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Venture capital firms (VCFs) often refer investments to their network peers. Scholars argue that referrals alleviate idiosyncratic risks and reduce the cost of sorting investments. Yet, research on the strategic implications of referrals for VCFs is scant. This study investigates the impact of network referrals on the redistribution of VCF resources within a referred deal and across other ventures in a VCF portfolio. At the deal-referral level, we show that VCFs respond to the fall in idiosyncratic risks by increasing their financial exposure to the venture while monitoring less. Accordingly, deal referrals allow VCFs to save resources while taking an advantageous financial position in the referred venture. We show that while referrals enhance information about deals, referrals do not diminish VCFs involvement in formal governance nor directly affect the probability of follow-on investment. We also show that deal referrals motivate VCFs to redistribute resources within their portfolio.
Rabi et al. (Tue,) studied this question.