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Venture capital returns, new firms and social networks

  • Author(s): Ewens, Michael
  • et al.
Abstract

These chapters study the return of venture capital investments with a focus on outliers and examine the formation of new firms that invest in entrepreneurial companies. First, I formulate a model and estimator of venture capital (VC) returns motivated by the entrepreneurial firm life-cycle and the extreme return outcomes of typical venture capital investments. The model incorporates tail events and the estimator corrects for sample selection bias and endogenous investment holding periods. I find that an asymmetric three-state mixture distribution is a better characterization of returns than the standard single-state model. Mixture states mimic typical VC outcomes : "winners", "break-even" and "failures." Imposing normality on venture capital investment returns understates downside risk and kurtosis. In contrast to earlier studies, the mixture model reveals a leptokurtic, negatively-skewed returns distribution. Next, I investigate the consequences of venture capital employee spinoffs for parent firms and the characteristics of their founders. As predicted by the spinoff formation model of Cabral and Wang (2009), high type partners and low type partners at failing parent firms are the most likely to leave and start a new venture capital firm. After accounting for the endogeneity of the timing of spinoff formation, estimates reveal a large, negative impact of spinoffs on parent firm performance. The results indicate that a renewed focus on the venture capital partner, rather than the whole firm, could reveal new features of venture capital performance. Finally, the source of the competitive advantage of employee spinoff firms and their formation's negative impact on parent firms is often attributed to a transfer of knowledge from parent firm to spinoff. The third chapter studies one potential asset transfer in the venture capital industry that can explain both patterns : social networks. Results comparing the social network evolution of venture capital spinoffs and other new firms show that the former have more central network positions and gain those positions more quickly. Non-spinoffs are more likely to join smaller, more isolated cliques in the network. Spinoffs also have higher survival rates, co-invest with more experienced investors and produce more positive exit outcomes for their investments

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