when do venture capitalists collaborate? evidence on the driving forces of venture capital...

When do venture capitalists collaborate? Evidence on the driving forces of venture capitalsyndicationAuthor(s): Christian HoppSource: Small Business Economics, Vol. 35, No. 4 (November 2010), pp. 417-431Published by: SpringerStable URL: http://www.jstor.org/stable/40927528 .

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Small Bus Econ (2010) 35:417^31 DOI 1 0. 1 007/s 1 1 1 87-008-9 1 69-z

When do venture capitalists collaborate? Evidence on the driving forces of venture capital syndication

Christian Hopp

Accepted: 11 December 2008 / Published online: 13 January 2009 © Springer Science+Business Media, LLC. 2009

Abstract Using a sample of 2,373 unique capital contributions from 437 venture capitalists (VCs) over subsequent rounds into 961 start-ups during the period 1995-2005 in Germany we disentangle the circumstances under which lead VCs engage in syndicate relationships with partner VCs. The results indicate that syndication is more pronounced when VCs face higher risks that need to be diversified and capital burdens are larger. Moreover, we document that industry investment experience lends legitimacy to lead VCs, allowing them to enter syndicate relationships to enhance their network positions. In general, greater industry experience is associated with more syndication. Lastly, the results show that lead VCs involve new/additional partners in subsequent financing rounds to leverage their idiosyncratic skills and knowledge to improve deal selection and/or provide a better quality of managerial advice.

Keywords Venture Capital • Entrepreneurship •

Syndication

JEL Classifications L26

C. Hopp (El) University of Vienna, Vienna, Austria e-mail: Christian. [email protected]

1 Introduction

Venture capitalists (VCs) provide the required funds and expertise to high-potential-growth companies and strive for substantial capital gains in the medium or sometimes long term, compensating them for the high risk and uncertainty associated with the investment(s) made (Sahlman 1990). VCs derive benefits from being able to offer technological, financial, and managerial expertise to the funded entrepreneur in order to better screen business proposals and offer a higher quality of advice. In venture capital (VC) financing the involvement of a partner VC is a common means to access new financial and managerial resources. Teaming up with a partner is referred to as syndication. Funded firms are thus backed by more than a single VC. In more- uncertain environments (with higher asset specificity and correspondingly greater dependence on entrepreneurial effort) VCs are more likely to encounter unforeseen contingencies and would benefit more from involving partner VCs and their corresponding managerial expertise and financial endowments to either improve selection of funded firms (Lerner 1994) or diminish individual capital contributions, thereby allowing participating VCs to invest smaller amounts of capital into a larger number of funded firms to diversify risks (Lockett and Wright 1999; Manigart et al. 2006). The benefit of involving co-investors is hence based on additional managerial and/or financial resources that partner VCs can bring into the relationship.

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418 C. Hopp

Using a sample of 2,373 unique capital contributions by 437 into 961 ventures we analyze the driving forces of VC syndication and disentangle the circumstances under which VCs engage in collaboration with partners. We start by analyzing the conditions under which VCs tend to invest jointly with partner VCs by focusing on the characteristics of the venture and the involved VCs alike. The results indicate that the likelihood for a lead VC to invest jointly with a partner is more pronounced when the underlying venture is younger. For firms where products are far from commercialization the risks that investors face are more severe and scrutiny in deal selection through syndication and subsequent managerial advice can be an important mechanism to align managerial effort with the goals of the financing VCs (Lerner 1994). Hence, VCs benefit from combining their investment expertise when risks are more pronounced. The larger amount of capital provided per financing rounds impacts the likelihood of syndication positively pre- senting transaction-based evidence for the questionnaire results of Manigart et al. (2006) that VCs tend to syndicate to mitigate risks and diversify funds. More risks and (potentially) higher capital requirements positively affect the incentives of VCs to involve partners.

With respect to the inherent VC characteristics, we find that VCs with more experience in the transaction relevant industry tend to rely more on syndication. Enhancing one's network position can be a vital strategy to improve deal flow and access to new knowledge (Hochberg et al. 2006, 2007). Hence, VCs that are more open to syndication enjoy more favorable network positions that enable them to benefit from high-quality relationships. As such, the syndication of VC investments affects the main drivers of performance: sourcing high-quality deals and promoting growth for the funded firms (Verwal et al. 2008). Given the underlying uncertainty associated with asymmetric information in partner selection, industry expertise can serve as a positive signal and lend legitimacy to lead VCs.

Moreover, we analyze the partner selection in VC syndicates in subsequent financing rounds. We document that a lack of industry experience drives the involvement of new partners as a source of expertise and knowledge. Consequently, our results show that new partners joining an incumbent syndicate (for a given venture) can be an important source of

knowledge that can help to broaden the scope of investing through an increased likelihood of obtaining new information. New partners in a syndicate can provide different knowledge and information, despite the uncertainty associated with selecting a new partner.

Our results therefore stress the importance of resource-based motives to understand the syndication of VC investments. In fact, better resources allow VCs to provide better advice and/or better screen business proposals of entrepreneurs (Lerner 1994; Brander et al. 2002). Consequently, we offer insights into VC syndication as a quest for resources (technological, financial, managerial expertise, and networking resources) and capabilities (the ability to better screen business proposals and offer a higher quality of advice to the funded entrepreneur) to close competency gaps between the existing repository of skills and knowledge and the potentially value- maximizing configuration. In line with the arguments made in Casamatta and Haritchabalet (2007) we document that risk mitigation might bear some relevance; it is however not the only determinant of syndication and cannot explain widely observed patterns of syndication and especially partner selection.

