Cost of Experimentation and the Evolution of Venture Capital
The Journal of Financial Economics (Forthcoming)
51 Pages Posted: 3 Nov 2015 Last revised: 21 Mar 2017
Date Written: March 2017
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: Suggested Citation