VCs invest better in start-ups by entrepreneurs of same ethnicity

New York University Stern Business School 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 analysed 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 their findings:

• 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 favour co-ethnic entrepreneurs for investment during early investment rounds
• Some ethnic groups (e.g., Chinese, Indian, Jewish and South European) favour 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 the venture 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  has been published in the journal Management Science.