Investor Horizon and the Life Cycle of Innovative Firms: Evidence from Venture Capital

This paper studies whether and how the contractual horizon of venture capital funds affects their investments in innovative firms. I find that funds with a longer remaining horizon select younger companies at an earlier stage of their development, which grow their patent stock significantly more than companies financed by funds with a shorter horizon. The sensitivity of investment decisions to horizon is stronger among experienced venture capital firms, who allocate investments across a larger number of fund vintages. Finally, I find that the interaction of funds’ fixed horizon with their option-like compensation structure affects their investment decisions: when early performance has been high, fund managers target less innovative companies. These findings shed light on the drivers of venture capital investment decisions and on their implications for the type of companies that receive venture capital financing. This paper was accepted by Gustavo Manso, finance.