How Important Is Innovation for Venture Capitalists' (VCs') Market Reputation?

This paper provides evidence that venture capitalists' (VCs') market reputation consists of two components: an expected component derived from "expectations about VCs' ability to deliver relatively safe ventures to market" and an unexpected component derived from "unanticipated improvements in VCs' ability to deliver relatively innovative ventures to market". These findings provide evidence of optimal levels of diversification within the venture captial market and evidence of demand for innovation from VCs' principals. Given both expected and unexpected market reputation are within reach of each venture capital firm, my findings provide evidence of two complementary paths to market reputation. While a focus on relatively safe ventures results in the development of market reputation, my findings show the combination of a focus on relatively innovative ventures and exits via third party acquisitions yields the best risk-return trade-offs and the highest estimates of idiosyncratic managerial ability within the cross-section of the venture capital market