Social Capital of Venture Capitalists and Start-Up Funding
Social Capital of Venture Capitalists and Start-Up Funding
DOI 10.1007/s11187-011-9337-4
opportunities to leverage them in the future, increasing their willingness to invest in these firms. Our
empirical results, derived from a novel dataset
containing more than 1,500 first funding rounds in
the Internet and IT sector, strongly confirm our
hypotheses. We discuss the implications of our
findings for theories of venture capital and entrepreneurship, showing that the role and effect of VCs
social capital on start-up firms may be more complex
than previously argued in the literature.
Keywords Venture capital Social capital
Start-ups Social networks Structural holes
JEL Classifications
1 Introduction
Venture capital investment plays a pivotal role in
entrepreneurial processes. Aside from the capabilities
and resources of the start-up and its founders (Burton
et al. 2002; De Clercq et al. 2006), venture capital
firms (VCs)1 arguably have the highest level of
P. Sandner
Munich School of Management, Chair for Strategy and
Organization, Technische Universitat Munchen (TUM),
Munich, Germany
e-mail: [email protected]
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O. T. Alexy et al.
123
information provider CrunchBase (Block and Sandner 2009). Within this dataset of over 4,300 firms,
3,800 financial organizations, and 11,300 funding
rounds, we focus on VC activity in the Internet
sector, for which (almost) complete network data
covering the last years are available. This allows us to
derive longitudinal, valued, network-based structural
and relational measures, while other work in this area
often relies on cross-sectional, survey-based, positional measures (Hoang and Antoncic 2003).
Our findings allow us to make three contributions
to the literature on entrepreneurship and venture
capital. First, we show that VCs structural position in
syndication networks positively influences the
amount of money they invest in start-ups. Specifically, structural embeddedness measured by the
number of connections gives VCs access to more
information, and the spanning of structural holes
increases the likelihood that incoming information
will be of unique value. Both effects positively
impact VCs willingness to invest in new firms.
Second, we also find clear indications for the
importance of relational attributes of VCs syndication networks. In particular, contrary to the extant
literature on venture capital that argues mainly in
favor of network specialization, we show that arguments from the social capital literature promoting the
positive effects of diversity amongst network partners
also hold for the setting of VC syndication and their
investment in start-ups. In addition, we highlight that
network strategies emphasizing either diversity or
similarity are preferential in their effect compared to
hybrid approaches. Taken together, our results reemphasize the importance of social networks and
social capital for entrepreneurship research and
entrepreneurs alike. In particular, we show that the
role of social capital in the VCventure relationship
may be more complex than previously hypothesized.
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O. T. Alexy et al.
identifying the most promising investment opportunities in the pre-investment phase, as well as
foreseeing opportunities to add value to the venture
after the investment has been made. Looking at the
potential for pre-investment information arbitrage,
VCs are competing against each other to identify and
invest in the most promising new ventures (Bygrave
1987). High social capital should give a VC an
advantage in spotting suitable candidates for investment (see Burt 2005; Granovetter 1985; Uzzi 1997)
and also increase the likelihood that their bid is
accepted (Hsu 2004). Subsequently, during the postinvestment phase, VCs can leverage their investment
through value-adding involvement in their ventures
as related to perceiving and responding to opportunities and threats to increase the chances of success of
the portfolio companies (Dimov and Shepherd 2005,
p. 5). High social capital should again increase the
likelihood that a VC will become aware of such
opportunities and threats (see Burt 2005; Coleman
1988). For example, a VC with high social capital
may be aware of specific customer groups or
complementary ideas in development stage that may
useful to the start-up it is considering investing in
(Bygrave 1988). For such a VC, therefore, the value
of future cash flows it may receive from the start-up
should increase, and the associated risk decrease,
which should lead to a higher willingness to invest
into the start-up at the present time (Tyebjee and
Bruno 1984). On the one hand, this higher willingness to invest may be expressed by a higher
willingness-to-pay for the same share of ownership
in the new venture. On the other hand, it may be
expressed by decreased risk-adversity, leading highsocial-capital VCs to invest more money into the
same venture to buy a large portion of ownership.
From the perspective of the start-up, this means that
the total funds it can raise in one funding round
should increase with the social capital of the
investors that participate in it.
There are two sources of social capital, which, in
distinct ways, will provide VCs with access to
valuable information from their environment as we
have described above, namely, the structural and
relational aspects of the syndication network in which
VCs are embedded. Structural aspects describe the
configuration of the network, such as the number and
intensity of connections a VC has with others (Uzzi
1997) and the position of the VC in the syndication
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O. T. Alexy et al.
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O. T. Alexy et al.
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a 1998-2002
b 2001-2005
c 2005-2009
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O. T. Alexy et al.
123
7.15
0
2.31
0.16
0.22
n = 3,173 observations; correlations with an absolute value [0.03 are significant at p B 0.05
7.38
3.26
(7) n participants in funding syndicate
0.59
33.44
0.003
(6) Investor is business angel
0.62
0.98
1.30
1.34
0.46
-0.02
0.02
0.01
0.02
0.03
0.03
-0.01
-0.02
0.04
0.04
0.00
-0.00
-0.01
0.02
0.02
0.05
0.05
0.02
-0.02
-0.03
Table 1 presents the descriptive statistics and correlations of the variables in our regression models. Not
surprisingly, the social network measures are correlated with each other. For example, the higher the
investors degree, the more likely this financial
organization is able to span structural holes. Yet,
given the large number of observations in our dataset
(n = 3,173), we regard the potential issue of multicollinearity to be only of minor concern. The variance
inflation factors (VIFs) belonging to our independent
variables are relatively low. Some descriptive statistics are noteworthy: about 98% of investors are VCs;
only a small portion of investors are strategic
investors, such as industrial firms (2%) or business
angels (0.3%). The mean syndicate size is 3.3, and
the mean number of total investments of each
investor is 21. About 20% of all prior investments
of the investors were in the start-ups sector. This
may seem low but can be explained by the finegrained categories which we use. The mean investment sum per funding round is US$ 13 million.
