XIAODAN ABBY WANG, B.S., M.B.A. A DISSERTATION BUSINESS ADMINISTRATION MANAGEMENT

Transcription

1 THREE STUDIES ON THE ROLE OF VENTURE CAPITAL FIRMS IN FUNDED VENTURES INTER-FIRM COLLABORATION by XIAODAN ABBY WANG, B.S., M.B.A. A DISSERTATION IN BUSINESS ADMINISTRATION MANAGEMENT Submitted to the Graduate Faculty of Texas Tech University in Partial Fulfillment of the Requirements for the Degree of DOCTOR OF PHILOSOPHY Approved Dr. William P. Wan Co-chairperson of the Committee Dr. G. Tom Lumpkin Co-chairperson of the Committee Dr. G. Tyge Payne Dr. Jeremy C. Short Dr. Peter H. Westfall Accepted Peggy Gordon Miller Dean of the Graduate School August, 2011

2 Copyright 2011, Xiaodan Abby Wang

3 ACKNOWLEDGMENTS I would like to express my appreciation to a number of people who provided valuable help and support in reaching this milestone in my life. I first would like to thank the faculty in the Area of Management at Texas Tech University, especially the members of my dissertation committee. Dr. William P. Wan and Dr. G. Tom Lumpkin, who served as the dissertation co-chairpersons, provided extensive hours of counsel, direction and support for the creation and completion of this dissertation. It was a great learning experience to work with them. Likewise, Dr. G. Tyge Payne and Dr. Jeremy C. Short committed their time and expertise to help, providing many unique insights and suggestions on theory building. Dr. Peter H. Westfall provided additional strength in the area of research methodology, which was of great importance to me. In addition to my committee, the other faculty in the Management Area at Texas Tech University was also instrumental in my completing the Ph.D. program. I am deeply grateful to each of you. In addition, I am grateful to my friends and fellow Ph.D. students. My friends Yang Yu, Xiaodong Cai, Dongri Meng and Yun Shen will likely never know how invaluable their friendship and technical support were to me as I went through the daunting process of completing my dissertation. Also, I want to thank my fellow Ph.D. students in the management Ph.D. program. Without your friendship and support, my time in the Ph.D. program would not be as enjoyable as what I experienced. Finally, my dear parents, Tiejun Wang and Fengzhen Zou, were always supportive throughout the process. Their love and support were priceless treasure in any time of my life. I love you. ii

4 TABLE OF CONTENTS ACKNOWLEDGMENTS... II ABSTRACT... V LIST OF TABLES... VII LIST OF FIGURES... VIII CHAPTER ONE... 1 CHAPTER TWO... 7 INTRODUCTION... 7 THEORETICAL BACKGROUND HYPOTHESES METHODOLOGY DISCUSSION AND CONCLUSION REFERENCES CHAPTER THREE INTRODUCTION THEORETICAL BACKGROUND HYPOTHESES METHODOLOGY DISCUSSION AND CONCLUSION REFERENCES CHAPTER FOUR INTRODUCTION THEORETICAL BACKGROUND iii

5 HYPOTHESES METHODOLOGY DISCUSSION AND CONCLUSION REFERENCES iv

6 ABSTRACT Despite the beneficial effects of alliances in facilitating survival, growth and performance of entrepreneurial startups, it is in general difficult for entrepreneurial startups to form alliances due to their poor resource endowments and lack of established social networks. Venture capital firms are active investors that support the development of entrepreneurial startups by providing both funding and a variety of non-pecuniary value-added services. In this dissertation, I examine the influence of VC firms on alliance formation by entrepreneurial startups in their investment portfolios (portfolio firms), which is a unique value-added service of VC firms that has been largely ignored in extant literature. In this three-paper dissertation, I posit that VC firms can influence portfolio firms alliance formation by providing reliable information about potential alliance opportunities. I investigate, respectively in three papers, the relationship between alliance formation by a portfolio firm and 1) composition of VC syndication, 2) alliance formation by firms in the same VC portfolio, and 3) network positions of VC firms. Specifically, in study one I argue that VC syndications with different compositional characteristics, such as size, experience and heterogeneity, offer different levels of information benefits for portfolio firms with respect to alliance opportunities, which influence the likelihood of alliance formation by portfolio firms. Strength of the relationship between VC firms and their portfolio firms is found to positively moderate the relationship between VC syndication composition and the alliance formation by portfolio firms. In study two, I examine the influence of VC interlocks on alliance formation by portfolio firms, as well as the cross-level v

7 moderating effects of tie strength and TMT size. In study three I propose that VC firms positions in their syndication networks network centrality and network constraint are positively associated with alliance formation by portfolio firms, and such relationship is weaker when the VC firms are corporate subsidiaries. To test the hypotheses of these three papers of the dissertation, I assembled three distinct data sets from multiple archival data sources. Conditional logit regression, longitudinal multilevel logit regression, and logit regression were employed respectively. These studies contribute to the strategy and entrepreneurship literatures in general and the alliance and VC literatures in particular. vi