The remainder of the paper is organized as follows. Section 2 introduces the theoretical background and develops the hypotheses. Section 3 describes the dataset and the sample characteristics. Section 4 discusses the empirical findings and potential limitations. Section 5 concludes.

2 Theoretical background and hypotheses

2.1 Transaction characteristics and VC syndication

VCs play a crucial role in providing growth capital to young and innovative entrepreneurial firms. Besides providing capital to cash-constrained entrepreneurs, they offer additional help through managerial expertise to their funded firms. In order to mitigate the tradeoff between specialization and diversification the syndication of investments is a common means to expand the investment portfolio along several dimen- sions. For VCs syndication can help to expand the portfolio radius without stretching effort over too

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many new projects.1 In this way, effort can be devoted to firms where the corresponding VC acts as sole or lead investor and money can also be invested where a partner VC spends more time and effort in advising the funded firm.

Manigart et al. (2006) suggest that in a European context VCs are focusing on diversification and access to additional financing to build their portfolio(s). So instead of the risk being taken on by a single VC it would be necessary to spread the risk associated with an investment among a group of VCs, thus allowing VCs to spread risk over a multitude of firms (and industries) in order to achieve diversification benefits. Likewise each single VC involved can invest lower amounts of capital by inviting partners to share the capital burden.

Moreover, the combined effort of multiple VCs to assess the quality of a venture helps them to overcome informational asymmetries as entrepreneurs typically know more about the investment opportunity they seek funding for and might overstate the attractiveness of their business proposal (Soren- son and Stuart 2001). Sah and Stiglitz (1986) conclude that the decision-making process is more efficient and leads to better results if a project is only financed when approved by two or more parties. Alternatively, syndicating with a more specialized partner can help to leverage his capabilities and competencies to offer a better quality of managerial advice to portfolio firms (Brander et al. 2002). The need for such additional partner skills is anticipated to be greater in earlier stages of an investment than in later-stage investments. This is mainly due to the fact that more-mature firms have an established management structure and market position and have already built relationships with suppliers and customers (Bygrave and Timmons 1992; Bygrave 1987; Lockett and Wright 1999, 2001; Brander et al. 2002).

This suggests that greater risk associated with the underlying transaction should be linked to greater syndication in order either to reduce individual capital contributions (to spread the capital that a VC manages

Syndication in its widest definition means that more than a single VC has injected capital, regardless of the rounds. Hence, simultaneous investments are no prerequisite for the notion of syndication. Fluck et al. (2005) and Brander et al. (2002) also use this definition of syndication, whereas Manigart et al. (2006) refer to syndication only when investments are made simultaneously.

over a larger number of funded firms and achieve diversification benefits) or to involve partners to mitigate risk through complementary expertise via improved selection of transactions or provision of better quality of advice. Based on these considerations we formulate the following hypothesis:

Hypothesis 1 A higher risk associated with the underlying transaction increases the benefits from involving partner VCs and leads to more syndication.

2.2 Industry experience and VC syndication

As current and desired competencies form the basis of value creation, strategic actions of VCs are characterized by new opportunities and the corresponding competencies to master them. Related work on resource dependency argues that VCs are likely to lack (at least to some extent) potential resources (technological or investment expertise) that are needed to achieve long-term competitive advantages. While proprietary VC resources are key to acquiring and sustaining competitive advantages, the lack thereof leads to alternative routes of generating and accessing knowledge to prosper (Pfeffer and Salancik 1978; Barney 1991). Brander et al. (2002) put forward the notion that syndication permits VCs to combine complementary knowledge. Each participating VC endows a set of resources that is combined with the partner's resources with the expectation of generating superior advice for the entrepreneur and/or better screening of the proposed transaction (Lerner 1994; Sorensen 2007). Given that it might be difficult for each VC to actually learn what the partner knows, syndicates provide a mode of combining specialized knowledge. In this way, VCs can gain access to valuable resources of partners that might aid in the management of financed transactions (Harrison et al. 2001; McEvily and Marcus 2005).

Investment experience within a transaction-relevant industry yields valuable insights into structuring deals and advising the funded entrepreneur and henceforth lies at the heart of understanding how VCs can create value. Those VCs that possess transaction-relevant investment experience do not need to rely on partners to offer a better quality of managerial advice to their funded ventures or to improve deal selection and subsequent continuation/ abandonment decisions (Verwal et al. 2008). Overall,

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the investment experience within the underlying industry of a prospective transaction should be negatively related to the VCs' propensity to syndicate. Accordingly, we formulate the following hypothesis:

Hypothesis 2a Industry experience mitigates the risks VCs face in a transaction and reduces the likelihood of syndication.

Verwal et al. (2008) distinguish between the necessity and capability to enter into syndicate relationships with partner VCs. While smaller/inex- perienced VCs would benefit more from syndication, they may lack the legitimacy to enter such partnerships. More reputable VCs, however, are more reasonable partners due to their status, network resources, and scope of operations.

