepreneurs with strong projects more often choose specialists, while entrepreneurs with weak projects select generalists to secure efficient continuation. The use of convertible securities or adjustment warrants in contracts cannot always eliminate the effect of asymmetric information. Several empirical implications derived from this tradeoff are provided for optimal investor choice.

Suggested Citation

  • Schwienbacher, Armin, 2013. "The entrepreneur's investor choice: The impact on later-stage firm development," Journal of Business Venturing, Elsevier, vol. 28(4), pages 528-545.
  • Handle: RePEc:eee:jbvent:v:28:y:2013:i:4:p:528-545
    DOI: 10.1016/j.jbusvent.2012.09.002
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    1. repec:eee:eecrev:v:101:y:2018:i:c:p:459-478 is not listed on IDEAS
    2. Mohammadi, Ali & Shafizadeh, Mohammadmehdi & Johan, Sofia, 2014. "A Signaling Theory Of Entrepreneurial Venture’S Valuation: Evidence From Early Termination Of Venture Capital Investment," Working Paper Series in Economics and Institutions of Innovation 349, Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies.

    More about this item

    Keywords

    Financing strategy; Investor specialization; Start-up finance; Stage financing; Asymmetric information;

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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