How Do Higher Quality Entrepreneurs Choose Venture Capitalists?

Abstract:     
This paper finds that higher quality entrepreneurs time their entry into the venture capital market to minimize the cost of equity financing, and as part of an IPO market timing strategy. Specifically, higher quality entrepreneurs are more likely to enter the venture capital market when average monthly initial returns to IPOs are low and they are more likely to go public in months when average initial returns to IPOs are high. In addition, they are more likely to obtain financing from venture capitalists that are younger, lack deal screening expertise, located outside of California, and not concentrated in risky ventures. They are also more likely to obtain financing from bank affiliated venture capitalists. However, higher quality entrepreneurs that obtain financing from venture capitalists with greater reputation capital, are more likely to end up with higher IPO prices. Hence, the opportunity cost of minimizing the cost of equity financing is likely to translate into smaller certification benefits at the IPO. Nevertheless, relative to expectations prior to the IPO, higher quality entrepreneurs that obtain financing from venture capitalists with smaller reputation capital fare no worse with respect to the IPO offer price.

Number of Pages in PDF File: 37

Keywords: Venture Capital, Entrepreneurship, IPOs, Certification, Adverse Selection

JEL Classification: G24, G28, F39, O10

working papers series