Opportunity Cost of Capital for Venture Capital Investors and Entrepreneurs
We use a database of recent high tech IPOs to estimate opportunity cost of capital for venture capital investors and entrepreneurs. Entrepreneurs face the risk-return tradeoff of the CAPM as the opportunity cost of holding a portfolio that necessarily is underdiversified. For early stage firms, we estimate the effects of underdiversification, industry, and financial maturity on opportunity cost. Assuming a one-year holding period, the entrepreneur's opportunity cost generally is two to four times as high as that of a well-diversified investor. With a 4.0% risk-free rate and 6.0% market risk premium, for the sample average, we estimate the cost of capital of a well-diversified investor to be 11.4%, which equates to 16.7% before the management fees and carried interest of a typical venture capital fund. For an entrepreneur with 25% of total wealth invested in the venture, our corresponding estimate of cost of capital is 40.0%.
Year of publication: |
2004
|
---|---|
Authors: | Kerins, Frank ; Smith, Janet Kiholm ; Smith, Richard |
Published in: |
Journal of Financial and Quantitative Analysis. - Cambridge University Press. - Vol. 39.2004, 02, p. 385-405
|
Publisher: |
Cambridge University Press |
Description of contents: | Abstract [journals.cambridge.org] |
Saved in:
Saved in favorites
Similar items by person
-
New venture opportunity cost of capital and financial contracting
Kerins, Frank, (2003)
-
Opportunity cost of capital for venture capital investors and entrepreneurs
Kerins, Frank <Jr.>, (2004)
-
Opportunity Cost of Capital for Venture Capital Investors and Entrepreneurs
Kerins, Frank, (2004)
- More ...