the structure and management of alliances: syndication in the venture capital industry

The Structure and Management of Alliances:Syndication in the Venture Capital Industry*

Mike Wright and Andy LockettNottingham University Business School

Syndicates are a form of inter-firm alliance in which two or more venturecapital firms co-invest in an investee firm and share a joint pay-off. Syndication is asignificant part of the venture capital market yet little research has been conductedinto the process of structuring syndicate deals and the management of syndicatesfollowing deal completion. This paper analyses the neglected issues concerning thestructuring and management of syndicated venture capital investments from theperspectives of both lead and non-lead syndicate members using two surveys ofventure capital firms and examination of syndication documents. Lead investorstypically have larger equity stakes and the syndicated investment agreement is adocument that enshrines the rights of participants rather than specifying behaviour.Contractual arrangements typically serve as a back drop to relationships as non-legalsanctions are important and decisions are typically reached following discussion andconsensus, but lead venture capital investors’ residual and specific powers areimportant in ensuring timely decision-making. The findings extend previous work onalliances by emphasizing the importance of non-legal sanctions, especially reputationeffects, in mitigating opportunistic behaviour by dominant equity holders. The paperalso adds to the limited research on the dynamics of alliances by highlighting the roleof repeat syndicates.

INTRODUCTION

Traditionally, the single firm has been the unit of analysis in economics and strat-egy. However, there is increasing examination of new organizational forms thathave arisen to cope with new environmental conditions (Child and McGrath,2001; Miles and Snow, 1986). In particular, inter-firm alliances have emerged asa response to changes in the competitive environment (Badarocco, 1991; Das andTeng, 1996; Mowrey et al., 1995; Yoshino and Rangan, 1995). The importance

Journal of Management Studies 40:8 December 20030022-2380

© Blackwell Publishing Ltd 2003. Published by Blackwell Publishing, 9600 Garsington Road, Oxford, OX4 2DQ,UK and 350 Main Street, Malden, MA 02148, USA.

Address for reprints: Mike Wright, Centre for Management Buy-out Research, Nottingham UniversityBusiness School, University of Nottingham, Jubilee Campus, Nottingham NG8 1BB, UK([email protected]).

of these inter-organizational collaborative arrangements can be seen in theincreased use of equity joint ventures, subcontracting, licensing etc. across anumber of different industries. In any alliance, there is a need for coordinationand cooperation between the parties if it is to function properly to achieve sharedobjectives and joint pay-offs for the investors (Kanter, 1994; Doz, 1996). Althoughexamples of collaborative arrangements are becoming increasingly common, ourunderstanding of their operation and management does not reflect their expand-ing role in economic activity. For example, there remains considerable debate con-cerning the nature of the ownership and control mechanisms in alliances(Steensma and Lyles, 2000; Yan, 1998). While formal contracts are typically inplace, other mechanisms such as trust and reputation may also be important (Dasand Teng, 1998).

Makino and Beamish (1998) observe that, since much research on alliances hasfocused on conventional types such as joint ventures between local and foreignfirms, a significant number of other types such as intra-firm joint ventures havebeen excluded from examination, thus limiting understanding of the phenome-non. The syndication of venture capital investments represents a further impor-tant, distinctive but neglected dimension of joint ventures. In a syndication, twoor more venture capital firms come together to take an equity stake in an invest-ment. However, unlike traditional equity joint ventures, there is typically a pre-existing operational legal entity and the venture capital firm is not involved in dayto day operations but performs a specialist monitoring role (Wright and Robbie,1998). Venture capital firms also typically perform repeat syndication arrange-ments over time with a network of partners, sometimes acting as the lead while atother times acting as a non-lead (Bygrave, 1987, 1988; Chiplin et al., 1997). Whilethere has been some attention to the extent (Bygrave, 1987, 1988), rationale forand the determinants of syndication (Chiplin et al., 1997; Lerner, 1994; Lockettand Wright, 2001), there has been no examination of the structuring and man-agement of the venture capital syndicate.

This paper therefore attempts to address two related issues that shed light onthe operation and management of alliances in general through the particular caseof venture capital syndication. First, the process of structuring syndicated invest-ments will be investigated. Second, the management of syndicates following dealcompletion will be investigated with particular focus on the nature of involvementbetween syndicate partners, the interactions between syndicate partners andinvestees, and the manner in which monitoring decisions are reached. We arguethat examining venture capital syndicates will enable us to shed new light onimportant aspects of the operation of alliances, notably in respect of the role ofequity ownership, contractual mechanisms and other aspects of control. From thepoint of view of venture capital practitioners, understanding the structuring andmanagement of syndicates has implications for the successful achievement oftarget rates of return. The study is based on two representative surveys of venture

2074 M. Wright and A. Lockett

© Blackwell Publishing Ltd 2003

capital firms in the UK together with examination of documentation relating tosyndication and in-depth interviews with venture capital executives.

The paper is structured as follows. The following section briefly outlines theextent and nature of syndication in the UK venture capital market. The subse-quent section discusses the theoretical framework for the study. This is followed byan outline of the data and methodology used. The findings from the study arepresented in the fourth section under the headings of structuring the syndicationagreement and managing the syndicate. Finally, we discuss the findings of thestudy and conclude by highlighting areas for future research.

VENTURE CAPITAL SYNDICATION

Syndication is an important and widespread part of the venture capital industry.The extent of syndication in the UK venture capital market rose in 1999 to 27per cent after having fallen for several years (Table I). However, this was followedby a sharp fall in 2000 to only 13.1 per cent as venture capital firms moved awayfrom the high tech sector (EVCA, 2002). Syndication also declined across Europeover the 1990s but remained at a higher share of total venture capital investmentsthan in the UK. However, in contrast, syndication of venture capital investmentsin the USA rose sharply in the second half of the 1990s with over three fifths

Structure and Management of Alliances 2075


Table I. Syndicated venture capital deals

Year UK syndicated European syndicated US syndicated

venture capital venture capital venture capital

investments1 investments1 investments2

% of no. of No. % of no. of No. % of no. of No.

venture capital venture capital venture capital

investments investments investments

1989 48.4 1107 56.0 3045 53.3 12661990 45.9 917 50.0 2684 47.6 10381991 59.2 1373 52.1 3601 45.5 8141992 61.9 1281 55.4 3432 49.2 10731993 46.3 800 48.4 2634 44.0 8471994 46.6 910 42.3 2404 47.1 9571995 41.8 716 40.6 2010 44.8 10041996 34.4 589 39.2 2031 47.2 16651997 21.1 355 22.5 1410 54.7 23451998 17.1 345 23.2 1767 50.1 26961999 27.0 671 32.1 3606 65.0 39802000 13.1 259 29.5 3863 63.6 61392001 13.6 281 28.7 3053 n.a. n.a.

Source: 1 EVCA Yearbook (various issues) for UK and Europe; 2 Venture Economics for US.

of all venture capital investments being syndicated by the end of the decade (Table I).

The limited available evidence in the UK (Table II), suggests that venture capitalsyndicated deals are generally small: 65 per cent had two partners, 25 per centhad three and the balance had more than three partners. There are differences inthe number of syndicate partners according to investment stage, with there beingfewer partners on average in later stage deals. In addition, within investment stages,there are significant differences between the number of syndicate partners accord-ing to investment size.

ALLIANCES AND SYNDICATION

Alliances are inter-firm cooperative arrangements aimed at achieving the strategicobjectives of the partners (Das and Teng, 1998). Inter-firm alliances can be clas-sified according to whether or not their governance structure involves equity. Thisdistinction has been made by a large number of different scholars (see: Das and



Table II. Investee firm level data on number of syndicate partners, investment stage and equity value– UK data

Investment stage Mean (std dev) Number of partners N Mean (SD)

syndicate size by stage1 value of equity (£m)2

Early stage 3.0 (1.3) 2 partners 6 2.3(2.2)

More than 2 partners 11 10.8(17.2)*

Expansion stage 2.8 (1.1) 2 partners 9 2.7(3.6)

More than 2 partners 9 10.6(13.0)***

Late stage 2.3 (0.5)*** 2 partners 43 16.3(30.3)

More than 2 partners 12 40.0(40.0)***

Notes

Data relate to 1997 and were obtained from the Centre for Management Buy-out Research (CMBOR) databaseon Management buy-outs and Management buy-ins and the trade publications Corpfin and Fininvest. Theapproaches to data collection adopted by CMBOR mean that information relating to buyouts and buyins is com-prehensive for the UK. However, because of confidentiality issues information on deal structures is difficult toobtain. Information for early stage and expansion deals needs to be considered as illustrative only.1 Difference between stages significant at *** p < 0.01 using Kruskal-Wallis.2 This column refers to the mean value of the total equity contributed by private equity firms in each transac-tion. Differences between each number of partners for each stage significant at *p < 0.1; ***p < 0.01 using MannWhitney U.

Teng, 1996, 1998, 2000; Gulati, 1995; Hennart, 1988; Pisano, 1991; Rugman,1982; Teece, 1992). Non-equity based alliances involve no form of equity trans-fer and include a wide variety of contractual based arrangements. Conversely,equity based arrangements involve the transfer or creation of equity ownership.This takes two main forms: direct equity investment and equity joint ventures. Inthe case of direct equity investment, one firm takes a partial equity stake inanother, hence creating a minority equity alliance. In the case of equity joint ven-tures, two or more sponsors bring assets to an independent legal entity and arepaid for some or all of their contribution from the profit earned by the entity, orwhen a firm acquires partial ownership of another firm (Hennart, 1988).

