Entrepreneurial Ability, Venture Investments, and Risk Sharing

Abstract

A number of issues that relate to the desirability and implications of new venture financing are examined within a principal-agent framework that captures the essence of the relationship between entrepreneurs and venture capitalists. The model suggests: (1) As long as the skill levels of entrepreneurs are common knowledge, all will choose to involve venture capital investors, since the risk sharing provided by outside participation dominates the agency relationship that is created. (2) The less able entrepreneurs will choose to involve venture capitalists, whereas the more profitable ventures will be developed without external participation because of the adverse selection problem associated with asymmetric information. (3) If a costly signal is available that conveys the entrepreneur's ability, some entrepreneurs will invest in such a signal and then sell to investors; these entrepreneurs, however, need not be the more able ones. The implications for new venture financing of these and other findings are discussed and illustrated by example.entrepreneurship, venture capital, adverse selection, moral hazard, risk reduction

Entrepreneurial Cognition

“…Indeed, stakeholders are generally people who are important to the entrepreneur and his or her venture (Mitchell et al 1997;Seldon and Fletcher 2015;Vandekerckhove and Dentchev 2005), friends and family often make equity investments in the business (Kotha and George 2012), and entrepreneurs frequently develop close relationships with their employees . Thus, financially costly failures are likely to upset investors who could potentially lose more money (Amit et al 1990;Mason and Harrison 2002), employees who could lose their jobs (or have to end relationships with people who are let go) (Fineman 1999;Jordan et al 2002), and other stakeholders who could potentially lose their reputation and/or social standing (Sutton and Callahan 1987). For instance, referencing an entrepreneur whose venture failed, the Scottish Star newspaper (April 23, 2011) reported that "Chief executive Sam said he 'had been left with no alternative' but to pull the plug.…”

Motivation and Entrepreneurial Cognition

“…Indeed, stakeholders are generally people who are important to the entrepreneur and his or her venture (Mitchell et al 1997;Seldon and Fletcher 2015;Vandekerckhove and Dentchev 2005), friends and family often make equity investments in the business (Kotha and George 2012), and entrepreneurs frequently develop close relationships with their employees (Breugst et al 2012). Thus, financially costly failures are likely to upset investors who could potentially lose more money (Amit et al 1990;Mason and Harrison 2002), employees who could lose their jobs (or have to end relationships with people who are let go) (Fineman 1999;Jordan et al 2002), and other stakeholders who could potentially lose their reputation and/or social standing (Sutton and Callahan 1987). For instance, referencing an entrepreneur whose venture failed, the Scottish Star newspaper (April 23, 2011) reported that "Chief executive Sam said he 'had been left with no alternative' but to pull the plug.…”

Contemplating an Evolutionary Approach to Entrepreneurship

“…In contrast to calls for a "predictive theory of the behavior of entrepreneurs" (Amit, Glosten & Muller, 1990: 1232, non-predictive evolutionary perspectives enable the specific issues raised by Low and MacMillan (1988) to be fully accommodated, thereby advancing the cause of entrepreneurship as a distinct research discipline.…”