Working Paper Revision

Financing Ventures


Abstract: The relationship between venture capital and growth is examined using an endogenous growth model incorporating dynamic contracts between entrepreneurs and venture capitalists. At each stage of Òˆnancing, venture capitalists evaluate the viability of startups. If viable, venture capitalists provide funding for the next stage. The success of a project depends on the amount of funding. The model is confronted with stylized facts about venture capital: viz., statistics for each round of funding that concern the success rates, failure rates, investment rates, equity shares, and IPO values. Counterfactual experiments suggest that long-term U.S. growth would drop from 1.8 percent to 1.4-1.5 percent if venture capital were replaced by more traditional methods of Òˆnance. Likewise, it would drop from 1.8 percent to 1.62 percent if VC-funded startups in the United States are taxed at the German rate. The welfare losses associated with these declines in long-term growth rates are large.

Keywords: dynamic contract; growth regressions; endogenous growth; startups; IPO; capital gains taxation; evaluating; monitoring; research and development; venture capital; funding rounds;

JEL Classification: E13; E22; G24; L26; O16; O31; O40;

https://doi.org/10.20955/wp.2017.035

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Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2020-04

Number: 2017-035

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