Liquidity constraint theory of entrepreneurship

Founding a new venture is more common among individuals with greater access to financial capital because financial capital makes it easier to acquire the resources needed to start ventures. For instance, Evans and Jovanovic (1989) find that wealthier individuals are more likely to enter into entrepreneurship because they can risk their own capital.

There is some evidence that many employees make the leap to entrepreneurship during liquidity events such as initial public offerings and acquisitions of their parent firms which can put significant financial resources into the hands of employees that own shares or options in the company. These employees, now flush with cash, have the financial freedom to spin out new ventures from their parent firms into independent companies (Stuart and Sorenson, 2003).

Hurst and Lusardi (2004) find some evidence for liquidity constraints however only at the top of the range, suggesting that only very wealthy individuals are more likely to become entrepreneurs, whereas increase access to capital among less wealthy individuals may not make a difference.

New ventures that are founded with a large pool of capital available to them can scale much more easily than those that enter with scarce capital. Scaling is considered key to financial performance through efficiency (economies of scale).

Recent developments in crowdfunding and now ICOs, have made available larger pools of capital for startups in some sectors. The theory would predict that crowdfunded startups would outperform those that receive no funding or just nominal funding. The theory would also predict that unicorns, that start with large investments of private capital should outperform all other startup types. The jury is out on these hypotheses. Some research suggests that ventures that receive VC funds gain more employees, which is positively associated with equity value growth (Davila, Foster and Gupta, 2003), at least in Silicon Valley.

Interestingly other scholars point out that starting a business does not necessarily require significant resources, rather, access to financial capital may be more important for firm growth (Davidsson and Honing, 2003). The Bricolage and Effectuation theories help to explain the process that entrepreneurs go through to start their ventures with minimal financial capital.

Sources:

Davidsson, P., and Honig, B. (2003). The role of social and human capital among nascent entrepreneurs. Journal of business venturing, 18(3), 301-331.

Evans, D. S., and Jovanovic, B. (1989). An estimated model of entrepreneurial choice under liquidity constraints. Journal of political economy, 97(4), 808-827.

Stuart, T., and Sorenson, O. (2003). Liquidity Events and the Geographic Distribution of Entrepreneurial Activity. Administrative Science Quarterly, 48(2), 175.

Davila, A., Foster, G., and Gupta, M. (2003). Venture capital financing and the growth of startup firms. Journal of business venturing, 18(6), 689-708.

Hurst, E., and Lusardi, A. (2004). Liquidity constraints, household wealth, and entrepreneurship. Journal of political Economy, 112(2), 319-347.