Hochberg et al. (2007) analyze the performance consequences of syndicate relationships formed in the US venture capital industry and show that funded firms whose investors enjoy a more influential position within the VC network perform substantially better (as measured by the number of IPO or trade-sale exits to the number of total investments). Given the high returns for well-networked VCs, Hochberg et al. (2007) suggest enhancing one's network position as a vital strategic consideration for a VC. Being able to syndicate with a larger number of partners improves the position of a VC substantially, raising the probability of being invited to join other profitable deals in the future. While smaller VCs would benefit most from accessing additional expertise they would be less likely to be able to reciprocate in the future due to the limited deal flow. Hence, they will find it more difficult to find appropriate ventures and actually act as lead VCs inviting partners. Accordingly, the capability to reciprocate in the future is more valuable for reputable VCs with a greater number of transactions and network partners (Verwal et al. 2008).

Syndication should therefore be more pronounced among more experienced VCs that can manage their network resources and have an existing universe of partners from which to select appropriate ties to better manage a given transaction or reciprocate existing deeds. Hence, VCs that are more open to syndication enjoy more favourable network positions that enable them to benefit from high-quality relationships. As such, the syndication of VC investments affects the main drivers of performance: sourcing high-quality deals and promoting growth for the

funded firms through combined expertise. Moreover, networking among incumbent VCs can help to deter entry. Denser networks see substantially less entry (Hochberg et al. 2007). Industry experience can therefore signal competencies and potential future value creation within a combined working relationship to potential partner VCs. Accordingly, possessing industry experience acts as a prerequisite for being able to invite other VCs to participate in a given transaction. Thus, we formulate the alternative hypothesis:

Hypothesis 2b Industry experience lends legitimacy to lead VCs and increases the likelihood of syndication.

2.3 Partner selection in subsequent rounds

Over time VCs have to bridge the trade-off between effectiveness and efficiency through recursive actions and the necessity to monitor and check capabilities to allow for timely actions to absorb environmental changes (Gompers and Lerner 2002). Through collaboration with new/additional partners in subsequent financing rounds lead VCs can avoid becoming stuck in competency traps. In this vein, new partnerships can provide new and different information than existing ties could, despite the uncertainty associated with the selection of a new partner. New partners in a VC syndicate can be an important source of knowledge that can help to broaden the underlying investment experience to improve continuation/abandonment decisions in future rounds or provide a higher quality of managerial advice. Teaming up with additional new partners can therefore be beneficial for already involved VCs through an increased likelihood of obtaining new information and increas- ing the diversity of information to which a lead VC is exposed (Dimov and De Clercq 2008).

Rothaermel (2001), however, finds a general tendency towards exploitation of complementary assets in alliances. Accordingly, firms tend to leverage experience from previous successful relationships and engage in recurrent alliances. Based on past successful implementation firms can judge the efficiency of established routines and might be tempted to reinforce given prior favorable outcomes. Thus, with an increase in transaction-relevant industry experiences, the value added stemming from

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exploring knowledge with new partners is diluted and lead VCs should turn towards exploitive strategies to leverage existing routines with previous partners rather than working with new partners.

We therefore argue that, if the existing repository of investment experience of the initial participating VC (or among a group of VCs that participated in previous rounds) is not sufficient to provide an edge, syndicating the investment in a subsequent financing round with a new partner VC can be a viable strategy to ensure future value creation. Hence, a lead VC might be tempted to syndicate his transaction in a future round by inviting an additional VC and expand the scope of the syndicate if he has not been able to acquire additional industry investment experience during the course of successive financing rounds. A lack of industry experience might therefore foster the necessity to rely on partner experience in subsequent rounds. Hence, we formulate the following hypothesis:

Hypothesis 3 A lack of industry experience of the incumbent financing VCs increases the likelihood of syndication with new/additional partner VCs in subsequent financing rounds.

3 Investment sample

3.1 Data collection and descriptive statistics

The sample consists of 2,373 venture capital transactions in Germany within the period 1995-2005. The number of total financing events comprises capital injections of 437 VCs that are subsequently made over different stages (start-up, early stage, and late stage) into 961 firms.2 The transactions were compiled by using the Thomson Venture Economics (TVE) database. We identified the involved parties in each transaction and the corresponding information on the VCs along with the funded firms. The result is a deal survey exhibiting who funded a new company and was joined by which partner. Moreover, we collected information about each financing round. As such, we identify which VC made an investment into

a target firm at which point in time. In addition we supplemented the database with information regard- ing the VCs and the funded firms, along with information specific on the actual deal. The analysis is made on the basis of investment rounds as indicated through TVE. A distinction between mile- stone and round financing cannot be observed.3

3.2 Dependent variable

As the dependent variable for the first two hypotheses we use the dichotomous decision of whether to syndicate (involve a partner VC) within a specific round, as indicated by TVE. Here, we analyze the narrow choice of syndication when two or more VCs invest simultaneously. When the investment was made by two or more distinct VCs the variable takes on the value of one, and is zero when only a single VC is involved. We will analyze the decision from the lead VC perspective. Hence, the results allow for inferences into the circumstances under which a lead VC is willing to join forces with partners.

Concerning hypothesis 3, we analyze what deter- mines the involvement of a new/additional VC in subsequent financing rounds, once the initial investment was made. Here, we use a wider definition of syndication (as in Brander et al. 2002 and Fluck et al. 2005) that accounts for differences among multiple VCs injecting capital in successive rounds. Hence, simultaneous investments are no prerequisite for the notion of syndication in this analysis. This analysis yield insights into the selection of partners in future round and helps to gain a better understanding of the driving patterns of syndication over time (e.g., syndicating down an investment with new partners). Accordingly, the dependent variable will take on a value of one when a new/additional VC (that has not been involved in any previous round) is providing capital in a given round and zero otherwise.

