SPECIALIZATION VERSUS DIVERSIFICATION AS A VENTURE CAPITAL-INVESTMENTSTRATEGY

Much important work has informed us of rates of return earned by ventu re capitalists, the importance of venture capitalists to the ''going p ublic'' process, and the criteria venture capitalists use to evaluate deals. This paper seeks to add to the literature by testing hypotheses , based upon both the finance and strategic management literature, reg arding certain venture capitalist investment practices. Venture capita lists seek to control or manage risk (Driscoll 1974; MacMillan, Siegel , and SubbaNarasimha 198.5). Financing structure and investment strate gy provide several means for venture capitalists to do this. Tools ava ilable to the venture capitalist include portfolio diversification to spread risk across different industries, firms, or hot/cold IPO market s to minimize unsystematic or investment-specific risk. Information sh aring, networking, and specialization can also be used to control unsy stematic risk. Several hypotheses are. developed from these conflictin g perspectives. Data used to test the hypotheses are derived from resp onses to a survey of venture capitalists. Three hundred surveys were m ailed to venture capitalists; 98, or 32.7%, returned usable responses. Portfolio diversification is a well-known means to control risk expos ure by reducing unsystematic or specific risks. However, Bygrave (1987 ,1988), as well as financial intermediation theorists, argues that mai ntaining a high degree of specialization is useful for controlling ris k as well as for gaining access to networks, information, and deal flo w from other venture investors. The analyses of this paper build upon Bygrave's work We construct more rigorous tests to resolve the conflic t between the diversification and information-sharing hypotheses. Our hypothesis tests were usually resolved in favor of the information-sha ring view. For example, venture capitalists in the sample that were he avily involved in seed round financing were diversified across fewer n umbers of firms and industries. Further evidence in favor of informati on sharing is seen in investment patterns across different financing s tages. Diversification would imply maintaining a portfolio of investme nts across the different investment stages. The information sharing/sp ecialization view would argue that it is best to stay focused on a sin gle stage or several ''connected'' stages. The empirical evidence from the sample once again favors the specialization perspective. This res earch provides information of use to venture capitalists, as they seek information on how best to control risk; to entrepreneurs, as they le arn of the factors venture capitalists consider in determining their i nvestment strategy; and to academicians, as such studies provide insig ht to general industry practice and thus help to form the basis of cla ssroom discussion and future research endeavors.