Venture capital syndication is closely related to equity joint ventures in that twoor more sponsors invest equity in an independent legal entity, and their returnsare determined by the performance of the entity. However, there are a number ofimportant differences. First, the syndicate is unusual in that typically the inde-pendent legal entity exists prior to the investment by the venture capital compa-nies.[1] The independent entity will be a company that requires equity finance fora number of reasons including: start-up, expansion and buyout. In the latter twocases, there will be a well-established record of performance and market presence.Second, a venture capital syndicate does not involve the creation of a new man-agement team as in the case of an equity joint venture. Also, the venture capital-ists in the syndicate do not perform a day to day management role as would bethe case with a traditional equity joint venture. Rather, the venture capitalist adoptsa specialist monitoring role. Third, each syndicate typically contains a lead firmand one or more non-lead firms, with an individual venture capital firm playingboth roles depending on the particular deal. Fourth, each syndicate is temporaryin nature, with the financing structure constructed specifically for that transaction,with possible staging of additional finance to enable the investee to developtowards a subsequent flotation or sale to a third party. However, venture capitalfirms also typically perform repeat syndication arrangements with a network ofpartners over time in different investments, sometimes acting as the lead while atother times acting as a follower or non-lead (Bygrave, 1987, 1988; Chiplin et al.,1997).

The traditional focus of research into the management of venture capital invest-ments has been the nature of the relationship between the investor and investee,the case of a classic vertical principal-agent agency relationship (e.g. Mitchell etal., 1995; Wright and Robbie, 1998). This relationship is characterized by well-defined lines of authority between the principal and agent. Although agencytheory has traditionally been employed in relation to the vertical relationshipswithin firms, notably the principal (owner) and agent (manager) relationship,agency costs arise in any situation involving cooperative effort by two or moreparties ( Jensen and Meckling, 1976). Therefore, agency problems do not requirea clearly defined principal and agent (Eisenhardt, 1989). Venture capital syndi-



cates are an example of such a situation, where the sharing of formal decisionmaking powers among the syndicate creates agency (or management) costs (Friedand Hisrich, 1995). These costs are associated with mitigating the problems ofagency (or management) risk. This creates the need to examine the structural andmanagement mechanisms venture capital firms use in syndications to mitigatethese problems.

Structure

As the different parties in a venture capital syndicate are expected to perform dif-ferent roles (i.e. lead and non-lead), there is a need for a satisfactory level of co-operation between the collaborating parties if the objectives of the syndicate areto be achieved (Doz, 1996; Kanter, 1994). Firms may employ a number of dif-ferent mechanisms in order to ensure confidence or a degree of certainty that partners will cooperate satisfactorily. Confidence in partner cooperation can beachieved through control and trust mechanisms, both of which supplement eachother (Das and Teng, 1998). Control involves mechanisms to make outcomes morepredictable and may be distinguished into ownership control and managementcontrol (Yan, 1998). Ownership confers ‘residual’ rights to making decisions(Grossman and Hart, 1986; Hart, 1995). Management control refers to the observ-able pattern of decision making and may involve ‘specific’ contractual arrange-ments.[2] Trust concerns expectations about the reliability of other parties’behaviour in a risky exchange situation and may be viewed as a substitute forcontrol (Aulakh et al., 1997; Zaheer and Venkatraman, 1995; Sapienza and Korsgaard, 1996). However, to reach a minimum level of confidence in coopera-tive actions, partners can use trust and control to complement each other. Toachieve a higher level of confidence in partner cooperation, trust and control maybe used simultaneously and in a parallel fashion and hence supplement each other(Das and Teng, 1998).

In what follows we derive propositions regarding the expected nature of thestructure of syndication arrangements that seek to ensure that partner coopera-tion is achieved in order to meet the aims of syndication. In particular, we examinein turn equity ownership, contractual measures and the relationship with analliance partner as reflected in the relative importance of legal versus non-legalsanctions.

Equity ownership. Equity stakes in syndicates provide for ex-ante deterrents toopportunism by the partners. There is considerable debate about the relativemerits of dominant versus 50:50 equity stakes in alliances. Shared equity owner-ship in alliances may bring benefits of higher levels of trust and knowledge acqui-sition (Beamish and Banks, 1987; Geringer and Woodcock, 1989), and may alsoprovide mutual forbearance and stability (Mjoen and Tallman, 1997; Yan, 1998).



However, shared ownership may lead to coordination problems while an imbal-ance in ownership may make decision making less time consuming and easier(Geringer and Herbert, 1989). Steensma and Lyles (2000) find that imbalances inequity ownership did not lead to greater conflict in the management of an alliance.Furthermore, the size of equity stake in an alliance may reflect the resourcesbrought to the alliance by the differing parties and hence the greater bargainingpower of one of the parties (Mjoen and Tallman, 1997; Yan and Gray, 1994,2001). Alliance members may still exert considerable control even with minorityequity stakes (Mjoen and Tallman, 1997).

In the case of syndicates, lead venture capital firms who have the task of coor-dinating the syndicate may seek a larger equity stake as a means of obtaining agreater return in recognition of this effort. The larger equity stake may also reflectthe role of the lead in identifying the deal, i.e. creating deal flow. Evidence fromthe UK venture capital industry that risk sharing is the dominant motive for syn-dication (Lockett and Wright, 1999, 2001) suggests that the lead is the party bring-ing the most resources to the syndicate in terms of the specific skills to identify,screen and monitor the investment. For these reasons, the size of an equity stakeshould be viewed as a device for allocating residuals that reflect differential con-tributions (Das and Teng, 1998) rather than just a control mechanism. Hence:

Proposition 1: The lead syndicate member is expected to have a larger equitystake in the venture capital investment than non-lead syndicate members.

Contractual control: the investment agreement. Although more equity gives a partnermore voting power, ownership may play only a partial role in the control ofalliances. The investment agreement may also have an important contractual rolein equity based arrangements in setting the boundaries of the behaviour of thealliance partners and providing an ex-post deterrent to opportunism (Das andTeng, 1998), particularly where there is an imbalance of ownership control. Theability of contracts to foster certainty of cooperation may be questionable becauseof the problems associated with the complexity of contracting. However, theinvestment agreement may still have an important role to play in establishing the rights of the different parties in a syndicate, for example regarding access toinformation.

The non-lead members of syndicates may suffer a severe informational disad-vantage in relation to the syndicate lead. In a multiple period dynamic environ-ment, the anticipation of future gains from co-operation (Axelrod, 1984; Cableand Shane, 1997) means that it is in the interests of the lead venture capital firmnot to mislead syndicate partners in sharing information because of the poten-tially damaging impact on reputation and lack of willingness to reciprocate futuredeals (Norton and Tenenbaum, 1993). However, without a specific agreement, thelevel and timeliness of information disclosure selected by the syndicate lead is not



clear. Therefore, it is expected that a syndicated investment agreement will includespecification of the items to be disclosed and their timing in order to mitigatepotential asymmetric information problems.

While the syndication agreement may specify the rights of the contractingparties, stipulation of behaviour, notably the reciprocation of future syndicatedinvestment opportunities and the commitment to additional financing rounds maybe more difficult. This is because it is not possible to write a complete contractdue to the bounded rationality of economic agents (Hart, 1995). Also, the draft-ing and enforcement of such contracts becomes prohibitively expensive (Al-Najjar,1995) and ineffective in getting parties to act in accordance with agreements(Charny, 1990; Macauley, 1963). Finally, syndicate partners will want the optionto keep some future deals for themselves or invest with other syndicate partners(Bygrave, 1988; Chiplin et al., 1997).

Similarly, syndicates may also be dynamic because of the need for several roundsof funding. Syndicate partners may be reluctant to commit contractually to futurerounds of financing since they will seek an option to terminate their involvementshould the project not perform to expectations (Gompers, 1995). Moreover, thereis a risk that such commitment would fall prey to asymmetric information prob-lems (Admati and Pfleiderer, 1994). This reluctance is reinforced by the limited lifeof closed end funds and the desire to maintain flexibility for investing in other pro-jects and dealing with potential demands from other portfolio investments that runinto problems.

This discussion suggests that the contract should be considered as a ‘backdrop’to the relationship between transacting parties (Das and Teng, 1998), that is a setof promises which the law recognizes as a duty and has some prescription whenbreached (Macneil, 1974). Therefore, it is important to draw attention to the dif-ferences between the residual rights of control that are bestowed through owner-ship and the specific rights of control that are detailed in contracts (Grossman andHart, 1986; Hart, 1995). This discussion leads to the following proposition:

Proposition 2: The syndicated investment agreement is a document that enshrinesthe control rights of members rather than specifying duties of behaviour.

Control and trust: legal versus non-legal sanctions. The problems associated with tryingto anticipate future contingencies in drawing up the initial contract are well-documented (Hart, 1995; Sahlman, 1990). Evidence from bank monitoring relationships (Citron et al., 1997; Holland, 1994) and venture capital firm-entrepreneur relationships (Mitchell et al., 1995; Sapienza and Korsgaard, 1996;Steier and Greenwood, 1995; Sweeting, 1991) suggests that in order to overcomethese problems, informal relationships or implicit contracts are used in addition toformal contracts. Informal relationships are viewed as complementary to formalcontracts as they can help build trust and confidence in situations of asymmetric



information and uncertainty. This mutual trust is critical for the success of alliances(Beamish and Banks, 1987).

