Investment Proximity and Venture Capital Returns

Abstract

Using a large dataset of 82,818 investments in start-up firms from December 1965 through August 2019, we document detailed descriptive statistics. The biggest group of investors are venture capital firms (about 79% of all observations). The number of all venture investments were few in the 60’s and 70’s, but peaked in the 90’s. The majority of in-state investments are found clustered in California (with the San Francisco VC Hub), Massachusetts (with the Boston VC Hub) and New York. Out-of-state investments are more widely spread-out. Returns generated from early round investing to late round decreases generally: early investors get a higher return than late stage investors, and IPO exits entail the highest return. We find that geographical proximity is significantly and positively associated with cumulative returns or annualized returns. This result holds whether we use actual distance (in km) between the VC investment firm HQ and portfolio firm HQ, or a cross-region indicator variable when the portfolio firm HQ is out-of-state as compared to VC investment firm HQ. Using both univariate as well as multivariate tests that control for other possible determinants of returns, we find that cross-region variable is a strong indicator of returns, being negative and statistically significant across all exits or only successful exits, across VC investor types, across entry timing – whether early stage or late stage, whether the VC firm HQ location is in a previously-documented VC hub or not, and whether the investment is to a previously-documented favored VC industry or not. The relation between investment proximity and returns continues to be robust even when we include additional portfolio company variables, and in a matched-sample analysis where we pair each proximate investment with a matched distant investment. We find that VC Director and other outside directors as a proportion of all Directors on the boards on portfolio companies is significantly higher, on average, for in-state and shorter distance investments as compared to out-of-state or longer distance investments, indicating better involvement by VCs in their more proximate investments. The percentage of VC-appointed and other outside directors in a portfolio company is also significantly and positively associated with both cumulative and annualized returns, indicating better governance, and better monitoring by VCs in their more proximate investments.