Cost of Experimentation and the Evolution of Venture Capital

Harvard Business School Entrepreneurial Management Working Paper No. 15-070

The Journal of Financial Economics (Forthcoming)

51 Pages Posted: 3 Nov 2015 Last revised: 21 Mar 2017

See all articles by Michael Ewens

Michael Ewens

Columbia Business School; National Bureau of Economic Research (NBER)

Ramana Nanda

Imperial College Business School; Harvard University - Entrepreneurial Management Unit

Matthew Rhodes-Kropf

Harvard Business School - Entrepreneurial Management Unit; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2017

Abstract

We study how technological shocks to the cost of starting new businesses have led the venture capital model to adapt in fundamental ways over the prior decade. We both document and provide a framework to understand the changes in the investment strategy of VCs in recent years - an increased prevalence of a \spray and pray" investment approach - where investors provide a little funding and limited governance to an increased number of startups that they are more likely to abandon, but where initial experiments significantly inform beliefs about the future potential of the venture. This adaptation and related entry by new financial intermediaries has led to a disproportionate rise in innovations where information on future prospects is revealed quickly and cheaply, and reduced the relative share of innovation in complex technologies where initial experiments cost more and reveal less.

Keywords: Innovation, Venture Capital, Investing, Abandonment Options

JEL Classification: G24, O31

Suggested Citation

Ewens, Michael and Nanda, Ramana and Rhodes-Kropf, Matthew, Cost of Experimentation and the Evolution of Venture Capital (March 2017). Harvard Business School Entrepreneurial Management Working Paper No. 15-070, The Journal of Financial Economics (Forthcoming), Available at SSRN: https://ssrn.com/abstract=2685208 or http://dx.doi.org/10.2139/ssrn.2685208

Michael Ewens

Columbia Business School ( email )

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HOME PAGE: http://michaelewens.com

National Bureau of Economic Research (NBER) ( email )

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Ramana Nanda (Contact Author)

Imperial College Business School ( email )

South Kensington Campus
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United Kingdom

Harvard University - Entrepreneurial Management Unit ( email )

Boston, MA 02163
United States

HOME PAGE: http://www.people.hbs.edu/rnanda

Matthew Rhodes-Kropf

Harvard Business School - Entrepreneurial Management Unit ( email )

Soldiers Field Road
Rock Center 312
Boston, MA 02163
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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