Both the traditions of economics and sociology have developed literature ontrust (Hosmer, 1995; Lyons and Mehta, 1997). The traditional economic per-spective focuses on self-interest (calculus-based) trust where individuals act in theirown best interest where controls have been established to influence their be-haviour. The sociological perspective views trust as the result of social orientationwith individuals bound together in some way via social relations in a community(Granovetter, 1985). Rather than trust being based on controlling the actions ofothers, as in the economics perspective, in the sociological perspective it is theresult of positive attitudes towards the motivations and actions of others, even inthe absence of controls, which is institutionalized or ingrained through culture.For this reason we employ the sociological perspective on trust in this paper.

The level of trust in an alliance is not exogenously determined (Blodgett, 1991;Yan and Gray, 1994). Partners can implement a number of activities to facilitatecooperation, such as close communication (Das and Teng, 1998). Repeated inter-action permits the evolution from calculus-based trust to knowledge-based trustand eventually to identification-based trust (Lewicki and Bunker, 1996).[3] The firstexists in the early stage of a relationship and focuses on calculating the cost-benefitfrom creating and sustaining a relationship. The second form of trust relates toparties who have a history of interactions that allows each to make predictionsabout the other. Finally, relationships may evolve to a stage where each partyunderstands the other’s position to such an extent that they can act on behalf ofor substitute for the other. The willingness of parties to engage in trusting behav-iour may be influenced by the perceived reputation and competence of partnersto take appropriate decisions, which may be reinforced by previous interactions,as well as the perceived riskiness of a situation (Mayer et al., 1995; Tyler andDegoey, 1996). Therefore, the investment agreement does not necessarily play ahighly visible role in the day to day management of the syndicate. Rather, theproblems associated with enforcing contracts through legal measures may meanthat non-legal sanctions are used extensively to get the parties to act in accordancewith the terms of the investment agreement.

The importance of non-legal sanctions is linked to the notion that transactionsin alliances are not necessarily discrete events (Gulati et al., 2000). Where trans-actions are not separable, but are bundled and interact, there may be a strong rolefor trust in the functioning of a cooperative relationship (Zucker, 1986). Pre-venture relationships (Yan, 1998) and socialisation of the parties concerned(Kumar and Seth, 1998) may help build mutual commitment and trust, renderingformal structures less important. These conditions have important implications forour understanding of control based mechanisms. Once it has been acknowledgedthat transactions are not separable, non-legal control sanctions such as the loss ofreputation in the future may become much more important.



In the case of syndicated private equity investments, transactions are not dis-crete and the interaction between firms continues over a considerable period oftime. This repeated interaction can lead to high levels of trust as syndicatemembers come to know how partners will behave. Where syndicates involve highlyexperienced venture capital firms, repeated interactions may mean that syndicatepartners can substitute for each other by taking the lead in different syndications.Prior interactions will also enable syndicate partners to judge the performance ofeach other and develop competence-based trust, i.e. trust in another’s ability toperform a specific function, which in turn will reinforce reputations. As venturecapital industries are typically small close knit communities, in which investmentexecutives from different firms know one another,[4] this scope for building trustand reputations is enhanced. Black and Gilson (1998) note that the closeness ofthe venture capital community also helps facilitate transparency and the emer-gence of a reputation market. They point out that venture capital firms that failto abide by the implicit contracts for control between themselves and entrepre-neurs risk damaging their reputation in an environment of repeat investing,making it very difficult for them to win competitions to be lead investor in the mostattractive companies. Similarly, the role of a venture capital firm’s reputation foracting in a co-operative manner may be very important in terms of partner selec-tion, and hence the operation of syndicates.

Existing research has highlighted the importance of past interaction, reputationand investment style when a lead venture capital firm selects its non-lead investors(Lockett and Wright, 1999). The threat of damage to firm and personal reputa-tions for non-compliance suggests a greater incentive to conform to syndicatedinvestment agreements than resorting to legal sanctions or the threat of future non-participation by other members in syndicating further deals. This is supported byevidence that the venture capital industry is characterized by a high degree ofnetwork connectivity (Bygrave, 1987, 1988; Chiplin et al., 1997). Firms, therefore,can select alternative partners in subsequent deals if a partner firm does not actin a reputable manner. Furthermore, the dynamic nature of individual syndicates,noted earlier, may also influence inter-relationships between lead and non-leadpartners. Venture capital investments may involve successive rounds of investmentby syndicate members, and it may be difficult to specify contractually that aventure capital firm must invest in subsequent rounds. Therefore, failure by thelead to behave in a manner that reinforces trust during earlier rounds may makenon-lead members unwilling to invest in subsequent rounds.

Finally, research into relationships between investee-entrepreneurs and venturecapital investors suggests that investees are more willing to accept decisions, irre-spective of whether they agree with them, if they perceive that the procedureswith which decisions are made are just (Sapienza and Korsgaard, 1996). This argu-ment can easily be extended to envelop the inclination of syndicate partners to



conform if they consider the syndicate is being operated fairly and they trust thesyndicate lead.

This discussion suggests that the syndicated relationship (i.e. co-operation bysyndicate members) is managed by non-legal sanctions or commitments that arenot enforceable under the formal rules of contract formation (Charny, 1990).Hence:

Proposition 3: Non-legal sanctions are more important than legal sanctions inensuring cooperation by syndicate partners.

Management

The previous section highlights the important need for balance between controland cooperation, for the syndicate to operate effectively. This section builds on thisidea to examine the implications for management of the syndicate with respect tocoordination of syndicates, monitoring of investees, nature of decision-makingand timeliness of decision-making.

Coordination of syndicates. Although the syndicate lead may select partners withwhom they know they can work, co-operation may involve complications anddelays in decision-making. The lower the certainty of co-operation by other syn-dicate members, the greater the levels of relational (agency) risk and hence theassociated agency (management) costs. Citron et al. (1997) show that syndicationcomplicates and slows decision making in the related case of loan covenantsbetween banks and MBOs. The origins of the agency (management) cost imposedby the syndicate may be created by the diverse objectives of members, which maybecome more apparent with larger numbers of partners. Evidence from the UKindicates that large syndicates have become more unusual (Chiplin et al., 1997),perhaps for this very reason. Furthermore, with larger numbers of syndicatemembers it may be more difficult and time consuming to renegotiate both theinvestment agreement and to take action with respect to problem investees. Thisis supported by evidence from the UK (see Table II), which indicates that there isa positive relationship between the size of a deal and the number of members ofa syndicate. This problem may be exacerbated where some partners have changedtheir investment focus since the initial syndicate was formed, either because theyface problems in their portfolios as a whole or because their fund is fully invested.[5]

Therefore, syndication is likely to increase the management costs associated witha venture capital investment. Hence:

Proposition 4: Syndication imposes an agency (management) cost that is reflectedin terms of coordination and timing difficulties regarding decision-making.



Monitoring of investees. The adoption of different roles by alliance and syndicatepartners may be a means of addressing coordination costs. Research into inter-firm alliances generally is somewhat limited when it comes to the particular rolesplayed by different parties. In the context of the venture capital industry, it wasclear from our preliminary interviews that the roles of the different venture capitalfirms in syndicates are well understood by the industry. In each syndicate there isa lead firm and a number of non-lead firms and an individual venture capital firmmay play both roles depending on the particular deal. Hence, while contracts mayspecify rights of access to information, board membership rights, etc., the type ofinformation received and the nature of interaction with investees may differaccording to whether a venture capitalist is a lead or non-lead.

(1) Information

Rights of access to information may be ‘specified’ in the syndicated invest-ment agreement (see Proposition 2 above). Information may be distin-guished broadly into: (i) accounting-based; (ii) major event-based; or (iii)management-based information. Accounting-based information includesmonthly, half yearly and annual accounts, forecasting and budgeting,management commentary on performance and debt repayment schedules.Second, major event-based information relates to significant events such aschanges in management, acquisitions/disposals and information relating tobreach of covenants. Third, management-based information includes morecommercially sensitive information such as order book levels and capitalexpenditure plans. Mitchell et al. (1995) note the emphasis on demands foraccounting information in venture capitalists’ contracts and the articles ofassociation of an investee company may typically also include powers for disclosure and approval of major events (Wright et al., 1998). Therefore,this accounting-based and major event-based information is likely to beavailable to all syndicate members. Hence:

Proposition 5a: It is expected that there will be no differences between leadand non-lead firms in terms of the accounting and major event-basedinformation they automatically receive.

Mitchell et al. (1997), highlight that information on order books and capitalinvestment proposals was more likely to be requested according to need. Itis anticipated, therefore, that the greater management role played by thesyndicate lead is more likely to be associated with their receipt of manage-ment-based information than non-lead members. Hence:

Proposition 5b: It is expected that management-based information is signifi-cantly more likely to be automatically available to lead than non-lead firms.



