The syndication of venture capital investments
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Omega 29 (2001) 375390www.elsevier.com/locate/dsw
The syndication of venture capital investments
Andy Lockett , MikeWrightNottingham University Business School, Jubilee Campus, Wollaton Road, Nottingham NG8 1BB, UK
Received 1 May 2000; accepted 21 February 2001
This paper examines competing .nance, resource-based and deal 0ow explanations for the syndication of venture capitalinvestments. Evidence from 60 .rms (a 58.8% response rate) is analysed. Overall the .nance perspective provides a strongexplanation of motives for syndication, but the resource-based view is found to be much more important for those .rmsinvolved in at least some early stage transactions. The implications for researchers are that venture capital .rms should not betreated as a homogeneous group and that the investment stages in which they operate may strongly in0uence attitudes towardssyndication. In addition, there are implications for practitioners as venture capital .rms may not be attributing su6cientattention to the need to augment their own resource base in order to enable them to make superior decisions when selectingdeals and managing investments. ? 2001 Elsevier Science Ltd. All rights reserved.
Keywords: Venture capital; Finance; Syndication; Resource-based theory
This paper examines the question of why venture capital.rms syndicate their investments. We de.ne the activitiesof venture capital .rms to cover the range of investmentbehaviours engaged in by members of the British VentureCapital Association (BVCA). As such, we include earlystage investment, usually regarded as classic venture cap-ital, through to management buy-out=buy-in (MBO=MBI)investments, sometimes referred to as private equity.Similarly, Ruhnka and Young  di?erentiate between theventure capital investment decision and the decision to pur-chase established companies while Bygrave and Timmons use the terms venture and merchant capital, respec-tively. In a venture capital syndication, two or more venturecapital .rms come together to take an equity stake in an
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investment. The operation of the syndicate involves the mak-ing of common decisions under conditions of uncertaintythat will result in joint pay-o?s for the investors .Venture capital .rms are characterised as providing com-
panies that have high potential growth and entrepreneurialtalent with .nance and business skills to exploit market op-portunities. The relatively high risks that venture capitalistsaccept are compensated by the possibility of high return,usually through substantial capital gains in the medium (tolong) term [4,5]. In order to accommodate these high levelsof uncertainty venture capital .rms have developed variousstrategies for dealing with risk, deal selection and monitor-ing [see: 6, for a review], one of which is the syndicationof investments. However, although syndication by venturecapital .rms is empirically signi.cant, it has received rela-tively little attention. This paper is an initial exploratory at-tempt to begin to redress this imbalance. The originality ofthe research stems from the use of survey data that makesthe study unique in this area.The objective of this exploratory study is to examine
the two dominant competing views as to why venture
0305-0483/01/$ - see front matter ? 2001 Elsevier Science Ltd. All rights reserved.PII: S0305 -0483(01)00024 -X
376 A. Lockett, M. Wright /Omega 29 (2001) 375390
capital .rms syndicate equity investments. 1 The traditionalapproach, developed from .nance theory, has been to viewsyndication as a means of risk sharing via portfolio diver-si.cation. In contrast, the resource-based perspective viewssyndication as a response to the need to share=access infor-mation in the selection and management of investments. Inaddition, the paper will also examine the importance of ac-cess to deal 0ow as a motivation for syndicating out a deal.US research indicates that syndication is both a function ofthe desire to spread .nancial risks as well as the need toshare information, with uncertainty and syndication beingpositively related [8,9]. The analysis conducted in the pa-per addresses these issues by posing two di?erent sets ofquestions to venture capitalists. First, what are the motivesfor syndication-out of deals? Second, what are the motivesfor not syndicating-out deals? It was anticipated that inves-tigating the syndication decision, from both a positive andnegative perspective, would lead to a more thorough under-standing of the salient issues.The motives for syndicating a deal may vary according
to the investment stage of the deal. Evidence indicates thatthe degree of syndication has generally been falling overtime. The available evidence permits a comparative analysisof the degree of syndication in MBO=MBI investments andfor all venture capital investments. This evidence indicatesthat the degree of syndication for MBO=MBI investments isbelow that for all venture capital investment stages taken to-gether, although this di?erence has been reducing (Table 1).Hence, in this study we also examine the di?erent motivesof MBO=MBI investors compared to investors participatingin at least some early stage investments for syndicating ornot syndicating out a deal.The paper is structured as follows. The .rst section out-
lines the theoretical perspectives on syndication and devel-ops propositions. The methodological approach is outlinedin the second section whilst the third section presents theresults from the study. The .nal section discusses the issuesarising from the study and identi.es managerial and practi-tioner implications as well as directions for further research.
