Despite the evidence on the positive effect of venture capital (VC) on portfolio firm performance, such evidence badly pulls up alongside the non-negligible number of entrepreneurial firms that chooses to refuse VC. This is the first study that investigates the determinants behind the missed realizations of VC investor-investee dyads by focusing on the Italian VC market. 

We theorize and empirically document that entrepreneurs’ human capital background and venture-specific characteristics influence the decision to accept or refuse VC. Specifically, our findings show that technically literate founders decrease the likelihood to refuse VC while family linkages in the ownership structure increase the likelihood to refuse VC.


1. Introduction

Schumpeter (1934, 1939) identified the entrepreneur as an individual with special traits. The alertness to profit opportunities is one of the most important features of entrepreneurial behavior (Casson, 2005; Kirzner, 1997; 2015). 

However, profit opportunities can remain unexploited simply because of the lack of sufficient funds, the highly idiosyncratic and non-transactional nature of entrepreneurial ideas (see Knight, 1921 and the “cephalization” process), and more generally information asymmetries between the entrepreneur and potential financiers (Carpenter and Petersen, 2002; del-Palacio et al., 2012). 

One of the most important financial intermediaries advocated in the finance and economics literature to overcome such information asymmetries is represented by venture capital (VC) funds (VCs). VCs have been portrayed as suitable financiers for young and risky high-tech ventures (HTVs), which would otherwise experience difficulties in attracting alternative sources of finance (Gompers and Lerner, 2001, 2004). 

Accordingly, the available empirical evidence has shown a positive impact of VC on both microeconomic – e.g., firm growth, productivity, and innovativeness (Colombo and Murtinu, 2017; Croce et al., 2013; Devigne et al., 2013; Kortum and Lerner, 2000; Puri and Zarutskie, 2012) – and macroeconomic performances – e.g., entrepreneurship rates, employment, aggregate income (Samila and Sorenson, 2011).

Despite the role-model played by VC worldwide, we do still know very little about the VC investor-investee relationship.

1 While many papers in the finance and economics literature have studied the decision criteria put in use by VCs in selecting promising entrepreneurial firms (Hellmann and Puri, 2000; Kaplan and Strömberg, 2003), very few works have attempted to understand the driving forces leading entrepreneurs to search for VC (Bertoni et al., 2016; Hellmann, 1998).

To the best of our knowledge, there are no studies that investigate the microeconomic determinants behind the missed realization of a VC investor-investee dyad. Therefore, the first contribution of this study is to understand which venture-level characteristics influence the likelihood that entrepreneurs refuse VC. 

This is extremely important because VC, in addition to advantages – such as financial resources, advice, and access to other investors, suppliers and clients –, may lead to disadvantages such as window-dressing effects (Cornelli and Yosha, 2003) or agency costs with the entrepreneurs, that is, conflicts about corporate strategy (Hellmann and Puri, 2000), appropriability hazards (Ueda, 2004), and excessive intrusion in a firm’s management (Cestone, 2013; Hellmann, 1998; Sapienza, 1992).

The second contribution to the VC literature is the focus on a thin VC market as the Italian one.

2 This is an ideal setting for our research strategy: the low number of VCs in the market make the entrepreneurial choice of refusing VC an almost ‘one-shot’ decision. In this thin market, VCs have strong bargaining power and thus they can make take-it-or-leave-it offers. 

Then, entrepreneurs need to have very strong motivations to refuse VC, such as private benefits in the form of non-monetary utility and sentimental attachment to the venture. Besides, our setting – an understudied geographic area with a rather thin VC market – seems, at first glance, to be not-so-generalizable; however, at global level, the thinness of the national VC industry represents the rule rather than the exception.

Indeed, only few markets beyond the US (e.g., Israel, Sweden, UK) have really matured (Economidou et al., 2018). Specifically, our study focuses on specific human capital characteristics of entrepreneurs (i.e., technical literacy of the founding team) and family linkages in the ownership structure, and investigates both theoretically and empirically how these two dimensions may influence entrepreneurial behaviors when deciding whether to accept or refuse VC. 

In fact, the entrepreneurial finance literature has highlighted how the human capital possessed by the founding team and family linkages represent two key determinants affecting the decision processes through which both VCs target investments and entrepreneurs search for VC. 

Adopting the “need and opportunity” approach suggested by Dimov and Milanov (2010), we argue that: 

  • i) the technical literacy of the founding team is complementary to the strategic and managerial assets of VCs and it actually represents a powerful signal to attract the interest of VCs; and 
  • ii) a concentrated family ownership structure likely signals that the venture has not (yet) solved the control dilemma (Wasserman, 2017; for instance, the founding team attaches a strong socio-emotional wealth to the control of their venture’s resources), and thus that the likelihood to refuse a VC deal will be higher.

We use a sample of 120 Italian HTVs that received a VC offer, 40 of which refused VC while the remaining 80 accepted it. This sample is suited for our identification strategy because it only includes ventures that did receive at least one VC offer during their life. 

Thus, it is not affected by any potential bias related to the inclusion in the estimation of firms that have never figured as credible targets for VCs. Our findings show that the presence of technical literacy within the founding team decreases the likelihood to refuse VC by 16.45% (and this results is even stronger for ICT firms), while family ownership increases such likelihood by +27.6%. 

