Responding to uncertainty: syndication partner choice by foreign venture capital firms in China

Abstract

Cross-border venture capital investment has grown dramatically. Drawing upon observations about the liability of foreignness, previous research has shown that foreign venture capitalists (VCs) tend to partner with local VCs in order to offset information asymmetry and the liabilities of foreignness. Much of the literature has suggested that local VCs should help reduce operational uncertainty. This paper examines syndication partner choice in China, which today is likely the most uncertain environment in which foreign VCs operate on a large scale. This provides an ideal environment for understanding partner selection under uncertainty. Our results show that foreign investors are more likely to choose Chinese investors in later rounds and in more mature portfolio firms. While foreign firms with more Chinese experience are more likely to co-invest with Chinese VCs, the older foreign VC firms are less likely to do so. Remarkably, having a Chinese office made foreign VCs less likely to co-invest. In seed-stage investments, when uncertainty is the greatest, foreign firms are least likely to co-invest with Chinese VCs, and this was not affected by the maturation of the market, while at the later stage, when uncertainty is lowest, they are most likely to co-invest.

Keywords::

• China
• foreign investors
• syndication
• venture capital

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

^1. Generally speaking, foreign VCs investing in China aim at U.S. exits because it eliminates the need to get Chinese government permission to convert the capital gains into U.S. dollars.

^2. This an important point where we diverge with previous research on VC globalization, as Thomson and most other sources of data classify foreign VC firms with an office in China as domestic. In contrast, we reclassify them as foreign.

^3. Portfolio firm industry was initially included in all our models, but in the results reported here it is omitted because it was not significant and the omission did not affect any of the other variables.

^4. Sorenson and Stuart (2008) defined syndicate round as financing rounds in which more than two new-to-the-company VC firms invested in the target company.

^5. In 15 cases, foreign VC firms joined a syndicate that Chinese VC firms had already established in an earlier round. As these foreign VC firms were unlikely to have been lead investors, they were eliminated from consideration.

^6. As suggested by Martin Haemmig, a Swiss VC industry consultant.

^7. The coefficient on the control variable co-investment order is positive at the 0.05 level in Model 6, suggesting that a Chinese partner in a first-time syndication is more likely than in syndications in later rounds. This result is somewhat surprising as we would have expected that the likelihood of a Chinese co-investor would be lower in a first-time syndication, not higher. In the regressions by stage, this control variable loses significance (see Table 5).