VC Firms: Choose Partners Carefully

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  • According to new research, mismatched VC partnerships — where a prestigious VC firm partners with another VC firm regarded as having lower status — can be vulnerable to inefficiencies and ineffectiveness.

In many ways, venture capital firms are the “parents” of the business world. They provide money and guidance to their offspring (startups), which they hope will be tomorrow’s success stories.

So perhaps this should come as no surprise: New research led by Drexel LeBow’s Dali Ma suggests that just like people looking to start a family, VCs should choose their partner VC firms carefully.

According to this research, mismatched VC partnerships — where a prestigious VC firm partners with another VC firm regarded as having lower status — can be vulnerable to inefficiencies and ineffectiveness. Specifically, when the prestigious firm has a much smaller financial stake than the lesser-known firm, an ambiguous ownership order can result; the prestigious VC firm may be offering directions without consulting the lesser-known firm, and the latter may also be providing direct guidance based on its legitimate ownership advantage.

The mismatch can result in a disaster, explains venture capitalist Brad Svrluga, whom Ma and his co-authors quote in their paper: “Come to a crossroads for the company and suddenly you’re trying to herd a whole bunch of cats into a decision, or fielding anxious phone calls from all directions. Without a strong lead investor helping to manage her co-investors through that process, you as CEO are in for a splitting headache.”

Ma says the main takeaway for the financial services industry – not just VCs but also other sectors like investment banking – “Is that we talk a lot about the importance of prestige, but we need to make sure that if prestigious VC firms do not put enough money into a deal, the lead VC investor can still find a way to exert control.”

He adds that his research uncovered a couple of exceptions. Notably, it may not matter to portfolio companies that are doing extraordinarily well, because just like know-it-all teenagers, the venture capitalists’ squabbles “won’t have any effect on a CEO who won’t listen to their advice anyway.”

Dali Ma, Ph.D., assistant professor of management at Drexel LeBow, wrote “Power Source Mismatch and the Effectiveness of Interorganizational Relations: The Case of Venture Capital Syndication,” published in the Academy of Management Journal. His co-authors are Mooweon Rhee and Daegyu Yang.

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