Vijay Yerramilli is Assistant Professor of Finance at University of Houston Bauer College of Business. This post is based on a recent paper authored by Professor Yerramilli and Buvaneshwaran Gokul Venugopal.
Networks are widespread in many financial markets, and play a crucial role in the transmission of information and mitigation of agency conflicts. In the context of entrepreneurial finance, Hochberg, Ljungqvist, and Lu (2007) show that venture capital (VC) funds with higher network centrality (i.e., better-networked VC funds) deliver better future performance, in terms of the proportion of their portfolio investments that successfully exit through an IPO or sale to another company. However, we know little about how networks are formed or how some investors end up becoming central to their networks. Is network centrality itself determined by reputation gained from good past performance? Do social connections translate into future co-investment connections? Addressing these questions is challenging because most financial markets are dominated by a few large institutions that became big via a series of consolidations, which makes it impossible to examine how their networks developed over time. Moreover, since individuals often move across institutions, the true relationship between individual performance and network connectedness may not be reflected in institution-level metrics of performance and network connectedness.
In our paper, How do Investors Accumulate Network Capital? Evidence from Angel Networks, which was recently made available on SSRN, we overcome these challenges by using the angel investor market to understand how investors accumulate network capital. This market provides an ideal setting because it allows us to focus on individual investors, and to examine how their position in the network changes over time with their performance. This is crucial because, unlike institutional investors such as VC funds or private equity groups, individual angels are not endowed with large network capital to begin with, and have to build their connections from the ground up. Given the high failure rate of start-ups, we can expect that angels who successfully guide their portfolio companies to the next stage of financing will subsequently become more important within their networks.
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