Managing investments in specific information: A comparison of business angels and venture capital firms

This research questioned why business angels (i.e., private individual investors) and venture capital firms exist simultaneously in venture capital markets if they both provide risk capital for new enterprises. We would expect to find the more efficient of the two driving the other out of business. It may be that they are both present because of comparative advantages in risk management.;Two types of risk were contrasted: market risk and agency risk. Market risk is due to unforeseen competitive conditions. Agency risk is caused by the separate and possibly divergent interest of investors and entrepreneurs. Agency risk results from entrepreneurs being incompetent, acting in bad faith, holding conflicting objectives, and the like.;To explain the simultaneous existence of venture capital firms and business angels, this research developed and tested a theory of comparative advantage based upon previous specific investments in risk-reducing information. These investments were viewed as related to either market or agency factors. Four subsidiary questions of theoretical interest were also investigated: (1) Do venture capital firms and business angels have separate investor networks for obtaining investment information? (2) Do venture capital firms and business angels specialize in the assessment of either market or agency risk? (3) Do venture capital firms and business angels depend upon their own investor networks as sources of risk-reducing information? (4) Once venture capital firms and business angels invest in information related to either market or agency risk, do they respond by implementing appropriate controls? Differences in the conduct of venture capital firms and business angels related to any of these questions were investigated as potential causes of their simultaneous existence.;This study drew upon evidence that venture capital firms invest relatively more in specific information regarding market risk and that business angels invest relatively more in specific information regarding agency risk. It hypothesized that venture capital firms and business angels relied upon separate networks for information regarding how to manage risk. The study pitted Williamson's (1975) transaction cost theory against Granovetter's (1985) theory of social network embededness as alternative explanations of the governance mechanisms that would emerge to control losses due to market and agency risk.;The hypotheses were tested using data compiled from mailed surveys and face-to-face interviews. Bentler-Weeks covariance structure modeling was utilized to predict the specific investments that would be made in risk related information.