These findings are robust to controls for 

  • i) the  presence of firms that have never received VC offers, 
  • ii) the nature of the received offer (i.e., solicited or unsolicited), and iii) the existence of financial alternatives to VC.

In addition, we also assess the impact that the decision to refuse VC has on the venture growth performance, and we find that such decision has a negative effect on the sales growth performance.

Then, by means of a switching regression-type methodology with endogenous switching we show that, on average, firms that refused VC show an yearly sales growth performance of +11.7%, while the same firms would have shown an increase in yearly sales growth equal to +30.9% if they have accepted VC funding. 

These findings are robust to alternative estimations (i.e., propensity score matching) and several sets of exclusion restrictions. The rest of the paper is organized as follows. Section 2 reviews the relevant literature and formulates research hypotheses. Section 3 describes the data. Section 4 explains the identification strategy and shows the econometric results. Section 5 concludes.

… …

1. Introduction

2. Literature review and research hypotheses

3. Data

4. Results

5. Conclusions

… …

VC is a key financing instrument for entrepreneurial ventures. These latter are usually priced by financial markets on their ability to attract rounds of investment from VCs. 

This is partly due to the fact that many US leading companies have been VC-backed entrepreneurial ventures. Accordingly, one would expect that a VC offer is celebrated by an entrepreneur like she had won one billion dollars, especially in countries where VC supply is rather thin. However, reality is far from this. 

In many cases, entrepreneurs do refuse VC. So, why does this happen? This study aims at shedding light on this issue that has been totally overlooked by the extant literature. 

We do provide some answers to this interesting question looking at a particularly underdeveloped VC market, such as the Italian one. Grounding on the economics and finance literature on VC, we theorize on which entrepreneurial team- and venture-specific factors could significantly influence the entrepreneurial decision to refuse VC. 

Furthermore, we show the impact of the refusal choice on firm growth performance, and highlight what would the growth of refusing firms have been had they got VC funding. 

Using a sample of 120 HTVs which received a VC offer during their life, we use multiple estimation strategies and find out a series of findings which have several implications.

First, the ownership structure of a venture is an important factor behind VC refusal. In particular, family ownership makes more likely for a venture to refuse VC. Given the hypothetical growth performance entrepreneurial ventures could have achieved with VC, family linkages in the ownership structure of nascent entrepreneurial ventures may represent an hurdle towards firm growth.

Specifically, the high percentage of family firms in the Italian (and European) economy and the dominant tight approach adopted by Italian families in the management of their firms19 may help explain the poor development of the VC industry in this context.

Second, VC refusal and its underlying motivations are influenced by the human capital characteristics of the founding teams. Specifically, ventures whose founders have educational literacy in technical subjects are less eager to refuse VC. 

This finding complements the literature explaining how high-tech ventures need to combine a strong technical core with economic and managerial competencies (e.g., Colombo and Grilli, 2005); more interestingly, we highlight how this combination can be realized through partnerships with VCs and not necessarily within the founding team.

Third, VC refusing ventures achieved a significantly lower growth performance than the one of VC-backed firms. Further, firms refusing VC show a lower growth than what the same firms would have achieved had they accepted VC funding. 

This latter result may represent a policy problem. In fact, the impact of ventures’ growth on the aggregate growth embodies a social welfare issue.

Specifically, our empirical evidence shows that some ventures have suitable a priori characteristics to enhance social welfare, but they choose not to do it.

A possible explanation relates to the potential agency conflicts with VCs in terms of different strategies, appropriability concerns, and potential loss of control. 

As to the latter, (some) entrepreneurs may be more likely to prefer private benefits of control (e.g., non-monetary benefits including sentimental attachment to the venture) than a higher venture growth “but shared with the VC” (see the “control dilemma” highlighted by Wasserman, 2017). The fact that the willingness to keep firm control at all costs may lead entrepreneurs to refuse VC, and thus choose sub-optimal growth paths for their firms, is surely worth of reflection from a policy perspective. 

Furthermore, the ways this problem can be ameliorated represent limitations in our study and promising future research avenues.

First, future studies should investigate how the entrepreneurial decision to refuse VC potentially interacts with funding alternatives available at the time of the VC offer, such as crowdfunding, business angel funding, loan guarantee schemes, bank loans, factoring and short-term finance provided by suppliers (Bruton et al., 2015). 

In the same vein, it would also be interesting to analyze whether the institutional heterogeneity of VC investors which is found to impact differently many dimensions of the investees (e.g., Bertoni et al., 2013) may also affect VC refusal patterns. 

Second, it is necessary to deeply investigate how the political, cultural, legal, and institutional barriers may shape the behaviors of entrepreneurs and VCs when interacting in entrepreneurial finance markets (Moore et al., 2015). Finally, research is needed to understand how entrepreneurs may deal with corporate governance problems with VCs. 

Being principal-principal conflicts a serious issue in HTVs (Colombo et al., 2014), particular attention should be devoted to understand the role of banks,

covenants and the maturity of debt in preventing horizontal agency problems, especially when these latter are associated with the allocation of control rights (Khanin and Turel, 2015).


By Annalisa Croce,+ Luca Grilli,+* Samuele Murtinu

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