Are California venture capitalists the best venture capitalists?

Abstract

We test if California VCs significantly outperform VCs from other US states. We additionally test in which instances California VCs outperform the other VC concentrated states of Massachusetts and New York. We find that VCs from California, Massachusetts, and New York have significantly greater probabilities of successfully exiting their investments than VCs from other states. Additionally, we show that California VCs are even more adept than VCs from Massachusetts and New York at 1. Early-stage investments, 2. Helping their entrepreneurial firms receive future rounds of financing, and 3. Helping their backed entrepreneurial firms receive higher IPO valuations and achieve superior post-IPO accounting ratios. Additional results suggest that VCs from California, Massachusetts, and New York are not only adept at selecting firms in which they invest in and continue to invest in, but they also enhance the value of the firms they select by means of monitoring their investments.

Keywords:

• venture capital
• geography
• proximity

PUBLIC INTEREST STATEMENT

We test the long-standing notion that venture capitalists (VCs) from California are the best venture capitalists. Our findings suggest that VCs from the states of California, Massachusetts, and New York all equally have significantly higher likelihoods of helping the firms that they invest in have an eventual successful exit. These same VC states also exhibit similar superior post IPO returns. Analyzing deeper, we find that California VCs significantly outperform even the VC specialized states of Massachusetts and New York when 1. Investing in early-stage investments, 2. Helping their backed investments receive future financing rounds, and 3. Helping their backed entrepreneurial firms receive higher IPO valuations and achieve superior post-IPO accounting ratios.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. It is worth mentioning that the next largest fund-raising state is Illinois which raised 3% of total VC funds invested and that the average state besides the three main VC states has raised only 0.4% of the total VC funds raised for 2021. This data comes from the National Venture Capital Association 2021 Yearbook.

2. The working paper, Obrimah (2018), also suggests that the States of California, Massachusetts, and New York are among the most efficient venture capital markets. Obrimah (2018) also suggests that Pennsylvania and Colorado are potentially more efficient VCs, in unreported tests we test if Pennsylvania and Colorado VCs should be counted as VC specialized states but find no support that these VCs exhibit exit success results beyond the average non-specialized VC state.

3. It is not our objective to explore VC and firm co-location, as this has been previously been explored (H. Chen et al., 2010; Griffith et al., 2007).

4. As exit outcomes are a key outcome variable in our study, we require that firms have at least 3 years to exit their investments, thus deals that are commenced after 2018 are excluded from our sample.

5. Additional summary statistics are contained in the online internet appendix in Table IA 1.

6. According to Hazarika et al. (2014), early stage investments are likely to be riskier, we use this variable to see if California VCs specialize in investing in a particular type of firm.

7. Results are similar when IPOs and mergers and acquisitions are considered as separate and distinct exit types and are tested separately.

8. This variable is called Next round financing and is equal to one if the firm has a future financing round or the firm has a successful exit, as a successful exit is also a round of financing. Thus, in many ways this will be a weaker or lower definition of exit success. Additional unreported results also exclude last round investments of successful exit investments and the results are similar.

9. Each of these variables are specific to the current investment round, exact definitions for these measures can be found in the online internet appendix.

10. As an additional robustness check we consider regression specifications which exclude the fixed effects for the initial investment year and/or the investment’s home state, these tests provide the same supportive results. The chosen fixed effect model also has the lowest Bayesian Information Criterion (BIC) values and the best McFadden Adjusted R-squared values. The authors wish to thank an anonymous referee for recommending testing BIC values.

11. As an additional robustness check, we explore the sensitivity of our results to various types of clustering (no clustering, industry clustering, VC investment stage clustering) and we find that our results are not sensitive to the type of clustering used.

12. As a robustness check a dummy for if the VC and entrepreneurial firm are co-located (reside in the same state) is added to all of the tests of Table 1 and does not affect the documented results, these results are available upon request.

13. This test was suggested by anonymous referees, we are grateful for the suggestion.

14. In unreported results, the main control variables from Nahata (2008), Hull (2021), Obrimah (2018), and Hochberg et al. (2007) were also added to these same specifications and have qualitatively similar results. These results are available upon request.

15. Flight data was downloaded from the TSA website and is said to contain the population of all flight data for the United States. To document a new direct flight, we find the first instance that the investment firm’s MSA has had a non-stop direct flight with the state of the investing VC. To ensure that we are focusing on direct flights that are not one-off flights, we require that the new flight must be offered monthly for the next year after the flight introduction.

16. It is worth noting that in these regressions the MA VC and NY VC dummies and their interactions with the direct flight dummies should indicate if the states of Massachusetts or New York have significantly different effects than the base case which is the California effect. This entails that an insignificant coefficient indicates that the effect is not significantly different than the California effect or the California direct flight effect.

17. Though seemingly marginal, this translates into $0.5 million in price premium for an average IPO size of $454 million in our sample.

18. These post IPO performance tests are also an important robustness check that these positive VC effects persist even after the IPO and indicate that these results are not due to grandstanding as documented by Gompers (1996).

Additional information

Funding

The authors received no direct funding for this research.

Notes on contributors

Tyler Hull

Tyler Hull is an assistant professor of finance at the University of Massachusetts-Boston and specializes in venture capital and private equity research. Luna Goldblatt is an assistant professor of accounting at Gettysburg College and specializes in the intersection of accounting and finance.