Size and Focus of a Venture Capitalist's Portfolio

Posted: 8 Dec 2009

See all articles by Paolo Fulghieri

Paolo Fulghieri

University of North Carolina Kenan-Flagler Business School; European Corporate Governance Institute (ECGI)

Merih Sevilir

Indiana University - Kelley School of Business - Department of Finance

Multiple version iconThere are 3 versions of this paper

Date Written: November 2009

Abstract

We take a portfolio approach to analyze the investment strategy of a venture capitalist (VC) and show that portfolio size and scope affect both the entrepreneurs' and the VC's incentives to exert effort. A small portfolio improves entrepreneurial incentives because it allows the VC to concentrate the limited human capital on a smaller number of startups, adding more value. A large and focused portfolio is beneficial because it allows the VC to reallocate the limited resources and human capital in the case of startup failure and allows the VC to extract greater rents from the entrepreneurs. We show that the VC finds it optimal to limit portfolio size when startups have higher payoff potential-that is, when providing strong entrepreneurial incentives is most valuable. The VC expands portfolio size only when startup fundamentals are more moderate and when he can form a sufficiently focused portfolio. Finally, we show that the VC may find it optimal to engage in portfolio management by divesting some of the startups early since this strategy allows him to extract a greater surplus.

JEL Classification: G24

Suggested Citation

Fulghieri, Paolo and Sevilir, Merih, Size and Focus of a Venture Capitalist's Portfolio (November 2009). The Review of Financial Studies, Vol. 22, Issue 11, pp. 4643-4680, 2009. Available at SSRN: https://ssrn.com/abstract=1519268 or http://dx.doi.org/hhp012

Paolo Fulghieri (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Merih Sevilir

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

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