Venture Capital: Location, Location

If you think setting up shop in Silicon Valley or on Massachusetts' Route 128 will help you get a better valuation from venture capitalists, here's a surprise: Valuations can be stingier in areas where there are a lot of venture firms working together on deals.

After looking at data on investment relationships among VC firms within states and metropolitan areas, economists Yael Hochberg of Northwestern University and Alexander Ljungqvist and Yang Lu of New York University Stern School of Business found that valuations were lower in areas where local firms frequently collaborated on deals.

Using data on venture funds that invested in U.S. companies from 1975 to 2003, the economists ranked cities according to how much networking there was among VCs. They found that the average valuation was $71 million in areas with little interaction between VC firms. But it was only $39 million in the more densely networked spots.

One explanation for the lower figure is that new VC firms tend not to move into areas where many VC firms are already established and cooperation among them is high. "Having to establish visibility, credibility, access to information, and local knowledge from scratch puts entrants at an obvious disadvantage relative to incumbents," says Ljungqvist. But those new firms often drive up valuations as they try to make their mark by outbidding local players.

Another factor may be at work: Entrepreneurs may choose a firm despite its lower offer if it promises better service. "The ability of a venture capital firm to call on other resources, such as suppliers, customers, or expertise at another firm, can make it more attractive to entrepreneurs," says Ljungqvist. If your priority is to get the most money or the best support when shopping around for VC funding, says Ljungqvist, "the choice of where to be headquartered matters."

By James Mehring

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