The role in managing (and monitoring) the underlying investment differs substantially between lead and nonlead investors. Gorman and Sahlman (1989) find that the lead investor spends about ten times

2 On average a funded firm has been provided with financing 2.2 times during the investigation period. This implies that either a firm has received financing 2.2 times from the same VC (in successive rounds) or by 2.2 VCs on average (in either successive rounds or in the same round).

The sample resembles the aggregate statistics published by the German Venture Capital and Private Equity Association and comparable representative studies in terms of industries and stages studied (see, among others, BVK 2005; Mayer et al. 2005; Bascha and Walz 2007).

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more effort (time) on monitoring and managing the investment. We have included a measure of a leading role of VCs for each transaction. Hochberg et al. (2007) define the lead investor as the investor who

acquires the largest stake in a portfolio company. Megginson and Weiss (1991) and Sorensen (2007) use a similar argument. As TVE only reports the total amount invested per round and does not distinguish between the sum invested by each VC involved on a stand-alone basis, we proxy for the lead investors) using two criteria that have to be fulfilled simulta-

neously: the maximum number of rounds and the involvement in the initial financing round. The lead investor is defined as the VC that has participated in the maximum number of rounds among all investing VCs and was also involved in the first round of

financing. This approach is identical to that adopted in Hopp (2008). Underlying this assumption is the same argument as in Megginson and Weiss (1991) or Sorensen (2007) that the lead investor usually has the

largest amount of money at stake and therefore an incentive to take a more active role in managing the

syndicate and advising the portfolio company. A lead VC is therefore the VC that has participated in the

highest number of financing rounds among all involved VCs. There can be multiple VCs or even no lead VC at all (in which case the venture drops from the analysis). Accordingly, the lead VC is assumed to invite partner VCs to take part in a

specific transaction. For all transactions with a single VC involved the lead investor naturally is equal to the

only participating VC. The study for hypothesis 1 and 2 thus analyzes syndication from the side of the

leading VC. For hypothesis 3 information on all

previously involved VCs enter the analysis.

3.3 Independent variables

Given that we can track the investment experience that VCs accumulated over time and in specific industries we can infer how the existing resource

configuration (and the potential erosion) impacts the decision of which partners to team up with and whether resource gaps warrant network expansions to

generate reconfigurations. The VC attributes are based on the cumulative cooperation behavior until the end of the year prior to the given year. The

resulting structure is a cross-section of transactions over time, with varying covariates over the years. All

measures are either calculated as the cumulative number until the end of the year prior to the given year (in which the deal takes place) or by just using the relevant information from events happening in the year prior to the given year (t - 1 analysis). In this way, issues of causality between the dependent and independent variables are circumvented; for example, the total number of transactions that a VC has made in (or until the end of the year) 2004 is used to explain his syndication decisions in 2005. Hence, syndication decisions in 2005 cannot influence the independent variables in 2004. We will measure experience and contacts on the basis of the VC firm level rather than for specific funds (of the same VC firm) separately. Underlying this assumption is the

argumentation that ties and experience acquired carry over to a VCs next fund (Hochberg et al. 2007). The

following explanatory variables are used in the estimation procedure:

3.3.1 Industry experience (in the previous year)

To measure the effect of industry experience on

syndication behavior, we calculated the total experience that the corresponding VC(s) acquired during the course of the previous year in the given industry in which a deal takes place. We used information from TVE to identify the industry of a particular venture and make use of the Venture Economics

Industry Classification (VEIC) - a Venture Economics

proprietary industry classification scheme. In order to draw more distinct conclusions we further split the industries in the sample, which results in finer

industry clusters. Namely, we divided the medical/ health classification into two separate categories. Moreover, we split the industrial sector into industrial

products (such as chemicals and industrial equip- ment) and industrial services (such as transportation, logistics, and manufacturing services). We created a

category for Internet firms to cope with the particu- larities of investments into "new economy" firms over the period.4 Accordingly, industry experience measures the previous number of transactions that the

corresponding VC carried out throughout the

4 Groupings have been made based on VEIC level 1 codes.

Firms that were solely focusing on the Internet to sell and market products were included in the separate Internet/ e-commerce category.

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previous year. We do not include further industry dummies as these would be highly correlated with the

experience of VCs in overrepresented industries, such as biotechnology and software. For the analysis of syndication patterns, industry experience within the

previous year allows for more variation in the

independent variables and circumvents problems of autocorrelation. Even for larger VCs we see more variation from year to year and hence can get more

insights into the changing syndication patterns by using a rolling measure of industry experience. Especially for hypothesis 3, this measure is more

appropriate to test the impact of generation and dilution of expertise over time and the necessity to syndicate in subsequent financing rounds.