(2) Involvement

In addition to access to information, the degree of contact between themembers of the syndicate and the investee is anticipated to differ accordingto their role. Absent this asymmetry of contact, there would be a consider-able degree of duplication of effort between the lead and non-lead firms.Evidence from alliances generally suggests that different parties may providespecialist non-capital resources to a particular functional area, earning themthe right to manage this area (Blodgett, 1991; Child and Yan, 1999; Yan,1998). However, skilled lead venture capital firms may be less reliant on thenon-lead for specialist information (Admati and Pfleiderer, 1994). In suchcases, lead investors may be more likely than non-leads to be board membersand to exert more frequent hands-on, formal and informal influence. Hence:

Proposition 5c: The frequency of both formal and informal contact withinvestee management is expected to be significantly greater for lead thannon-lead syndicate members.

Nature and timeliness of decision making between syndicate members. Notwithstandingexpected differences in the extent of information provision and involvement bylead and non-lead investors, decisions concerning the investee’s progress need tobe made. The development of relationships between syndicate members mayenhance transparency in decision-making and thus co-operation. Steensma andLyles (2000) find that, while uneven equity ownership did not lead to conflict,inequities in decision-making enhance conflict and reduce the stability of alliances.Similarly, notwithstanding Propositions 1 and 2 relating to residual and specificrights, where trust has been established, formal control structures may be renderedless important as decisions are made on the basis of consultation between theparties rather than by imposing the division of power prescribed by the formalcontrol structure. Evidence that venture capital firms select syndicate partners withwhom they can work (Lockett and Wright, 1999) suggests a notable level of trustand that decision-making will be based primarily on discussion and the reachingof consensus. Hence:

Proposition 6a: Decision making within syndicates is generally more likely toinvolve discussion and collective agreement than the imposition of a decisionby the lead investor.

The alliance literature has paid little attention to the potential problems arisingwhere decisions need to be made in a timely manner and consensual agreementmay sometimes be difficult to reach to meet a hard deadline. This problem maygive rise to tensions between the need for control and co-operation. In such cases,formal agreements and equity ownership may play an important role in breaking



through a deadlock. Such powers may need to be used sparingly and carefully toavoid destroying trust (Sweeting, 1991). However, in the presence of trust, thetaking of decisions in such circumstances by a dominant party is more likely to beperceived neutrally in terms of its effect on the venture, rather than it being perceived to be in the interests primarily of the dominant party (Yan, 1998).

The presence of knowledge and competence based trust also suggests that non-leads give discretion to the lead as they trust what the lead will do. Certain deci-sions concerning the venture capital investee may need to be made in a timelymanner, such as how to restructure a distressed firm to prevent it becoming insol-vent or achieving an exit by deciding to accept an unexpected offer from a strate-gic buyer (Relander et al., 1994). In such cases, there may need to be a mechanismto take a decision where consensus does not emerge. This discretion can be writteninto the investment agreement as ‘specific’ rights. In addition, the extent to whicha lead syndicate member holds a larger equity stake in an investee than non-leadmembers, bestows on it greater residual power to take decisions. This residualpower of ownership increases with the degree of ownership by the lead relativeto other syndicate members. In extremis, the lead may be able to take major decisions in a unilateral manner. Therefore, although there is the need for co-operation for syndicates to operate effectively, this is tempered by the need forcontrol if decisions are to be taken in a timely manner. Hence:

Proposition 6b: Lead investors are likely to maintain dominant ‘specific’ and‘residual’ decision-making powers

DATA AND METHODOLOGY

The study employs a two-stage survey together with examination of venture capitalists’ documentation relating to syndication and discussions with venture capitalists. The first stage involved the development of a questionnaire based onavailable literature, which focused on the structure of syndicates. The question-naire was piloted in six interviews with a range of executives in venture capitalfirms involved in different stages of venture capital investment. The interviewslasted between one and two hours. The venture capital firms ranged from a firmthat only invested in early stage investments through to those that invested acrossthe board and those that invested in late stage investments only. The individualsinterviewed in each company were at the level of investment executive upwards,including assistant directors and directors. The pilot interviews identified that keyterms such as syndication and lead and non-lead investors were clearly and unam-biguously understood in the industry. In the pilot interviews it was suggested thatventure capital firms were likely to have corporate policies with regard to the issueof syndication. In order to check whether syndication was a corporate level policy,the questionnaire was sent to both the national offices of venture capital firms as



well as their regional offices for those firms with regional networks. However, ofthe 63 firms contacted, only two returned multiple copies of the questionnaire.Follow-up telephone interviews conducted by the researchers with the non-respondents established that one person from each organization as a whole hadbeen selected to give the company view of syndication. In the two cases provid-ing multiple responses, the responses were consistently similar. This strongly sug-gests that it was appropriate to send the questionnaire only to a representative atventure capital firms’ head offices.

Following the pilot study, the questionnaire was administered by post to the headoffices of all 106 venture capital firms in the UK, identified using the BritishVenture Capital Association (BVCA) directory, during the early summer of 1998.In order to increase the response rate, a second round of the questionnaire wasmailed after one month.

The questionnaire was mailed to the representatives of the venture capital firmslisted in the BVCA directory. These individuals’ presence in the handbook suggeststhat they held significant decision-making roles within their firms. From theresponses, 20 per cent did not report a job title. However, over half of all respon-dents were at managing director/CEO or director level (55 per cent) with theremainder of the sample being either assistant director or investment executive (25per cent). This pattern of respondents is in line with that of other recent studies ofUK venture capitalists (e.g. Wright and Robbie, 1996) and suggests that we havesuccessfully targeted individuals who possessed the appropriate knowledge of theirfirm and the issue of syndication. Selective recall bias is unlikely to be a problemgiven that respondents were senior executives in their firms, were involved in dealstructuring issues on a daily basis and were asked questions that relate to their firms’policies rather than to information specific to a particular investment or event.

Of the 106 companies targeted, 63 responses were obtained relating to oneresponse per venture capital firm. Of these, five were unusable because theresponding firm had never syndicated a deal. The analysis that follows is, there-fore, based on the remaining 58 cases, giving a usable response rate of 54.7 percent. This sample size and response rate are in line with other recent studies ofventure capital related issues (e.g. Birley et al., 1999; Wright and Robbie, 1996) aswell as work on alliances (e.g. Kumar and Seth, 1998; Mjoen and Tallman, 1997;Yan and Gray, 2001). The first step in the analysis of the results was to check the representativeness of the sample of responding firms and whether any non-response bias existed.

The representativeness of the sample was tested using the venture capital firmspecific characteristics available for the population as published in the BVCA direc-tory, the results of which are presented in Table III. The characteristics were thenumber of investment executives, the firms’ minimum and maximum investmentpreferences, average current investment size, total funds managed/advised, fundsinvested to date at cost and the number of investments in current portfolio. Poten-



tial differences between respondents and non-respondents with respect to thesevariables were analysed using Mann-Whitney non-parametric tests. These testswere preferred as they have less rigorous assumptions than parametric tests regard-ing the normality of the data (De Vaus, 1991). For ease of interpretation, we reportz-statistics derived from the procedure in SPSS which transforms the Mann-Whitney U statistic into a standard normal deviate z-statistic in order to computesignificance levels. The results presented in Table III indicate that there were nosignificant differences between respondents and non-respondents at the 5 per centlevel of significance or better except with respect to the maximum investment preferences, where respondents had on average larger maximum investment preferences.

The second stage of the research involved a second questionnaire focusing onthe differences between lead and non-lead members of syndicates with respect tothe management of syndicates and access to information. After piloting, the surveywas administered to venture capital executives through telephone interviews in aneffort to maximize the response rate. In a number of cases, however, respondentsrequested that the questionnaire be posted to them in order to enable them to givemore considered views. For this survey, the 124 full member firms of the BVCAlisted in its directory for 1999–2000 were approached. Where possible, attemptswere made to contact the same individuals as for the first survey but this was notalways possible because of job changes, retirements, new entrants, etc.



Table III. Tests for the representativeness of the sample for Survey 1 and Survey 2

Survey 1 Survey 2

Mean SD Mann Mean SD Mann-

Whitney Whitney

Z-stat Z stat

Number of investment Respondent 11.8 18.5 -1.13 12.2 31.4 -0.216executives Non-respondent 8.6 11.1 10.6 14.1

Minimum investment Respondent 2.9 5.6 -0.12 1.3 2.9 -1.824*preference (£m) Non-respondent 1.7 4.0 5.2 14.6

Maximum investment Respondent 26.7 48.3 -2.21** 14.7 31.3 -0.212preference (£m) Non-respondent 5.8 11.2 16,351.0 114,282.2

Average current Respondent 4.5 5.6 -0.28 5.4 14.0 -1.723*investment size (£m) Non-respondent 3.6 7.7 12.8 34.2

Total funds managed/ Respondent 303.3 621.2 -0.18 290.7 723.0 -0.609advised (£m) Non-respondent 416.7 934.0 605.6 1,303.1

Funds invested to date Respondent 349.8 1,215.4 -0.52 325.1 1,462.8 -0.773at cost (£m) Non-respondent 172.1 441.0 323.6 699.9

Number of investments Respondent 119.7 445.1 0.20 87.0 384.8 -0.386in current portfolio Non-respondent 40.3 48.3 47.5 69.4

Asterisks relate to levels of significance for independent sample tests where *p < 0.1; **p < 0.05 level of significance.

