Robustness checks

Our findings are based on a comparison of VCs’ syndicates during an economic crisis to an earlier baseline period selected to represent the VC market in a “normal” state. For the fi- nancial crisis, this baseline year was 2004; for the dot-com crisis, we chose the years 1997

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VC syndication in times of economic crisis Chapter 3

and 1998 (two years were used to create a more balanced sample with respect to the num- ber of funding rounds). As a robustness check, we used different baseline years. Table 3.5 extends our previous analysis by reporting the results of propensity score matching for multiple baseline years, focusing on second and later funding rounds. For the dot-com cri- sis, the year 1999 is taken as an additional year. Because the VC market was heating up during 1999, the number of rounds was larger than in the years 1997 and 1998 combined. For the financial crisis, we used the years 2005, 2006, and 2007 as separate baseline peri- ods. To summarize, Table 4 reports patterns similar to those of our main analysis; we ob- serve a reduction in the variables syndicate size and syndication dummy during the crisis in comparison to the baseline period. When controlling for IPO and fund-raising conditions, the effects became insignificant.

Table 3.5: Propensity score matching – robustness checks

Later rounds only

Syndicate size Syndication dummy Robustness checks Diff. in mean (t - Stat) Diff. in mean(t - Stat) Dot-com crisis Comparison period: 1997-1998

Excl. IPO- and fund inflow cond. -10% (-2.05) * -12% (-3.38) **

Incl. IPO- and fund inflow cond. -8% (-1.39) -9% (-1.85)

Comparison period: 1999

Excl. IPO- and fund inflow cond. -9% (-2.04) * -4% (-1.25)

Incl. IPO- and fund inflow cond. -2% (-0.04) -22% (-0.90)

Financial crisis

Comparison period: 2004

Excl. IPO- and fund inflow cond. -10% (-3.07) ** -5% (-1.93)

Incl. IPO- and fund inflow cond. +14% (0.63) +30% (1.42)

Comparison period: 2005

Excl. IPO- and fund inflow cond. -12% (-4.04) ** -5% (-1.96) *

Incl. IPO- and fund inflow cond. -2% (-0.08) -15% (-0.88)

Comparison period: 2006

Excl. IPO- and fund inflow cond. -5% (-1.74) -1% (-0.67)

Incl. IPO- and fund inflow cond. +10% (0.50) +28% (1.53)

Comparison period: 2007

Excl. IPO- and fund inflow cond. -13% (-4.94) ** -5% (-2.41) *

Incl. IPO- and fund inflow cond. +3% (0.08) -21% (-0.94)

Notes: This table reports % differences in means of matched cases for syndicate size and syndication dum-

my variables for before versus during the dot-com and financial crises. Propensity scores were estimated by

both excluding and including IPO and VC fund inflow measures. The symbols * and ** denote significance levels of 5% and 1%, respectively. Two-sided tests were employed. Data source: VentureXpert (accessed September 6, 2010).

57 V C s yn dicatio n in t imes o f e co n o mic c ris is Chapter 3

3.6 Discussion

This study addressed the influence of economic context on VC syndication. In particular, we analyzed the effect of an economic crisis on the likelihood of syndicate creation and syndicate size. When exploring VC syndication, previous studies have considered contex- tual aspects such as legal and institutional conditions (Cumming et al., 2010), cross-border contexts (Meuleman and Wright, 2011), the competition for new investment opportunities (Lockett and Wright, 1999), and the liquidity state of the IPO market (Cumming et al., 2005). We considered the effect of the dot-com crisis and the recent financial crisis on the likelihood of syndication as well as the syndicate size. The main findings of this study can be summarized as follows: (1) VCs have a lower tendency to syndicate their investments during a period of economic crisis, (2) in addition to a decrease in the share of syndicated rounds, syndicate size (the number of participants within a funding round) also decreased during both the dot-com and the financial crisis, and (3) the effect of an economic crisis on VCs’ tendency to syndicate and syndicate size was primarily found for later-stage rounds.