3.3.2 Increase in industry experience

Concerning hypothesis 3 we also account for a possible change in the level of industry experience among the VCs involved in a previous round. We only measure the additional industry experience that the incumbent VCs have gained between the last time financing was provided and the given round. Hence, we would expect that, if incumbent VCs have only made a few transactions (or no transaction at all) in the meantime, the likelihood that they will invite a new VC for a subsequent round is higher. The change

Table 1 Summary statistics by industry

Total No. of Syndicated firms investors (%)

Biotechnology 142 1.41 61.27 Consulting/services 68 1.18 27.94 Consumer products 27 1.19 25.93 Electronics 105 1.29 40.00 Utilities 12 1.25 41.67 Financial institution 17 1.06 5.88 Industrial products 102 1.13 16.67 Industrial services 26 1.12 19.23 Internet/e-commerce 104 1.25 44.23 Life science/pharma 32 1 .3 1 46.88 Media/communications 59 1.20 30.51 Medical products 52 1.29 32.69 Software 215 1.23 37.67 Total 961 1.22 37.46

in industry experience is calculated for all incumbent VCs that participate in a subsequent round and over the interval between the current and the preceding round of financing.

Table 1 gives a brief overview of the industry distribution of VC investments during the investigation period. We can infer that biotechnology and software are the industries with the highest number of firms financed. They rank top, with 142 and 215 funded ventures, respectively. Additionally, there are some 100 transactions in electronics, industrial products, and Internet. Concerning the use of syndication, biotechnology is the industry with more pronounced syndication. Almost 61% of all firms funded (regardless of the rounds) have more than one investor. Among the other industries, industrial products and service exhibit a lower level of syndication, with slightly below 20% of the firms being backed by more than a single investor.

3.3.3 Type of current financing round (dummy)

Additionally, TVE gives information about five different stage categories: start-up/seed, early stage, expansion, later stage, and other. Similar to Gompers (1995) who labels the categories for bridge, second, and third stage financing as "late-stage" financing, we combined the TVE categories of expansion, later stage, and other to form a new category, which we also label "late stage". As there is no clear distinction between expansion financing that almost always occur in later phases and other financing activities, namely bridge financing or special-purpose financing, from the "later-stage" category, this combination appears to be the most reasonable classification scheme.

3.3.4 Funded firm age

With respect to hypothesis 1, arguing that with a higher risk of investing VCs should rely to a larger extent on syndication, we gathered data about the funded firms founding date and combined that information with the investment date to arrive at the age of the funded firm at the date of each capital infusion. As pointed out by Bygrave (1987) younger firms are more likely to fail and consequently firm age at investment can serve as a proxy for the riskiness of a venture.

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3.3.5 Amount of financing provided

According to Lockett and Wright (1999) the size of an investment plays an important role in the decision to syndicate. When VCs want to avoid clustering of risks or when the venture under consideration is

simply too large for the corresponding VCs the chances are higher that a deal will be carried out by a

syndicate. These elaborations are supported by the

findings of Manigart et al. (2006) that mitigation of risk is predominantly important for VCs. In order to test for the impact of the size of an investment we include the total amount provided for a given round

(regardless of whether a syndicate or a single investor provided the financing) into the empirical analysis.

3.4 Control variables

3.4.1 Type of VC investor (dummy)

As shown by Cumming (2006) the heterogeneity of VCs plays a significantly more important role in

providing growth capital to entrepreneurial firms in other countries than in the USA. Given the diversity of VC types in Germany we also control for the various affiliations of lead VCs (see, among others, Tykvova 2004). We classify the VC as being independent if there are no links to other firms or banks. Secondly, we classify VCs as bank dependent when a private bank founded them or a private bank holds more than 50% of the shares. Thirdly, we

classify a VC as public if the shares are hold by either the German government or one of the German public banking associations, i.e., Sparkassen or Landesbanken.

Additionally, we classified a VC as being a corporate VC when there were links to a large corporation or when a larger corporation founded the corresponding VC. Lastly, we include a dummy for cooperative VCs if one of the German cooperative banks holds more than 50% of the shares.

Moreover, the German VC market is characterized

by a vast number of foreign investors playing a

significant role in providing growth capital (Achleitner and Klöckner 2005). The data also allows meaningful conclusions to be reached on the use of syndication to access specialized market knowledge for VCs more unfamiliar with the market and cultural environment

in which they are acting by controlling for the origin of the corresponding VCs. Hence, we control for the origin of the various VCs using a dummy variable for

foreign VCs. An investor is recorded as foreign if he comes from a foreign origin and did not operate from a German branch.

3.4.2 VC investment focus (dummies)

We included three different investment focus variables for the VCs to control for experience within a focus industry, which proxies for more specific knowledge acquired. TVE includes three different investment domains. The respective dummies take on the value of one if the corresponding VC invests

mainly in high technology, medical/health, and non-

high industries or has no stated investment focus, respectively, and zero otherwise. A distinction using percentages is not carried out. We do, however, include the number of total investments into the given industry (in which the venture is active) as an

explanatory variable into the analysis to allow for a more fine-grained analysis.

3.4.3 (Cumulative) capital and funds managed

In order to proxy for experience acquired through the

management of capital over the past years we include a variable indicating the cumulative capital and

specific investment funds that the corresponding lead investor has managed until the end of the previous year. These measures are calculated using VC fund information from Thomson Venture Economics. Due to the high correlation among these variables, both will enter the regressions separately. Both variables are used as the log.

3.4.4 Previous round syndication (dummy)

In order to rule out any dependencies between the

given and the preceding rounds, we control for the

syndication behavior of VCs during the preceding round. We would expect that, if the preceding round has been financed by a syndicate, the chances for a

continuing joint effort are higher. Hence, we include a dummy into our analysis for subsequent financing rounds, controlling whether the preceding round was carried out by a syndicate, regardless of the size.

