What Do Entrepreneurs Pay for Venture Capital Affiliation?

This study empirically evaluates the certification and value-added roles of reputable venture capitalists (VCs). Using a novel sample of entrepreneurial start-ups with multiple financing offers, I analyze financing offers made by competing VCs at the first professional round of start-up funding, holding characteristics of the start-up fixed. Offers made by VCs with a high reputation are three times more likely to be accepted, and high-reputation VCs acquire start-up equity at a 10–14% discount. The evidence suggests that VCs’ “extra-financial” value may be more distinctive than their functionally equivalent financial capital. These extra-financial services can have financial consequences. A CENTRAL ISSUE for early-stage high-tech entrepreneurs is obtaining external resources when the assets of their start-up are intangible and knowledge-based. Particularly for entrepreneurs without an established reputation, convincing external resource providers such as venture capitalists (VCs) to provide financial capital may be challenging. The literature contains two main lines of research for overcoming this problem. One research stream has concentrated on designing institutional structures to permit financing early-stage ventures. This contractualand monitoring-based approach is aimed at solving potential agency problems between investors and entrepreneurs (e.g., Admati and Pfleiderer (1994), Lerner (1995), Hellmann (1998), and Kaplan and Strömberg (2001, 2002, 2003)). A second research stream has suggested that when the quality of a start-up cannot be directly observed, external actors rely on the quality of the start-up’s affiliates as a signal of the start-up’s own quality ∗The Wharton School, University of Pennsylvania. Respondents to the MIT Sloan Financing New High-Tech Ventures Survey made this project possible. I would like to thank Diane Burton, Joshua Gans, Rick Green (the editor), Thomas Hellmann, Steve Kaplan, Augustin Landier, Josh Lerner, Ken Morse, Ed Roberts and especially Scott Stern and an anonymous referee, for supplying helpful comments and suggestions. I thank seminar participants at Boston University, Carnegie Mellon, Case Western, Columbia, Harvard, INSEAD, University of Maryland, the MIT Organizational Economics lunch, Michigan, the NBER Productivity lunch, National University of Singapore, New York University, Stanford, University of Toronto, University of Texas, Washington University, Wharton, and the 2002 Yale Conference on Entrepreneurship, Venture Capital and Initial Public Offerings for interesting comments and discussions. Jaimie Lien provided excellent research assistance. Funding for this project from the Wharton Management Department, the MIT Entrepreneurship Center and the MIT Center for Innovation in Product Development through NSF Cooperative Agreement EEC-9529140 is gratefully acknowledged.