Alumni networks are the key to fundraising for startups. Here is the surprise.



It’s no surprise that founders looking for early-stage funding are turning to their alumni networks. After all, information on private markets is scarce, so people turn to those they know.

But researchers who have analyzed nearly two decades of data on early-stage venture capital activity have found evidence of the power of these alumni networks for the ultimate viability of start-ups.

In fact, the size of a founder’s alumni network can be the deciding factor in the success of the entrepreneur’s early stage fundraising. Investors are more likely to position their portfolios to invest in startups created by founders of their alma mater and to place larger bets on those companies. For investors and founders alike, the effect is paying off, according to a new research paper, titled “Alumni Networks in Entrepreneurial Financing”.

In one-third of all early-stage venture capital investments over a 19-year period, the founder and investor attended the same college or university. Start-up investors are more inclined to invest in startups led by founders of their alma mater – even when the new business is “relatively similar” to other companies in the same industry at the time, according to authors Jon Garfinkel, Professor of Finance at the University of Iowa School of Business, Erik Mayer, Assistant Professor of Finance at Southern Methodist University, and Emmanuel Yimfor, Assistant Professor of Finance, at Ross School of Business at the University from Michigan.

“Alumni networks are an important channel for connecting start-up-investors. It’s not a surprise, ”said Yimfor Institutional investor. “What was a surprise was the magnitude of this in our data.” For the study, the researchers compiled PitchBook data on all transaction activity from 2002 to 2020 in which the founders of the start-up or venture capital firm attended one of America’s top 550 universities. .

The researchers focused on early-stage equity investments, as “alumni networks are likely to play a larger role in this space given the general lack of information about” emerging companies. In public markets, companies file regulatory documents with the Securities and Exchange Commission, signaling to the investor universe that they are trying to raise capital. In contrast, in private markets, Yimfor said, it is often difficult for investors to know who is looking for funds and even more difficult to access detailed information about a startup’s business model, potential competitors, potential market size and other data. .

“It is very difficult to get the list of companies that raise funds. And even if you get the list, it’s not easy to filter out, ”Yimfor said.

But, if an investor went to the same school as the founder, he or she may have better access to “background information” about the company. For example, Yimfor said, “Now [as an investor], I have the list, and I know [a founder] raises funds. I know the founder went to the University of Iowa and got an A in math. But how difficult are math lessons? If I’ve been to Iowa, I know they’re tough. Otherwise, I would only know the general reputation of the University of Iowa.

The study’s findings come at a time when beneficiaries and asset managers, including venture capitalists, are striving to diversify the ranks of their employees as well as senior management. With venture-backed companies also accounting for over 40% of initial public offerings in the United States, startups make up a significant portion of the economy. Networks can both strengthen the status quo and be an untapped avenue for reaching new communities.

The research study offered a more nuanced view of networks, showing “that the founders’ connections to early stage investors through shared education networks [were] more important “than the academic quality of the school or the shared geography, according to the authors.

The educational bond between founder and investor is more critical than the quality of the school, according to the study. For example, the same alma-mater effect is even stronger when the founder and investor went to a less prestigious school, according to the research. To determine the “prestige” or investor perception of the founders’ alma maters, Garfinkel, Mayer and Yimfor calculated the average SAT scores, that is, the average SAT scores of incoming students to the school. university attended by the founder of the portfolio companies. They did this for each university included in the sample. For schools with higher SAT scores, the positive effect of a shared alma mater is lower than for founders of schools with average and lower SAT scores. In fact, an inflated average SAT score reduces the effect on the likelihood of investing by 0.06 percentage points, according to the report.

“This result suggests that connections matter less when founders have strong public signals of their quality, implying that the importance of connections may stem from their ability to resolve information asymmetries,” the authors wrote.

This shows, the authors argue, that it is not a matter of preference; it is information. The research results seem to suggest one of two things, Yimfor said: either investors have a preference to invest in startups with links to their alma mater, or they are able to learn solid information about startups. . If the pairing was simply the result of preference, Yimfor argued, it would be reflected in the company’s performance.

“If it was just a preference, when you look at the results of the investments, they might not do as well,” Yimfor said. “Because instead of looking hard, [the investors] do it according to their preferences.

Stocks of investors in founders with a common educational background tend to outperform their other investments. In fact, startups are 33% more likely to IPO after funding and are 10% more likely to receive patents.

“If I’m an investor, maybe I have a bar – or a standard – that an investor needs to cross before investing in them,” Mayer said. II. “If I show favoritism to invest in people from my alma mater, I might lower the bar for them a bit. ”

But, as evidenced by the outperformance of old-connected startups, lowering the bar is not happening, Mayer said. Instead, because of their connection to the university, investors gain access to more solid information about the company they are investing in.

“It’s an informational story, not a bar lowering story,” Mayer said.

The effect is also stronger when the investor does not have “alternative ties” to the startup, which means that he or she has no ties to other investors involved in the founder’s business.

“If you look at a group of investors who are investing in a start-up for the first time and they don’t know each other – so they never collaborated on a prior agreement – the alumni network seems to be particularly important” , says Yimfor.

The researchers also found that a shared alma mater had a greater effect on early-stage fundraising than the company’s geographic location. Taking into account all of the factors that could improve early-stage fundraising, the authors found that a shared alma mater, on average, translates to 19% more early-stage fundraising.

As a result, founders who went to schools with large alumni networks are able to raise more capital than other founders, according to the report. In fact, the size of the alumni network may be the most important factor in seed funding. The authors controlled for other factors that typically affect early stage financing, including distance between entrepreneur and investor, age of the venture capital firm, size of founder’s university, the academic quality of the university and the number of alumni who are early stage investors. .

“None have understood the importance of alumni relationships within the investor-founder dyads,” the authors wrote.


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