Investment Risk Allocation and the Venture Capital Exit Market

Abstract:     
We examine how the reward-to-risk signaled by recent exits and failures of venture-backed companies affect venture capitalists’ risk allocations (proportion of early versus late stage investment), and returns. We show a sharply diminishing reward-to-risk over time that results in significantly lower allocations to early stage investments. Ceteris paribus, aggregate risk allocations and capital inflows have opposing effects on the returns to future exits. Conditional on exit, exit returns are positively (negatively) related to risk allocations (capital inflows) at the time of investment initiation. The negative effects on exit returns owing to lower risk allocations are a strong influence mitigating the positive effects of reduced capital inflows since the Dotcom collapse.

Number of Pages in PDF File: 53

Keywords: venture capital, investment, risk, M&A exits, IPO exits

JEL Classification: G24

working papers series