Previous literature has shown that the principle motives for VCs to engage in syndi- cates are characterized by portfolio diversification (Bygrave 1988; Lockett and Wright, 1999), the securing of future deal flow (Lockett and Wright, 2001; Manigart et al., 2006; Sorenson and Stuart, 2001), and knowledge sharing (Brander et al., 2002; Bygrave, 1987; Lerner, 1994b). Our study contributes to this literature by examining VCs’ tendencies to syndicate under changing economic contexts over time. We found that the formation of syndicates, as driven by the motives stated above, receives a lower priority during econom- ically turbulent times. Propensity score matching analysis supported Hypotheses 1 and 2, which state that both the likelihood to syndicate and the size of syndicates decreased during the dot-com and the financial crises. When controlling for less favorable fund-raising and IPO market conditions, differences in syndicate formations before versus during a crisis were no longer significant. We suggest that the worsened fund-raising and exit conditions during an economic crisis lead VCs to prioritize their engagement towards their core pro- jects. As less money was available for non-lead or new syndicate projects, a reduction in syndication was observed during both the dot-com and the financial crises. The reduction in VCs’ syndicates was only found for second and later funding rounds, supporting Hy- potheses 3 and 4. This result is consistent with the notion that exit markets are more likely to influence later-round versus first-round investments (Giot and Schwienbacher, 2007; Gompers and Lerner, 2004; Jeng and Wells, 2000).

Our findings do not support the argument that a rapid increase in the supply of capital leads to a lower tendency to engage in syndication (Lerner, 2002b). It has been argued that a VC is tempted to increase the amount of invested funds per start-up, keeping the number

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of portfolio firms on a manageable level. The potential advantages of syndication in this case would not be fully utilized. Our findings suggest the opposite: syndication is higher during economically prosperous times versus crisis times.

Previous research has shown that VCs engage in syndicates primarily to reduce and mitigate uncertainty (Brander et al., 2002; Bygrave, 1987; 1988; Lerner, 1994b; Lockett and Wright, 1999; 2001; Manigart et al., 2006; Sorenson and Stuart, 2001). Consistent with this argument, we should observe more syndication in times of economic crisis. A period of crisis may trigger a greater need for information and a sense of security. Grouping together with other VCs may address this need. Still, we found the opposite to be the case. Syndica- tion seems to decrease during an economic crisis. We suggest that, during a crisis, a new type of uncertainty arises as fund-raising and exiting become more uncertain and threaten the very existence of the VC. VCs adjust to this situation not through more syndication but by “retreating” to their existing portfolio and concentrating on their existing investments.

3.7 Conclusions

This chapter contributes to the syndication literature by examining VCs’ tendencies to syn- dicate under differing economic contexts over time. We compared VC syndication under more typical economical circumstances to VC syndication during the dot-com crisis and the financial crisis.

The observed decrease in syndication during an economic crisis can have consequenc- es for both VCs and start-up firms. First, lead VCs will find it increasingly difficult to ac- quire sufficient external funds for their start-ups. Second, they will become increasingly dependent on their own knowledge and expertise. Third, portfolio performance may be negatively affected because more connected VCs are likely to have better performing start- ups (Hochberg et al., 2007). For start-ups, fewer syndicate partners are likely to provide fewer financial means. Further, start-ups may experience a lower availability of industry- specific knowledge (Saetre, 2003), managerial experience (Kanniainen and Keuschnigg, 2004; Schefczyk and Gerpott, 2001), and access to distribution networks (Timmons and Bygrave, 1986). A start-ups business plan may need to be reassessed; cutting costs or post- poning expansion plans may be necessary countermeasures to survive a period of economic crisis.

Further research could be directed toward the question of whether VCs syndicate rela- tively more with familiar partners in familiar start-ups during periods of economic crisis. In the alliance literature, the concept of relational embeddedness (Uzzi, 1997) indicates that partners who have collaborated more frequently in the past are more likely to engage in

59 V C s yn dicatio n in t imes o f e co n o mic c ris is Chapter 3

joint problem-solving. In addition, during times of increased uncertainty, collaboration with familiar partners is preferred over the formation of new relationships (Gulati, 1995; Gulati and Gargiulo, 1999). Network analysis may confirm that VC syndicates are more explorative during periods of economic prosperity, and focus more on existing relation- ships during periods of economic crisis. Second, the identity of a VC’s syndicate partners may change during economically prosperous vs. turbulent times. Co-investors, such as banks, insurance companies, industrial firms and pension funds, are likely to be more pas- sive and less engaged in comparison to the leading VC (see also Sorenson and Stuart, 2008). They may therefore have a greater incentive to reduce their exposure to the VC market during more turbulent times. Lastly, where our analysis has been on the funding round level, we were not able differentiate in the effect of a crisis for lead- versus non-lead syndicate partners. Lead VCs hold the highest stakes in a startup and therefore have a greater incentive to assure the survival of a startup during a crisis.

PART II