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Cost of Experimentation and the Evolution of Venture Capital

Michael Ewens Author-Email: mewens@caltech.edu, Ramana Nanda () and Matthew Rhodes-Kropf ()
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Michael Ewens Author-Email: mewens@caltech.edu: California Institute of Technology,

No 15-070, Harvard Business School Working Papers from Harvard Business School

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 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: Innovation; Venture Capital; Investing; Abandonment Option; Failure Tolerance (search for similar items in EconPapers)
JEL-codes: G24 O31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn, nep-ent and nep-ino
Date: 2015-02, Revised 2017-03
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