Insider Financing and Venture Capital Returns

54 Pages Posted: 9 Oct 2016 Last revised: 4 Nov 2016

See all articles by Michael Ewens

Michael Ewens

California Institute of Technology - Division of the Humanities and Social Sciences; National Bureau of Economic Research (NBER)

Matthew Rhodes-Kropf

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

Ilya A. Strebulaev

Stanford University - Graduate School of Business; National Bureau of Economic Research

Date Written: October 7, 2016

Abstract

Staged financing of venture capital-backed firms is valuable to both investors and entrepreneurs, but comes with a potential cost: hold-up. With asymmetric information and strong control rights, financial intermediaries may earn rents on their inside knowledge. We find that environments where insiders have the significant potential to hold-up the entrepreneur -- financings where only previous investors participate -- have predictable outcomes and returns. However, in contrast to predictions from the theory of hold-up, we show that these inside financings lead to a higher likelihood of failure, lower probability of IPOs, and lower cash on cash multiples than rounds with new (outside) investors. Inside financings also appear to be negative NPV, suggesting that investors make inefficient continuation decisions. We propose a novel alternative and show how the findings are consistent with a manifestation of an agency problem driven by changing opportunity costs over the VC fund life-cycle.

Keywords: venture capital, financial intermediation, hold up, entrepreneurship

JEL Classification: G24, G24

Suggested Citation

Ewens, Michael and Rhodes-Kropf, Matthew and Strebulaev, Ilya A., Insider Financing and Venture Capital Returns (October 7, 2016). Stanford University Graduate School of Business Research Paper No. 16-45. Available at SSRN: https://ssrn.com/abstract=2849681 or http://dx.doi.org/10.2139/ssrn.2849681

Michael Ewens (Contact Author)

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

1200 East California Blvd.
Pasadena, CA 91125
United States

National Bureau of Economic Research (NBER) ( email )

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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
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Ilya A. Strebulaev

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

HOME PAGE: http://faculty-gsb.stanford.edu/strebulaev/

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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