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Startup companies traditionally seek the most experienced venture capitalists (VCs) they can find to launch their businesses and support their growth. That’s not always the case anymore, according to a study by Robert H. Smith School assistant professor Rich Matthews and co-author Naveen Khan of Michigan State University. They argue that startups often choose to work with new venture capitalists rather than established ones right out of the gate.

Research shows that there are two important qualities that entrepreneurs look for in venture capital. The first is the ability to provide services such as mentoring, and the second is reliability, which refers to venture capital backing a startup through multiple rounds of funding. “Although the track record of new VCs is unknown, their stronger incentives to stay committed and their willingness to provide a good environment to attract entrepreneurs — to in some sense share the value of the reputation they (VCs) are trying to build — make them attractive ” says Matthews.

As unknown venture capitalists try to build a reputation, they compete fiercely with established venture capitalists, often accepting less capital in a new company in exchange for their services than a more experienced venture capitalist. At the same time, the demand for well-known venture capital is also an obstacle for their takeover of startups. New companies have to get in line to get their attention, and many new startups aren’t interested in waiting.

Mastery vs. Reliability in Venture Capital Research in Journal of Financial Economics, believes that this new modus operandi in the VC orbit leads to skill crowding, reduced reputational value, and a loss of social welfare. Matthews says: “A good startup ecosystem is essential to a culture of innovation that leads to breakthrough products that change people’s lives for the better. Our research shows a potential threat to this ecosystem, which can reduce the pace of innovation if traditional long-term VC/launch the relationship cycle is broken.”

Established VCs being pushed out by new VCs in the opportunity to invest in startups is turning tradition on its head to some extent. However, Matthews points out that all is not lost for experienced VCs. He says they will still be able to find good deals, but “terms will not be as attractive as they would like and they may have to change their strategy to maintain their advantage.”

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Additional information:
Naveen Khanna and others. Mastery vs. Reliability in Venture Capital Journal of Financial Economics (2021). DOI: 10.1016/j.jfineco.2021.07.007

Citation: The venture capital landscape is changing, and maybe not for the better (2022, October 11) Retrieved October 11, 2022, from

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