Innovation partnerships between new technology ventures and their funding partners – venture capital (VC) firms and corporates – are essential to the success of these ventures. Such partnerships are, however, not always effective and easy to maintain. In fact, the tension between collaboration and competition with large corporates can also expose new technology ventures to risks of interest misalignments or misappropriation. This case is particularly relevant to the formation of ties between these ventures and the venturing arms of large, established corporations.
While the vast majority of research on the defences against resource misappropriation focuses on the role of formal legal instruments and the importance of partnering with trusted strategic investors, such as corporate investors that are highly regarded in the VC community, a recent study, due to be published in the Academy of Management Journal, extends the work of network theorists and analyses the ability of third parties to facilitate trust in relationships and reduce misappropriation.
The study, co-authored by Benjamin Hallen of London Business School, Riitta Katila of Stanford University and Jeff Rosenberger of Wealthfront, empirically examined the effects of social defences using both qualitative evidence and quantitative data from 1979 to 2003 on 700 US ventures in five technology-intensive industries that entered into corporate venturing relationships.
The results uncover “the effects of social defences and find, intriguingly, that third-party social defences are particularly significant when more traditional defences are unavailable. Beyond providing resources and legitimacy, ties with centrally positioned third parties are a critical mechanism whereby young low-power firms can enhance their power in tie formation.”
Two specific effects of third-party social defences – capable of shielding against different risks – are important.
The first is disciplining. Third parties can influence tie formation because they represent a potential reputational threat to opportunistic partners, with broad future implications. For example, third parties could not only terminate or modify future relationships with the offending party, but also disseminating allegations of opportunistic behaviour that could affect the reputation of the offending party.
The second effect is alignment. In fact, third parties may influence the goal alignments and the tie formation – for example, influencing the choice of partners by leveraging industry knowledge and information on prospective partners.
Interestingly, the results show that the effects of social defences on tie formation are significant even when controlling for more traditional defences, such as formal legal instruments. Also, and even more significantly, the authors found that social defences may take the place of traditional defences when the latter are weak or non-existent.
This finding suggests an equifinality of defence mechanisms, such that firms with weak trade-secret protection or low timing defences might instead gain protection from social defences and vice-versa. Moreover, the results show the importance for entrepreneurs to build and maintain a portfolio of diverse relationships. Such early connections are not only a source of legitimacy but they can be instrumental in effective partnerships with investors with different resources.
Reference
Hallen, BL, Katila, R and Rosenberger, JD (forthcoming) Unpacking social defences: a resource-dependence lens on technology ventures, venture capital, and corporate relationships, Academy of Management Journal.
Boris Battistini is a senior research fellow at Swiss Federal Institute of Technology (ETH Zürich) and an associate at Metellus, a venture capital firm based in Zürich, London and San Diego. Email: boris.battistini@metellus.ch. Martin Haemmig is an adjunct professor at Cetim at UniBW Munich and Leiden University. Email: martinhaemmig@cetim.org
Network centrality
This is a measure of how connected a VC firm or corporate venturer is with other firms or units in the industry, as networks have been proven to be a critical driver of venture performance. The higher a firm’s network centrality, the better its access to dealflow, follow-on funding, and industry information. Network centrality is analogous to Google PageRank for investors, in that those who share investments with high-quality investors and who have a diverse set of connections have higher a network centrality ranking than those that do not. In a network-driven industry like venture capital, who you know is as important as what you know.
Network centrality between VC firms and between VC firms and corporate venturing units: At first sight in the first graph below, it becomes obvious that VC firms generally syndicate a lot more with other VC firms than with corporate investors. This investment syndicate heat map shows a subset of the most active VC firms and corporate venturing units. Boxes with the darkest blue indicate a high rate of co-investment in companies, for example, Google Ventures and SV Angels, while lighter colours indicate less frequent or no co-investments, for example SV Angels and American Express, plotted by unique company rounds over the period.
Network centrality between corporate venturing units: Co-investments between corporate venturing units are rather rare. However, they occurs more in non-competitive or complementary situations, or when a new technology standard needs to be pushed for the benefit of the industry. Analysing the investor syndicate network is extremely valuable for both venturers and for LPs (limited partners or fund investors). For venture firms it can help identify potential follow-on investors or sources of dealflow. For LPs, those venturers with stronger networks generate better returns.