8 LIST OF TABLES 1.1 Variable Operationalization (Study 1) Descriptive Statistics and Correlations (Study 1) Conditional Logistic Regression Results (Study 1) Variable Operationalization (Study 2) Descriptive Statistics and Correlations (Study 2) Multilevel Logit Regression Results (Study 2) Variable Operationalization (Study 3) Descriptive Statistics and Correlations (Study 3) Logit Regression Results (Study 3) vii

9 LIST OF FIGURES 1.1 The Framework (Study 1) Significant Moderating Effects Full Range (Study 1) Significant Moderating Effects ± 1 Standard Deviation (Study 1) The Framework (Study 2) Significant Moderating Effects (Study 2) The Framework (Study 3) Significant Moderating Effects Full Range (Study 3) Significant Moderating Effects ± 1 Standard Deviation (Study 3) viii

10 CHAPTER ONE VENTURE CAPITAL FIRMS AND ENTREPRENEURIAL STARTUPS ALLIANCE FORMATION This dissertation, entitled Three Studies on the Role of Venture Capital Firms in Funded Ventures Inter-Firm Collaboration, is completed in a three-paper format, with each paper addressing a distinct aspect of venture capital (VC) firms influence on the alliance formation of portfolio firms that receive VC financing. The research questions of this dissertation are: (1) how the network resources (e.g., information) portfolio firms gain from their VC investors influence their likelihood of alliance formation; (2) whether or not alliance formation of portfolio firms in the same VC investment portfolio increases the likelihood of alliance formation by the focal portfolio firm; and (3) whether or not VC firms positions in the syndication network influence the likelihood of alliance formation by portfolio firms. Firms can enjoy a number of benefits from alliances, such as acquiring complementary resources, reducing environment uncertainty, increasing market power, and entering new markets (e.g., Das & Teng, 2000; Eisenhardt & Schoonhoven, 1996; Hennart, 1988; McEvily & Zaheer, 1999; Rothaermel & Boeker, 2008; Uzzi, 1997). Particularly, alliances substantially benefit entrepreneurial startups in resource endowments improvement and in network expansion (Stuart, 2000; Stuart, Hoang & Hybels, 1999). However, it is in general difficult for startups to identify alliance opportunities and attract potential partners due to their lack of stable social and business networks, their low visibility and attractiveness, and the high uncertainty associated with their products or business models (Hsu, 2006). As such, how entrepreneurial startups 1

11 overcome the obstacles in expanding their networks (e.g., form alliances) becomes relevant and of great interest. The structure of the networks in which firms are embedded and the pattern of interaction with current social contacts have been found to be important catalysts of alliance formation (e.g., Gulati, 1995; Gulati, 1998; Walker, Kogut & Shan, 1997). However, the antecedents of alliances identified in studies based on established firms may not be readily applicable to the cases of entrepreneurial startups due to the latter s limited networks. For entrepreneurial startups, their affiliation with VC firms may be the most important basis to build their various social relationships, such as strategic alliances. In addition to financial resources, VC firms provide a variety of value-added services to portfolio firms to facilitate the latter to proceed toward a profitable exit. By leveraging their extensive network relationships, VC firms help build and expand portfolio firms networks by referring them to potential suppliers, customers, service providers and job candidates. I suggest that VC firms, which are deemed relationship investors (Fried & Hisrich, 1995), are also capable of facilitating portfolio firms alliance formation. Toward this end, the three studies in this dissertation collectively explore the role of VC firms in portfolio firms alliance formation by examining the influence of several types of network relations involving VC firms and portfolio firms. The first study, which is entitled Composition of VC Syndication and Portfolio Firms Alliance Formation: A Network Resource Perspective, explores the quantity and quality of informational benefits a portfolio firm can get access to through its affiliation with VC firms as well as the influence of these informational benefits on its alliance formation. The availability and reliability of alliance information have a direct bearing 2

12 on a firm s likelihood of alliance formation. Network composition is a key factor that influences the network benefits a firm can derive from its network (Gulati, 1998, 2007). The overall network benefits portfolio firms can gain from VC affiliation vary in accordance with the composition of the VC syndication. In other words, the quantity and quality of network resources (e.g., information) that portfolio firms gain from VC affiliation depend on the aggregative characteristics of their VC investors including syndication size, experience and diversity. Using a matched sample of 322 independent, private U.S. portfolio firms between 2001 and 2007 and the conditional logit regression, we found that portfolio firms financed by 1) more VC firms, 2) younger VC firms and 3) diverse VC firms are more likely to form alliances. Results also indicated that the strength of the relationship between portfolio firms and VC firms has a moderating effect. The findings of this study both support and extend those of previous research. In line with recent research (e.g., Hsu, 2006; Lindsey, 2008), this study illustrated the informational benefits VC firms provide in facilitating portfolio firms alliance formation. However, previous studies have merely examined the presence or absence of VC ownership, implicitly assuming that portfolio firms funded by different VC firms (or different groups of VC firms) enjoy the same opportunity to form alliances. This study challenges such assumption by explicitly examining the effects of VC firm heterogeneity on this dyadic relationship, which have been largely ignored in extant literature (Lockett, Ucbasaran & Butler, 2006). In addition, this study explicitly investigated the joint effects of the quality of nodes and the strength of ties on generation of network benefits, integrating the two primary elements of network. 3