Some 66 firms responded to the second survey, a response rate of 53 per cent.As with the first survey, responses from firms that had never syndicated a deal weredeemed unusable. Therefore, the analysis was performed on the remaining 56cases, giving a usable response rate of 45.2 per cent. The distribution of responsesand the job levels of respondents were similar to that for the first survey. The testsfor representativeness were then replicated for the second survey, the results ofwhich are presented in Table III. There is weak evidence that respondents hadstatistically significant smaller minimum investment size preferences and averagecurrent investment sizes than non-respondents. Here and throughout the paper,the convention is adopted that a 10 per cent level of significance indicates weakevidence of differences between groups.

The second survey provided information relating to the degree to which eachrespondent was involved in syndication, and revealed that not all the secondsample participated in syndication. Three quarters of the second sample (50 firms)had acted as a lead investor in a syndicate at some point and 71 per cent werepresently acting as a syndicate lead. The same proportion of firms had ever actedas a non-lead investor in a syndicate but only 62 per cent were acting as a non-lead investor at the time of the survey. Interestingly, almost a quarter of firms (24.2per cent) had never acted as a syndicate lead and 28.8 per cent had never actedas a non-lead investor. A total of 41 firms (62.1 per cent) had experience as botha lead and non-lead investor in syndicated investments. A relatively small propor-tion of the sample syndicate a majority of their investments. Less than three inten firms (27.9 per cent) syndicate more than 40 per cent of investments. A quarterof firms were a syndicate lead in less than 20 per cent of their investments, while28.3 per cent took the lead in the syndicate in over 80 per cent of their invest-ments. Only 5.1 per cent of venture capital firms were a non-lead syndicatemember in over 80 per cent of their investments.

Tests were then conducted for differences between venture capital firms that wereand were not syndicating at the time of the survey. The tests indicated that syndi-cators were significantly more likely to prefer expansion or MBO/MBI stage invest-ments, less likely to be regional specialists and to have larger maximum investmentsize preferences, indicating that size is a major driving factor in syndication.

In addition to the two questionnaire surveys, syndication documentation heldby venture capitalists was also examined and discussions were held with venturecapital executives. In total the complete documentation relating to three separaterecently completed deals was examined, which were in different sectors (e-commerce, automotive components distribution) and different investment stages(early stage, management buy-out). The documentation included both copies ofthe full contractual agreement as well as correspondence between the lead andnon-lead investor regarding terms and conditions. This information was used totriangulate (Deshpande, 1983) the empirical evidence, in order to further ourunderstanding of the structure and management of syndicates.



RESULTS

Structure

The data relating to the structure of syndicates, in particular equity ownership,contractual control and control and trust were gathered via the first survey.

Equity ownership. The study found some variety in the structuring of equity hold-ings in syndicated deals but that syndicate leads were generally agreed to holdlarger equity stakes than non-leads (mean score = 2.2, std deviation = 1.1 on 1 to5 scale where 1 = strongly agree and 5 = strongly disagree) though not necessar-ily greater than all syndicate members combined (mean score = 3.6, std deviation= 1.0). These findings provide support for Proposition 1 that lead syndicatemembers may be expected to have larger equity stakes in venture capital invest-ments than non-lead syndicate members.

Contractual control: the syndicated investment agreement. With respect to the scope of syn-dicated investment agreements, rights of access to information, rights of consul-tation and commitments to provide timely information are the three most explicititems set out in syndication agreements (Table IV). Commitments to share infor-mation and commitments to manage the syndicated investments were also likelyto be explicit, but were not given as much importance. In contrast, commitmentsto provide additional rounds of financing and reciprocation of deal flow were lesslikely to be explicit in syndication agreements.

These findings suggest the syndicated investment agreement does not specifythe behaviour of the syndicating parties, rather it enshrines a number of basicrights for its members. Our examination of venture capitalists’ documentationreinforces this view. Syndication agreements are explicit in specifying rights ofaccess to information, etc. Differences between investment agreements were



Table IV. The scope of the syndicated investment agreement

To what extent are the following factors covered by the investment agreement between syndicate Mean SD

members? (Please rate each item from 1–5, 1 = highly explicit . . . 5 = not covered)

Rights of access to information 1.6 0.7Rights of consultation 1.7 0.8The commitment to provide timely information 1.8 0.8The commitment to share information 2.0 0.9The commitment to manage the syndicated investment 2.5 1.1The appointment of auditors 2.6 1.1The commitment of additional financial resources for future rounds of financing 3.2 1.4The reciprocation of future syndicated investment opportunities (deal flow) 4.4 0.9

evident in respect of contractual provisions relating to board representation, accessto information and the controls to be put in place in order to keep the businessfocused on its business plan. Where a syndicate member is not to have formalboard representation, because of their small equity stake, rights of access to infor-mation will be specified. These rights may include board observer status or someother form of face-to-face investor liaison meeting that provides for access to man-agement. These findings provide support for Proposition 2 that the syndicatedinvestment agreement is a document that enshrines the rights of members ratherthan specifying behaviour.

Control and trust: legal versus non-legal sanctions. With respect to legal sanctions, penal-ties stipulated in the syndicated investment agreement and the threat of legalaction were relatively neutral factors in persuading syndicate members to actappropriately (Table V). A number of non-legal sanctions were reported to bemore important than legal sanctions in ensuring syndicate members acted in accordance with the agreement. These non-legal sanctions were: potential damaging effects on the reputation of firms and individuals, the possibility forwithholding deal flow and the threat of non-investment in subsequent rounds of financing (Table V).

Of most importance were reputational factors relating to the potential damageto both venture capital firms and individual executives. The impact on the repu-tation of a venture capital firm is important because turnover of staff can be highand so a number of different people may manage a particular deal over time. Itwas also evident that syndicate members would be prepared to act in accordance



Table V. Legal and non-legal sanctions

How important are the following factors in getting other members of the syndicate to act in Mean SD

accordance with the terms of the investment agreement? (Please rate each item from 1–5,

1 = very important . . . 5 = very unimportant)

Legal sanctions

Penalties stipulated in the contract 3.3 1.4The threat of legal action 3.3 1.2

Non-legal sanctions

Potential damage to the future reputation of the firm 2.1 1.0Potential damage to future personal reputations 2.3 1.0The potential to withhold deal flow in the future 3.0 1.0The threat of non-investment during future financing rounds by other syndicate 3.1 1.0

membersThe potential for reciprocal action by other syndicate members in other investments 3.4 1.0

Other

Fair and just procedures in the making of syndicate group decisions 2.5 0.9

with agreements if they felt that fair and just procedures were involved in themaking of syndicate group decisions. These findings provide some support forProposition 3 that non-legal sanctions are more important than legal sanctions inthe management of the syndicate.

Management

The data relating to the management of syndicates, in particular coordination,monitoring of investees and the nature and timeliness of decision making weregathered through the second survey.

Coordination of decision-making. There was agreement that coordinated action anddecision-making took longer in syndicated than in non-syndicated investments(mean score = 2.1, std deviation = 0.9 on 1 to 5 scale where 1 = strongly agree and5 = strongly disagree) and that particular difficulties regarding coordination (meanscore = 1.8, std deviation = 0.9) and decision timing were posed by larger syndicates(mean score = 1.9, std deviation = 0.9). These findings provide support for Propo-sition 4 that syndication imposes an agency (management) cost that is reflected interms of coordination and timing difficulties regarding decision-making.

Monitoring of investees. Analysis of the interaction with investees is based on thoseventure capital firms that had acted both as lead and non-lead investors.

(1) Information

The information received by venture capital firms was found to depend ontheir role in the syndicate (Table VI). The results indicate little differencebetween the accounting-based and major event-based information automat-ically provided to both lead and non-lead firms. The only significant findinghere was that lead firms are, somewhat surprisingly, significantly more likelyto receive information about debt repayment schedules than non-lead firms.This apart, there is generally support for Proposition 5a, that there are no significant differences between lead and non-lead firms in terms of theaccounting and major event-based information they automatically receive.Differences between lead and non-lead firms were identified in relation to theautomatic receipt of management information. In particular, lead firms aresignificantly more likely to receive information relating to order books andcapital expenditure plans than non-lead firms. These results provide supportfor Proposition 5b, that management-based information is significantly morelikely to be automatically available to lead than non-lead firms.

(2) Involvement

Lead investors were more likely to be represented on the board (mean score= 1.6, std deviation 0.9 on 1 to 5 scale where 1 = strongly agree and 5 =



strongly disagree) than a non-lead investor (mean score = 3.3, std deviation= 0.9). The mean scores for these variables were significantly different at the1% level.[6] Furthermore, the lead investor is more hands-on in their moni-toring than non-lead investors (mean score = 2.0, std deviation 1.1) and morelikely to have more frequent contact with investee management (mean score= 2.1, std deviation = 1.2). Finally, non-lead are more likely to look for guid-ance from lead investors (mean score = 2.4, std deviation = 1.3).

