45 Pages Posted: 19 Jan 2016 Last revised: 12 Oct 2016
Date Written: October 11, 2016
We provide causal evidence that venture capitalists (VCs) improve the performance of their portfolio companies by replacing founders. Augmenting a database of U.S.-based, VC-backed startups from 1995-2008 with hand-collected information regarding turnover, we exploit shocks to the supply of outside executives via state-level changes in the enforceability of employee non-compete agreements. Although naive regressions of startup performance on founder replacement would suggest a negative correlation, this may be due to selection as founders are likely to leave or be pushed out of poorly-performing startups. Indeed, instrumented regressions reverse the sign of this effect, suggesting that replacing founders improves the performance of venture-backed entrepreneurial firms. Replacement helps more when founders hold CXO roles and when the incoming replacement has substantial work experience. The evidence points to the replacement of founders as a specific mechanism by which VCs add value.
Keywords: Executive turnover, venture capital, financial intermediation, entrepreneurship
JEL Classification: G24, G34, L2, M12
Suggested Citation: Suggested Citation