Ethnic matching in the U.S. venture capital market

https://doi.org/10.1016/j.jbusvent.2014.09.001Get rights and content

Highlights

  • We study founder and venture capitalist (VC) co-ethnicity in shaping whether, when, and how investments take place.

  • A shared ethnicity increases the probability of an investment match.

  • Conditional on an investment, co-ethnicity is associated with earlier and deeper VC involvement.

  • However, matches based on a shared ethnicity are associated with less successful company outcomes.

Abstract

We document the role of entrepreneurial founder and venture capital (VC) partner co-ethnicity in shaping investment relationships. Co-ethnicity increases the likelihood that a VC firm invests in a company. Conditional on investment, co-ethnicity strengthens the degree of involvement by raising the likelihood of VC board of director involvement and increasing the size and scope of investment. These results are consistent with trust and social-network based mechanisms. Shared ethnicity in our sample is associated with worse investment outcomes as measured by investment liquidity, however, which our results suggest might stem from looser screening and/or corporate governance.

Section snippets

Executive summary

In addition to being resource-poor like other entrepreneurs, ethnic entrepreneurs face a further challenge of financial resource assembly by virtue of their ethnic status. While most of the existing literature studies remedies involving the rise of informal institutions (such as rotating credit associations) or changes to formal ones (such as changes to legal or regulatory rules affecting banks), we explore how co-ethnicity between venture capitalists (VCs) and entrepreneurs can accomplish a

Prior literature and hypotheses

Based on the perspective that entrepreneurship is a process embedded within a social context (Aldrich and Zimmer, 1986), there might be two mechanisms by which ethnic entrepreneurs may disproportionately match with co-ethnic VCs (and do so in a “deeper” fashion when there is such a match) in the face of resource mobilization challenges: a pure preference-based/trust mechanism and an “enforced” trust one in which network closure and other sanctioning mechanisms within an ethnic group may lower

Sample design

We collect our data, which spans 1984–2009, from VentureEconomics (VE), which is one of the largest and most complete databases on VC investments.6

Initial evidence

If ethnic ties were important for how matches are formed in the VC industry, we would expect to observe them occurring more frequently than would otherwise be expected. Table 2 presents statistics consistent with this expectation. In the first column, labeled “VC firms where (at least) one partner has ethnicity”, we report the frequency of pairs with (at least) one ethnic partner. As for the most common ethnicities, we note that about 20% of VC firms have a Jewish partner, 14% an Indian

Concluding discussion

We investigate the empirical relevance of personal similarity in the U.S. VC market, focusing on co-ethnicity between VC partners and company founders. Our results show that person-based matching based on shared ethnicity is a strong predictor of the likelihood of an investment. Our study moves beyond this likelihood analysis, and investigates investment behavior conditional on an investment match: the likelihood that a VC partner takes a board seat in the company, the timing and stage of

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    We appreciate the comments from Bill Kerr, Antoinette Schoar, Morten Sorensen, Ivo Welch, seminar participants at the RFS/Kauffman Entrepreneurial Finance and Innovation Conference, the Academy of Management Annual Meeting, UNC-Chapel Hill, and the editorial team, especially the editor, Gavin Cassar. We thank our institutions for funding this project, and Kyle Wang for the excellent research assistance. Professor Ola Bengtsson sadly passed away in January 2014. He devoted his academic career to the study of entrepreneurial finance, and he is greatly missed by that research community and by his family and friends.

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