Syndication of Venture Capital Investments - Lerner (1994) Why do Venture Capitalists Syndicate? 1. Syndication (in the first round) may lead to a superior selection of investments. Another venture capitalist’s willingness to invest in the new firm may be an important factor in the lead venture investor’s decision to invest. George Middlemas (a practitioner): “If two or three funds whose thinking you respect agree to go along, that is a double check to your own thinking.”

Syndication of Venture Capital Investments - Lerner (1994) Why do Venture Capitalists Syndicate? 2. Syndication (in later rounds) resolves information asymmetries between the initial venture investors and other potential investors in later rounds. Initial venture investor is very closely involved with the day-to- day running of the firm. Will have a more precise estimate of the value of the firm than outside investors. Initial venture capitalist has an incentive to understate/overstate the proper price for the securities in the next financing round. The only way to avoid this opportunistic behavior is if the lead venture capitalist maintains a constant share of the firm’s equity. => Later-round financing must be syndicated.

Syndication of Venture Capital Investments - Lerner (1994) Why do Venture Capitalists Syndicate? 3. Syndication is a mechanism through which venture capitalists collude to overstate their past-performance to potential investors. It is difficult to evaluate the performance of a pension fund by considering its quarterly or annual return. Pension funds “window dress.” Pension fund managers adjust their portfolios at the end of quarter by buying firms whose shares have appreciated and selling “mistakes.” Initial-stage venture capitalists may generate goodwill with their colleagues by permitting them to invest in later-round financings in promising companies. Quid pro quo: The syndication partners will in turn offer such opportunities to invest in the later rounds of their promising companies.

Syndication of Venture Capital Investments - Lerner (1994) Practical Implications 1. Syndication (in the first round) may lead to a superior selection of investments. Experienced venture capitalists will primarily syndicate first- round investments with other experienced venture investors. 2. Syndication (in later rounds) resolves information asymmetries between the initial venture investors and other potential investors in later rounds. Established venture capitalists will syndicate to peers and less well-experienced venture investors. 3. Syndication is a mechanism through which venture capitalists collude to overstate their past-performance to potential investors. When experienced venture capitalists invest for the first time in later rounds, the firm is usually doing well.