13 Study Two, which is entitled VC Interlocks and Alliance Formation of Entrepreneurial Startups: A Longitudinal Cross-level Study, examines the role of VC firms as informational conduits among their portfolio firms, which may increase the likelihood of interfirm imitation of the latter. In the management literature, it has been found that interfirm relational ties represent an effective channel through which information about a practice s utility or value spreads (Haunschild, 1993; Marsden & Friedkin, 1993; Williamson & Cable, 2003). Drawing on social contagion theory and the structural equivalence perspective, I argue that portfolio firms connected by their shared VC firm are well aware of one another s strategic actions (e.g., alliance formation). The likelihood of a portfolio firm to form alliance increases when portfolio firms in the same VC portfolio have formed more alliances. Although VC interlocks are an influential source of interfirm information, they are unlikely to influence outcomes uniformly across different portfolio firms. I argue that the influence of VC interlocks on a specific portfolio firm depends on 1) the extent to which the portfolio firm views the information conveyed by VC interlocks as reliable and trustful, and 2) the extent to which the portfolio firm relies on VC interlocks as key information sources. Using a sample of 2145 firm-year observations (independent, private U.S. portfolio firms) between 2003 and 2007, I used three-level logit regression analysis to test the hypotheses and results provided general support to this study s core arguments. This study contributes to both the strategy and entrepreneurship literatures in three ways. First, this study demonstrates the special role of VC firms as information conduits among portfolio firms. Second, this study contributes to the strategy literature by responding to Hough s (2006: 60) recent call for re-examination of the results in any 4

14 area of strategy research based upon hierarchical data structures that has not explicitly modeled the inherent nesting of the data. Third, this study illustrates the contingent nature of the effects of VC interlocks on portfolio firms alliance formation. The last study, which is entitled Effects of VC Firms Network Positions on Alliance Formation of Portfolio Firms, addresses the relationship between a VC firm s position in the syndication network and the likelihood of alliance formation by its portfolio firms. I argue that a VC firm s capability of facilitating portfolio firms alliance formation critically depends on its position in the syndication networks different types of network positions imply different informational advantages. Syndication partners share industrial information, knowledge and wisdom. VC firms can rely on their syndication networks to identify alliance opportunities for their portfolio firms to cooperate with established corporations or other entrepreneurial startups. I suggest that a central and constrained position in the syndication network is the most favorable in terms of seeking alliance opportunities for portfolio firms. However, syndication network is not the only source of information for VC firms. I argue that the availability of alternative network relations that provide similar information also influences the effects of VC firms positions in the syndication networks. Using a sample of 417 independent, private U.S. portfolio firms, I found supports for the core arguments of this study. This study contributes to the network and VC literatures in several ways. First, by highlighting the valuable supports VC firms can provide to their portfolio firms in networking building and expansion, this study sheds light on an interesting but largely ignored issue in the network literature the transfer of social capital across firms. Second, this study identifies the most favorable network structure for VC firms to seek 5

15 relational benefits for their portfolio firms. Third, this study demonstrates that the effects of positions in a given network are contingent on the availability of alternative networks. I formatted each study in accordance with the Academy of Management Journal style guidelines. Because all three studies are intended for future publication, the tables, figures and references were placed at the end of each study. 6

16 CHAPTER TWO COMPOSITION OF VC SYNDICATION AND PORTFOLIO FIRMS ALLIANCE FORMATION: A NETWORK RESOURCE PERSPECTIVE INTRODUCTION Strategy and organization scholars have emphasized the benefits that accrue to a firm from entering alliances in terms of reduced transaction costs (Hennart, 1988), strengthened resource configuration (Das & Teng, 2000), mitigated environmental uncertainty (Uzzi, 1997), and improved competitive position (McEvily & Zaheer, 1999). Particularly, strategic alliance is an effective way to solve the problem of resource constraint. By allying with resource-rich partners, firms are able to get access to valuable resources that contribute to better outcome and greater success. Given these benefits associated with alliances, resource poor entrepreneurial startups are typically eager to form alliances so as to reduce their resource constraint and increase their visibility and status (Eisenhardt & Schoonhoven, 1996; Stuart, Hoang & Hybels, 1999). However, it is usually difficult for them to identify alliance opportunities and attract desired partners due to their lack of stable networks and reliable track records (Hsu, 2006; Lindsey, 2008). In this regard, research examining how such obstacles are reduced and alliance formation is facilitated for entrepreneurial startups should become relevant and of great interest to researchers. In recent years, the application of network perspectives for studying interorganizational relationships, such as cooperative alliances, has proliferated. The structure of the networks in which firms are embedded and the pattern of interaction with current social contacts have been found to be important catalysts of alliance formation (e.g., Gulati, 1995; Gulati, 1998; Walker, Kogut & Shan, 1997). However, startups are 7

