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Venture Capitalists Do Better Investing in Start-Ups Run by Entrepreneurs of Same Ethnicity

By Deepak Hegde

Deepak Hegde_article

VCs are systematically more likely to invest in start-ups when the VC and start-up have top-level executives of the same ethnicity.

In research that is forthcoming in the journal, Management Science, NYU Stern Professor Deepak Hegde and his co-author, Justin Tumlinson of the IFO Institute at the University of Munich, found that US venture capitalists (VCs) were more likely to invest in start-ups led by executives of the same ethnic origin, particularly when the probability of the start-ups’ success appears low. They also found that when VCs and entrepreneurs shared the same ethnic origin that the start-ups were more successful as measured by IPOs and net income after IPOs.

The professors analyzed data from almost all US-based venture deals from 1991-2010, assembling 22,000 US-based venture capital (VC) partners and 85,000 US based start-up executives, who represent 10 distinct ethnic groups.

Key insights from the paper include:
  • VCs are systematically more likely to invest in start-ups when the VC and start-up have top-level executives of the same ethnicity
  • VCs are more likely to favor co-ethnic entrepreneurs for investment during early investment rounds
  • Some ethnic groups (e.g., Chinese, Indian, Jewish and South European) favor co-ethnic investments more than others (e.g., Anglo-Saxon or West European)
  • The chance of a successful IPO or acquisition and post-IPO or acquisition performance is higher when VC and company share same ethnicity, and the enhanced performance persists
  • Within a VC’s portfolio, ethnically closer start-ups perform better
  • The positive performance of start-ups is largely due to superior communication and coordination between VCs and entrepreneurs of the same ethnicity after the investment
  • To the extent that VCs expect to work better with startups with co-ethnic leaders, they invest in co-ethnic ventures of lower observable quality than non-co-ethnic ventures
The article, "Does Social Proximity Enhance Business Partnerships? Theory and Evidence from Ethnicity’s Role in US Venture Capital” is forthcoming in the journal Management Science.