Print
E-MailOfer Eldar is Professor of Law, and Jillian Grennan is an Associate Adjunct Professor of Finance and Sustainability at the University of California, Berkeley. This post is based on their article forthcoming in the The Review of Financial Studies.
Venture capital (VC) investors play an important role in advising, monitoring, and providing expertise to entrepreneurial startups. VC investors typically have substantial control rights, and actively seek to constrain managerial discretion over key decisions through the appointment of board representatives. A key, yet often overlooked, feature of VC investments is that VC portfolios tend to include many startups in the same industry. In fact, the rate of startups in the same industry with a common VC investor has risen dramatically in recent years (Eldar and Grennan 2021). Most startups nowadays share a VC investor with at least one other startup in the same industry. Even startups that operate in the same line of business, such as Uber and Lyft, often raise capital from the same VC investors.
In our paper, Common Venture Capital Investors and Startup Growth, published in the Review of Financial Studies, we explore the relation between common VC investment and startups’ trajectory for growth and success. On one hand, VC investors could play favorites by diverting valuable competitive information from one startup to another. Startups that operate in complementary spaces within the same industry (such as software and media) may seek similar business opportunities, whether developing a new service or pursuing an attractive contract, and there is a risk that VCs will favor some startups at the expense of others. On the other hand, VC investors can act as incubators for valuable information and expertise. The expertise acquired through common investments at the industry level could benefit all portfolio companies and maximize VC investors’ returns. VCs can allocate different business opportunities efficiently to the startups that, based on the common VC’s information, are best positioned to pursue them.
Our paper examines the impact of common VC investment and startup performance, building on prior research that suggests that common VC investment facilitates strategic alliances (Lindsey 2008) and innovation spillovers among startups (Gonzalez-Uribe 2020). Our paper focuses on how common VC investment relates to pivotal startup outcomes, such as follow-on funding rounds, initial public offerings (IPOs), sales, and failures. These metrics are essential to discern if startups with common VC investments fare better or worse than their counterparts without such investments.
We use a novel empirical strategy based on the staggered adoption of laws that enable corporations incorporated in these states to adopt corporate opportunity waivers (COW laws). These waivers exempt investors and directors from litigation risk if they usurp a business opportunity in a way that conflicts with the firm’s best interest (see Rauterberg and Talley 2017). In particular, VC board members are privy to information that may bolster their expertise and effectiveness in managing startups but could also expose them to liability if it enables them to divert business opportunities from one startup to another. In our data of startups over the period of 1995-2018, we show that startups affected by the laws are more likely to have a within-industry common VC investor after the adoptions of the COW laws, suggesting that these laws had an impact on common VC investments.
Using the passage of COW laws as an instrumental variable (IV) for common VC investment, we find that common VC investment is associated with a variety of positive outcomes, including a higher probability of receiving an additional round of VC financing, a higher probability of an exit through an IPO, higher valuations when startups undergo IPOs, a higher probability of sale, and a lower probability of failure. This is consistent with common VC investors creating value for startups through efficient allocations of opportunities among startups in their portfolios rather than advantaging one startup at the expense of another.
Importantly, we uncover a channel through which startups benefit from positive spillovers in the portfolios of the same VCs – the appointment of directors on the boards of startups in the same portfolio. To our knowledge, our study is the first to spotlight this overlap. We first find that startups with a common VC owner have more VC directors on their boards, and that VC directors who sit on the boards of commonly held startups have thicker networks, meaning that they sit on the boards of multiple startups, especially same-industry startups. We then link startup outcomes to the cross-appointment of directors. Specifically, we find that common investment has little or no effect on startup growth and exits for startups without a VC director but stronger effects for those with VC directors and well-connected ones. Thus, our analysis suggests that information flows through VC directors drive the positive outcomes for startups that are associated with common VC investors.
We undertake many steps to address various concerns with the empirical strategy we undertake in the paper, including the exclusion of various subsamples that are susceptible to endogeneity, matching estimators, placebo tests, and a survey of startup lawyers. Despite all these steps, we acknowledge that we cannot rule out endogeneity concerns. However, our extensive analyses suggest that the COW laws are plausibly exogenous with respect to the outcomes we analyze.
Our study contributes to several broader strands of academic literature. We add to a large body of research that explores how VCs make investment decisions, especially studies emphasizing networks and economic ties. We contribute to the study of the role of overlapping directors, particularly studies that document information flows, and studies that document the role of VC directors in advising and monitoring startups. Next, we contribute to the emerging study of common ownership by extending it to the VC industry. Our study is the first to link common ownership to the cross-appointment of directors, thus providing evidence of an active channel through which common owners can influence firm policy. Finally, we contribute to the law and finance literature on what constitutes sound practice in corporate governance. Our results are consistent with a view that governance is not one size-fits-all, and in some cases, what might be considered lax governance – diluting the duty of loyalty with COWs – can be beneficial.
