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Entrepreneurial Finance: Risk and Return

Paper Session

Sunday, Jan. 5, 2020 10:15 AM - 12:15 PM (PDT)

Manchester Grand Hyatt, Seaport F
Hosted By: American Finance Association
  • Chair: Arthur Korteweg, University of Southern California

The Returns from Early-Stage Investment

Katja Kisseleva
,
European School of Management and Technology
Aksel Mjøs
,
Norwegian School of Economics
David T. Robinson
,
Duke University

Abstract

This paper provides direct measures of the returns from investing in newly established,
innovative companies. By exploiting a large and detailed data set provided to us by the
Norwegian Tax Authority, we trace out the entire funding and pricing history of each
firm and study performance measures at firm, investment and transaction levels. We
demonstrate how firm-level returns are divided between different investor classes and
explore the cross-sectional properties of transaction returns across different investor
classes and transaction types. The picture that emerges from our analysis helps to
illustrate the nature of market frictions often associated with early-stage investment in
innovation.

Evaluating Private Equity Performance Using Stochastic Discount Factors

Oleg Gredil
,
Tulane University
Morten Sorensen
,
Copenhagen Business School
William Waller
,
Tulane University

Abstract

We examine the performance of 2,790 private equity (PE) funds incepted during 1979-2008 using Stochastic Discount Factors (SDFs) implied by the two leading consumption-based asset pricing models (CBAPMs)---external habit and long-run risks---as their assumptions appear consistent with investment objectives of avid PE investors. In contrast to CAPM-based inference, venture funds did not destroy value under these CBAPMs in post-2000 vintages and may even have outperformed buyouts and generalists in the full sample. We find that 2007-08 venture vintages provide a better hedge for post-crises consumption shocks than other types of PE, and that the temporal variation in PE excess returns is significantly smaller under CBAPMs. Our contribution is also methodological. We extend the realized risk premia matching insight of Korteweg and Nagel (2016) to a more general class of SDFs, namely portfolio-specific discount factors that reflect non-tradeable assets unspanned by standard benchmarks. To this end, we propose a more efficient estimation of SDF parameters in this context and develop a finite sample bias correction for NPV-based inference with long-duration assets.

Entrepreneurial Experimentation and Duration

Guojun Chen
,
Nanyang Technological University
Jianjun Miao
,
Boston University
Neng Wang
,
Columbia University

Abstract

Entrepreneurial ventures surviving longer tend to earn more. Therefore, censoring on entrepreneurial duration may bias the average earnings, causing discrepancies between observed earnings and its expected long-run value. We propose a continuous-time dynamic model in which a risk-averse entrepreneur learns the unknown venture quality through experimentation over time and chooses the optimal time to exit. We derive in closed form the optimal decision rules and the risk-adjusted expected value of entrepreneurship. In the model, duration captures the optimal amount of experiment, which predicts long-term success and thus the expected earnings. The structural estimation suggests that the bias of entrepreneurial earnings due to right-censoring on duration in our current sample is 4.7% of the annual wage of salaried workers, or $1,652 per year.

Life Cycle Cash Flows of Ventures

Ravi Jagannathan
,
Northwestern University
Shumiao Ouyang
,
Princeton University
Jiaheng Yu
,
Massachusetts Institute of Technology

Abstract

We compute the collective return to investors in all the funding rounds of a venture by examining the net present value (NPV) of its life time cash flows. We use data for 16,396 ventures funded by venture capitalists (VC), with 57,884 funding rounds from 1980 to 2018 from VentureXpert. Post-money valuation is missing for more than 76% of the funding rounds, making it difficult to compute the return to investing in any given funding round. However, the amount raised is missing for only 3% of the funding rounds, making it feasible to estimate the collective return to all investors based on cash flows over the life cycle of ventures. While the realized NPV per dollar invested in the first round of funding – normalized NPV – is positive on average, there is large cross sectional variation. More than 64% of ventures have negative normalized NPV. In the aggregate, a hypothetical investor who holds all the ventures that had the first funding round in a specific quarter had to wait 5 to 60 quarters for the realized NPV to become positive – depending on the quarter of the first rounds. There is a structural break – ventures that started after 1999 tend to be less profitable. Before the structural break, ventures that had participation by more experienced VCs in the first round were more successful, and had more patent grants over their life cycle.
Discussant(s)
Ayako Yasuda
,
University of California-Davis
Anisha Ghosh
,
McGill University
Christian Opp
,
University of Rochester
Morten Sorensen
,
Copenhagen Business School
JEL Classifications
  • G2 - Financial Institutions and Services