When and why do venture-backed companies obtain venture lending?

Drawing on data from 40 countries, this project explores the relationship between the degree of law enforcement (captured by the rule of law index) and the success of venture capital investments. More important, we seek to answer whether this relationship varies with the type of venture capitalists and, if so, in what way.
The first question is whether international VCs have more or less difficulties to cope with problems that result from weak law enforcement in the investment country that their domestic counterparts. On the one hand, domestic VCs, which are familiar with country norms and institutions and have closer connections to local authorities, might easier find ways how to mitigate the difficulties resulting from an ineffective law enforcement in their home country than VCs coming from abroad, which face the liability of foreignness problem (e.g., Zaheer 1995). On the other hand, international VCs may be harmed less with problems that result from an ineffective law enforcement because their portfolio companies can more easily relocate (Cumming et al. 2009; Bertoni and Groh 2013) and thus escape from the weak enforcement country. Moreover, contrary to international VCs, domestic VCs may be not experienced enough (e.g., Dai et al. 2012; Chemmanur et al. 2013) to develop effective alternative control mechanisms to cope with weak enforcement. In addition, VCs located in countries with weak law enforcement may, themselves, operate less efficiently than VCs coming from countries with stronger law enforcement, as the relationships towards their investors likely will be ruled by suboptimal contracts (Cumming and Johan 2006, 2009).
The second question is how the negative impact of ineffective law enforcement differs in syndicated and in stand-alone investments. Syndication has several benefits, such as better selection (e.g., Casamatta and Haritchabalet 2007) and higher value adding (e.g., Brander et al. 2002). Nevertheless, it also incurs costs, which do not exist in stand-alone investments, because syndicate formation (Cestone et al. 2007) and operations (Wright and Lockett 2003) may be plagued by information problems and misaligned incentives between the participating VCs. To mitigate these costs, VCs close contracts (e.g., Bachman and Schindele 2006; Cestone et al. 2007). Ineffective law enforcement may lead to suboptimal contracts, which increase agency costs in syndicated investments. Based on this view, we should would expect a stronger negative effect of ineffective law enforcement in syndicated than in stand-alone deals. However, it is also possible that ineffective law enforcement has a weaker negative effect in syndicated than in stand-alone deals. This is because different investors may hold complementary know-how and expertise (Manigart et al. 2006), which makes a syndicate better equipped to cope with ineffective enforcement than a stand-alone investor.