torstai 25. heinäkuuta 2013

Whom You Know Matters in Venture Capital

Whom you know matters in venture capital business. That statement sounds like self-evident for private equity professionals. But is this statement also a scientific truth? How can you prove it? Why does it matter? How does it matter? Does it apply only in certain stage of investments or is it more general theory?

Yeal Hochberg, Alexander Ljungqvist and Yang Lu wanted to find a scientific evidence for this reseach question in their Journal of Finance's article "Whom You Know Matters: Venture Capital Networks and Investment Performance". I had a chance to analyze this article in depth while attending EDEN Corporate Finance Seminar in Berlin. Here is attached my presentation. The full article can be dowloaded here (PDF).


The paper presents fivefold contribution. According to authors:

1.       This is the first paper to examine the performance consequences of the VC industry’s predominant choice of organizational form: networks. Previous work focuses on describing the structure of syndication networks (Bygrave (1988), Stuart and Sorensen (2001)) and motivating the use of syndication (Lerner (1994a), Podolny (2001), Brander, Amit, and Antweiler (2002)).

2.       The findings shed light on the industrial organization of the VC market. Like many financial markets, the VC market differs from the traditional arm’s-length spot markets of classical microeconomics. The high network returns documented suggest that enhancing one’s network position should be an important strategic consideration for an incumbent VC, while presenting a potential barrier to entry for new VCs. The results add nuance to Hsu’s (2004) finding that portfolio companies are willing to pay to be backed by brand-name VCs and suggest that there are real performance consequences to the contractual differences illustrated in Robinson and Stuart’s (2004) work on strategic alliances.

3.       The findings have ramifications for institutional investors choosing which VC funds to invest in, as better-networked VCs appear to perform better.

4.       The analysis provides a deeper understanding of the possible drivers of cross-sectional performance of VC funds, and points to the importance of additional fundamentals beyond those previously documented in the academic literature.

5.       It provides preliminary evidence regarding the evolution of a VC firm’s network position.


It's easy to agree with the main findings presented in this paper. Venture capital is by nature the business of contacts. However, one must put the findings into context in order to understand that having contacts is not a primary matter, but a secondary matter for defining investment performance. Fundamentally, investment performance is still measured by what you buy, what you pay and how you exit. Having good contacts and getting access to best syndicates can enlarge one's investment potential, but without the right choises and right decisions by the actor itself, it doesn't automatically lead to a better performance.
Authors focused on networks between venture capital companies. Furthermore, one might ask are other VCs really the most important contacts for a VC? Venture capital industry is an ecosystem of value-adding stakeholders combining investors (capital), entrepreneurs (ideas), banks (debt) and service providers (advice) in order to create value for each players involved. In the ecosystem like this, defining the most relevant partner might be difficult, but I doubt that for many VCs other VCs are not the most relevant ones. Based on my experience, I would say that access to capital (investors) and access to deal flow (entrepreneurs) are the ones whom pays the most to know in venture capital.

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