17 typically lack stable social and economic networks and are often poorly embedded. The initial network of a startup may have to limited to its founder s personal network of contacts. However, for a VC-backed startup, its relationship with VC investors expands its networks, thus representing an important conduit of external resources. Through their extensive networks, VC firms substantial social capital can be leveraged to offer crucial supports to their portfolio firms. For example, portfolio firms may obtain valuable alliance opportunities from VC investors, who obtain such information through their various network contacts. In addition, due to the signaling or certification effects of VC ownership (Hsu, 2006; Megginson and Weiss, 1991), VC-backed startups become more attractive in the eyes of potential alliance partners than do non-vc-backed startups and therefore are more likely to realize alliance opportunities. Extant knowledge on strategic alliances has primarily come from studying established, large firms. Research on alliance formation by startups or poorly embedded firms only emerge in recent years (e.g., Ahuja, Polidoro & Mitchell, 2009; Hsu, 2006; Park, Chen & Gallagher, 2002). Although this line of research has suggested that affiliation with VC firms is likely to increase the likelihood of portfolio firms to form alliances (Hsu, 2006), the focus centers on the role of VC firms serving as information intermediaries in portfolio firms alliance formation. Little attention has been paid to the heterogeneity in the informational advantages VC firms can provide to their portfolio firms that facilitate the alliance formation of the latter. Because many portfolio firms are jointly invested by multiple VC firms, through syndication, that differ in their capabilities of providing useful information and valueadded services, it is therefore important to distinguish between the informational 8

18 advantages that different portfolio firms can obtain from their VC investors. Syndication is a common practice in the VC industry, whereas a lead VC firm initiates a new investment and invites other VC firms to join (Fried & Hisrich, 1995; Wright & Lockett, 2003). Startups financed by multiple VC firms have access not only to the resources of the lead firm but also those of the syndication partners. In other words, VC syndication offers a larger source of network resources than does a single VC firm. The question of how and to what extent portfolio firms can benefit from this enlarged source of network resources thus deserves exploration. Given the differences among VC firms, the implicit assumption that startups funded by different VC firms enjoy the same chance to form desirable alliances is unlikely to be valid. Furthermore, prior studies on this topic have primarily treated the informational benefits provided by VC firms as a single dimensional construct, ignoring the various forms informational benefits can take (Koka & Prescott, 2002). In this paper, I argue that portfolio firms differ in the informational benefits they obtain from their VC investors in terms of information volume, information relevance and information diversity, depending on the composition of VC syndication. In addition, the network resource perspective suggests that quality of both the nodes and the ties constituting a network decides the benefits a firm can actually realize from the network (Gulati, 2007). To date, the VC literature has primarily focused on examining what benefits VC firms can provide to its portfolio firms (e.g., Amit, Brander & Zott, 1999; Sapienza, 1992), but has only paid little attention to the effects of the strength of investor-investee relationship. Given that tie strength is an important determinant of realized network benefits, the neglect of examining the role of tie strength 9

19 may lead to an incomplete understanding of how and when VC firms support is most facilitative. To fill this gap in the VC literature, I incorporate tie strength in this study as a moderator, suggesting that portfolio firms that are strongly connected to their VC investors are likely to realize more network benefits. Building on and extending prior studies, this study explores the effects of compositional attributes of VC syndication on portfolio firms likelihood to form alliances, as well as the moderating effect of the strength of ties defined by the equity relationship (see Figure 1 for the framework). A sample of U.S. VC-backed entrepreneurial startups between year 2000 and 2004 will be assembled to test the relationship between VC syndication composition and portfolio firms likelihood to form alliances. This study intends to contribute to the entrepreneurial literature, particularly VC literature, in three major ways. First, this study explores VC firms role in facilitating portfolio firms alliance formation, which is a unique value-added service of VC firms that has been largely ignored in extant literature. Particularly, this study highlights the multidimensional nature of informational benefits portfolio firms can obtain from their relationship with VC firms. Second, this study demonstrates how the composition of VC syndication affects portfolio firm level outcomes. Different compositional attributes have different implications on the informational benefits portfolio firms obtain, which influence portfolio firms likelihood to form alliances. Third, by examining the moderating role of tie strength that has received little research attention, this study illustrates the joint effects of the quality of nodes and the strength of ties on determining the network benefits firms can obtain from their network connections. 10

20 THEORETICAL BACKGROUND Antecedents and Consequences of Strategic Alliances A strategic alliance is commonly defined as a voluntarily initiated cooperative agreement between independent firms, aiming to achieve mutually beneficial goals by resource exchange, knowledge sharing and co-specialization (Gulati, 1999). Strategic alliances may take several forms based on the amount of equity involved in the inter-firm relationship, such as non-equity alliances and equity alliances (e.g. joint ventures) (Das & Teng, 1996; Hennart, 1988; Teece, 1992). Examples of non-equity alliances include joint R&D projects, joint manufacturing, technology exchange, marketing agreements, to name a few. The structure and governance of non-equity and equity alliances differ substantially. Researchers have provided many theoretical and empirical accounts for strategic alliances, including both internal motives and external catalysts. Resource scarcity and market uncertainty are two key motives for alliance formation (Park, Chen & Gallagher, 2002). The major benefits include obtaining access to complementary resources, gaining legitimacy, increasing market power and reducing environmental uncertainty (Baum & Oliver, 1991; Burgers, Hill & Kim, 1993; Kogut, 1988). The economic rationale for resource needs and the sociological justification for status seeking represent two major streams of research on internal benefit-seeking motives of strategic alliances (Lin, Yang & Arya, 2009). Adopting the resourced-based view (RBV) (Wenerfelt, 1984; Barney, 1991), researchers argue that firms form alliances to acquire valuable resources (Das & Teng, 2000; Eisenhardt & Schoonhoven, 1996; Kogut, 1988; Park, Mezias & Song, 2000). Resources of particular interest in alliance formation include financial resources, technologies, and managerial capabilities, to name 11

