Performance reversals and attitudes towards risk in the venture capital (VC) market

In this paper, we find evidence of reversals in relative exit performance between the "short" and "long-run" in the VC market, with the short-run defined to be the first 5 years of business, and the long-run, the 6th year of business onwards. Using proxies for the risk of venture capital assets that are derived from VCs' risk management strategies--investment staging and deal syndication--we find reversals in relative performance are explained by the coexistence of persistent and non-persistent attitudes towards risk along two complementary dimensions. First, while syndication strategy is persistent, attitudes towards portfolio risk reverse between the short- and long-run periods, such that syndication is associated with high risk portfolios in the short-run, and low risk portfolios in the long-run. Second, VCs that hold high quality portfolios in the short-run do not persist with this strategy; however, high quality portfolios are associated with superior long-run exit performance. The performance effects of the transitions in attitudes towards risk that we observe are consistent with theories of costly reputation building in markets characterized by adverse selection problems and empirical evidence that VCs' deal screening skills are more important for success than advisory or monitoring skills.