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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.

Suggested Citation

  • LESHCHINSKII, Dima, 2002. "Indulgent angels or stingy venture capitalists? The entrepreneurs' choice," Les Cahiers de Recherche 769, HEC Paris.
  • Handle: RePEc:ebg:heccah:0769
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    File URL: http://www.hec.fr/var/fre/storage/original/application/52e2d5d6d1944697479fb6a6162679c5.pdf
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    References listed on IDEAS

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    1. Kanniainen, Vesa & Keuschnigg, Christian, 2003. "The optimal portfolio of start-up firms in venture capital finance," Journal of Corporate Finance, Elsevier, pages 521-534.
    2. Rafael Repullo & Javier Suarez, 2004. "Venture Capital Finance: A Security Design Approach," Review of Finance, European Finance Association, pages 75-108.
    3. 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.
    4. Masako Ueda, 2000. "Bank versus venture capital," Economics Working Papers 522, Department of Economics and Business, Universitat Pompeu Fabra.
    5. Masako Ueda, 2000. "Bank versus venture capital," Economics Working Papers 522, Department of Economics and Business, Universitat Pompeu Fabra.
    6. Ilya Segal, 1999. "Contracting with Externalities," The Quarterly Journal of Economics, Oxford University Press, vol. 114(2), pages 337-388.
    7. Prowse, Stephen, 1998. "Angel investors and the market for angel investments," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 785-792, August.
    8. 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.
    9. Bhattacharya Sudipto & Chiesa Gabriella, 1995. "Proprietary Information, Financial Intermediation, and Research Incentives," Journal of Financial Intermediation, Elsevier, pages 328-357.
    10. Steven N. Kaplan & Per Stromberg, 2001. "Venture Capitalists As Principals: Contracting, Screening, and Monitoring," NBER Working Papers 8202, National Bureau of Economic Research, Inc.
    11. Cabral, Luis M. B., 2000. "R&D cooperation and product market competition," International Journal of Industrial Organization, Elsevier, pages 1033-1047.
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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.

    More about this item

    Keywords

    investment choice; venture capitalist; angel; project financing;

    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

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