A study finds that the pandemic led to a 43% increase in distance between venture capitalists and their portfolio companies, resulting in more investment in distant startups and a preference for mature firms, but no significant difference in company valuations.
Summary:
VCs invested in more distant startups during the pandemic, resulting in a 43% increase in distance between investors and their portfolio companies. VCs were more likely to invest in mature firms, appoint fewer board members post-pandemic, and there was no significant difference in company valuations.
The study suggests that it is impossible to perfectly replace soft information through online communication and the findings should be interpreted with caution due to the short time available to observe exits.
Full report available: HERE (ResearchGate)
Below you can find key takeaways from the report:
- The pandemic-induced shift from in-person to online interactions impacted the behavior of venture capital investors, and uses data to show that the distance between VC investors and their portfolio companies increased by 43%.
- VCs invest 15% less in their own state after Covid, equally invest in hub areas, and invest in more mature firms with fewer board members appointed, while showing no significant difference in company valuations; they are also up to 13% more likely to engage in syndicated deals post-Covid, and deal-sourced online VC investments have no significant difference in the likelihood of raising a second financing round.
- VCs invested more remotely and cautiously, made smaller steps towards a new model, and selected startups with more similar characteristics to distant investments. The results also suggest that expanding geographic investments might decrease the importance of traditional clusters of entrepreneurship and that online communication cannot replace in-person interactions for collecting soft information.
Literature review
- This study shows that as a result of the pandemic, VCs adjusted their selection criteria for portfolio companies. Furthermore, VCs were more likely to co-invest with known syndicate parties, and information technologies played a role in new collaborations, with an equalizing force on middle-tier universities, women, and scientists from non-elite institutions, while new investment behavior is not restricted to the US, and older and more focused VCs are adapting the most to new market opportunities.
Data
- This paper analyzes the effects of Covid-19 on the US-based VC industry using Refinitiv and Pitchbook datasets, as well as Compustat, BFS, and SBPS data sources. It focuses on U.S.-based entrepreneurial companies and examines the impact of new businesses and industry changes on VC investments, highlighting the importance of soft information collection and the role of in-person interactions, which has been altered by new communication technologies.
VC industry
- After the onset of the Covid-19 pandemic, VC investors adopted videoconferencing and expanded their geographical investment horizons, investing on average 43% to 51% farther away from them, with less experienced VCs being more likely to invest in more distant companies, and investing in companies located in entrepreneurial hubs less frequently.
- VC firms located in entrepreneurial hubs invest differently compared to those outside the hubs, with in-hub VCs investing farther away from their headquarters, and out-of-hub VCs investing farther away from their headquarters; this change in behavior by in-hub VCs investing less in hub companies may explain the increase in distance between VCs and their portfolio companies, which may be due to new opportunities or an increase in new businesses in distant states.
Industry Change
- VCs may have preferred to invest in distant states due to the Covid-19 crisis impact on the overall economy and changes in industry composition. To control for some states experiencing higher VC financing post-Covid, the change in portfolio company's state growth rate due to Covid-19 was estimated. The relationship between distance and the industry hit variable was found to be not significant, indicating that the increase in distance is not mainly explained by growth in industries located farther from an average VC.
Business Creation
- To investigate if the Covid-19-induced increase in distant investments is related to state-level factors, the study analyzed the growth rate of business applications per state and found no significant correlation. The study suggests that the increase in distance may be due to higher local competition among VCs, which results in them seeking opportunities in more remote areas. The impact of Covid-19 is not driven by too much money flowing into the state.
Startup Characteristics
- VCs responded to the Covid pandemic by investing in more mature companies, with a longer track record, and investing in more distant companies. VCs may prefer to deviate from their focus industries, which suggests risk-taking behavior or chasing hot opportunities. Startups receiving VC financing post-Covid are less likely to have received pre-VC financing. Pre-money valuations decreased after Covid-19, but adding VC firm fixed effects did not result in a significant change in valuation. Videoconferencing may enable VCs to invest in younger firms and/or appoint more board members for distant firms.
Board Control
- After the Covid pandemic, venture capitalists (VCs) received fewer board seats in their portfolio companies, and the decrease in board seats is not significantly related to the distance between the VC and the company. VCs prefer investing and monitoring local portfolio companies. However, the increase in distance to investments did not necessarily result in a corresponding increase in syndication, suggesting that online meetings may be a good alternative to in-person interactions. Post-pandemic, VCs relied more on their networks to obtain information, but distance did not play a significant role in syndication decisions. The decrease in board seats after Covid suggests that online interactions may not be optimal for fulfilling board responsibilities, and VC networks may become more distant due to increased remote communication.
- In this study, the impact of the Covid pandemic on syndicate member geography is examined using regression analysis. The results show that syndicate members became more geographically distant by 22% to 32% after the pandemic, primarily due to the focal VC's distant investments. VCs are less likely to partner with old syndicate members after Covid, but this effect is weaker when accounting for VC firm fixed effects. However, VCs outside large entrepreneurship hubs are more likely to syndicate with prior partners. After the pandemic onset, VCs invest with fewer local VCs but are as likely to ensure that there is at least one investor within a short drive distance from the company. VCs appear to be reaching out to a wider network, but they still prefer to partner with their old connections and reach out to at least one VC located in the company's local area.
- This section presents initial findings on the performance of online deal sourcing. Using Refinitiv data until July 2022, we analyze the probability of receiving a second round of financing within 6, 12, and 18 months, as well as the probabilities of exiting via IPO or M&A within 18 months. We include relevant controls in our exit regressions and find that the likelihood of receiving a second round is not significantly different for companies that received their first round during the post-Covid period. However, for those that did receive their first round during this period, the probability of receiving a second round within 12 or 18 months increases by 5 or 11 percentage points, respectively. Results remain consistent when extending the pre-Covid period and including industry-state fixed effects. Overall, companies that received VC financing after the Covid-19 pandemic perform similarly in terms of fast exits.
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Reference:
- https://www.researchgate.net/publication/363562934_From_in-person_to_online_the_new_shape_of_the_VC_industry