ENTREPRENEURIAL DISCOVERY CAPITAL

Raymond Niles

No 2018-03, Working Papers from DePauw University, School of Business and Leadership and Department of Economics and Management

Abstract: This paper identifies how capital losses are unavoidably incurred in the discovery of viable entrepreneurial ventures. Losses are proportional to the novelty and perceived profit potential of a prospective venture, exemplified by the high risk/high return nature of high technology start-ups. Venture capitalists internalize the costs and benefits of this discovery process, and set up portfolios where the majority of funded ventures unavoidably fail or earn subpar returns. They incur these losses in order to discover the one Winner venture whose outsize returns will compensate for the capital losses in the failed ventures. The investment in failing ventures is unavoidable and necessary to discover the Winner because the winning business model cannot be determined ex ante. I call this investment “Entrepreneurial Discovery Capital.” This paper hypothesizes that many industry and economy-wide cycles may be the result of such a process that occurs at a much larger scale than a single fund. Venture capital in microcosm provides a model of an economy-wide process where the decisions of myriad market participants are coordinated “as if by an invisible hand” by signals from the capital markets.

Keywords: venture capital; business cycle; Schumpeter; discovery; innovation; high technology; entrepreneurship; cognitive (search for similar items in EconPapers)
JEL-codes: E32 E71 G01 G24 G41 L26 M13 O31 (search for similar items in EconPapers)
Date: 2018-10
New Economics Papers: this item is included in nep-ent, nep-ino, nep-mac and nep-sbm
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Persistent link: https://EconPapers.repec.org/RePEc:dew:wpaper:2018-03

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