Coordination Frictions in Venture Capital Syndicates

by Ramana Nanda and Matthew Rhodes-Kropf
 
 

Overview — A startup typically has more than one investor, each with different incentives. Drawing on the authors’ experience, this paper documents frictions occurring when VCs with differing objectives work together in syndicates. Entrepreneurs must be careful about selecting and building the syndicate of VCs who back their firm.

Author Abstract

An extensive literature on venture capital has studied asymmetric information and agency problems between investors and entrepreneurs, examining how separating entrepreneurs from the investor can create frictions that might inhibit the funding of good projects. It has largely abstracted away from the fact that a startup typically does not have just one investor but rather several VCs that come together in a syndicate to finance a venture. In this paper, we therefore argue for an expansion of the standard perspective to also include frictions within VC syndicates. Put differently, what are the frictions that arise from the fact that there is not just one investor for each venture, but several investors with different incentives, objectives, and cash flow rights who nevertheless need to collaborate to help make the venture a success? We outline the ways in which these coordination frictions manifest themselves, describe the underlying drivers, and document several contractual solutions used by VCs to mitigate their effects. We believe that this broader perspective provides several promising avenues for future research.

Paper Information