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Cost of Experimentation and the Evolution of Venture Capital

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

Michael Ewens

California Institute of Technology - Division of the Humanities and Social Sciences

Ramana Nanda

Harvard University - Entrepreneurial Management Unit

Matthew Rhodes-Kropf

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

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. Available at SSRN: https://ssrn.com/abstract=2685208 or http://dx.doi.org/10.2139/ssrn.2685208

Michael Ewens

California Institute of Technology - Division of the Humanities and Social Sciences ( email )

1200 East California Blvd.
Pasadena, CA 91125
United States

Ramana Nanda (Contact Author)

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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