📖 Daily Journal | Common Venture Capital Investors and Startup Growth

✍🏻️ Author: Ofer Eldar, Jillian Grennan

📖 Source: The Review of Financial Studies, Volume 37, Issue 2, February 2024,

Introduction

The article "Common Venture Capital Investors and Startup Growth" explores the impact of common venture capital (VC) investors on the trajectory of startup growth and success. It addresses the problem by investigating the potential implications of common VC investment, such as the risk of favoritism, information spillovers, and the potential vulnerability of startups operating in complementary spaces within the same industry. The study also delves into the influence of common ownership on the cross-appointment of directors, providing evidence of an active channel through which common owners can influence firm policy.

Discussion

The study employs a novel empirical strategy based on plausibly exogenous legal changes to states’ corporate laws, which facilitated common VC investment by reducing the liability risk associated with VCs holding stakes in multiple startups in the same industry. The study uses this approach to investigate the direct mechanisms for informational exchanges prompted by VC investors, shedding light on the intricate dynamics of common VC investment and its potential impact on startup performance.

The study explores the relationship between common VC investment and startup growth using the IV strategy. The results suggest that greater common VC investment is associated with about one additional round of financing, and there is suggestive evidence that their valuations are more favorable when they undergo an IPO. Similarly, the study finds that the VC investors with more common VC investments are able to shift some startups from failure and low-return multiples to higher multiples, likely via sales to would-be acquirers.

The study also examines the relationship between common VC investment and startup director networks. The results suggest that startups with greater common VC investors are associated with a rise in the number of well-connected VC board representatives. These findings uncover a mechanism through which VC investors acquire information on startups’ aptitudes and may allocate business opportunities among their portfolio companies.

The study also explores the potential risks and benefits associated with common VC investment for startups. On one hand, the study suggests that common VC investors could potentially play favorites by diverting valuable competitive information from one startup to another, posing a risk of favoritism and unequal resource allocation. On the other hand, the study uncovers evidence suggesting that common VC investment can also provide opportunities for startups to benefit from shared expertise, resources, and strategic alliances facilitated by common VC investors.

Conclusion

The conclusions drawn from the study are multifaceted, highlighting both the positive and negative implications of common VC investment for startups. On one hand, the study suggests that common VC investors could potentially play favorites by diverting valuable competitive information from one startup to another, posing a risk of favoritism and unequal resource allocation. This aligns with existing concerns in the literature regarding the potential vulnerability of startups within the same VC portfolio, particularly when they operate in complementary spaces within the same industry.

On the other hand, the study uncovers evidence suggesting that common VC investment can also provide opportunities for startups to benefit from shared expertise, resources, and strategic alliances facilitated by common VC investors. This implies that the accumulated information and expertise of VC investors who invest in startups within the same industry enables them to better allocate resources and opportunities among startups, potentially leading to enhanced growth and success.

Overall, the article provides valuable insights into the complex dynamics of common VC investment and its implications for startup performance. By shedding light on the potential risks and benefits associated with common VC investment, the study contributes to the ongoing discussion on sound practices in corporate governance and the role of VC investors in the success of entrepreneurial ventures. It emphasizes the importance of considering the specific context and industry dynamics when evaluating the impact of common VC investment on startup growth and success, offering valuable implications for both practitioners and policymakers in the venture capital ecosystem.