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...C i versus those led by VC j.6 Networks are not static. Relationships may change, and entry to and exit from the network may change each actor’s centrality. We therefore construct our adjacency matrices over trailing five-year windows. Using these matrices, we construct five centrality measures based on three popular concepts of centrality: Degree, closeness, and betweenness. Using a numerical example, the Appendix shows in detail how these centrality measures are constructed. Here, we focus on how each measure captures a slightly different aspect of a VC’s economic role in the network. 3 See Wasserman and Faust (1997) for a detailed review of network analysis methods. 4 For tractability, the graph excludes biotech-focused VC firms that have no syndication relationships during this period. 5 As the example in the Appendix illustrates, this method of coding ties produces a binary adjacency matrix. It is possible to construct a valued adjacency matrix accounting not only for the existence of a tie between two VCs but also for the number of times there is a tie between them. While the results reported in the following sections utilize the binary matrix, we note that all our results are robust to using network ...

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...he aggregate VC fund inflows in the year a sample fund was raised and the year a portfolio company completed a funding round, respectively. Table I shows that the average sample fund was raised in a year in which $23.8 billion flowed into the VC industry. This ranges from a low of $2.3 billion (1980) to a high of $84.6 billion (1999). Controlling for the investment opportunities open to a VC is harder. Gompers and Lerner (2000) propose public-market pricing multiples as indirect measures of the investment climate in the private markets. There is a long tradition in corporate finance, based on Tobin (1969), that views low book-tomarket (B/M) ratios in an industry as an indication of favorable investment opportunities. Price-earnings (P/E) ratios are sometimes used for the same purpose. By definition, private companies lack market value data, so we must rely on multiples from publicly traded companies. To allow for inter-industry differences in investment opportunities, we map all COMPUSTAT companies into the six broad Venture Economics industries. We begin with VC-backed companies that Venture Economics identifies as having gone public, and for which therefore SIC codes are available. We then i...

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...underwrite securities offerings with banks they have long-standing relationships with (Corwin and Schultz (2005)). In the same spirit, networks feature prominently in the venture capital industry. VCs tend to syndicate their investments with other VCs, rather than investing alone (Lerner (1994a)). They are thus bound by their current and past investments into webs of relationships with other VCs. Once they have invested in a company, VCs draw on their networks of service providers – head hunters, patent lawyers, investment bankers etc. – to help the company succeed (Gorman and Sahlman (1989), Sahlman (1990)). Indeed, one prominent VC goes as far as describing itself as a venture keiretsu (Lindsey (2003), Hsu (2004)). The capital VCs invest in promising new ventures comes from a small set of institutional and other investors with whom they tend to have long-established relationships. In all these instances, many VCs show a preference for networks rather than arm’s-length, spot-market transactions. While the prevalence of networking in many financial markets has been documented in the literature, the performance consequences of this organizational choice remain unknown. In the venture capital mark...

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...rocity (Lerner (1994a)). Second, by checking each other’s willingness to invest in potentially promising deals, VCs can pool correlated signals and thereby may select better investments in situations of often extreme uncertainty about the viability and return potential of investment proposals (Wilson (1968), Sah and Stiglitz (1986)). Third, individual VCs tend to have investment expertise that is both sector-specific and location-specific. Syndication helps diffuse information across sector boundaries and expands the spatial radius of exchange, thus allowing VCs to diversify their portfolios (Stuart and Sorensen (2001)). In addition to improving deal flow, syndication networks may also help VCs add value to their portfolio companies.1 Syndication networks facilitate the sharing of information, contacts, and resources among VCs (Bygrave (1988)), for instance by expanding the range of strategic alliance partners and launch customers for their portfolio companies. No less importantly, strong relationships with other VCs likely improve the chances of securing follow-on VC funding for portfolio companies, and may indirectly provide access to other VCs’ relationships with service providers such as head hunters an...

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... ability to add value to portfolio companies). Syndication likely affects both of these performance drivers. 2 There are at least three reasons to expect syndication networks to improve the quality of deal flow. First, VCs invite others to co-invest in their promising deals in expectation of future reciprocity (Lerner (1994a)). Second, by checking each other’s willingness to invest in potentially promising deals, VCs can pool correlated signals and thereby may select better investments in situations of often extreme uncertainty about the viability and return potential of investment proposals (Wilson (1968), Sah and Stiglitz (1986)). Third, individual VCs tend to have investment expertise that is both sector-specific and location-specific. Syndication helps diffuse information across sector boundaries and expands the spatial radius of exchange, thus allowing VCs to diversify their portfolios (Stuart and Sorensen (2001)). In addition to improving deal flow, syndication networks may also help VCs add value to their portfolio companies.1 Syndication networks facilitate the sharing of information, contacts, and resources among VCs (Bygrave (1988)), for instance by expanding the range of strategic al...

