The likelihood of venture capital (VC) firms’ forming partnerships with others is strongly influenced by their relative status, say HKUST’s Pavel I. Zhelyazkov and his co-author Adam Tatarynowicz (Singapore Management University). In a timely and incisive study, the authors investigate “status-asymmetric ties” to understand why and how unequal partners choose to work together.

VC firms often coinvest (syndicate) in order to share financial risks and benefit from their complementary capabilities in driving the start-up to a successful exit. Much research has been done on how VCs select their investment targets and syndication partners and, in particular, the role of social networks in that process. However, while most research has treated syndication as an undirected process (two VCs are working together), the research team focuses on the direction of the syndication process: who was the lead investor that initiated the relationship and brought the second firm as a follower.

As a result, the researchers are able to distinguish two types of syndication relationships between VCs of unequal status: upward-status asymmetric relationships (in which a low-status lead VC brings in a higher-status follower VC) and downward-status asymmetric relationships (in which a high-status VCs bring in lower-status followers). They use this topology to explore the syndication patterns of U.S. VC firms between 1990 and 2017.

The researchers find that the latter type of relationship is more common – likely because high-status VCs are much more comfortable playing the lead role, rather than accept the humiliation of playing a second fiddle to a lead investor of a lower status. There are two necessary conditions for the rare upward-status asymmetric relations to happen. First, the venture needs to present a compelling investment opportunity, with an impressive valuation trajectory. Second, markets must be running hot, creating a fear of missing out for the high-status investors. If those two factors are present, even high-status investors are likely to swallow their pride and accept a subordinate position to a lower-status VC. By contrast, high-status VCs are especially likely to bring lower-status VCs as followers to struggling ventures that cannot attract higher-status syndication partners.

The paper provides fascinating insights into the power dynamics among institutional investors. It shows an underappreciated advantage of high-status actors: not only do they get preferential access to better deals, but they are able to push off low-quality investments to lower-status syndication partners. This is one explanation for the rich-get-richer dynamics observed in the VC industry. Further, it highlights the role of hot markets, and the pressures they put on high-status investors to turn a blind eye to status differences when they are about to lose out on a good deal.