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3.4.5 Days between subsequent financing rounds

To account for the time between subsequent financing rounds we count the number of days between when the previous financing was provided and the current round. This should control for a possible erosion of industry knowledge beyond the experience gathered in the previous year and between successive financing rounds.

3.5 Empirical methodology

The empirical part of this paper consists of two separate analyses looking at syndication patterns within specific investment rounds and partner selection in later rounds that are used to test the impact of VC (and funded-firm) characteristics on the propensity to syndicate and into the decision with whom to syndicate. First of all we fit a logistic regression with the 1/0 decision to syndicate/invest alone. Thereby we control for year effects using yearly dummy variables (not tabulated) and also allow for clustering in the error terms over the VC investors, to cope with overrepresented VCs in the sample. Secondly, we fit another set of logit regressions with the 1/0 variable representing the decision to involve a new VC partner that has not invested in the previous round.

4 Analysis and results

Table 2 presents the summary statistics for the variables used in the empirical analysis. Concerning the stages one can infer that around 12% of the investments are done in the start-up stage, 25% in early-stage firms, and that the main bulk of the investments were carried out in late-stage investments. Due to the larger number of syndication in later stages (Table 3) the summary statistics might be slightly misleading a first glance. Due to double counting of investments (when more than a single VC provided financing and when more than a single round was provided) the actual number of firms initially financed in either stage is around 25% for both the start-up and the early stage. The remaining 50% of investments were made at later stages. Apparently, all ventures that run through subsequent stages are accounted for in the summary statistics as often as they receive financing (depending on the number of rounds and VCs involved).

With respect to the origin of the VCs one can infer that around 23% of the capital contributions stem from a VC with a foreign headquarter. Moreover, independent VCs account for the main body of the transactions and were involved in more than 60% of the individual capital contributions. The remainder is split among banking-dependent VCs (with 15%) and public VCs (with 13%). Cooperative and corporate VCs account for only 1% and 7%, respectively. Additionally, the main body of VCs has no specific investment focus (around 50%) whereas the other VCs concentrate on information-technology ventures (37%) and medical and health products (around 12%). Due to the low number of data points for some of dummy variables (namely cooperative and corporate VCs as well as VCs focusing on non-high- technology firms, these dummies had to be dropped from part of the empirical part when additional covariates were added). Noticeably, VCs managed on average five funds and had an average capital invested of some 40 million Euros and provided some 1.8 million Euros in a specific round on average. Again, these numbers are in the aggregate skewed towards overrepresented, larger VCs in the dataset. In fact, standard errors in the following empirical part were adjusted for clustering on the lead VC level to avoid a bias from overrepresented VCs.

With respect to hypothesis 1 , arguing that a higher risk associated with the investment influences the decision to syndicate positively, we find in specifications two to five (Table 3) that the age of the funded firm has a significant negative effect (at the 1% and 10% level, respectively) on propensity to syndicate. Younger and more risky companies call for a higher level of syndication. Accordingly, when the investment is provided to an older firm, less partner involvement is required and lead VCs syndicate to a lesser extent. Moreover, we can see that the amount provided in a given round is positively associated with the likelihood of syndication (at the 1% level). The more capital that is provided, the more the lead VC will invite partners to share the capital burden. The required investment amount can have a negative effect on the size of the overall portfolio and larger companies require VCs to take a much higher exposure when acquiring a sizeable equity stake, leading to a higher incentive to syndicate due to the intensified need to spread financial risks.

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Table 3 Investment round, lead VC characteristics, and the likelihood of investment round syndication

12 3 4 5

Start-up/seed -0.423 -0.446 -0.374 -0.232 -0.419 0.222* 0.279 0.286 0.209 0.359

Early stage 0.465 0.376 0.217 0.602 0.277 0.190** 0.228* 0.216 0.186*** 0.275

Industry experience 0.129 0.149 0.079 0.113 0.054 0.052** -0.055*** 0.042* 0.052** 0.030*

Non-high-tech -0.953 -0.555 -3.953 -0.767 -0.787 0.488* 0.571 0.979*** 0.488 0.737

Information tech -0.186 -0.153 -0.026 -0.19 0.047 0.188 0.232 0.213 0.177 0.252

Medical/health 0.071 -0.08 -0.237 -0.033 0.122 0.473 0.697 0.528 0.441 0.582

Foreign 0.867 0.769 0.473 0.812 0.913 0.213*** 0.280*** 0.421 0.204*** 0.341***

Banking -0.41 -0.114 -0.666 -0.4 0.409 0.395 0.513 0.659 0.371 0.486

Cooperative -0.288 0.066 -1.858 -0.18 0.549 0.567 0.744** 0.526

Independent -0.866 -0.93 -1.757 -0.907 -0.618 0.300*** 0.410** 0.565*** 0.284*** 0.378

Public -0.371 -0.388 -0.989 -0.338 -0.92 0.44 0.584 0.677 0.427 0.704

Age -0.033 -0.051 -0.088 -0.032 -0.104 0.02 0.036 0.025*** 0.018* 0.027***

Funds managed -0.056 0.095

Amount provided 0.897 0.117***

Previous round syndication 1.271 0.171***

Capital managed 0.022 0.055

Observations 1,616 1,123 704 1,616 742 Pseudo /?-squared 0.08 0.09 0.26 0.10 0.10

