The Venture Capital Syndication Model

The Venture Capital Syndication Model Early in venture capital’s development, individual funds were small. Multiple VC firms therefore began investing jointly in the same company: the syndication model. Syndication is now widespread. Among more than 30,000 US startups founded from 1980 to 2005, 70% received investment from two or more VCs. Eighty-eight percent of VC-backed companies that went public received funding from syndicates. How does syndication perform? What role does it play in startup value creation? Does it affect technological innovation? Xuan Tian empirically examined these questions in a 2012 Review of Finance article on the role of VC syndication in value creation for entrepreneurial firms. Mini-Case: Didi’s Prominent Investor Lineup Founded in 2012, Didi Chuxing, formerly Didi Dache, currently has a valuation exceeding $50 billion and is the undisputed leader in China’s smart-mobility sector. Its success owes much to support from many investors. (Its latest Nasdaq market capitalization is down to $12.5 billion, and it is about to delist from Nasdaq.) Initially, Didi positioned itself simply as a taxi-hailing app. In every round after Series B, powerful VC investors joined, greatly strengthening marketing, technology, connections, international expansion, and media relations. Its capabilities and ambitions grew rapidly. Take Series F: Didi raised $4.5 billion from a syndicate including Apple, China Life, Ant Financial, Tencent, China Merchants Bank, and SoftBank China. Apple’s participation cemented its smart-mobility identity. Tencent and Alibaba’s continued support made mobile use more convenient, extending the potential user base to almost all smartphone users and helping it become a sharing-economy pioneer. China Life, China Merchants Bank, and others also provided strong support for operating cash flow. With these resources combined, the original small boat became a luxury liner sailing toward tomorrow. ◇Product-Market Value Syndication brings together VC firms with different expertise, information sources, and networks, supplying startups with richer resources and guidance. Some are better at selecting ventures and willing to commit more to risky investments. Others have networks that help recruit high-quality employees, find suppliers and customers, and develop product markets. Still others excel at fundraising and provide substantial financial support. Few individual VCs possess all these resources. Compared with solo investment, syndication can therefore better enhance a company’s value in its product market. Diverse expertise, networks, and information also improve selection and management capabilities, encouraging investment in riskier innovative companies and, to some extent, fostering innovation. ◇Financial-Market Value Syndicated and solo investments differ in financial-market value creation. As noted earlier, company insiders and outside investors have asymmetric information. Demand for VC funds in capital markets also far exceeds supply. Multiple VCs choosing to invest in the same company therefore send a favorable signal to capital markets—an effect a single VC backer does not provide. Based on these differences, I believe the two approaches have different probabilities of successful exit, along with systematic differences in IPO underpricing and market valuation. But another possibility exists. A VC actively involved in a portfolio company’s early daily operations may acquire extensive firsthand information and discover exceptionally bright prospects. To avoid competition and keep the investment gains, it may exclude other VCs. In that case, solo investment could yield a higher probability of successful exit than syndication, along with stronger innovation and post-listing performance.