1 There are clear analogies between syndication and the reinsur-ance literature which generally predicts di?erences between .rmsin their reinsurance practices. For example, Borch  using ex-pected utility with risk aversion shows that optimal risk sharingoccurs when insurers participate in a reinsurance pool in proportionto their respective degrees of risk tolerance. Garven and LoubergLe develop a model under risk neutrality where the optimal shar-ing rule is related to the endowed .nancial capacity of each insurerrather than risk aversion. Re-insurance models tend to be basedon the existence of a reinsurance pool and that each insurer hasa homogeneous portfolio of claims. There is no clear evidence ofsyndication pools in the venture capital market and syndication isconducted on a deal by deal basis. Thus, the re-insurance modelswould require signi.cant modi.cation to be directly applicable tothe venture capital market. This is beyond the scope of this paper.We take the view that syndication should be viewed as a methodof reinsurance, rather than as a direct competitor to reinsurance.
2. The syndication of venture capital investments
Syndication by venture capital .rms may be based on adesire both to share and to reduce risks. Venture capital.rms attempt to share the risk associated with a particularinvestment by involving another venture capital .rm in the.nancing. Venture capital .rms also try to reduce the risksassociated with investing by sharing information with otherventure capital .rms in order to bene.t from a superior se-lection and management of investments [8,9,11,12]. In do-ing so, it is expected that venture capitalists will raise themean expected return on their investments but not the vari-ance of the underlying distribution of returns. US researchby Bygrave [8,9] indicates that syndication is both a func-tion of the desire to spread .nancial risks as well as theneed to share information (reduce risks) with uncertaintyand syndication being positively related. In addition, Chiplinet al.  in their study of syndication in the UK marketfor MBO=MBIs found a relationship between risk reductionand syndication although it was not particularly strong.The traditional perspective on why venture capitalists syn-
dicate equity investments, developed from .nance theory,views syndication as a means of risk sharing via portfoliodiversi.cation. However, although the venture capital .rmhas traditionally been viewed as a .nancial intermediary, itmay also be thought of as a collection of productive re-sources . A resource is considered to be anything thatcould be thought of as a strength or a weakness of a given.rm , with syndication being a method of accessing spe-ci.c resources from other .rms in order to reduce the riskof investment. The following section develops propositionsbased on these di?erent perspectives on syndication.
2.1. The traditional 6nance=risk sharing perspective
The risk associated with any investment can, in general,be sub-divided into two groups: unique (non-systematic orcompany) risk and market (systematic) risk. Unique risk isthe risk associated with a particular investment whereas mar-ket risk is associated with market wide variations. Uniquerisks relate to internal company factors associated with theskills of the entrepreneur, the growth and pro.tability pro.leof the .rm, its technology, etc.  Investors, via diversi.ca-tion, can eliminate unique risk by holding a well-balancedportfolio of investments in companies whose returns do notco-vary. This view implicitly assumes that investors are un-able to take actions to a?ect the risk in any particular com-pany. Whilst this may be the case for investors in listedcompanies, venture capital .rms with their speci.c skillsand powers may be able to intervene to manage and re-duce unique, company speci.c risks. We examine the linkbetween these actions and syndication in the next section.Here we consider the role of syndication in sharing the riskassociated with a particular investment by facili