Comparisons between the interaction of venture capital firms with investee com-panies yielded significant differences between the cases where they acted in leadand non-lead positions.[7] The analysis in Table VII compares the perceptions of



Table VI. Information provision to lead and non-lead syndicate firms1

Please indicate what information you automatically Lead Non-lead McNemar

receive as a lead and non-lead syndicate member member member test2

N N

(%) (%)

Accounting-based information

Half yearly/annual accounts 37 35 0.50(100) (95)

Management commentary on performance 37 35 0.50(100) (95)

Forecasting and budgeting information 37 35 0.50(100) (95)

Monthly accounts 37 34 0.25(100) (92)

Debt repayment schedules 36 29 0.016**(97) (78)

Major event-based information

Changes in management 37 34 0.25(100) (92)

Acquisitions/disposals 37 34 0.25(100) (92)

Information regarding the breach of covenants 36 33 0.25(97) (89)

Management-based information

Information on order books 37 28 0.004***(100) (76)

Capital expenditure 36 28 0.008***(97) (76)

Notes1 Sample only includes those firms that have acted as both a lead and non-lead firm.2 Calculated using a binomial distribution.Asterisks relate to levels of significance for related sample tests where **p < 0.05 and ***p < 0.01 level ofsignificance respectively.

venture capital firms when they act as lead or non-lead syndicate members. Whenventure capital firms acted as syndicate leads, they were significantly more likelyto interact more frequently and through more informal contact with investee man-agement than when they were non-leads. When acting as a lead, they were onaverage likely to contact investees by post or telephone more frequently than everyfortnight, whereas as non-leads the frequency of this form of contact was likely tobe approximately monthly. With respect to formal board meetings, venture capitalfirms acting as lead investors were also likely on average to contact investees morefrequently, approximately monthly, whereas as non-lead investors the average timewas closer to quarterly, with the large standard deviation suggesting that some non-lead participated in monthly board meetings whereas for others it might be onlysix monthly.

Taken together, these findings provide support for Proposition 5c that the fre-quency of both formal and informal contact with investee management is expectedto be significantly greater for lead than non-lead syndicate members.

Nature and timeliness of decision-making. The evidence shows that although the leadmember is the most influential member of the syndicate in the decision-makingprocess (mean score = 1.9, std deviation = 1.0 on 1 to 5 scale where 1 = stronglyagree and 5 = strongly disagree), decisions were likely to be reached through aprocess of collective discussion (mean score = 2.0, std deviation = 0.8) and the



Table VII. Lead and non-lead’s interaction with investee management1

As a lead and non-lead syndicate member, what is the frequency with which

you have contact with the management of an investee company when

monitoring your investment? (Please tick as appropriate). (0 = daily,

1 = weekly, 2 = two weekly, 3 = monthly, 4 = six monthly, 5 = annually)

Nature of contact Role Mean SD Wilcoxon Z stat

Post/fax messages Lead 1.8 0.9 -3.77#Non-lead 3.0 1.1

Telephone calls Lead 1.8 0.9 -3.75#Non-lead 3.0 1.1

Board meetings Lead 2.9 0.8 -2.98***Non-lead 3.5 1.1

Face to face meetings Lead 3.3 1.0 -2.96***Non-lead 3.9 1.2

Notes1 Sample only includes those firms that have acted as a lead and non-leadfirm.Asterisks relate to levels of significance for related sample tests where ***p < 0.01, # p < 0.001 level of significance respectively.

reaching of consensus (mean score = 2.2, std deviation = 1.0). In general, deci-sions were not made by lead members or in proportion to equity holdings (bothmean score = 3.3, std deviation = 1.3). This finding provides some support forProposition 6a that decision making within syndicates is generally more likely toinvolve discussion and collective agreement than the imposition of a decision bythe lead investor. However, the higher agreement that the lead is the most influ-ential member of the syndicate and the relatively large standard deviations surrounding these responses suggests that in the management of some syndicates,decisions do not always require the agreement from, or consultation with, othersyndicate members (even if board members).

Documentary evidence and our discussions with venture capitalists suggest thatthe residual rights of control bestowed by equity ownership are the most impor-tant factor in terms of power in timely decision making. The importance of resid-ual rights over specific rights is highlighted by the fact that a dominant equityholder can force all other syndicate members to comply with their decisions if theyown enough equity. Although a contract may stipulate other syndicate members’rights of consultation this does not necessarily mean that they will be able to influ-ence the outcomes of decisions. An example of this are the so-called ‘come alongletters’ we examined, which enable a syndicate lead to communicate a decision toother non-lead members. The letter effectively states that a decision has been takenand that the letter is notice of this decision (usually 14 days); i.e. you can eithercome along or not, the decision has been made. Such a letter might be used forexample to force other investors to sell when the lead investor has received an offerfor the investee. In a multi-period world where the venture capital firm wishes toinvest again with its syndicate partner, this approach may need to be used spar-ingly. Where a syndicate partner is uncomfortable with this arrangement, the rightto consultation may be incorporated into the side letter.

The syndicate documentation we examined indicates that the syndicate lead willhave discretion to the extent stipulated in the investment agreement, i.e. ‘specificrights’. This difference in the roles of syndicate members is reflected in the dif-ferent roles that directors play in the management of a company. A special direc-tor can frequently approve things such as capital expenditure up to a given amountand the adoption of annual budgets without involving all the shareholders. Theseobservations support the finding from the survey noted above that the lead is sig-nificantly more likely to be on the board than the non-lead. There is thus consid-erable support for Proposition 6b that lead investors are likely to maintaindominant ‘residual’ and ‘specific’ decision-making powers.

DISCUSSION AND CONCLUSION

This research extends previous studies on monitoring by venture capitalists, whichhas tended to focus on the vertical investor-investee relationship, to the horizontal



relationship between syndicate partners. The findings of this paper facilitate abetter understanding of the structuring and management of syndicated venturecapital deals. The findings also have more general implications for understandingthe neglected area of the management and coordination of alliances.

We find that a high proportion of venture capital firms act as both leads andnon-leads in different syndicates over time. Lead investors typically have largerequity stakes and the syndicated investment agreement is a document thatenshrines the rights of participants rather than specifying behaviour. Informationalasymmetries are dealt with through contracting arrangements between the leadand non-lead syndicate members. In terms of the management of the syndicate,non-legal sanctions, relating to effects on reputation and the potential for futurebusiness are more important. Extending arguments that reputation is an impor-tant feature of the relationship between venture capital firms and entrepreneurs(Black and Gilson, 1998), the study’s findings highlight that reputation is also highlyimportant in encouraging other parties to continue to syndicate with a venturecapital firm both in further investment rounds of a particular deal and in subsequent deals. These reputation effects linked to repeat syndication are important in helping to minimize potentially opportunistic behaviour by lead syndicate members with larger equity stakes who obtain greater access to investeeinformation.

While we find that contractual arrangements may serve as a ‘back drop’ to rela-tionships and that decisions are typically reached following discussion and consensus, we also highlight the importance of the lead venture capital investor’s‘residual’ and ‘specific’ powers from the perspective of ensuring timely decision-making. These powers may be especially important when there is a need torespond to unsolicited offers from strategic buyers to purchase the investee and toundertake restructuring actions to avoid bankruptcy. We also suggest that, while a differential level of interaction between leads and non-leads vis-à-vis investees isto be expected, the extent of this difference is somewhat surprising. In contrast tosuggestions that syndication primarily takes place on the ‘two heads are better thanone’ (i.e. risk reduction) argument, our findings suggests that in the UK at leastthe risk sharing argument is more prevalent. This is consistent with other evidencethat the finance motivation is a stronger motivation for syndication than theresource based argument (Lockett and Wright, 2001).

The paper also adds to the general debate in the management literature con-cerning ownership and control in alliances (Mjoen and Tallman, 1997; Steensmaand Lyles, 2000; Yan, 1998). Following recent developments in the alliance liter-ature, our analysis has separated the roles of equity ownership and managerialaspects of control. Our finding that syndicate leads generally hold larger equitystakes than non-leads may reflect their greater relative bargaining power in termsof their resource inputs to the syndicate in terms of specialist skills in screeningand monitoring investees, although further research is needed to test this directly.



This conjecture is consistent with Mjoen and Tallman (1997) who find that thegreater bargaining power of one party will also be associated with control over specific activities. However, our findings extend previous work by also empha-sizing the importance of non-legal sanctions, especially reputation effects, inhelping to ensure that dominant equity holders do not engage in opportunisticbehaviour.

The findings of our study of venture capital syndication also add further insightsconcerning the important but neglected notions of dynamic stability (Yan, 1998)and strategic interdependence (Kumar and Seth, 1998) in alliances over time. Thegeneral alliance literature has tended to adopt a static approach to the determi-nants and effects of control in alliances (Yan, 1998). Yet firms may engage in repeatalliances where there is strategic interdependence over time such that there areextensive pre-venture relationships. The prevalence of repeat syndicates betweenthe same parties in different transactions may play an important role in mediat-ing some of the potential downsides of dominant equity stakes and may substitutefor the role of mutual forbearance in 50:50 joint ventures. Where the dynamicsof the industry are such that firms continually re-contract with each other in dif-ferent alliances, there is a need for fair dealing by dominant firms in one allianceto maintain trust and reputation, otherwise partner firms are likely to be reluctantto re-contract. Moreover, a dominant firm that acts opportunistically in onealliance may be open to reciprocal opportunistic behaviour when it becomes anon-dominant partner in a subsequent alliance. In this way, the maintenance of areputation for fair dealing and trustworthiness may contribute to the dynamic sta-bility of alliance arrangements through enhancing congruence between the struc-ture of control and relative bargaining power (Yan, 1998).

The evidence in this paper is based on questionnaire surveys of venture capitalexecutives and as such suffers from the limitations inherent in such surveys.However, the respondents were senior executives closely involved in syndicationarrangements. In addition, access to syndication documentation provides sup-porting evidence for the questionnaire findings. Although this study obtained ahigh response rate, the relatively small size of the population in the UK has limitedthe nature of the analysis.

