Strategic Decertification in Venture Capital

Abstract

Early round VC syndicates can strategically threaten not to participate in a follow-on round of financing. The negative signal their non-pursued certification would send to alternative syndicates reduces the value of the entrepreneur's reservation strategy in the later round. In competitive early rounds, syndicates with highest expertise often cannot fully precommit against doing so in later rounds and become unattractive to entrepreneurs. Strategic decertification drives syndicate composition towards heterogeneity in expertise levels, which acts as a precommitment device. A large scale empirical analysis of VC investments finds that syndicates start out with higher levels of heterogeneity in early rounds and tend towards homogeneity in later rounds. This is inconsistent with previous theories of syndicate formation but consistent with strategic decertification.