As this is a working paper, and obviously open for discussion, it will probably evolve, but:
1. The paper does not analyze the pre-money valuations of companies in CSAs vs rest of the country. This could explain why investments are more profitable out of these CSAs for VCs venturing out.
The reasons of higher pre-money valuations in the CSAs are:
i) a higher level of costs locally (that would need to be sustained with national statistics on office space prices and salaries as well).
The volatility of costs in CSAs and the rest of the nation could also be analyzed to see if this explains why investing in a downturn (when resource prices are depressed) is more profitable, even in CSAs.
ii) a higher level of competition as for VCs willing to invest in a company based in a given CSA (number of term sheets issued and eventually declined could be a useful indication).
In that respect, the statement (page 24) « While branch office investments and outside investments are more likely to IPO, exit multiples are similar across main office investments, branch office investments and outside investments» . How is this substantiated that? I may have missed the data. I thought that IPO exits presented almost systematically an upside in terms of multiple of investments compared to trade sales. Otherwise, it would make no sense to go through the costly and painful process of an IPO.
2. Assuming that companies have a higher pre-money valuation in CSAs than in the rest of the country (this can be checked with the Dow Jones VentureSource database), we would then need to see what is their exit price in CSAs vs the rest of the country.
My guess is that if valuations for VC rounds can significantly change according to local conditions (i.e., belonging to a CSA or not), exit prices are valid nation-wide. Said differently, a company bought out or going public will not be priced differently if it is based in Milwaukee or San Francisco. This creates however a significant difference for the investors, as they earn the difference, of course.
3. The reputation effect of VCs, which enables them to negotiate discounts if they are highly regarded in a region versus other term sheets, is another factor which could explain the discrepancies between the VCs in a given CSA (otherwise, the effect should be homogeneous). See HSU D., What Do Entrepreneurs Pay for Venture Capital Affiliation?, 2004.
4. Another reason of the subsequent performance (which could be measured by the mortality rate of companies in a given VC portfolio located in a CSA or not), is that the screening is probably tougher for distant deal flow. Bengtsson and Ravid (2009) are rightfully quoted as for the contractual clauses which are tougher as the investor is more distant. The introduction should be more qualified, notably because the reputation effect is lower (unless the VC fund manager is known nationwide) and it is more difficult to attract co-investors in a distant investment.
5. Given the level of management fees charged (2 to 2.5% p.a.), and the costs supported by the firm, costs of visiting are not a determining factor. If you think so, maybe you could provide some hard data on this ground, because my experience is that this does not play any major role in investments decisions. Due diligences are made on-site, that’s true, but phone is the major contact medium post-investment (actually, going from San Francisco to San Jose can take as much time with the traffic than going by plane to Seattle). Onsite presence once the investment made is not so frequent – at least not enough to weight in the choice of a VC fund manager to invest or not.
If you look at the amounts of money spent in traveling for fund raising purpose (which means that there is no guarantee whatsoever of success for a given travel), that should put some perspective on traveling to monitor and investment. As for due diligence travelling, this is usually pooled with other purposes such as monitoring, networking, etc.
I hope that these comments will be useful.
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