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The entrepreneur's investor choice: The impact on later-stage firm development

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  • Schwienbacher, Armin
Abstract
This article analyzes how early-stage financing decisions may affect how entrepreneurial firms ultimately grow. This theoretical study considers an entrepreneur seeking early-stage financing from either a specialist or a generalist investor in the context of stage financing. It is assumed that an early-stage specialist is less efficient in assisting a venture beyond the early-stage round than a generalist. This leads to the following tradeoff: by initially selecting an early-stage specialist, the entrepreneur benefits from increased investor incentives in the first round. Such incentives generate additional value for the entrepreneurial venture, improving valuation in the interim round and thereby mitigating the risk of dilution against follow-up investors and potentially even of premature discontinuation of the project. However, early-stage specialists are more reluctant to finance later rounds. Conversely, using a generalist secures efficient follow-up funding but also leads to weaker investor incentives in the early stage. With this tradeoff, the presence of asymmetric information about the quality of entrepreneurial projects particularly affects generalists; entrepreneurs with strong projects more often choose specialists, while entrepreneurs with weak projects select generalists to secure efficient continuation. The use of convertible securities or adjustment warrants in contracts cannot always eliminate the effect of asymmetric information. Several empirical implications derived from this tradeoff are provided for optimal investor choice.

Suggested Citation

  • Schwienbacher, Armin, 2013. "The entrepreneur's investor choice: The impact on later-stage firm development," Journal of Business Venturing, Elsevier, vol. 28(4), pages 528-545.
    • Handle: RePEc:eee:jbvent:v:28:y:2013:i:4:p:528-545
    DOI: 10.1016/j.jbusvent.2012.09.002
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    3. Ritesh Shahi & Nadiya Parekh, 2022. "Financing Social Enterprises: An Upper Echelon Perspective," FIIB Business Review, , vol. 11(2), pages 235-250, June.
    4. Magnus Schückes & Tobias Gutmann, 2021. "Why do startups pursue initial coin offerings (ICOs)? The role of economic drivers and social identity on funding choice," Small Business Economics, Springer, vol. 57(2), pages 1027-1052, August.
    5. Sebastian Schmidt & David Bendig & Malte Brettel, 2018. "Building an equity story: the impact of effectuation on business angel investments," Journal of Business Economics, Springer, vol. 88(3), pages 471-501, May.
    6. Salvatore Di Novo & Giorgio Fazio & Jonathan Sapsed & Josh Siepel, 2022. "Starving the golden goose? Access to finance for innovators in the creative industries," Journal of Cultural Economics, Springer;The Association for Cultural Economics International, vol. 46(2), pages 345-386, June.
    7. Andrieu, Guillaume & Peter Groh, Alexander, 2021. "Strategic exits in secondary venture capital markets," Journal of Business Venturing, Elsevier, vol. 36(2).
    8. Thomas W. Archibald & Edgar Possani, 2021. "Investment and operational decisions for start-up companies: a game theory and Markov decision process approach," Annals of Operations Research, Springer, vol. 299(1), pages 317-330, April.
    9. Kang Hyunsung D, 2018. "A Start-Up’s R&D Stages and the Evolution of Financing Sources: Evidence from the Biotechnology Industry," Entrepreneurship Research Journal, De Gruyter, vol. 8(3), pages 1-19, July.
    10. S. Sinan Erzurumlu & Nitin Joglekar & Moren Lévesque & Fehmi Tanrisever, 2019. "How Angel Know-How Shapes Ownership Sharing in Stage-Based Contracts," Entrepreneurship Theory and Practice, , vol. 43(4), pages 773-801, July.
    11. Zichun Yan & Kai Wang & Sang-Bing Tsai & Lili Zhou, 2018. "An Empirical Study on Internet Startup Financing From a Green Financial Perspective," Sustainability, MDPI, vol. 10(8), pages 1-16, August.
    12. Max Berre & Benjamin Le Pendeven, 2023. "What do we know about startup-valuation drivers? A systematic literature review 1," Post-Print hal-04232855, HAL.
    13. Jerry Coakley & Aristogenis Lazos & Jose Liñares-Zegarra, 2022. "Strategic entrepreneurial choice between competing crowdfunding platforms," The Journal of Technology Transfer, Springer, vol. 47(6), pages 1794-1824, December.
    14. Block, Joern & Fisch, Christian & Vismara, Silvio & Andres, René, 2019. "Private equity investment criteria: An experimental conjoint analysis of venture capital, business angels, and family offices," Journal of Corporate Finance, Elsevier, vol. 58(C), pages 329-352.
    15. Christos Cabolis & Mian Dai & Konstantinos Serfes, 2023. "Competition and Specialization in the VC Market: A Non-monotonic Relationship," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 62(3), pages 241-269, May.
    16. Marcos Antonio González M & Orestis Terzidis & Phillip Lütz & Benedict Heblich, 2024. "Critical decisions at the early stage of start-ups: a systematic literature review," Journal of Innovation and Entrepreneurship, Springer, vol. 13(1), pages 1-40, December.
    17. Mohammadi, Ali & Shafizadeh, Mohammadmehdi & Johan, Sofia, 2014. "A Signaling Theory Of Entrepreneurial Venture’S Valuation: Evidence From Early Termination Of Venture Capital Investment," Working Paper Series in Economics and Institutions of Innovation 349, Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies.
    18. Munjae Lee & Sewon Park & Kyu-Sung Lee, 2019. "What Are the Features of Successful Medical Device Start-Ups? Evidence from KOREA," Sustainability, MDPI, vol. 11(7), pages 1-17, April.
    19. Niclas Dombrowski & Wolfgang Drobetz & Lars Hornuf & Paul P. Momtaz, 2023. "The Financial and Non-Financial Performance of Token-Based Crowdfunding: Certification Arbitrage, Investor Choice, and the Optimal Timing of ICOs," CESifo Working Paper Series 10393, CESifo.
    20. Cole, Rebel A. & Sokolyk, Tatyana, 2018. "Debt financing, survival, and growth of start-up firms," Journal of Corporate Finance, Elsevier, vol. 50(C), pages 609-625.

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    More about this item

    Keywords

    Financing strategy; Investor specialization; Start-up finance; Stage financing; Asymmetric information;
    All these keywords.

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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