The table reports a logit model estimating the likelihood of lead VCs to involve partners during a specific round of investment. The table reports the coefficient estimate in the first line along with robust standard errors in the line below for each variable. Intercepts are not shown. Year dummies have been included in all regressions but are not tabulated. The year dummies 2004 and 2005 are positive and significantly different from the omitted 2000 year dummy in all regression specifications. The capital and funds managed enter the regression as the log. The variables "corporate" and "no focus" have been dropped to avoid perfect collinearity. Standard errors are adjusted for clustering on the VC level. Missing values for coefficients indicate that the corresponding variables have been omitted from the regression due to the low number of data points available *, **, *** denotes significance at the 10%, 5% or 1% level, respectively

With respect to the industry experience of the lead VCs, the results show support for hypothesis 2b, indicating that VCs with more industry experience

syndicate to a larger extent. The coefficient associated with industry experience that lead VCs have gained during the course of the preceding year is

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428 C. Hopp

positive and significant in all five regressions (significance levels vary, however). Hence, industry experience does not mitigate investment risks faced, but rather acts as a certification argument for

potential new partners. Only those VCs that possess industry experience can make use of syndication. Accordingly, our findings stress the importance of

enhancing a VCs network position as a vital strategy to improve deal flow and access to new knowledge (Hochberg et al. 2006, 2007). Moreover, the results show that syndicate financing seems to be rather stable over time. If a preceding round has been financed through a syndicate the likelihood that a future round will be financed by a group of VCs is

significantly higher. The coefficient associated with the dummy variable indicating whether the previous round has been subject to syndication is positive and

significant (at the 1% level). This indicates that in

general syndication for a given venture is not a one- time event. VCs investing in syndicates tend to build

upon their joint effort and rely on partner efforts in future rounds.

Concerning the control variables, Table 3 reveals that among the various VC types independent VCs

syndicate significantly less (when compared with the omitted corporate VC dummy). The coefficient associated with the dummy for independent VCs is

negative and significant in four out of five regression specifications (at the 5% level the least). Moreover, foreign VCs are also more likely to work with

partners when financing investments. The coefficient associated with the foreign VC dummy is highly significant in four out of five regression specifications estimated. This indicates that due to the nonfamiliar-

ity with the local market foreign VCs face a higher risk when investing and hence benefit more from

involving co-investors to access new expertise. With respect to stage of development, Table 3

indicates that more syndication occurs in the early- stage category. The coefficient associated with this variable is positive and significant (when compared with the omitted late-stage dummy). This indicates that, when investments are made in earlier stages (and investors face more risks), syndication is more

pronounced. However, for the start-up dummy this effect cannot be confirmed with the dataset. The start-

up dummy is not statistically significant at conventional levels. Lockett and Wright (1999, 2001) point out that the capital requirements for transactions are

lower in the earliest stages of company development. Accordingly, a lower capital burden in the start-up stage might offset the generally more pronounced risk and lower a VCs incentive to syndicate. Conse- quently, lead VCs benefit more from inviting partners in the early stage where ventures are still very risky but capital burdens become more intense. Thus, individual capital contributions could become more heavily clustered into single risky ventures and/or industries. Hence, the involvement of a partner VC might be a valid means to limit individual investment exposure.

For hypothesis 3 we would expect VCs to rely on previously established ties (partners already present in the syndicate) when industry experience is sufficient to make continuation/abandonment decisions and provide a higher quality of managerial advice. Hence, new partners should be invited in later rounds when leads VCs (and the partners that were invited previously) do not have enough industry knowledge or have not gained additional experience over the course of successive financing rounds. From the results in Table 4 we can infer that the industry experience of incumbent VCs is negative and significant (at the 1 % level), indicating that those syndicates that possess industry expertise are likely to reinforce their relationship and do not expand their partner radius. On the contrary, these results imply that networks are likely to be expanded when incumbents lack relevant industry experience. Moreover, the increase in industry experience (measured between two subsequent financing rounds) shows the same negative impact and is also significant at the 1% level. Hence, new partners are a valid alternative if the existing repository of

knowledge and information that different incumbents can contribute to the management of the funded venture are not sufficient to add value through better continuation/abandonment decisions and/or a higher quality of managerial advice.

Concerning the stage variables, we do not find any evidence that the involvement of new partners differs between subsequent stages of development. None of the dummy variables is significant at conventional levels. VC characteristics seem to be the main driving force of partner selection patterns here, and characteristics of the underlying transaction do not

significantly impact the likelihood of inviting a new

partner to join a subsequent financing round. How- ever, when a previous round has been subject to

syndication this significantly reduces the chances of a

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Table 4 Investment round, lead VC characteristics, and the involvement of new/additional partner VCs

12 3 4 5

Start-up/seed 0.22 0.245 0.235 0.369 -0.025 0.383 0.316 0.534 0.43 0.336

Early stage 0.114 0.303 0.213 0.474 0.109 0.199 0.204 0.191 0.393 0.277

Foreign -0.025 0.338 0.333 0.34 0.486 0.217 0.208 0.239 0.335 0.214**

Banking 0.041 -0.152 -0.108 0.044 -0.174 0.255 0.294 0.337 0.522 0.289

Independent -0.672 -0.967 -0.804 -1.335 -1.04 0.234*** 0.238*** 0.268*** 0.394*** 0.256***