Additional research based on multi-national studies may afford larger samplesizes and facilitate the adoption of multivariate approaches to data analysis. Multi-variate studies are necessary to take into account the simultaneous effects of size,investment stage, experience and reputational factors, and other factors relating toventure capital firms that may affect the structuring and management of a syndi-cate and which we have not been able to address here. Multi-national studies mightenable potential between-country differences in the process of managing syndi-cates to be identified. Such analysis is important to establish whether the resultsreported here in relation to the UK are generalizable to another context. The sub-stantially higher degree of syndication in US venture capital investments noted in



Table I and the indication from previous studies that risk reduction motives maybe more important in the USA than the UK (Gompers and Lerner, 1999) suggeststhere may be contextual differences. To date there is limited research on cross-country differences in the behaviour of venture capital firms, but the researchwhich is available has suggested significant differences between countries in respectof monitoring (Sapienza et al., 1996) and valuation approaches (Manigart et al.,2000). The absence of multi-national studies is an important omission given theincreasing cross-border investment by venture capital firms. A further dimensionof multi-national studies is to examine the nature of syndicates involving venturecapital firms based in different countries. For example, to what extent might aforeign firm become part of a syndicate as a means of initial entry to learn abouta new market before leading deals on their own? What are the respective roles ofthe domestic and foreign syndicate partners in these cases? Do foreign partnersprovide expertise that domestic players lack, hence emphasizing a risk reductionapproach? To what extent do foreign syndicate partners become actively involvedin the operation of the syndicate?

A number of other research areas are suggested. First, there is a need to con-sider the process by which venture capital firms select syndicate partners, partic-ularly in the light of our evidence of the need for trust. Second, there is a needfor further research that examines the differential nature of added value to theinvestee by lead and non-leads. Given the grounding of this paper in the generalalliance literature, we gave particular emphasis to the links between the lead andnon-lead investors. The differential level of interaction found between the leadand non-lead investors and the investee suggests a significantly lower added valuecontribution by non-leads. Similarly, with significantly lower access to informationon order books, capital expenditure and debt repayment non-lead investors seemless well-placed to provide added value in these areas. Further research mightexamine these added value contributions in more depth. Third, further analysisof the nature of trust in syndicates may be warranted since trust as we have shownhas several dimensions (Das and Teng, 1996). It was beyond the scope of this paperto examine empirically the development of trust between private equity firms overtime. However, given the varying intensity and longevity of linkages betweenprivate equity firms (Chiplin et al., 1997), examination of the different levels oftrust in these differing relationships seems warranted. Fourth, although we haveprovided some evidence on the dynamics of syndication in relation to subsequentinvestment rounds in the same company and subsequent syndicates in differentcompanies, further research might usefully explore the process of selecting sub-sequent syndicate partners, the determination of the nature of their roles and thechanging roles of syndicate partners over subsequent rounds of investment in thesame deal. Fifth, as relatively little is known about the success of syndicated invest-ments compared to venture capital investments that are not syndicated, furtheranalysis may be helpful in explaining the incidence of syndication in venture



capital markets. Sixth, although the analysis here has focused on the perspectivesof venture capital investors there is a need to consider the impact of syndicatedversus non-syndicated investment from the perspective of the investee. Thisresearch theme might also usefully include a dyadic or tryadic approach wherebylead and non-lead venture capital firms’ and entrepreneurs’ perspectives are exam-ined for potential asymmetries. Seventh, future research might also examine syn-dicates between venture capital funds and other types of investor such as businessangels and corporate venture capital investors. Eighth, there is a need to enhanceunderstanding of the extent to which syndication is undertaken by lead investorsto enable them to access necessary information for the investment decision. Sim-ilarly, there is a need to examine the extent to which venture capital firms becomenon-lead members of syndicates as they do not possess the expertise or resourcesto acquire information independently. In this sense, becoming a syndicate membermay also be part of a learning process prior to becoming a deal leader.

NOTES

*This paper was accepted by the previous editors.The authors thank participants at a staff seminar at Lancaster University, participants at the BabsonEntrepreneurship Conference, David Citron, Steve Toms and three anonymous referees for com-ments on an earlier draft. Thanks are also extended to Barclays Private Equity and Deloitte & Touchefor financial support, to Gordon Murray and Dimo Dimov for providing US syndication data andto Juliet Cripps for research assistance.[1] Note that in seed capital investments a legal entity may not previously exist while in other venture

capital investments, such as management buy-outs, an ‘off the shelf ’ company or speciallycreated company may be used to effect the arrangements.

[2] These contractual arrangements are akin to ‘specific rights’ of control as outlined by Grossmanand Hart (1986) and Hart (1995).

[3] It is important to note that economic trust may facilitate the development of sociological basedtrust through creating the conditions for repeated interaction.

[4] For example, the British Venture Capital Association organizes both industry wide trainingcourses and social events such as ski trips. Many of the executives in the industry were alsoformer employees of the largest VC firm, 3i.

[5] It was suggested to us, for example, that where syndicate partners were facing problems in theirportfolios as a whole they may be reluctant or unable to invest further. Similarly if a fund is fullyinvested it will be problematical to make further investments.

[6] Significance values were calculated employing the Wilcoxon pair-wise tests for difference.[7] Significance values were calculated employing the Wilcoxon pair-wise tests for difference.

REFERENCES

Admati, A. and Pfleiderer, P. (1994). ‘Robust financial contracting and the role of venture capital-ists’. Journal of Finance, 49, 371–402.

Al-Najjar, N. I. (1995). ‘Incomplete contracts and the governance of complex contractual relation-ships’. American Economic Review: Papers and Proceedings, 85, 2, 432–6.

Aulakh, P. S., Kotabe, M. and Sahay, A. (1997). ‘Trust and performance in cross border marketingpartnerships’. In Beamish, P. W. and Killing, J. P. (Eds), Cooperative Strategies: Vol. 1. North Ameri-can Perspectives. San Francisco: New Lexington Press, 163–96.

Axelrod, R. (1984). The Evolution of Cooperation. New York: Basic Books.Badorocco, J. L. Jr (1991). The Knowledge Link: How Firms Compete Through Strategic Alliances. Boston,

MA: Harvard Business School Press.



Beamish, P. and Banks, J. (1987). ‘Equity joint ventures and the theory of the multinational enter-prise’. Journal of International Business Studies, 18, 2, 1–16.

Birley, S., Muzyka, D. and Hay, M. (1999). ‘Management buyout: perception of opportunity. Aresearch note’. Journal of Management Studies, 36, 1, 109–22.

Black, B. and Gilson, R. (1998). ‘Venture capital and the structure of capital markets: banks versusstock markets’. Journal of Financial Economics, 47, 3, 243–78.

Blodgett, L. L. (1991). ‘Partner contributions as predictors equity share in international joint ven-tures’. Journal of International Business Studies, 22, 63–78.

Braddach, J. L. and Eccles, R. G. (1989). ‘Price, authority and trust: from ideal types to plural forms’.Annual Review of Sociology, 15, 97–118.

Bygrave, W. (1987). ‘Syndicated investments by venture capital firms: a networking perspective’.Journal of Business Venturing, 2, 139–54.

Bygrave, W. (1988). ‘The structure of investment networks in the venture capital industry’. Journal ofBusiness Venturing, 3, 137–57

Cable, D. and Shane, S. (1997). ‘A prisoner’s dilemma approach to entrepreneur-venture capitalistrelationships’. Academy of Management Review, 22, 1, 142–76.

Charny, D. (1990). ‘Non legal sanctions in commercial relationships’. Harvard Law Review, 104,375–467.

Child, J. and McGrath, R. (2001). ‘Organizations unfettered: organizational form in an informationintensive economy’. Academy of Management Journal, 44, 6, 1135–48.

Child, J. and Yan, Y. (1999). ‘Investment and control in international joint ventures: the case ofChina’. Journal of World Business, 34, 1, 3–15.

Chiplin, B., Robbie, K. and Wright, M. (1997). ‘The syndication of venture capital deals: buy-outsand buy-ins’. In Reynolds, P. et al. (Eds), Frontiers of Entrepreneurship Research 1997. Wellesley, MA:Babson College.

Citron, D., Robbie, K. and Wright, M. (1997). ‘Loan covenants and relationship banking in MBOs’.Accounting and Business Research, 27, 4, 277–96.

Das, T. K. and Teng, B-S. (1996). ‘Risk types and inter-firm alliance structures’. Journal of Manage-ment Studies, 33, 6, 827–43.

Das, T. K. and Teng, B-S. (1998). ‘Between trust and control: developing confidence in partner coop-eration in alliances’. Academy of Management Review, 23, 3, 491–512.

Das, T. K. and Teng, B-S. (2000). ‘A resource-based theory of strategic alliances’. Journal of Man-agement, 26, 1, 31–61.

Deshpande, R. (1983). ‘Paradigms lost: on theory and method in research in marketing’. Journal ofMarketing, 46, 101–10.

