It’s a natural impulse: When people are looking for partners on a deal, they seek out people with whom they have a lot in common.
For venture investors, though, that kind of familiarity can be costly.
Recent research has found that investors are more likely to work together if they share certain traits, including gender, ethnicity and educational and employment history. But doing so often reduces their chances of financial success.
For instance, the chance of a deal’s culminating in a public offering or in a profitable sale fell by 19% if both investors attended the same college, and by 17% if they previously worked at the same company. Working with a partner with the same minority ethnicity diminished the chances of an IPO or a profitable sale by 20%.
The research, published in the Journal of Financial Economics, examined 3,510 individual venture capitalists who invested in 12,577 companies from 1973 to 2003.
In the study, two venture capitalists who both held degrees from top-tier universities were 16.3% more likely to invest together as a syndicate than two who weren’t both alumni of top schools. Two investors who studied at the same college were 34.4% more likely to be partners on a deal than two who attended different schools. Investors belonging to the same ethnic minority were 39.2% more likely to pair up.
The authors speculate that matches based on most affinities may encourage “groupthink” that diminishes critical thinking for the sake of maintaining a harmonious relationship. “People who have the same background are likely to make the same mistakes,” says lead author Paul A. Gompers, professor of business administration at Harvard Business School, who wrote the study with Vladimir Mukharlyamov, currently assistant professor of finance at Georgetown University, and Yuhai Xuan, currently associate professor of finance at the University of Illinois at Urbana-Champaign.
By contrast, people with varying backgrounds are more likely to question each other and frame issues in different ways, leading to more critical thinking and, ultimately, better decisions, he says. “This points in the direction of a big benefit of a diverse set of backgrounds in this setting.”
The study found that the negative financial effect of having similar backgrounds was most pronounced when the pair invested in a company during its early stage. In such a case, the investors had “more decisions to make [and] more chances to mess up” than if they’d bought into a late-stage company where most crucial decisions had already been made, says Dr. Gompers.
Only one affinity helped the chances of a pair’s financial success: attending a top-tier university. But that was true only if the partners attended different top-tier universities. Why? The authors say that particular connection, unlike a shared gender or ethnicity, may reflect actual high ability.
“Having two smart people look at a deal is probably better than having one smart person look at the deal,” says Dr. Gompers. That advantage fades, though, if both attended the same school because of the groupthink that the affinity of a shared college tends to produce.
Look for biases
The research suggests that venture capitalists as well as those in other industries need to be aware of their biases toward hiring and working with people similar to them and the potential negative effects of those biases.
“They should proactively think about issues of diversity and try to hire and work with people who have different backgrounds,” says Dr. Gompers.
For their part, the entrepreneurs seeking funds should consider that “having a diverse set of investors in their company is probably a good thing.”
Lee is a writer in Palo Alto, Calif. She can be reached at email@example.com.