The Need for Diversification and its Impact on the Syndication Probability of Venture Capital Investments

Abstract

In recent years, the venture capital and private equity industries have witnessed significant growth in assets under management. Investors prefer investing in funds instead of single investments primarily for the diversification benefits and hence the need to determine whether growing fund volumes are beneficial for diversification is of significant importance. To examine this issue, this article uses a unique dataset that includes fully and partially realized investments portfolio companies worldwide. The results show that diversification benefits in this industry can be limited by transaction costs due to information asymmetries. Syndication is a common instrument that is used to overcome these limitations and achieve sufficient diversification, especially for smaller fund sizes. The results also show fund size and investment experience are negatively correlated with syndication probability, while early-stage investments and venture deals are positively correlated.

TOPICS: Private equity, portfolio construction, quantitative methods