Do Startups Benefit from Their Investors’ Reputation? Evidence from a Randomized Field Experiment

Ting Xu is Assistant Professor of Finance at the University of Virginia Darden School of Business; Shai Bernstein is the Marvin Bower Associate Professor of Business Administration at Harvard Business School; and Richard Townsend is Associate Professor of Finance at the University of California San Diego, Rady School of Management. This post is based on their recent paper. Related research from the Program on the Corporate Governance includes Carrots and Sticks: How VCs Induce Entrepreneurial Teams to Sell Startups by Brian Broughman and Jesse Fried (discuss on the Forum here); Agency Costs of Venture Capitalist Control in Startups by Jesse Fried and Mira Ganor (discuss on the Forum here); Do VCs Use Inside Rounds to Dilute Founders? Some Evidence from Silicon Valley by Jesse Fried and Brian Broughman (discussed on the Forum here).

It is widely believed that venture capitalists (VCs) actively add value to startups beyond providing funding. For example, VCs may provide advice, connect startups to their networks, or help startups professionalize. However, it is also possible that VCs add value passively as well, simply by attaching their names to startups. Reputable VCs may attract important resources to their portfolio companies, like talent, customers, suppliers, or strategic partners. This helps startups overcome the “cold start” problem, namely convincing stakeholders to work with a firm that has little to no track record. While the potential for such passive value adding by VCs has long been discussed, there is scant empirical evidence on whether it actually occurs or is important in practice.

In a recent working paper, we test for passive value adding by VCs using a field experiment. Specifically, we focus on the labor market and study whether reputable VCs can passively attract talented employees to their portfolio companies. We analyze a field experiment conducted by AngelList Talent, the largest online search platform for startup jobs. Startups with job openings can post them on the site, and those interested in working for a startup can search these postings and apply. Beginning in February 2020, AngelList Talent began adding “badges” to their job search results. One badge highlighted whether a job was associated with a startup that was funded by a top-tier VC. A separate badge highlighted whether a job was associated with a startup that recently closed on a round of VC funding. The visibility of each type of badge was randomly enabled at the user level. Thus, a user with the top investor (recently funded) badge feature enabled would see the badge for all startups that merited it, while a user with the feature disabled would never see it.

This experiment allows us to assess how the attractiveness of a startup to potential employees depends on each dimension of VC funding information. The experiment also overcomes two empirical challenges. First, while we often observe whom startups hire, it is hard to observe the interest of job seekers in a startup. In the AngelList data, we can observe job seekers’ clicks for further information, clicks to begin the application process, and clicks to submit an application, which we use to proxy their interest in a startup. Second, there is endogeneity issue. For example, firms with better prospects may attract both reputable VCs and talent, without a necessary causal relationship between VCs and talent flow. The experiment overcomes this identification issue by allowing us to observe how potential employee interest in the same startup changes when positive funding information about that startup is randomly provided.

Our main finding is that reputable VCs do passively attract employees to their portfolio companies. Specifically, we find that the same startup receives significantly more interest from potential employees when it is represented with the top investor badge than when it is not. The magnitudes are economically large. The top investor badge causes a 30% increase in the probability of a user clicking on a job posting, relative to base rates. This is driven by a 26% increase in the probability of a click for further information about a job, a 35% increase in the probability of a click to begin the application process, and a 67% increase in the probability of actually submitting an application, when compared to base rates. These results show that employees prefer to work at startups funded by top-tier investors. Interestingly, we find no significant effect of the recently-funded badge on employee interest, nor any significant interaction between the effect of the recently-funded badge and the effect of the top-investor badge. These findings suggest that employees care much less about whether a startup was recently funded than who it was funded by. The lack of an effect of the recently-funded badge also shows that badges do not mechanically increase interest simply by drawing visual attention. Rather, the top-investor badge seems to have an effect due to the specific information that it encodes.

We then explore whether the effect of the top investor badge varies across startups with different characteristics. One might expect that potential employees would find the presence of top investors most informative for less-developed startups that are harder to evaluate. Consistent with this idea, we find that job seekers react more strongly to the top investor badge when it is associated with an early-stage startup (pre-Series-B) than with a later-stage one (post-Series-B).

We also explore whether the effect of the top investor badge varies across different types of job seekers. It seems plausible that those who are located in innovation hubs may be more familiar with venture capital and therefore may react more strongly to the presence of top investors. When we partition users into those who are located in innovation hubs (San Francisco Bay Area, New York, and Boston) and those who are not, we indeed find significantly stronger response by candidates located in innovation hubs.

One may be concerned that reputable VCs primarily draw the interest of low-quality candidates. This could occur, for example, if low-quality candidates tend to chase past success while high-quality candidates try to independently assess a startup’s prospects. If this is the case, the actual recruiting benefit from being backed by a top VC is smaller than what we think. However, we find that responsiveness to the top investor badge does not differ by candidate quality, measured in a variety of ways. Thus, top-tier investors seem to increase the size of the candidate pool, without changing the quality distribution of the pool.

Our paper provides insight into what drives talent flows to startups. Attracting talent is widely believed to be critical to a startup’s success. Indeed, it is often claimed that people are a startup’s most valuable asset, and that there is currently a skill shortage hindering startups’ success.

Thus, a key challenge that startups face is how to convince talented individuals to work for them rather than pursuing other, potentially more stable, career opportunities. Our study shows that investors’ reputation can help startups overcome this challenge. Top-tier VCs can aid in recruiting, not only by actively convincing talented individuals in their network to join their portfolio companies, but also by passively attracting talent from outside of their network. It is plausible that similar effects extend to other outcomes as well such as attracting valuable customers, suppliers, or strategic partners.

Our results also provide a new potential channel for performance persistence among VCs. Even without superior skills or access to deals, VCs with good past performance may be aided by reputation spillovers to their portfolio companies in achieving good future performance.

The complete paper is available for download here.

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