June 26, 2009
A group of researchers from Harvard Business Scholl recently published a study that showed that startups whose headquarters are further away from their VCs are more likely to be successful than companies that are closer to their investors. Xconomy and PEHub both ran articles about the study and reach similar interesting conclusions about why this effect may occur.
Researchers hypothesis that the fact that the portfolio company is further away, implies that the cost of hands on monitoring are greater, and therefore VCs do more due diligence before making these investments. Presumably this greater diligence results in better odds of picking winners.
“A takeaway might be that firms should think very carefully about their decision-making process in terms of geographic criterion,” says HBS professor Josh Lerner, who co-authored the study with Henry Chen, Paul Gompers and Anna Kovner. “I think there’s a mental trap in saying that because a company is so nearby, it’s not as costly to do the transaction.”
Hmmmm, that could be. Maybe it is about better investment selection. But maybe we should also consider the other potential side effects of having your investors right next door. Is it possible that these near by investors who are more engaged in their local portfolio companies are actually causing the poorer performance?
It’s clear that the objective of the VC fund is to grow the enterprise value as fast as possible. So, that, as we’ve discussed in many other posts, they can eventually find a buyer who is interested in paying a greater price for the company than they paid for it. They’re looking for an exit, and are less focused on building a sustainable defensible business.
Notice I was clear in saying that the goal is to grow the “enterprise value” of the company. I didn’t say “business” or “revenue” or “profits”. Sure, those “minor” details contribute to the enterprise value, but for early stage growth companies they aren’t nearly as important if you’re going for a “mega exit”. Scale is the only thing that matters!
Imagine for a moment that YouTube had not been acquired by Google. Where would they be today? They’ve got a ton of traffic, and they’ve got a ton of expense; but they still have yet to figure out a monetization strategy for all that traffic. You can be certain that if YouTube was still independent, that the investors would be doubling down on growth and still ignoring monetization.
So is it that VCs are willing to invest in distant companies because they believe they have the right mix of assets to be successful without significant oversight and intervention? Or are smart entrepreneurs willing to take money from distance VCs because they know it will reduce the distractions that often comes attached to that investment?