De vaus, D. A. (1991). Surveys in Social Research, 3rd edn. London: Allen & Unwin.Doz, Y. L. (1996). ‘The evolution of cooperation in strategic alliances: Initial conditions or learning

processes?’. Strategic Management Journal, 17, 55–83.Eisenhardt, K. M. (1989). ‘Agency theory: an assessment and review’. Academy of Management Review,

14, 1, 57–74.EVCA (1999). EVCA Yearbook. Zaventem: European Venture Capital Association.Fried, V. H. and Hisrich, R. D. (1995). ‘The venture capitalist: a relationship investor’. California

Management Review, 37, 2, 101–13.Geringer, M. J. and Hebert, L. (1989). ‘Control and performance of international joint ventures’.

Journal of International Business Studies, 20, 2, 235–54.Geringer, J. M. and Woodcock, P. (1989). ‘Ownership and control of Canadian joint ventures’. Busi-

ness Quarterly, 54, 97–101.Gompers, P. (1995). ‘Optimal investment, monitoring, and the staging of venture capital’. Journal of

Finance, 50, 5, 1461–89.Gompers, P. and Lerner, J. (1999). The Venture Capital Cycle. New York: Wiley.Granovetter, M. (1985). ‘Economic action and social structure: the problem of embeddedness’.

American Journal of Sociology, 91, 481–510.Grossman, S. and Hart, O. (1986). ‘The costs and benefits of ownership: a theory of vertical and

lateral integration’. Journal of Political Economy, 94, 4, 691–719.Gulati, R. (1995). ‘Does familiarity breed trust? The implications of repeated ties for contractual

choice in alliances’. Academy of Management Journal, 38, 85–112.Gulati, R., Nohria, H. and Zaheer, N. (2000). ‘Strategic networks’. Strategic Management Journal, 21,

203–15.



Hart, O. (1995). Firms, Contracts and Financial Structure. Oxford University Press.Hennart, J. F. (1988). ‘A transaction costs theory of equity joint ventures’. Strategic Management Journal,

9, 361–74.Holland, J. (1994). ‘Bank lending relationships and the complex nature of bank-corporate relation-

ships’. Journal of Business Finance and Accounting, 21, 3, 367–93.Hosmer, L. (1995). ‘Trust: the connecting link between organisational theory and philosophical

ethics’. Academy of Management Review, 20, 379–403.Jensen, M. C. and Meckling, W. H. (1976). ‘The theory of the firm: managerial behavior, agency

costs and ownership structure’. Journal of Financial Economics, 3, 305–60.Kanter, R. (1994). ‘Collaborative advantage: the art of alliances’. Harvard Business Review, 72, 96–108.Kumar, S. and Seth, A. (1998). ‘The design of coordination and control mechanisms for managing

joint venture-parent relationships’. Strategic Management Journal, 19, 579–99.Lerner, J. (1994). ‘The syndication of venture capital investments’. Financial Management, 23, 3, 16–27.Lewicki, R. and Bunker, B. (1996). ‘Developing and maintaining trust in work relationships’. In

Kramer, R. and Tyler, T. (Eds), Trust in Organizations: Frontiers of Theory and Research. ThousandOaks, CA: Sage, 114–39.

Lockett, A. and Wright, M. (1999). ‘The syndication of private equity: evidence from the UK’. VentureCapital, 1, 4, 303–24.

Lockett, A. and Wright, M. (2001). ‘The syndication of venture capital investments’. OMEGA: TheInternational Journal of Management Science, 29, 375–90.

Lyons, B. and Mehta, J. (1997). ‘Contracts, opportunism and trust: self interest and social orienta-tion’. Cambridge Journal of Economics, 21, 239–57.

Macauley, S. (1963). ‘Non-contractual relations in business’. American Sociological Review, 28, 55–67.Macneil, I. R. (1974). ‘The many futures of contracts’. Southern California Law Review, 47, 3, 691–

816.Makino, S. and Beamish, P. (1998). ‘Performance and survival of joint ventures with non-

conventional ownership structures’. Journal of International Business Studies, 29, 4, 797–818.Manigart, S., De Waele, K., Wright, M., Robbie, K., Desbrieres, P., Sapienza, H. and Beekman, A.

(2000). ‘Venture capitalists, investment appraisal and accounting information: a comparativestudy of the USA, UK, France, Belgium and Holland’. European Financial Management, 6, 3,389–404.

Mayer, C., Davis, J. and Schorman, F. (1995). ‘An integrative model of organizational trust’. Academyof Management Journal, 20, 709–34.

Miles, R. E. and Snow, C. C. (1986). ‘Organizations: new concepts for new forms’. California Man-agement Review, 28, 3, 62–73.

Mitchell, F., Reid, G. and Terry, N. (1995). ‘Post investment demand for accounting information byventure capitalists’. Accounting and Business Research, 25, 186–96.

Mitchell, F., Reid, G. and Terry, N. (1997). ‘Venture capital supply and accounting informationsystem development’. Entrepreneurship Theory and Practice, 21, 4, 45–62.

Mjoen, H. and Tallman, S. (1997). ‘Control and performance in international joint ventures’.Organization Science, 8, 3, 257–74.

Mowrey, D. C., Oxley, J. E. and Silverman, B. S. (1995). ‘Strategic alliances and interfirm knowl-edge transfer’. Strategic Management Journal, 17, 77–91.

Murray, G. (1999). ‘Early-stage venture capital funds, scale economies and public support’. VentureCapital, 1, 4, 351–84.

Norton, E. and Tenenbaum, B. (1993). ‘The effects of venture capitalists’ characteristics on the struc-ture of a venture capital deal’. Journal of Small Business Management, 31, 32–41.

Pan, Y. and Li, X. (2000). ‘Joint venture formation of very large multinational firms’. Journal of Inter-national Business Studies, 31, 1, 179–89.

Pisano, G. P. (1991). ‘The governance of innovation: vertical integration and collaborative arrange-ments in the biotechnology industry’. Research Policy, 20, 237–49.

Relander, K., Syrjanen, A. and Miettinen, A. (1994). ‘Analysis of the trade sale as a venture capitalexit route’. In Bygrave, W., Hay, M. and Peeters, J. (Eds), Realizing Investment Value. London: FT-Pitman.

Rugman, A. M. (1982). ‘Internationalization and non-equity forms of international involvement’.In Rugman, A. M. (Ed.), New Theories of the Multinational Enterprise. New York: St Martin’s, 9–23.

Sahlman, W. A. (1990). ‘The structure and governance of venture capital organizations’. Journal ofFinancial Economics, 27, 473–521.



Sapienza, H. and Korsgaard, A. (1996). ‘Procedural justice in entrepreneur-investor relations’.Academy of Management Journal, 39, 3, 544–74.

Sapienza, H., Manigart, S. and Vermeir, W. (1996). ‘Venture capital governance and value added infour countries’. Journal of Business Venturing, 11, 6, 439–69.

Steensma, H. K. and Lyles, M. A. (2000). ‘Explaining IJV survival in a transitional economy throughsocial exchange and knowledge-based perspectives’. Strategic Management Journal, 21, 831–51.

Steier, L. and Greenwood, R. (1995). ‘Venture capitalist relationships in the deal structuring andpost-investment stages of new firm creation’. Journal of Management Studies, 32, 3, 337–57.

Sweeting, R. (1991). ‘Early-stage new technology-based business: interactions with venture capital-ists and the development of accounting techniques and procedures’. British Accounting Review,23, 3–21.

Teece, D. J. (1992). ‘Competition, cooperation, and innovation: organizational arrangements forregimes of rapid technological progress’. Journal of Economic Behavior and Organization, 18, 1–25.

Tyler, T. and Degoey, P. (1996). ‘Trust in organizational authorities: the influence of motive attribu-tions on willingness to accept decisions’. In Kramer, R. and Tyler, T. (Eds), Trust in Organiza-tions: Frontiers of Theory and Research. Thousand Oaks, CA: Sage, 331–56.

Wilson, R. (1968). ‘The theory of syndicates’, Econometrica, 36, 1, 119–32.Wright, M. and Robbie, K. (1996). ‘Venture capitalists, unquoted equity investment appraisal and

the role of accounting information’. Accounting and Business Research, 26, 2, 153–68.Wright, M. and Robbie, K. (1998). ‘Venture capital and private equity: a review and synthesis’.

Journal of Business Finance and Accounting, 25, 5 & 6, 521–70.Wright, M., Robbie, K., Mason, C. and Harrison, R. (1998). Venture Capital in Europe. London: The

Stationery Office.Yan, A. (1998). ‘Structural stability and reconfiguration of international joint ventures’. Journal of

International Business Studies, 29, 4, 773–96.Yan, A. and Gray, B. (1994). ‘Bargaining power, management control, and performance in United

States-China joint ventures: a comparative case study’. Academy of Management Journal, 37,1478–517.

Yan, A. and Gray, B. (2001). ‘Antecedents and effects of parent control in international joint ventures’. Journal of Management Studies, 38, 3, 393–416.

Yoshino, M. and Rangan, U. S. (1995). Strategic Alliances: An Entrepreneurial Approach to Globalization.Boston, MA: Harvard Business School Press.

Zaheer, A. and Venkatraman, N. (1995). ‘Relational governance as an interorganizational strategy:an empirical test of the role of trust in economic exchange’. Strategic Management Journal, 16,373–92.

Zucker, L. G. (1986). ‘Production of trust: institutional sources of economic structure, 1840–1920’.In Staw, B. M. and Cummings, L. L. (Eds), Research in Organizational Behavior, Vol. 8. Greenwich,CT: JAI Press Inc., 53–111.



the structure and management of alliances: syndication in the venture capital industry

Documents