In the paper, The Consequences of Entrepreneurial Finance: A Regression Discontinuity Analysis, which was recently made publicly available on SSRN, my co-authors (William Kerr and Antoinette Schoar) and I document the role of angel funding for the growth, survival, and access to follow-on funding of high-growth start-up firms. We use a regression discontinuity approach to control for unobserved heterogeneity between firms that obtain funding and those that do not. This technique exploits that a small change in the collective interest levels of the angels can lead to a discrete change in the probability of funding for otherwise comparable ventures.
The results of this study and our border analysis in particular, suggest that angel investments improve entrepreneurial success. By looking above and below the discontinuity in a restricted sample, we remove the most worrisome endogeneity problems and the sorting between ventures and investors. We find that the localized increases in interest by angels at break points, which are clearly linked to obtaining critical mass for funding, are associated with discrete jumps in future outcomes like survival and stronger web traffic performance.
Our evidence regarding the role of angel funding for access to future venture financing is more mixed. The latter result could suggest that start-up firms during that time period had a number of funding options and thus could go to other financiers when turned down by our respective angel groups. Angel funding per se was not central in whether the firm obtained follow-on financing at a later point. However, angel funding by one of the groups in our sample does positively affect the long run survival and web traffic of the start-ups. We do not want to push this asymmetry too far, but one might speculate that access to capital per se is not the most important value added that angel groups bring. Our results suggest that some of the “softer” features, such as their mentoring or business contacts, may help new ventures the most.
Overall we find that the interest levels of angels at the stages of the initial presentation and due diligence are predictive of investment success. However, additional screening and evaluation do not substantially improve the selection and composition of the portfolio further. These findings suggest that the selection and screening process is efficient at sorting proposals into approximate bins: complete losers, potential winners, and so on. The process has natural limitations, however, in further differentiating among the potential winners (e.g., Kerr and Nanda, 2009).
At the same time, this paper has important limitations. Our experiment does not allow us to identify the costs to ventures of angel group support (e.g., Hsu, 2004), as equity positions in the counterfactual, unfunded ventures are not defined. We thus cannot evaluate whether taking the money was worth it from the entrepreneur‘s perspective after these costs are considered. On a similar note, we have looked at just a few of the many angel investment groups that are active in the US. Our groups are professionally organized and managed, and it is important for future research to examine a broader distribution of investment groups and their impact for venture success. This project demonstrates that angel investments are important and also offer an empirical foothold for analyzing many important questions in entrepreneurial finance.
The full paper is available for download here.