Networks in Venture Capital Markets

Abstract

This paper sheds light on the significant role of networks, particularly alumni networks, in venture capital markets. I leverage the instance of a new partner, carrying new alumni networks, entering a venture capital firm as a plausible exogenous shock to the VC's alumni networks. This introduction of new alumni connections prompts an 8.21% increase in investments of startups founded by alumni. This impact is more pronounced in markets characterized by high risk, or founders who are underrepresented minorities, women, or from less prestigious universities. Conversely, these alumni ties trigger a 22.93% increase in failure rates, a 17.53% decline in acquisition rates, and 66.45% decline in IPO rates. Supplementary tests indicate that despite venture capitalists gaining better information from networks, the inherent preference for alumni startups offsets these advantages, leading to potential capital misallocation.

Keywords: Venture Capital, Alumni Networks, Information, Homophily Bias

JEL Classification: G02, G24, G3, L14, L02, L26