Public 0.473 -0.1 0.133 0.019 -0.125 0.361 0.311 0.39 0.506 0.296

Information tech 0.125 0.025 0.044 -0.019 -0.079 0.22 0.192 0.217 0.279 0.206

Medical/health 0.152 -0.048 -0.098 -0.651 -0.02 0.277 0.308 0.311 0.646 0.3

Age -0.033 -0.055 -0.042 0.008 -0.057 0.018* 0.024** 0.03 0.013 0.023**

Industry experience -0.124 0.042***

Increase in industry experience -0.538 0.167***

Amount provided 0.383 0.070***

Days since last round 0.001 0.000**

Previous round syndication -0.841 0.151***

Observations 1045 1045 746 493 1045 Pseudo /?-squared 0.1 0.09 0.08 0.09 0.07

The table reports a logit model estimating the likelihood of lead VCs inviting new partners during a specific round of investment. The table reports the coefficient estimate in the first line along with robust standard errors in the line below for each variable. Intercepts are not shown. Year dummies have been included in all regressions but are not tabulated. None of the year is robustly and significantly different from the omitted 2000 year dummy in the regression specifications. The variables "cooperative" and "no focus" have been dropped to avoid perfect collinearity. The dummy variable for the non-high-technology focus of VCs has been dropped due to the low number of observations. Standard errors are adjusted for clustering on the VC level. Missing values for coefficients indicate that the corresponding variables have been omitted from the regression due to the low number of data points available * ** *** denotes significance at the 10%, 5% or 1% level, respectively

new partner joining; the coefficient is negative and

highly significant. Accordingly, incumbent VCs generally aim at providing money in subsequent rounds within the existing syndicate structure and only aim at new partners/knowledge when the existing repository does not suffice to provide an edge, as indicated

by the industry experience variables. Moreover, the amount provided positively influences the decision to invite a new VC. The variable is highly significant. Again, the higher the capital contributions become, the more likely a concentration of capital towards specific investments and industries becomes. For this

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430 C. Hopp

reason, the incentives for incumbent VCs to share the capital burden with new investors increase. Among the different groups of VCs, independent VCs tend to invite new partners to a lesser extent (when compared with the omitted cooperative dummy variable). This coefficient is negative and highly significant in all regression specifications. Concerning the focus variables, none of the coefficients is significant at conventional levels. None of the VCs focusing on certain industries seems to differ in their partner selection behavior. Lastly, the coefficient associated with the age variable is negative and significant in three out five regressions, but becomes insignificant when we control for other variables measuring the development of the firm. Hence, there is weak evidence that lower firm risk (as measured by the age variable) negatively affects the need to invite new partners.

5 Conclusion

In this paper we shed light on the syndication behavior of VCs in Germany. Using a sample of 2,373 unique capital contributions from 437 VCs over subsequent rounds into 961 start-ups during the period 1995-2005 in Germany we hypothesize investment behavior and test the potential consequences against the actual empirical outcome of the data set. We provide evidence that, for funded firms where products are far from commercialization, the risks that investors face are more severe and scrutiny in deal selection through syndication and subsequent managerial advice can be an important mechanism to align managerial effort with the goals of the financing VCs. Hence, VCs benefit from combining their investment expertise when risks are more pronounced.

We believe that situating the necessity to engage in interfirm relationships and the partnering choices of VCs in the dynamic environmental context by focusing on partnering decisions over time and rounds yields a better understanding of the importance of industry knowledge for the involvement of partners and especially for expansion of syndication networks to new partners. Industry experience in general is associated with more syndication. While we cannot distinguish between deal-flow reciproca- tion and management resources directly, the proxies illustrate the overall tendency of more experienced

VCs to enter to a larger extent into syndicate relationships. This provides evidence for networking motives and the legitimacy of more experienced VCs with respect to syndicate formation. More experienced lead VCs can capitalize on their previously acquired expertise and further expand their network through syndication. In line with the results of Hochberg et al. (2006, 2007) we find that syndication appears to be a vital strategy to enhance one's network position.

Moreover, we find that syndication in subsequent rounds serves as a means to combine industry experience to better select ventures and/or offer a higher quality of managerial advice. Hence, one can see that VCs tend to team up with new partners if the current network might not provide the necessary repository of skills and investment knowledge that might be needed to successfully finance and guide new ventures. By tracking the VC networks over time and industries, we open up the black box of network expansion strategies and show how a quest for partner resources can explain the dynamic patterns in VC collaboration by paying attention to the combination, generation, and dilution of investment experience. Syndication networks will only be broadened if potential new partners can offer additional value beyond the current composition of incumbent syndicate members.

Our results provide initial evidence that different forms of relationships matter for venture financing. Nevertheless, we need to gain further insights into the formation and closure of networks within the VC industry in order to gauge new perspectives on how and why firms syndicate. It might be interesting to investigate further with whom VCs syndicate and in which sense later-stage syndication involves more reputable partners in order to cushion potential transaction costs owed to more intense monitoring among the parties. The timing of partner involvement in certain stages and the reputation and the rank within the VC network could therefore yield more valuable insights into the mechanics of VC syndication. Additionally, the role of building up network ties and the impact of reciprocity and expected deal flow would present an interesting avenue for future research.

As the decision of whom to invite to participate in VC transactions lies at the heart of understanding why syndication might add value to the funded firm it

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When do venture capitalists collaborate? 43 1

might be worthwhile to investigate further which partners VCs tend to team up with and under which circumstances these relationships are established.

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