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The Color of Money: A Start-Up's Choice Among Venture Capitalists

Krishnamurthy Subramanian

Indian School of Business (ISB), Hyderabad

March 13, 2011

Venture Capitalists (VCs) differ significantly from one another with respect to the non-financial resources -- from business expertise to the network of contacts with potential suppliers, customers, employees and IPO underwriters -- they offer their portfolio firms. In this paper, I develop a theoretical model incorporating such differences in resources to examine an entrepreneur's choice among VCs. By relating the costs and benefits of associating with a VC ab initio to the resources offered by the VC, the model examines the conditions under which financing by a more resourceful VC is optimal. The results rationalize the empirical findings that: (1) Startups prefer more resourceful VCs even though they have to offer equity at a considerable discount to such VCs. (2) More resourceful VCs may not only create successful startups but are also able to appropriate the benefits from the same and thereby consistently outperform their less resourceful competitors. However, the model points out that these results may only hold locally depending upon the intensity of product market competition and the entrepreneur's and VC's ability to hold each other up. The model generates the following new predictions: (1) In contrast to the hold-up by an informed bank, hold-up by a VC does not necessarily dampen entrepreneurial incentives and can therefore be value-adding. (2) While hold-up involving physical assets is zero-sum, hold-up involving intangible assets is not necessarily so. (3) Financing from a more (less) resourceful VC is optimal when product market competition is low (high) and the likelihood of hold-up is low (high).

Number of Pages in PDF File: 33

Keywords: Complementary Assets, Financing Choices, Financial Intermediation, Resources, Start-up Financing, Venture Capital

JEL Classification: G24, G32, L22

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Date posted: March 14, 2011  

Suggested Citation

Subramanian, Krishnamurthy, The Color of Money: A Start-Up's Choice Among Venture Capitalists (March 13, 2011). Available at SSRN: https://ssrn.com/abstract=1785097 or http://dx.doi.org/10.2139/ssrn.1785097

Contact Information

Krishnamurthy Subramanian (Contact Author)
Indian School of Business (ISB), Hyderabad ( email )
Hyderabad, Gachibowli 500 019

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