Insights On Why Venture Capital Firms Syndicate

Monday, February 14, 2005

Profs. Dirk De Clercq and Dimo Dimov Vlerick Leuven Gent, Management School & Ghent University, Belgium, http://

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Abstracted from: Explaining Venture Capital Firms' Syndication Behaviour: A Longitudinal Study
By: Profs. Dirk De Clercq and Dimo Dimov Vlerick Leuven Gent Management School & Ghent University, Belgium (DC); Instituto de Empresa, Madrid, Spain (DD)
Venture Capital: International Journal of Entrepreneurial Finance - Vol. 6, No. 4, Pgs. 243-256

A band of brothers.
Why venture capitalists often band together to invest in the same company­a practice known as syndication­has been the subject of scrutiny by numerous researchers in recent years. Some of them conclude that venture capitalists participate in syndicates to leverage their knowledge and experience in a specific industry or development stage, and invest in companies accordingly. Others assert that syndicates form because participants want to spread the financial risk. Seeking an answer, entrepreneurship scholars Dirk De Clercq and Dimo Dimov explored the relationship between the investment strategies of 200 venture capital firms between 1990 and 2001 and their syndication behavior.

Spreading the risk factor.
The authors argue that the desire to decrease investment uncertainty motivates venture-capital firms to invite participation in portfolio company investments. This added level of comfort may come from the sharing of complementary knowledge, both before and after investments are made. By cooperating with syndicate partners, the organizing VC firm collects a broad level of complementary information, which might help it find desirable investment targets and increase its ability to add value. If VC firms indeed syndicate to share complementary knowledge, their portfolio companies should have similar stage or industry characteristics. An alternative explanation is the desire to reduce financial risk. To achieve that goal, venture capitalists should invest in a wider range of deals to achieve diversification. A high level of investment specialization would therefore decrease the likelihood of participating in a syndicate.

Augmenting expertise not obvious.
The results of the authors' study suggest that the extent to which a VC firm participates in a syndicate depends on its historic investment strategy, as well as some baseline, inherent characteristics. Examination of intra-firm syndication patterns reveals more frequent syndication for later rounds and less specialized industry knowledge. Both results point to reduced financial risk and the desire to jump in just before companies go public as syndication drivers. However, an examination of VC funds' strategic decisions on a year-to-year basis offers little insight on the extent to which firms rely on syndicate partners to augment their own expertise.

Some patterns emerge.
An analysis of the activity between VC firms supports both the financial and the knowledge-based arguments. VC funds that join in later rounds also have more syndicate partners. This finding suggests the financial motivation for syndication, since later-round financing usually requires more capital and more participants to provide it. At the same time, however, the authors find support for the theory of knowledge-sharing motivation in the fact that funds investing in earlier-stage companies also tend to have more syndicate partners. Since early­stage companies require less capital, the desire to alleviate uncertainty by tapping a broad knowledge base­rather than to spread financial risk-may be the motivating force behind syndication. However, maintaining deal flow through deal sharing, or spreading the risk of potentially bad deals, may also push venture capital firms toward syndication.

Abstracted from Venture Capital:
International Journal of Entrepreneurial Finance
published by Routledge (part of Taylor & Francis Ltd.)
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