Some interesting observations and analyses on VCs:
More information can lead to overconfidence - “VCs' investment decisions are biased by overconfidence. Specifically, this overconfidence increases with more information, unfamiliar framing of information, moderate performance predictions relative to more extreme predictions, and with failure predictions relative to extreme success predictions. This can have a negative effect on decision accuracy. VCs can use counter factual reasoning, the "humbling effect," and actuarial decision aides to deal with overconfidence." - “The nature of information and overconfidence on venture capitalists' decision making” | Zacharakis and Shepherd (2001)
“We find a strong positive relationship between the degree of specialization by individual venture capitalists at a firm and its success. At the same time, however, the marginal effect of increasing specialization at the firm is much weaker when the individual investment professionals are highly specialized themselves. The deterioration in performance appears due to both an inefficient allocation of funding across industries and poor selection of investments within industries. Organizational characteristics, however, are not irrelevant: venture capital organizations with more experience tend to outperform those with less experience.” - “Specialization and Success: Evidence from Venture Capital” | Gompers et al (2009)
“Early-stage investors, such as angels, often face extreme uncertainty where traditional predictive models fail. We find that expert entrepreneurs and investors utilize 'effectual' logic, focusing on controlling what they can and co-creating opportunities with available means, rather than solely trying to predict future market outcomes. This contrasts with the 'causal' or predictive logic often emphasized in later-stage investment.” - “Prediction and control under uncertainty: Outcomes in early-stage new ventures.” | Wilbank et al (2009)
“We provide evidence of a strong local bias in venture capital (VC) investments, meaning VCs disproportionately invest in companies located near their own offices. This bias is more pronounced for earlier-stage investments and less experienced VC firms. Our findings suggest that information acquisition and monitoring costs, which are reduced by proximity, play a significant role in shaping VC investment patterns […] ” - “Local bias in venture capital investments” | Cumming & Bai (2010)
“VCs use a rich set of contractual provisions to allocate cash flow rights (e.g., dividends, liquidation preferences, anti-dilution rights) and control rights (e.g., board representation, voting rights, veto rights over key decisions) separately. We find that liquidation preferences are ubiquitous and often multiple (e.g., 2x or 3x the original investment), ensuring VCs get their capital back plus a preferred return before common shareholders in downside scenarios." - “Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts” | Kaplan & Strömberg (2003)
“We study how firm characteristics evolve from early business plan to IPO to public company for 50 venture capital (VC) financed companies. We find that firm business lines remain remarkably stable while management turnover is substantial. Management turnover is positively related to the formation of alienable assets. We obtain similar results from an out-of-sample analysis of all 2004 IPOs indicating that our main results are not specific to VC-backed firms or to the time period. The results suggest that, at the margin, investors in start-ups should place more weight on investing in a strong business ("the horse") than on a strong management team ("the jockey").” - “Should Investors Bet on the Jockey or the Horse? Evidence from the Evolution of Firms from Early Business Plans to Public Companies.” | Kaplan et al (2005)
“[…] convertible securities, which give the venture capitalist the option to convert debt into equity, can be an optimal contractual response to the specific agency problems encountered in venture capital financing. Convertibles can mitigate the entrepreneur's incentive to take excessive risks (moral hazard) and can help screen entrepreneurs based on their private information about project quality." - “Convertible Securities and Venture Capital Finance” | Schmidt (2003)
“The compensation of new and smaller funds displays considerably less sensitivity to performance and less variation than that of other funds. The fixed base component of compensation is higher for younger and smaller firms. We observe no relation between incentive compensation and performance. Our evidence is consistent with a learning model, in which the pay of new venture capitalists is less sensitive to performance because reputational concerns induce them to work hard.” - “An analysis of compensation in the U.S. venture capital partnership” | Gompers & Lerner (1999)
“Early-stage investors, such as angels, often face extreme uncertainty where traditional predictive models fail. We find that expert entrepreneurs and investors utilize 'effectual' logic, focusing on controlling what they can and co-creating opportunities with available means, rather than solely trying to predict future market outcomes. This contrasts with the 'causal' or predictive logic often emphasized in later-stage investment.” - “Prediction and control under uncertainty: Outcomes in early-stage new ventures.” | Wilbank et al (2009)
“Reported valuations assume that all shares are as valuable as the most recently issued preferred shares. We calculate values for each share class, which yields lower valuations because most unicorns gave recent investors major protections such as initial public offering (IPO) return guarantees (15%), vetoes over down-IPOs (24%), or seniority to all other investors (30%). Common shares lack all such protections and are 56% overvalued. After adjusting for these valuation-inflating terms, almost one-half (65 out of 135) of unicorns lose their unicorn status.” - “Squaring Venture Capital Valuations with Reality” | Gornall & Strebulaev (2020)
“While complex state-contingent contracts could theoretically specify all desired actions, they are often infeasible due to verifiability problems or unforeseen contingencies. The model shows that simple allocations of control rights (e.g., the right to fire the entrepreneur or to force a sale) can be an effective, albeit blunt, instrument to address these contracting imperfections. These rights become valuable precisely when detailed contingent contracts fail […] The model suggests that control rights and monetary incentives can be substitutes in aligning the entrepreneur's actions with the investor's interests.” - “The Allocation of Control Rights in Venture Capital Contracts” | Hellmann (1998)