DDBA 8541 Week 9 Sample Frame Appraisal Example

Which Ventures the Studies Could Not See: Appraising Twelve Entrepreneurial Finance Studies by Their Sample Frames and Asking Which Claims Survive for the Ordinary New Business That Never Raises Outside Equity

Student Name

Walden University

DDBA 8541: Seminar in Entrepreneurial Finance

Instructor Name

Month Day, Year

Which Ventures the Studies Could Not See: Appraising Twelve Entrepreneurial Finance Studies by Their Sample Frames and Asking Which Claims Survive for the Ordinary New Business That Never Raises Outside Equity

The Question

The seminar's reading list teaches a great deal about how ventures are financed, but nearly all of it was learned from ventures that raised venture capital. Most new businesses never do. This appraisal reads twelve studies for their sample frames: where the data came from, which ventures the data could observe, when a venture entered the data and which ventures the study could not see. It then asks which claims survive for the ordinary new business.

The Twelve Studies

[after]

Table 1

Sample Frames of Twelve Studies

The First Gap: Only Funded Firms

Nine of the twelve studies enter a venture into their data only when it raises venture capital. Sahlman (1990), Gompers (1995), Kaplan and Stromberg (2003), Gompers et al. (2010), Hall and Woodward (2010) and Kerr et al. (2014) all observe ventures that have already passed a venture investor's screen. Their findings about contracts, staging, founder persistence and risk are well grounded for that population. They cannot say whether the same patterns hold for the great majority of ventures that never apply for, or never receive, venture funding.

The Second Gap: Selection on Success

Some studies select even more narrowly. Kaplan et al. (2009) followed firms that eventually went public, so their finding that business lines stayed stable while management changed describes successful firms. Firms that changed business lines and failed are absent. Gornall and Strebulaev (2020) studied only companies valued above $1 billion; their finding that reported valuations overstate fair value applies to the instruments those companies used, which are more elaborate than those most ventures use.

The Third Gap: Observation Only at Events

Cochrane (2005) addressed a different selection problem. Venture-backed firms are valued only when they raise a new round or exit, and firms that are doing well are more likely to raise new rounds or go public. Measuring returns only at those events therefore biases them upward. Cochrane corrected for this selection and found that average returns, while still high, were much lower than uncorrected figures suggested. His work shows that the timing of observation, not only the population, shapes conclusions.

Studies That Can See Further

Three studies reach beyond venture-backed firms. Puri and Zarutskie (2012) compared venture-backed firms with similar non-venture firms in census data and reported that venture-backed firms reached greater scale and were less likely than their matched peers to fail in their early years. Moskowitz and Vissing-Jorgensen (2002) used household survey data covering private businesses regardless of financing and found that returns to private business ownership were no higher than returns to public equity, despite the far greater risk owners bear. Robb and Robinson (2014), using the Kauffman Firm Survey, found that new firms rely heavily on external debt, especially bank loans backed by owners' personal assets, rather than on equity from outside investors.

Which Claims Survive for the Ordinary Venture?

Claims about the structure of venture contracts do not transfer, because ordinary ventures do not sign them. Claims about information problems between founders and funders likely transfer in spirit, since lenders also face asymmetry, but the remedies differ: banks rely on collateral and personal guarantees rather than staging and board seats. Claims about high returns do not transfer. Moskowitz and Vissing-Jorgensen's evidence suggests ordinary owners earn modest returns for large risks. Claims about the value of a founder's track record may transfer partly, but Gompers et al. (2010) measured success only as venture-backed success.

Limits of the Appraisal

Twelve studies are a small part of the literature. Sample frames are described from published accounts, which may omit details. And ventures that never borrow or hire, the smallest, remain invisible to nearly every study here.

Conclusion

Readers of this literature should ask, of every finding, at what point a venture entered the data. Much of what the seminar teaches is true of ventures that passed a venture capitalist's screen, and should be applied elsewhere with care.

References

Cochrane, J. H. (2005). The risk and return of venture capital. Journal of Financial Economics, 75(1), 3-52. https://doi.org/10.1016/j.jfineco.2004.03.006

Gompers, P. A. (1995). Optimal investment, monitoring, and the staging of venture capital. Journal of Finance, 50(5), 1461-1489. https://doi.org/10.1111/j.1540-6261.1995.tb05185.x

Gompers, P., Kovner, A., Lerner, J., & Scharfstein, D. (2010). Performance persistence in entrepreneurship. Journal of Financial Economics, 96(1), 18-32. https://doi.org/10.1016/j.jfineco.2009.11.001

Gornall, W., & Strebulaev, I. A. (2020). Squaring venture capital valuations with reality. Journal of Financial Economics, 135(1), 120-143. https://doi.org/10.1016/j.jfineco.2018.04.015

Hall, R. E., & Woodward, S. E. (2010). The burden of the nondiversifiable risk of entrepreneurship. American Economic Review, 100(3), 1163-1194. https://doi.org/10.1257/aer.100.3.1163

Kaplan, S. N., Sensoy, B. A., & Stromberg, P. (2009). Should investors bet on the jockey or the horse? Evidence from the evolution of firms from early business plans to public companies. Journal of Finance, 64(1), 75-115. https://doi.org/10.1111/j.1540-6261.2008.01429.x

Kaplan, S. N., & Stromberg, P. (2003). Financial contracting theory meets the real world: An empirical analysis of venture capital contracts. Review of Economic Studies, 70(2), 281-315. https://doi.org/10.1111/1467-937X.00245

Kerr, W. R., Nanda, R., & Rhodes-Kropf, M. (2014). Entrepreneurship as experimentation. Journal of Economic Perspectives, 28(3), 25-48. https://doi.org/10.1257/jep.28.3.25

Moskowitz, T. J., & Vissing-Jorgensen, A. (2002). The returns to entrepreneurial investment: A private equity premium puzzle? American Economic Review, 92(4), 745-778. https://doi.org/10.1257/00028280260344452

Puri, M., & Zarutskie, R. (2012). On the life cycle dynamics of venture-capital- and non-venture-capital-financed firms. Journal of Finance, 67(6), 2247-2293. https://doi.org/10.1111/j.1540-6261.2012.01786.x

Robb, A. M., & Robinson, D. T. (2014). The capital structure decisions of new firms. Review of Financial Studies, 27(1), 153-179. https://doi.org/10.1093/rfs/hhs072

Sahlman, W. A. (1990). The structure and governance of venture-capital organizations. Journal of Financial Economics, 27(2), 473-521. https://doi.org/10.1016/0304-405X(90)90065-8