They're less attached to local entrepreneurs, write David Devigne, Sophie Manigart and Mike Wrigh

Devigne, David

Manigart, Sophie

Wright, Mike

Seed and early-stage venture capital were mainly provided by local investors in the past, as entrepreneurial companies need the hands-on advice of their investors to grow and develop. Investors also need to understand and monitor what their portfolio companies are doing. Investing across borders thus puts investors at a disadvantage compared to local investors: it brings liabilities of foreignness

Wright, Michael

Ghent University Academic Bibliography

Cross-border venture capitalists are less patient with under-performers

LSE Research Online

6/28/2016Cross-border venture capitalists are less patient with under-performersblogs.lse.ac.uk /businessreview/2016/06/28/cross-border-venture-capitalists-are-less-patient-with-under-performers/Oxstem, an Oxford biotech spin-off focusing on regenerative medicine for age-related diseases, recently raised arecord £16.9 million at start-up (Ward, 2016). The money was invested by the local Oxford Sciences Innovation fundand two American venture capital (VC) investors. Why is this important?Seed and early-stage venture capital were mainly provided by local investors in the past, as entrepreneurialcompanies need the hands-on advice of their investors to grow and develop. Investors also need to understand andmonitor what their portfolio companies are doing. Investing across borders thus puts investors at a disadvantagecompared to local investors: it brings liabilities of foreignness.Nevertheless, the VC industry is becoming increasingly international and foreigners invest abroad at an earlierstage. Syndicating with a local investor is one strategy to overcome the liabilities of foreignness: the local investorcan interact frequently with the entrepreneurs, help them and monitor what they’re doing. For a start-up, it isbeneficial to get money from a combination of local and international investors, as both bring complementary skills,experiences and networks to the table. There is strong empirical evidence that entrepreneurial companies funded bya combination of local and international investors tend to outperform those that have only local investors.Venture capital investors are frequently confronted with under-performing ventures, however. We know from earlierresearch that U.S. VC investors tend to escalate their commitment to under-performing ventures and continue toinvest, even when new information shows the portfolio company does not meet expectations (Guler, 2007). Thisnon-rational human decision-making has been widely documented in other situations. What is novel about ourresearch is that we differentiate between domestic investors, cross-border investors and foreign investors investingthrough a local branch office.We studied 684 young European high-tech companies that received VC and followed them until the VC investorsexited or up to ten years after the first investment (whichever came first). In total, 1060 different VC firms had1/3invested in these companies, in more than 1600 rounds. Combined, this allowed us to analyse 3222 investmentdecisions, of which 2399 by domestic investors, 568 by cross-border investors and 255 by branch investors. Almosthalf of the cross-border VC investors’ investments originate outside the EU.Our results suggest that, on average, VC investors in European ventures tend to escalate their commitment to afailing course of action. Additionally, we show that domestic VC firms have a significantly higher probability toescalate commitment when a portfolio company fails to meet its expectations compared to cross-border VC firms.We argue that these findings are driven by the larger geographical and cultural distance between entrepreneurs andcross-border investors. This makes cross-border investors less emotionally attached to the entrepreneur and lesssocially embedded in the portfolio company’s community compared to domestic investors. They thereby face loweremotional, social and normative pressures from entrepreneurs and stakeholders, such as the government or otherlocal businesses, making it easier for them to stop investing – which often leads to bankruptcy or liquidation.Branch investors share characteristics of both local and international investors. International venture capitalistsinvesting from a local branch typically employ local investment managers. The proximity of the branch office to theentrepreneurial company, and the strong embeddedness of local investment managers in the entrepreneur’scommunity, should make them behave like local investors. We nevertheless find that branch investors behave morelike cross-border investors in terminating underperforming ventures: their probability to escalate commitment islower than that of domestic VC firms. We explain this by branch investment committees including both local andhead office executives preventing escalation of commitment. Head office executives are less embedded in the localcommunity and have lower emotional ties to the entrepreneurs, hence effectively shielding them from institutionalpressures to continue to invest.Our research has implications for VC investors. We show that being a foreign VC investor has positive effects as iteases terminating underperforming investments. The finding that branch investors are less prone to escalatecommitment compared to domestic investors – despite employing local investment managers and the geographicalproximity to the portfolio companies – suggests that their organizational safeguard provided by investmentcommittees consisting of both local and head office executives prevents them from escalating commitment to afailing course of action. Domestic VC investors may hence mimic this organizational safeguard by including distantexecutives in their investment committees. Further, if foreign syndicate members abandon a project, domesticinvestors should carefully consider whether and why they should invest further in the same project.Our study also has important implications for high-tech entrepreneurs. Given the difficulty in raising finance fromoutside investors, high-tech entrepreneurs are often under pressure to accept finance whenever and wherever theycan find it. Yet, as we show, not all investors have the same commitment to portfolio companies that do not meetexpectations. While attracting foreign investors may be beneficial for portfolio companies when they perform well(Devigne et al., 2013), they terminate investments more easily when portfolio companies do not meet expectations.Entrepreneurs searching for finance should therefore carefully evaluate and target investors that match their needs.♣♣♣Notes:This article is based on Escalation of commitment in venture capital decision making: Differentiating betweendomestic and international investors, in Journal of Business Venturing, Volume 31, Issue 3, May 2016, Pages253–271The post gives the views of its authors, not the position of LSE Business Review or the London School ofEconomics.Featured image credit: Public DomainBefore commenting, please read our Comment Policy2/3David Devigne currently works as a Life Science investment manager at ParticipatieMaatschappijVlaanderen (an investment company managing a portfolio of €1,1 billion in assets) and is active asa research fellow at Vlerick Business School and Ghent University. He obtained a master degreein Pharmaceutical Sciences (2005), a master degree in Economics and Business Administration(2006), and a PhD degree in Applied Economics (2013) from Ghent University. He worked as aresearcher at the Department of Corporate Finance at Ghent University in 2007, and at VlerickBusiness School from 2008 to early 2014. His doctoral research focused on private equity andentrepreneurial ventures in Europe, which is the topic he continues to investigate in his currentresearch.Sophie Manigart is full professor of corporate finance and Gimv Private Equity Chair at VlerickBusiness School and Ghent University. She is associate editor of Entrepreneurship Theory andPractice. She has published numerous articles in leading international academic journals. Herresearch focuses on entrepreneurial finance, both from the demand and the supply perspective,and on the real effects of entrepreneurial finance choices on a venture’s development. She is arecipient of the Academy of Management Entrepreneurship Division Mentor Award. She is amember of the board of Gimv, AXA Belgium, the Belgian Venture Capital and Private EquityAssociation, among others.Mike Wright is Professor of Entrepreneurship at Imperial College Business School, Director of theCentre for Management Buyout Research, and a visiting professor at Ghent University. He is co-editor of Strategic Entrepreneurship Journal and of Academy of Management Perspectives. Hehas published over 50 books and more than 400 articles in leading international journals. Hisresearch focuses on entrepreneurial ownership mobility and entrepreneurial finance. He is Chair ofthe Society for the Advancement of Management Studies. He is a Past Chair of the Academy ofManagement Entrepreneurship Division and a recipient of that Division’s Mentor Award. He hasbeen ranked #1 worldwide for publications in academic entrepreneurship and in entrepreneurship.He is a member of the BVCA Research Advisory Committee. His research is regular covered in the financial andother media. Copyright © 2015 London School of Economics3/3

Cross-border venture capitalists are less patient with under-performers

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