Propagation of Financial Shocks: The Case of Venture Capital

In this paper, I investigate whether venture-backed companies can be negatively affected when others that share the same investor perform poorly. To this end, I examine the impact of the collapse of the technology bubble on non-information-technology (non-IT) companies held alongside internet companies in venture portfolios. Using a difference-in-differences framework, I find that the end of the bubble was associated with a 26% larger decline in the probability of raising continuation financing for these non-IT companies in comparison to others. This does not appear to be driven by unobservable company characteristics such as IT-relatedness; for the same portfolio company receiving capital from multiple venture firms, investors with greater internet exposure were significantly less likely to continue participating in follow-on rounds. Overall, these results suggest that structuring intermediaries to be less fragile, as venture intermediaries have been, does not eliminate the possibility of contagion among portfolio companies. JEL Classification: G11, G24