21 a few (Hitt et al., 2000). By partnering with firms that can provide missing or complementary resources, the focal firm can strengthen its resource configuration and generate more value. Researchers subscribing to the social embeddedness and institutional perspective argue that firms establish alliances to conform to social justification and social obligation (Zukin & Dimaggio, 1990), or to improve their images or status in the eyes of key constituents (Dacin, Oliver & Roy, 2007). In this sense, firms with a positive image and high social status are viewed as desired partners. By partnering with reputable firms, the focal firm may enhance its own status and image and improve its economic performance in the marketplace (Dacin, Oliver & Roy, 2007; Podolny, 1994). In addition, some researchers have made efforts to integrate these two theoretical arguments and examined the interaction between resource needs and status seeking to explain alliance formation and partner selection (e.g., Lin, Yang & Arya, 2009). Increasing market power and decreasing environmental uncertainty also represent major motives for alliance formation. Alliances have been found to be an effective means to deal with market changes in terms of both structure and dynamics (Beckman, Haunschild & Phillips, 2004). Particularly, strategic alliances can be viewed as a firm s adaptive response to environmental changes. Prior research has indicated that industry level factors such as competition intensity and industrial alliance formation rates have direct bearings on firms strategic choice to form alliances (Ang, 2008; Garcia-Pont & Nohria, 2002). Studies on external catalysts of strategic alliances, or the enabling conditions, have largely been built on network theory. Research has shown that preexisting network structure influence the formation of new inter-firm alliances (e.g., Gulati, 1995; Walker, 12

22 Kogut & Shan, 1997). The network perspective on inter-firm collaboration contends that alliance activities are embedded in a wider social network resulting from prior exchanges and collaborative activities (Granovetter, 1985). Structural embeddedness has been found to be the key enabling condition or catalyst of inter-firm collaboration. The network structure in which a firm is embedded influences the availability of and access to alliance opportunities (Nahapiet & Ghoshal, 1998). While richly connected firms are more likely to form new alliances due to their access to a wider array of information about potential alliance opportunities and their high network status attributable to their central position, poorly connected firms have much less inter-firm collaboration opportunities due to their lack of reputational and informational advantages. Relational embeddedness has also been found to be positively associated with the likelihood of a firm s alliance formation (Gulati, 1998). Relational embeddedness concerns the properties of the relational ties developed through a history of interactions (Granovetter, 1985). Relational embeddedness has often been used to explain repeated collaborative activities - the inclination of a firm to partner with firms with which it has prior experience of cooperation (Gulati, 1998). While research on strategic alliances has traditionally focused on established, large firms, studies on the strategic and performance implications of alliances for entrepreneurial, small firms have only captured academic attention in recent years (e.g., Alvarez & Barney, 2001; Ireland, Hitt & Webb, 2006). Startups are usually assumed to be typified by a lack of sufficient resources and stable relational networks (Baum, Calabrese & Silverman, 2000). By allying with established, reputable firms, startups can get access to valuable tangible and intangible resources, which help mitigate the liability 13

23 of newness (Freeman, Carroll & Hannan, 1983), increase their chance of survival (Baum, et al, 1998; Eisenhardt & Schoonhoven, 1996) and increase their IPO valuation and overall IPO success (Higgins & Gulati, 2003; Stuart et al., 1999). Given the uncertain market conditions they face and their resource constraints, entrepreneurial startups typically have strong incentive to form alliances, but often do not have the necessary capabilities to do so. This is especially true for startups that rely on uncertain technologies, that have unclear market prospects, or whose early stage development may take a protracted period to develop and involve substantial R&D expenditures. Entrepreneurial startups rely on different networks for seeking different supports (Hanlon & Saunders, 2007). None of these networks can provide all the resources and supports entrepreneurial startups need. For example, entrepreneurs look for seed capital, basic advices and emotional supports from their personal networks including families, friends and prior colleagues. They seek other supports in terms of professional network referrals and strategic information from business partners and professional advertisers such as VC firms, service providers and public agencies. Particularly, by affiliating with VC firms, startups can get access to a number of valuable resources, such as funding, industrial knowledge and managerial capabilities. However, these resources are necessary but not sufficient for their survival and success. Although VC firms can provide a variety of value-added services at the strategic level, they cannot help much at the operational level, such as new product design and development. For entrepreneurial startups, especially the ones in industries where collaborative R&D activities are common, strategic alliances with industrial partners can generate benefits at the operational level that beyond VC firms capability to bring about. 14

