Harvard Business School Study – Venture Capitalists and Collabration to Exits

The more affinity there is between two Venture Capitalists investing in a firm, the less likely the firm will succeed, according to research by Harvard Business School researchers Paul Gompers, Yuhai Xuan and Vladimir Mukharlyamov.

In venture capital, friendship can be expensive. Using the VC industry as a testing ground, the authors seek to answer two questions about collaboration: What personal characteristics influence individuals’ desires to work together in venture capital syndication? And given the influence of these personal characteristics, does attraction help or hurt investment performance?

After examining the biographical characteristics and activities of more than 3,500 individual venture capitalists from 1975 to 2003, the authors show that people are more likely to collaborate with those who share similar characteristics with them. Findings also show that individual venture capitalists collaborate with other venture capitalists for both ability- and affinity-based characteristics. When they collaborate for ability-based characteristics it enhances investment performance; but when they partner for affinity-based characteristics it dramatically reduces investment returns.

Key concepts include:

  • It is costly for “birds of a feather” to flock together for reasons other than ability.
  • Collaborating for ability-based characteristics enhances investment performance. But collaborating due to shared affinities dramatically reduces the probability of investment success.
  • The probability of a successful exit outcome decreases by 18 percent if two venture capitalists who previously worked at the same company partner up in the syndication.
  • The likelihood of success drops by 22 percent if co-investors attended the same undergraduate school.
  • The negative effect of shared affinity is even stronger when it relates to ethnicity: Collaborating with someone from the same ethnic minority group comes at the expense of a 25 percent reduction in performance.
  • This research contributes to the study of working groups, the success implications of social ties, and the ability of venture capitalists to add value.

In addition to granting cash, venture capitalists are heavily involved in hiring or firing the CEO of the portfolio company, choosing a board of directors, devising an overall strategy, identifying potential partners, and so on. Indeed, the researchers found that the negative affinity effect was strongest in early-stage deals, which generally require more input from investors than do later-stage deals.

“[The] lower likelihood of success of co-investments between venture capitalists that share similar characteristics is triggered by them making inefficient decisions or even mistakes that they would otherwise avoid,” the researchers write in The Cost of Friendship.

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