However, this number is highly skewed. The median
investment sum is only 9 million. To account for
this high degree of skewness in the regressions, we
use the natural logarithm of the raised amount.
-1.66
0.19
(5) Investor is VC
1.55
-0.01
0.01
0.01
-0.03
0.12
0.12
-0.01
0.03
-0.02
0.23
20
1
1.84
-0.01
-0.07
-0.05
-0.07
0.05
1
0
0.03
0.23
-0.08
0.89
-1
-0.61
(4) Network specialization index
0.18
-0.30
0.13
-0.09
1.76
0.03
0.05
0.31
0.56
0.36
1.03
6.82
-4.42
(1) Log (raised amount)
0.24
0.20
2.07
1.04
920
0.01
21.20
n of prior investments of the investor
28.35
13.00
Raised amount
0.09
(8)
(7)
(6)
(5)
(4)
(3)
(2)
(1)
Maximum
Minimum
SD
Mean
Variable
4 Results
0.11
1.17
1.07
7.47
1.56
1.07
1.26
(9)
VIF
1.36
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O. T. Alexy et al.
Table 2 Linear regression on log (raised amount)
Independent variables
Model I
Coeff (SE)
Model II
Coeff (SE)
Model III
Coeff (SE)
-0.29 (0.07)***
-0.25 (0.07)***
-0.32 (0.07)***
0.16 (0.04)***
0.28 (0.10)***
0.15 (0.04)***
-0.042 (0.031)
-0.58 (0.15)***
-0.59 (0.15)***
0.45 (0.16)***
0.22 (0.29)
-0.22 (0.29)
-0.24 (0.30)
0.11 (0.19)
0.11 (0.19)
0.10 (0.19)
11 cat. (p \ 0.01)
11 cat. (p \ 0.01)
11 cat. (p \ 0.01)
0.33 (0.04)***
0.33 (0.04)***
0.33 (0.04)***
-0.025 (0.005)***
-0.025 (0.005)***
-0.025 (0.005)***
0.13 (0.03)***
0.03 (0.04)
0.13 (0.03)***
0.03 (0.04)
0.13 (0.03)***
0.03 (0.04)
0.15 (0.04)***
0.15 (0.04)***
0.14 (0.04)***
10 cat. (p \ 0.01)
10 cat. (p \ 0.01)
10 cat. (p \ 0.01)
9 cat. (p \ 0.01)
9 cat. (p \ 0.01)
9 cat. (p \ 0.01)
36 cat. (p \ 0.01)
36 cat. (p \ 0.01)
36 cat. (p \ 0.01)
Constant
1.53 (0.42)***
1.45 (0.44)***
1.65 (0.42)***
3,173 (1,649)
3,173 (1,649)
3,173 (1,649)
F test
p \ 0.01
p \ 0.01
p \ 0.01
R2
0.31
0.31
0.31
Observations with missing values are proxied by the sample mean. To control for this, we included also a dummy variable which
indicates whether the firm age was missing or not. The variable shows a significant effect (e.g., b = 0.37 *** in Model I)
123
positively associated to the investment sum. Furthermore, exploratory analysis showed that both high
levels of specialization and diversity of a VCs
syndication network have positive effects on investment sum. In the following, we analyze the implications of these findings for theory and practice.
5.2 Implications for theory
With this study, we make three contributions to the
literature on entrepreneurship and venture capital.
First, we indicate how the structure of past syndication networks affects investment into start-ups by
facilitating knowledge flows between the involved
investors (Bygrave 1987, 1988). We highlight the
effects of degree and brokerage, which represent,
respectively, the sheer volume of incoming information available to an investor and the uniqueness of
this information, resulting in opportunities for information arbitrage. First, we show that the sheer
amount of information that VCs have at their disposal
will increase the amount of money they put into startups. In doing so, we show that structural embeddedness (Uzzi 1997) in the social network of investors
has a clear effect on the investment decisions that
VCs make. In addition, we show that brokerage (Burt
2005), as in many other fields, matters for venture
capital. Specifically, the spanning of structuring holes
allows VCs to achieve abnormal returns and lower
risk through information arbitrage (Burt 2005), thus
positively affecting their willingness to spend money
on a start-up.
Second, we add to the literature by shedding light
on the role and importance of relational network
attributes. In particular, we offer a new perspective
on the debate about the relative advantageousness of
investors having either similar (Bygrave 1987; De
Clercq and Dimov 2004; Dimov and De Clercq 2006)
or diverse (Fleming and Waguespack 2007; Granovetter 1985; Reagans and McEvily 2003) syndication
networks. Importantly, we show that, in terms of the
relative composition of network partners investment
portfolios, diverse networks affect investment sum
more strongly than similar ones. However, on closer
inspection, we see that both similarity and diversity
have positive effects on the information available to a
VC and the investments they are willing to make.
Thus, our findings suggest that VCs may be successful by strategically building networks alike to both
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O. T. Alexy et al.
123
positive effects on them extracting valuable information from the network, we cannot draw any conclusions on the circumstances under which one of the
two strategies would be preferable, and thus leave
this question open for future research. Finally, our
paper raises the question of how social capital in
general, and specific attributes of it, may affect new
ventures beyond the funding decision. In particular,
we encourage future research to take a closer look at
the impact of VCs social capital on new venture
survival, growth, and, ultimately, success.
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