Referrals and their effect on Venture Capital Due Diligence

Abstract

Venture capital is a socially embedded business where VCs refer investment opportunities to one another. While we know that these referrals increase the chances of a start-up passing the initial screening process, we investigate to what extent the intensity of relational embeddedness between referrer and referee relates to the length of the due diligence process of the start-up being referred. Building on social exchange theory, we find that referees do not take the referral as a simple heuristic cue to shortcut the due diligence process, but rather reciprocate the favor by commitment towards the relationship and expending additional time on due diligence. Moreover, we find that the individual investment manager’s current performance and experience moderate this relationship.