NBER Publications by Susan E. Woodward

In the standard venture capital contract, entrepreneurs have a large fraction of equity ownership in the companies they found and are paid a sub-market salary by the investors who provide the money to develop the idea. The big rewards come only to those whose companies go public or are acquired on favorable terms, forcing entrepreneurs to bear a substantial burden of idiosyncratic risk. We study this burden in the case of high-tech companies funded by venture capital. Over the past 20 years, the typical venture-backed entrepreneur earned an average of $4.4 million from companies that succeeded in attracting venture funding. Entrepreneurs with a coefficient of relative risk aversion of two and with less than $0.7 million would be better off in a salaried position than in a startup, despite ...

The standard venture-capital contract rewards entrepreneurs only for creating successful companies that go public or are acquired on favorable terms. As a result, entrepreneurs receive no help from venture capital in avoiding the huge idiosyncratic risk of the typical venture-backed startup. Entrepreneurs earned an average of $9 million from each company that succeeded in attracting venture funding. But entrepreneurs are generally specialized in their own companies and bear the burden of the idiosyncratic risk. Entrepreneurs with a coefficient of relative risk aversion of two would be willing to sell their interests for less than $1 million at the outset rather than face that risk. The standard financial contract provides entrepreneurs capital supplied by passive investors and rewards entr...