What do entrepreneurs pay for venture capital affiliation?

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Citation: David H. Hsu (2004) What do entrepreneurs pay for venture capital affiliation?. The Journal of Finance (RSS)
Internet Archive Scholar (search for fulltext): What do entrepreneurs pay for venture capital affiliation?
Tagged: Business (RSS) Entrepreneurship (RSS), VC (RSS), Finance (RSS)


David Hsu offers an econometric evaluation of role that venture capitalists (VC) play in terms of certification and value-added. He looks at the rate at which offers from "reputable" VCs are accepted and at the amount of money in each offer. He uses a dataset that includes both accepted offers and rejected offers (a unique factor from the MIT entrepreneurship lab) and shows that reputable VCs are both much more likely to be accepted (almost three times) and that high-reputation VCs acquire equity with a 10-14% discount. He concludes that this supports that idea that reputable VCs are providing extra-financial services which entrepreneurial firms are willing to pay for.

Hsu argues that the finance literature (his paper is published in the Journal of Finance) has largely treated venture capital investment as "commodity like" but that there is reason to suspect that VCs offers other resources in terms of connections, advice, and introductions. He offers two hypotheses:

  1. Offers made by more reputable VCs are more likely to be accepted.
  2. The price that entrepreneurs pay in the market for affiliation is inversely associated with VC reputation.

Hsu empirical analysis uses a hand-collected sample that includes 148 financing offers from 51 early-stage high-tech firms that had received multiple offers (almost all of them Internet companies of one type or another) collected using a survey instrument. The analysis uses two sets of models: a logistic regression on whether on an offer will be accepted and OLS on the size of the investment.

Hsu seems to leave the question of "what is it that the start-ups are buying" largely open. He seems to strongly believe that it is either the VCs information network or the VCs ability to evaluate deals. Although some work suggests that VC ties may be used to signal quality (e.g., Stuart, Hoang, and Hybels (1999)), Hsu seems someone what confident that this going on, but is unclear about why he feels that.

Theoretical and Practical Relevance

Hsu's article has been cited 340 times in the 6 years since it was published, almost entirely in the literature on venture capital.