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Entrepreneurial Discovery Capital

Author

Listed:
  • Raymond C. Niles

    (Department of Economics and Management, DePauw University)

Abstract

This paper identifies how capital losses are unavoidably incurred in the discovery of viable entrepreneurial ventures. Losses are proportional to the novelty and perceived profit potential of a prospective venture, exemplified by the high risk/high return nature of high technology start-ups. Venture capitalists internalize the costs and benefits of this discovery process, and set up portfolios where the majority of funded ventures unavoidably fail or earn subpar returns. They incur these losses in order to discover the one Winner venture whose outsize returns will compensate for the capital losses in the failed ventures. The investment in failing ventures is unavoidable and necessary to discover the Winner because the winning business model cannot be determined ex ante. I call this investment “Entrepreneurial Discovery Capital.” This paper hypothesizes that many industry and economy-wide cycles may be the result of such a process that occurs at a much larger scale than a single fund. Venture capital in microcosm provides a model of an economy-wide process where the decisions of myriad market participants are coordinated “as if by an invisible hand” by signals from the capital markets.

Suggested Citation

  • Raymond C. Niles, 2018. "Entrepreneurial Discovery Capital," Working Papers 2018-03, DePauw University, School of Business and Leadership and Department of Economics and Management.
    • Handle: RePEc:dew:wpaper:2018-03
    as

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    File URL: https://www.depauw.edu/site/learn/dew/wpaper/workingpapers/DePauw2018-03-Niles-EntrepreneurialDiscoveryCapital.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    venture capital; business cycle; Schumpeter; discovery; innovation; high technology; entrepreneurship; cognitive;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E71 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on the Macro Economy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • L26 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Entrepreneurship
    • M13 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - New Firms; Startups
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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