Recent Research: Social connections more important than geography in accessing investment capital

The strength of personal relationships and social connections are the most important factors for accessing capital markets according to a recent working paper from the National Bureau of Economic Research (NBER). Theresa Kuchler, Yan Li, Lin Peng, Johannes Stroebel, and Dexin Zhou — using a novel modeling system and index of “social connectedness” — conclude that physical, geographical proximity has long served as the primary proxy for measuring how the social connections among firms and investors across geographies affect access to capital markets and investment decisions. These findings may have far reaching impacts for businesses from any region—not just those closer to investment hubs—as well as for entrepreneurial support organizations and other stakeholders seeking to strengthen their local innovation communities.

The prevailing theory has been that companies located geographically closer to areas with a greater number of investment firms are better able to access investment capital due to that physical proximity than companies located further away from these investment hubs. This new research, however, provides empirical evidence that institutional investors are more likely to invest in companies headquartered in regions to which the investors themselves have stronger social ties.

While it is likely to influence the dynamics of individuals’ social connections, geographic proximity fails to account for personal histories and how they impact institutional decisions. For example, many college graduates move out of the county in which their school is located, yet maintain strong social ties to the people and organizations they met and engaged with during their time on campus. Similarly, when investors move from one firm to another over the course of their careers, they may retain connections and investment alignment with their former colleagues.

These connections can impact the focus of an individual’s attention, and for fund managers specifically, their investment decisions. The authors suggest companies seeking capital in areas in which investment firms have a collectively greater level of social connectedness are more likely to gain the attention of fund managers than similar companies that are simply headquartered closer to investment firms.

Kuchler, et al., find this effect to be greater for companies that have less analyst coverage and for investment firms with less capacity for analyzing vast amounts of information. Although the research focuses on companies trading stock on public markets and investment firms managing $100 million or more in securities, this is an important finding for innovative startups that have little to no analyst coverage and for smaller venture capital firms.

By building and strengthening entrepreneurial and innovation support communities in regions not traditionally associated with large investment hubs, companies, venture development organizations and individual investors in these regions can expand their social networks and increase the visibility of investment opportunities in their communities — leading to better investment outcomes for all.