Working Paper: NBER ID: w24523
Authors: Michael Ewens; Ramana Nanda; Matthew Rhodes-Kropf
Abstract: We study how technological shocks to the cost of starting new businesses have led the venture capital model to adapt in fundamental ways over the prior decade. We both document and provide a framework to understand the changes in the investment strategy of venture capitalists (VCs) in recent years — an increased prevalence of a “spray and pray” investment approach — where investors provide a little funding and limited governance to an increased number of startups that they are more likely to abandon, but where initial experiments significantly inform beliefs about the future potential of the venture. This adaptation and related entry by new financial intermediaries has led to a disproportionate rise in innovations where information on future prospects is revealed quickly and cheaply, and reduced the relative share of innovation in complex technologies where initial experiments cost more and reveal less.
Keywords: venture capital; cloud computing; investment strategy; startup financing; entrepreneurship
JEL Codes: G24; O31; O32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| AWS introduction (L93) | lower initial costs of starting new ventures (M13) |
| lower initial costs of starting new ventures (M13) | increase in number of investments made by VCs in treated sectors (G24) |
| AWS introduction (L93) | shift towards 'spray and pray' investment strategy (G11) |
| shift towards 'spray and pray' investment strategy (G11) | minimal funding and governance to larger number of startups (M13) |
| AWS introduction (L93) | fall in average initial funding size for startups in treated sectors (M13) |
| fall in average initial funding size for startups in treated sectors (M13) | higher likelihood of failure for startups (M13) |
| higher likelihood of failure for startups (M13) | higher step-ups in valuation when receiving follow-on funding (G24) |
| shift towards 'spray and pray' investment strategy (G11) | relative decline in funding for complex technologies (O38) |