24 However, resource poor startups have limited abilities to form alliances (Park et al., 2002). Prior studies have revealed the important roles of existing social connections of startups in their network development and expansion (e.g., Higgins & Gulati, 2003; Kim & Higgins, 2007). Startups rely heavily on the social contacts of their founders and VC investors to build their network connections. Particularly, affiliations with VC firms have been found to increase startups likelihood of inter-firm collaborations (Hsu, 2006; Lindsey, 2008). VC Network and VC Syndication The role of VC in facilitating the development of entrepreneurial startups has been widely accepted. VC-backed startups have been found to perform better and are more likely to reach the IPO stage than startups financed by other sources of capital (Gompers & Lerner, 2002). In addition to financial capital, VC firms provide their portfolio firms with a variety of other benefits in the post-investment stage, such as recruiting key personnel, access to business contacts, general business knowledge, and financial and strategic discipline (Fried & Hisrich, 1995; Gorman & Sahlman, 1989). By offering these value-added services, VC firms play an active role in shaping portfolio firms strategic direction and action, such as professionalization (Hellmann & Puri, 2002; Wijbenga, Postma & Stratling, 2007), internationalization (Fernhaver & McDougall- Covin, 2009) and cooperative commercialization (Hsu, 2006). VC firms capabilities of providing value-added services are closely related to their capabilities of leveraging network resources. VC firms are embedded in multiple networks defined by the specific relational ties. Bygrave (1987) viewed VC firms as having extensive networks that include their fund providers, portfolio firms and other VC 15

25 firms. An even broader definition of VC networks encompasses various service providers such as head hunters, lawyers, and investment bankers. These broad VC networks are called VC constellations (Echols, 2000). Indeed, one prominent VC firm goes so far as describing itself as a venture keiretsu (Lindsey, 2005; Hsu, 2004), alluding to a Japanese business group. When VC firms make new investments, they draw on the members in the constellation or keiretsu to help their portfolio firms succeed. VC firms rely on their overall networks as the sources of most of the value-added services they provide, such as collecting strategic information, identifying candidates for employment, locating service providers and potential customers and finding acquisitions or corporate partners (Fried & Hisrich, 1995). Syndication is a common practice in VC industry, through which a VC firm builds its network with other VC firms (Lockett, Ucbasaran & Butler, 2006). In 2000, 63.6 percent of VC investments in the United States were syndications (Wright & Lockett, 2003). VC syndication is a voluntary arrangement among independent VC firms to co-invest in a portfolio firm for a joint payoff (Bygrave, 1987; Wilson, 1968), either in the same investment round or at different points in time (Brander, Amit, & Antweiler, 2002). Typically, VC investment syndications are initiated by a lead VC firm that often holds the largest VC equity stakes in the portfolio firm (Wright & Lockett, 2003). Cooperating with the portfolio firm, the lead VC firm then invites other VC firms to participate in the financing rounds. VC syndications involve information sharing and syndication partners often engage in co-development of the portfolio firms. According to the extant research on motivation of VC syndication, syndication activities were either driven by individual deal management motives such as deal selection and resource 16

26 seeking (e.g., Brander, Amit & Antweiler, 2002) or by portfolio management motives such as risk sharing and portfolio diversification (e.g., Manigart et al., 2006). It has been found that syndicated VC investments generate higher returns than stand-alone VC investments (Brander, Raphael & Werner, 2002). One of the most critical factors explaining such higher returns is the improve value-added supports in the form of a larger variety of social and economic contacts received by the portfolio firms funded by syndicated VC firms than a single VC firm. VC Syndication as Important Source of Network Resources of Portfolio Firms The adaptation and adoption of social network approaches for studying interorganizational relationships have proliferated in the past few decades. Social network perspectives have now dominated research on inter-organizational relationships, anchoring a large number of studies examining the antecedents and consequences of inter-organizational networks (e.g., Gulati, 1998; Stuart, 1998; Tsai & Ghoshal, 1998). Network resources refers to tangible and intangible assets, such as technology, information and reputation, that reside outside of a firm s boundaries but can be accessed or leveraged through relational ties (Gnyawali & Madhavan, 2001; Lavie, 2006). By this conceptualization, network resources are external resources possessed by the firm s partners. The ties between the firm and its partners serve as conduits of resource flows. Network resources perspective contends that both ties and partners resource endowments are critical for the firm to generate value from its network (Gulati, 2007). If a firm is embedded in a network whose members have poor resource endowments (e.g., outdated 17

27 technologies, low reputation), it faces few options to generate value from this network no matter what the structural and relational properties of the network are. Startups typically lack valuable network connections (Eisenhardt & Schoonhoven, 1996). As parts of the limited networks of portfolio firms, VC firms represent a major, stable source of network resources. Portfolio firms can rely on VC firms to obtain a number of resources necessary for development and success, such as follow-on financial inputs and connection to potential suppliers and customers. The investor-investee relationships represent channels for information and resource flows. The strength of the equity ties between VC firms and portfolio firms is considered strong (Stuart, Hoang & Hybels, 1999). The investor-investee relationship is stable compared with many nonequity based relational ties. Such equity relations are akin to strong ties (Granovetter, 1973) because of VC firms intensive interactions with portfolio firms and their active monitoring activities. Also, there is often a shared vision between VC firms and portfolio firms that embodies the collective goals and aspirations. All these features of relationships between VC firms and portfolio firms indicate the reliability of VC firms as a source of network resources. However, the effectiveness of VC firms as a source of network resources depends also on their specific capabilities and resource endowments. For a portfolio firm jointly funded by multiple VC firms, the total benefits it can obtain by virtue of the relationship with its VC investors are determined collectively by these VC investors. Viewed from the network resources perspective (Gulati, 2007; Lavie, 2006), the composition of VC syndication determines the quality and quantity of network resources a portfolio firm can obtain, which have direct implications on its strategy and performance. 18

