Working Paper: NBER ID: w14219
Authors: Robert E. Hall; Susan E. Woodward
Abstract: In the standard venture capital contract, entrepreneurs have a large fraction of equity ownership in the companies they found and are paid a sub-market salary by the investors who provide the money to develop the idea. The big rewards come only to those whose companies go public or are acquired on favorable terms, forcing entrepreneurs to bear a substantial burden of idiosyncratic risk. We study this burden in the case of high-tech companies funded by venture capital. Over the past 20 years, the typical venture-backed entrepreneur earned an average of $4.4 million from companies that succeeded in attracting venture funding. Entrepreneurs with a coefficient of relative risk aversion of two and with less than $0.7 million would be better off in a salaried position than in a startup, despite the prospect of an average personal payoff of $4.4 million and the possibility of payoffs over $1 billion. We conclude that startups attract entrepreneurs with lower risk aversion, higher initial assets, preferences for entrepreneurship over employment, and optimistic beliefs about the payoffs from their products.
Keywords: No keywords provided
JEL Codes: G12; G24; G32; H1; L14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| entrepreneurs with lower risk aversion (L26) | pursue startups (M13) |
| higher initial assets (G32) | pursue startups (M13) |
| idiosyncratic risk burden (D81) | choice between entrepreneurship and salaried employment (L26) |
| risk of failure (G32) | zero returns to entrepreneurs (L26) |
| higher exit values (D46) | shorter venture lifetimes (D25) |