The venture capital (VC) industry has undergone a profound transformation over the past two decades with the emergence of common VC investors — that is, VC firms that hold ownership stakes in multiple startups within the same industry or product markets. In a forthcoming article, we describe the origins and implications of common VC investment and highlight research questions about its benefits and costs.

The rise of common VC investors is noteworthy for its dramatic and rapid acceleration. In just over two decades, the percentage of startups with a common VC investor has surged from less than 10 percent in 1995 to over 50 percent in 2018. This shift is more than just a statistical anomaly; it signals a fundamental restructuring of the relationships among investors, startups, and markets, underscoring the urgency of understanding it.

The reasons for the shift are multifaceted and intertwined with broader changes in entrepreneurial finance. The overall growth in VC activity has created fertile ground for investment overlap. A key factor has been regulatory changes, which have enabled late-stage startups to raise unprecedented amounts of capital in private markets, further expanding opportunities for common VC investment.

One regulatory change that has contributed to common VC investment is corporate opportunity waivers (COWs). From 2000 to 2016, eight states enabled corporations to adopt COWs, which permit firms to waive a fiduciary obligation of directors known as the corporate opportunity doctrine; these COWs essentially remove directors’ obligation to always act in the best interests of the firm on whose board they serve. This is especially salient in VC settings because VC investors frequently require board representation. Without a COW, a VC investor sitting on boards of similar startups could face litigation risk if she were approached with a business opportunity that could benefit one startup at the expense of another. Adopting COWs provides a liability shield, thus reducing a key impediment to common VC investment.

What is the impact of expanding common VC ownership?  So far, the research shows that it substantially improves startup outcomes.  Startups with common VC investors tend to raise significantly more VC financing rounds, receive higher valuations, and have higher probabilities of successful exits through IPOs. Their failure rates are also lower. The primary reason appears to be that well-networked directors with industry expertise are placed on startup boards, which helps to facilitate knowledge sharing and resource pooling across the VC’s portfolio.

However, this trend’s long-term and broader market implications remain subjects of intense debate. While the immediate effects on startups seem beneficial, questions arise about potential impacts on market power and innovation. In some industries, such as pharmaceuticals, common VC investors may influence R&D strategies to enhance efficiency but potentially concentrate market power among the best-performing startups. This raises important questions about the balance between fostering innovation and maintaining healthy market competition.

To fully appreciate the significance of common VC investors, it’s best to situate this phenomenon within the broader context of the common ownership debate.  In public markets, the impact of common ownership on firm behavior and market outcomes has sparked considerable controversy. Some studies have suggested that common ownership by institutional investors leads to anticompetitive effects. However, other studies have challenged these findings and questioned whether the key assumptions necessary for common ownership to cause anticompetitive effects are satisfied in the public market.

Importantly, the assumptions necessary for common ownership to influence firms are much better satisfied in private markets and the realm of VC. The first assumption relates to control rights: VC investors typically acquire larger ownership stakes and more extensive control rights in their portfolio companies than do public company investors. The second assumption relates to ownership: VC portfolios tend to be concentrated within the same or related industries, thereby providing incentives to maximize company profits without worrying about effects on downstream industries. The structure of the VC industry creates a setting where common ownership could, in theory, have a more pronounced influence on firm and market dynamics.

These distinctions highlight new avenues for exploring how ownership structures influence market dynamics across the public-private divide. How, for example, might the effects of common ownership evolve as private companies go public, and does the influence of common VC ownership persist? How do the incentives and behaviors shaped by common VC ownership affect a company’s ability to compete in the public market?

The rise of common VC investors challenges us to adapt our analytical approaches. When applied to the VC context, the metrics and methodologies developed for studying common ownership in public markets may require significant revision – or perhaps a complete rethinking. This challenge, however, also presents an exciting opportunity for researchers to develop new models that can capture the full implications of common ownership across a company’s life.

Beyond these methodological considerations, the phenomenon of common VC investors raises many economic questions about its broader impacts. How do common VC investors influence labor market dynamics within portfolio companies?  In what ways might VC investors reshape industry composition and alter the balance between public and private companies?  As we seek to distinguish between efficiency-enhancing collaborations and potentially anticompetitive practices among startups with common VC investors, we must also grapple with how innovation strategies influenced by these investors affect broader social welfare, particularly in critical industries.

Given that startups are vital to economic growth and technological advancement, the implications of common VC investment extend far beyond the confines of boardrooms and pitch meetings. Those implications include changes in how ideas are funded, nurtured, and brought to market. The insights gleaned from research in this area will shape policies and strategies that can harness the benefits of common VC investment while mitigating potential risks.

The rise of common VC investors marks an exciting new chapter in the story of innovation and entrepreneurship. While challenges and questions remain, this trend also brings tremendous potential for fostering collaboration, driving efficiency, and accelerating the pace of technological advancement. As we continue to explore and understand this phenomenon, we can shape a future where the power of shared knowledge and resources can be leveraged to create more resilient, innovative, and successful startups.

This post comes to us from professors Jillian Grennan at Emory University and Michelle Lowry at Drexel University. It is based on their forthcoming article, “Common Venture Capital Investors,” available here.