Signaling value to businessangels: The proportion of the entrepreneur's net worth invested in a new venture as a decision signal

Abstract

Prior investigations have demonstrated that, under the assumption of unlimited available personal funds, the proportion of equity retained by the entrepreneur in a new venture is an indicator of the proposed project's quality. Signaling theory argues that this signal of quality can be used by investors to help evaluate and decide which potential projects to fund. However, this paper will demonstrate that since many entrepreneurs have limited personal capital, a more appropriate signal is the proportion of the entrepreneur's initial wealth invested in the project (φ) since it indicates both the project's value and the entrepreneur's commitment to the project. Such information is beneficial to both investors and entrepreneurs as all parties seek to better understand the commitment of the entrepreneur, and the ultimate investment quality of a proposed venture.