28 Expanding the Investor Side in Examining the Investor-Investee Relationship Examining the strategic implications of VC syndication as a whole on portfolio firms is of great importance. The relationship between VC firms and portfolio firms has received considerable attention in the entrepreneurship literature. Prior studies have sought to understand this dyadic relationship by examining the interaction between the two parties, such as mutual learning (Clercq & Sapienza, 2005) and venture capitalist- CEO interaction (Arthurs & Busenitz, 2003; Cable & Shane, 1997; Sapienza & Gupta, 1994), and by investigating the impacts of VC firms on portfolio firms development and performance (e.g., Dushnitsky & Lenox, 2006; Wijbenga, Postma & Stratling, 2007). These studies have primarily treated the dyadic investor-investee relationship as one involving just two players: one VC firm and one portfolio firm (Lockett, Ucbasaran & Bulter, 2006). However, both side of the investor-investee relationship may involve multiple players (Lockett & Wright, 2001). Multiple VC firms may co-invest in a single startup through syndication, and a VC firm typically invests in a number of startups constituting an investment portfolio. In recent years, some research efforts have been made to broaden the investorinvestee dyad by expanding the investee side from individual portfolio firms to the whole investment portfolio. This stream of studies have examined the impacts of VC firm level factors on portfolio size (Bernile, Cumming & Lyandres, 2007), portfolio composition (Patzelt, Knyphausen-Aufseb & Fischer, 2009) and portfolio performance (Dimov & De Clercq, 2006). However, in studies examining portfolio firms strategies and performance, the theoretical focus on the investor side is still primarily on the lead firm only. Although VC syndication is a topic that has attracted substantial research attention 19

29 (e.g., Bygrave, 1987; Manigart et al., 2006; Wright & Lockett, 2003), extant studies on VC syndication have primarily conducted from the lenses of VC firms. Major streams of research on VC syndication include the motives for syndication, the management of syndication, and the effects of syndication on investment performance (Lockett, Ucbasaran & Bulter, 2006). However, a lead VC firm typically select syndication partners based on its own interests and strategic considerations. A syndication comprised of partners that is most beneficial to the lead VC firm may not necessarily be the most favorable to the portfolio firm. To date, our knowledge with respect to the topic of how VC syndication partners jointly influence portfolio firm level outcomes is still limited. Although non-lead VC firms are typically not involved in the day-to-day management of the portfolio firm, they can benefit the portfolio firm in other ways such as the increased legitimacy resulting from mere affiliation and information sharing in board meetings. I contend that, in studying portfolio firms strategic actions in which external information plays a key role (e.g., alliance formation), ignoring the role of non-lead VC firms is likely to lead to an incomplete understanding, or even an incorrect conclusion. As such, this study examines how the composition of VC syndication influences the alliance formation of portfolio firms. HYPOTHESES Effects of Compositional Characteristics of VC Syndication Optimal strategic actions of a firm are the results of a match between the firm s competencies and the availability of new opportunities in the environment (Andrews, 1971). In the case of alliance formation, the presence or lack of certain competencies 20

30 propel firms to enter into new alliances while the identification of and the access to alliance opportunities determine the realization of new alliances. In other words, in addition to internal motives, the likelihood of a firm s alliance formation also depends on its engagement in identifying and responding to partnering opportunities (Sarkar, Echambadi & Harrison, 2001). By virtue of the relationship with VC firms, portfolio firms can get valuable network resources supporting the opportunity identification process. One of the key network resources firms can gain by virtue of their network of social relationships is information (Gulati, 1999; Koka & Prescott, 2002). Researchers have demonstrated the multidimensional nature of information benefits derived from social network and the differential effects of information dimensions on firm performance (e.g., Koka & Prescott, 2002). Adopting the multidimensional view of information benefits, I suggest that a firm s likelihood to form alliances depends on both the quantity and the quality of alliance information it can have access to. Specifically, the volume of information, the relevance of information and the diversity of information contribute to the identification of alliance opportunities and potential partners. With extensive social networks and in-depth understanding of portfolio firms capabilities and needs, VC firms enjoy advantageous positions in collecting information that are useful for portfolio firms. Through formal and informal communications with VC firms, portfolio firms gain access to an enlarged alliance opportunity set. Compared with portfolio firms financed by a single VC firm, portfolio firms funded by VC syndications consisting of multiple VC partners have more information channels to collect alliance information. Equipped with larger information pools, they are more likely to identify 21