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... only robust to these modifications, but their economic significance increases substantially. In the California network, exit rates improve by approximately five percentage points relative to the unconditional mean of 35.7% among California VCs. Our contribution is fivefold. This is the first paper to examine the performance consequences of the VC industry’s predominant choice of organizational form: Networks. Previous work has focused on describing the structure of syndication networks (Bygrave (1987, 1988), Stuart and Sorensen (2001)) and motivating 5 the use of syndication (Lerner (1994a), Podolny (2001), Brander, Amit, and Antweiler (2002)). Second, our findings shed light on the industrial organization of the VC market. Like many financial markets, the VC market differs from the traditional arm’s-length spot markets of classical microeconomics. The high returns to being well-networked we document suggest that enhancing one’s network position should be an important strategic consideration for an incumbent VC, while presenting a potential barrier to entry for new VCs. Third, our findings have ramifications for institutional investors choosing VC funds to invest in, as better networked VCs app...

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... value to portfolio companies). Syndication likely affects both of these performance drivers. 2 There are at least three reasons to expect syndication networks to improve the quality of deal flow. First, VCs invite others to co-invest in their promising deals in expectation of future reciprocity (Lerner (1994a)). Second, by checking each other’s willingness to invest in potentially promising deals, VCs can pool correlated signals and thereby may select better investments in situations of often extreme uncertainty about the viability and return potential of investment proposals (Wilson (1968), Sah and Stiglitz (1986)). Third, individual VCs tend to have investment expertise that is both sector-specific and location-specific. Syndication helps diffuse information across sector boundaries and expands the spatial radius of exchange, thus allowing VCs to diversify their portfolios (Stuart and Sorensen (2001)). In addition to improving deal flow, syndication networks may also help VCs add value to their portfolio companies.1 Syndication networks facilitate the sharing of information, contacts, and resources among VCs (Bygrave (1988)), for instance by expanding the range of strategic alliance partners and launc...

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..., deal flow, expertise, contacts, and pools of capital it has access to; the frequency with which it is invited to co-invest in other VCs’ deals, thereby expanding its investment opportunity set; its ability to generate such co-investment opportunities in the future by syndicating its own deals today in the hope of future payback from its syndication partners; its access to the best-connected VCs; and its 1 The literature has documented a number of ways in which VCs add value to their portfolio companies, such as addressing weaknesses in the original business plan or the entrepreneurial team (Kaplan and Strömberg (2004)), professionalizing the company (Hellmann and Puri (2002)), reducing the time to product market (Hellmann and Puri (2000)), facilitating strategic alliances among portfolio companies (Lindsey (2003)), and ensuring strong governance structures at the time of the IPO (Hochberg (2004)). 2 Examples of prior applications of network analysis in a financial context include Robinson and Stuart (2004), who study the governance of strategic alliances, and Stuart, Hoang, and Hybels (1999), who focus on the effect of strategic alliance networks on the performance of biotech ventures. 3 ability to act as ...

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... they hold, and occasionally lacks information even on the amount invested.14 Instead, we use two indirect measures of company-level performance. Most venture-backed investments are “staged” in the sense that portfolio companies are periodically reevaluated and receive follow-on funding only if their prospects remain promising (Gompers (1995)). Thus, we view survival to another funding round as an interim signal of success. Eventually, successful portfolio companies are taken public or sold. Absent return data, we follow Gompers and Lerner (1998, 2000), Brander, Amit, and Antweiler (2002) and Sorensen (2003) in taking the 14 But see Cochrane (2005) for an analysis of company-level rates of return using data from an alternative database (VentureOne), and see Ljungqvist and Richardson (2003) for similar analysis using a proprietary dataset of 4,000 private equity-backed companies. 13 occurrence of an IPO or M&A transaction as a final signal of the investment’s success.15 We restrict the dataset to companies that received their first institutional funding round between 1980 and 1999, and record their subsequent funding rounds and, if applicable, exit events through November 2003.16 Figure 3 shows wh...

