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 O╠łnancing, 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 O╠łnance. 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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