31 partnering opportunities. As such, I predict that portfolio firms receiving financing from larger number of VC investors enjoy a higher chance of alliance formation. Hypothesis 1. VC syndication size is positively associated with the likelihood of a portfolio firm to form alliances. Both the quantity and quality of network resources supporting alliance formation are important in determining the likelihood of a firm to form alliances. As Adler and Kwon (2002) highlighted, the competencies and resources at the nodes of the network influence the benefits a focal firm can obtain from the network it is embedded. A focal firm can benefit more by connecting to quality nodes. No two VC firms are identical in terms of resource endowments. Therefore, VC syndications differ in their resource aggregate. Characteristics of VC syndication partners jointly determine the syndication s quality as a source of network resources. As investment experience is accumulated, VC firms become better at detecting and evaluating portfolio firms true needs and potential. Based on prior experience of financing similar portfolio firms, VC firms may be able to visualize the appropriate network structure of alliances for their portfolio firms in the future and work backwards to help build these portfolio firms current alliance strategy. Experienced VC firms not only provide relevant and useful alliance information, but also provide this information at a right time. Therefore, I suggest that a VC syndication consisting of experienced VC partners is better at facilitating portfolio firms alliance formation. Hypothesis 2. The experience of VC syndication partners is positively associated with the likelihood of a portfolio firm to form alliances. 22

32 The diversity of information refers to the variety or range of information, or the extent to which the information is not redundant. While syndication size determines the volume of information and experience of syndication partners decides the relevance of information, the diversity of information is proportional to the heterogeneity of VC syndication partners. VC firms with different backgrounds typically have different social networks. For example, there are more established large corporations in corporate VC firms networks while VC firms affiliated to financial institutions have more contacts with investment banks and other financial service providers. The heterogeneity of VC syndication partners determine the extent to which additive or redundant information may be provided. In other words, the more diverse the syndication partners are, the richer the information available to the portfolio firm is. Irredundant information means a larger set of effective alliance opportunities, which increases the likelihood of the portfolio firm to find ideal potential partners. Hypothesis 3. The heterogeneity of VC syndication partners in terms of type is positively associated with the likelihood of a portfolio firm to form alliances. Moderating Effects of Tie Strength According to the network resource perspective, both ties and partners resource endowments are critical for the firms to generate value from its network (Gulati, 2007). In essence, the strength of relational ties between partners and their resources endowments jointly determine the benefits stemmed from inter-firm relations. As such, a firm may enjoy more network benefits from a tightly connected partner with rich resources than from a loosely connected one. However, compared with partners resource 23

33 endowments, tie strength has received less research attention in the network literature, particularly in firm level studies. Furthermore, few studies have examined the joint effects of tie strength and partner s resource endowments on network benefits generated. The concept of tie strength was initiated by Granovetter s (1973) paper titled The Strength of Weak Ties, whereby he conceptualized tie strength as the combination of the amount of time spent in the relationship, emotional intensity, intimacy and reciprocal services associated with the relational tie. The concept of tie strength has then been used in a number of studies in both management and sociology areas treating it as a predictor of outcomes at both individual and organization level (e.g., Lechner, Frankenberger & Floyd, 2010). The strength of the tie connecting two actors (e.g., individuals, organizational units or firms) has been found to influence the levels of trust and efficiency of information sharing/transfer between them (Krackhardt, 1992; Szulanski, 1996). Stronger ties often mean higher levels of trust and moral obligation as an underlying support mechanism to reduce the risk of opportunism and cheating (Johanson & Mattson, 1987; Powell, 1990). The effectiveness of a relational tie in channeling network benefits is contingent on its strength. Extant literature examining effects of tie strength on information sharing or knowledge transfer has largely focused on relational ties between individuals or teams, measuring the strength of ties by assessing the closeness, duration and frequency of the relationship through five- or seven-point scale survey questions (e.g., Lechner, Frankenberger & Floyd, 2010; Perry-Smith, 2006; Pil & Leana, 2009; Reagans & McEvily, 2003). In firm level studies, researchers typically use repeated relational ties to capture the strength of the relationship between firms, arguing that prior network 24

34 connections between a pair of firms are important catalysts of new alliance formation between them (e.g., Gulati, 1999). I argue that a higher level of strength of the ties between VC firms and portfolio firms are likely to enhance the effectiveness of communication between the two parties and increase the network benefits portfolio firms can obtain from the relationship. The primary relationships between VC firms and their portfolio firms are built on equity holding. The strength of such equity ties is determined by the amount of equity stakes held by VC firms. The larger the amount of VC financing that portfolio firms receive, the stronger the investor-investee ties are. VC firms make substantial investment in a portfolio firm only if they trust its founding team and have confidence on its growth potential and prospects. Large equity stakes held by VC firms are thus often associated with high level of commitment to portfolio firms. When VC firms make large amounts of investment in their portfolio firms, such significant financial commitment will motivate them to work even harder to facilitate the latter to succeed so that they can harvest the resulting financial returns. Such commitment is also likely to increase portfolio firms trust on VC firms and deem the information they convey more reliable. In addition, more equity holding means more powerful position on the board, through which VC firms exert their influence on portfolio firms. Therefore, I hypothesize that the strength of equity ties moderates the relationships between compositional characteristics of VC syndication and the alliance formation of portfolio firms, making the relationships stronger. 25