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...hat are distributed to the fund’s investors. The exit phase typically occupies the second half of the fund’s life. At the end of the fund’s life, any remaining portfolio holdings are sold or liquidated and the proceeds distributed to the investors. Owing to this investment cycle, relatively recent funds have not yet operated for long enough to measure their lifetime performance. But simply excluding relatively recent funds is sometimes felt to result in performance measures that do not reflect the changes in, and current state of, the VC industry. As a compromise, Kaplan and Schoar (2005) and Jones and Rhodes-Kropf (2003) consider all funds raised up to and including 1999, but also show robustness to excluding funds that have not yet completed their ten-year runs as of the end of their sample period. In the same spirit, we consider all investments made by VC funds raised between 1980 and 1999 that are included in the Venture Economics database. We begin in 1980 because venture capital as an asset class that attracts institutional investors has only existed since the 1980 ERISA “Safe Harbor” regulation.9 Closing the sample period at year-end 1999 provides at least four years of operation for the youngest funds,...

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...panies. At the fund level, we examine “exit rates” in the absence of publicly available data on VC fund returns. We define a fund’s exit rate as the fraction of portfolio companies that are successfully exited via an initial public offering (IPO) or a sale to another company. At the portfolio company level, we examine not only whether or not the portfolio company achieved a successful exit, but also intermediate performance, namely whether the portfolio company survived to obtain an additional round of funding. Controlling for other known determinants of VC fund performance such as fund size (Kaplan and Schoar (2005)) as well as the competitive funding environment and the investment opportunities facing the VC (Gompers and Lerner (2000)), we find that VCs that are better networked at the time a fund is raised subsequently enjoy significantly better fund performance, as measured by the rate of successful portfolio exits over the next ten years. Comparing our five centrality measures suggests that the size of a VC firm’s network, its ability to be invited into other VCs’ syndicates, and its access to the best networked VCs have the largest effect economically, while an ability to act as an intermediary in b...

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...e not stock 8 Formally, given an adjacency matrix A, the eigenvector centrality of actor i is given by evi=a∑Aijevj where a is a parameter required to give the equations a non-trivial solution (and is therefore the reciprocal of an eigenvalue). As the centrality of each actor is determined by the centrality of the actors he is connected to, the centralities will be the elements of the principal eigenvector. 9 market traded, nor do they disclose fund valuations. The typical fund spends its first three or so years selecting companies to invest in, and then nurtures them over the next few years (Ljungqvist and Richardson (2003)). Successful portfolio companies are exited via IPOs or sales to other companies, which generate capital inflows (and hopefully capital gains) that are distributed to the fund’s investors. The exit phase typically occupies the second half of the fund’s life. At the end of the fund’s life, any remaining portfolio holdings are sold or liquidated and the proceeds distributed to the investors. Owing to this investment cycle, relatively recent funds have not yet operated for long enough to measure their lifetime performance. But simply excluding relatively recent funds is sometimes felt to result ...

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...Schultz (2005)). In the same spirit, networks feature prominently in the venture capital industry. VCs tend to syndicate their investments with other VCs, rather than investing alone (Lerner (1994a)). They are thus bound by their current and past investments into webs of relationships with other VCs. Once they have invested in a company, VCs draw on their networks of service providers – head hunters, patent lawyers, investment bankers etc. – to help the company succeed (Gorman and Sahlman (1989), Sahlman (1990)). Indeed, one prominent VC goes as far as describing itself as a venture keiretsu (Lindsey (2003), Hsu (2004)). The capital VCs invest in promising new ventures comes from a small set of institutional and other investors with whom they tend to have long-established relationships. In all these instances, many VCs show a preference for networks rather than arm’s-length, spot-market transactions. While the prevalence of networking in many financial markets has been documented in the literature, the performance consequences of this organizational choice remain unknown. In the venture capital market, for instance, some VCs presumably have better-quality relationships and hence enjoy more influ...

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...Cs; and its 1 The literature has documented a number of ways in which VCs add value to their portfolio companies, such as addressing weaknesses in the original business plan or the entrepreneurial team (Kaplan and Strömberg (2004)), professionalizing the company (Hellmann and Puri (2002)), reducing the time to product market (Hellmann and Puri (2000)), facilitating strategic alliances among portfolio companies (Lindsey (2003)), and ensuring strong governance structures at the time of the IPO (Hochberg (2004)). 2 Examples of prior applications of network analysis in a financial context include Robinson and Stuart (2004), who study the governance of strategic alliances, and Stuart, Hoang, and Hybels (1999), who focus on the effect of strategic alliance networks on the performance of biotech ventures. 3 ability to act as an intermediary who can bring together VCs with complementary skills or investment opportunities who lack a direct relationship between them. In addition to measures of how well networked each VC is, we require data on the performance of VC investments. We examine both the performance of the VC fund and of the fund’s portfolio companies. At the fund level, we examine “exit rates” in the absenc...