Venture capitalists face more risk and uncertainty when they invest in companies that are far away compared to startups in their own region or country. Yet more cross-border VC investment is happening than ever before. New research from Wharton assistant management professor Exequiel (Zeke) Hernandez and Sarath Balachandran, assistant professor of strategy and entrepreneurship at the London Business School, looks at why that’s happening. In a paper titled “Mi Casa Es Tu Casa: Immigrant Entrepreneurs as Pathways to Foreign Venture Capital Investments,” the two authors examine the role immigrants play in facilitating these investments. Hernandez spoke with Knowledge@Wharton about their research.

Knowledge@Wharton: In your paper, you say that growth in cross-border investments by VC firms, which have risen to record levels over the past decade, is both an important and a puzzling trend. Why is that?

Exequiel (Zeke) Hernandez: It’s important because the globalization of capital to fund startups allows both investors and entrepreneurs to find each other more effectively than before. And it reflects that the sources of entrepreneurial ideas and talent — and also capital — are more globalized than before. Even a few years ago, most of the highgrowth startups came from just a few countries in the world, like the United States or the United Kingdom, or Israel more recently. Now, we’re seeing a change. The reason it’s puzzling is because the venture capital industry is famously very localized. There have been quite a few studies before mine that have shown that venture capital investment is very unlikely to happen more than about 40 to 60 miles from the headquarters of the VC firm. Silicon Valley investors invest in the Valley, Boston investors in Boston, etc. Why does this happen? Because it’s really hard to get information about startups and to monitor their performance. Proximity allows you, as an investor, to find out what new startups are out there and to meet the founders and develop a relationship with them before you invest. After you invest, proximity is really important to monitor performance of the startup, to meet, to provide advice when things come up, etc. The puzzle is that international venture capital investment violates this proximity rule. You invest in a startup abroad: Obviously, you’re very far away, but you have other risks beyond geographic separation. You take on cultural differences, legal differences, and other institutional factors that come in just because countries differ from one another.

K@W: What was the main question you set out to answer with this research?

Hernandez: Broadly, we wanted to know why VC firms would take on the risks of investing in start-ups from other countries and, importantly, where they invest. As we looked at the data, we noticed that as we compared firms, there was a lot of variation in where they invested. Some invested in Israel, Canada, China, India. How do we explain the destination of their investments? That was the broad thing we were trying to understand. We had a very specific hypothesis: One mechanism that explained this was that immigrant entrepreneurs play a really crucial role in facilitating cross-border venture capital investment. The more a venture capital firm — in this case, in the U.S. — invests in startups that have immigrant founders, the more that firm will later invest in startups located in the country the immigrant founders are from.

K@W: Your study focuses specifically on the role that immigrant entrepreneurs play in this scenario. How do they facilitate these investments?

Hernandez: The mechanism is pretty straightforward. An immigrant entrepreneur has knowledge about the home country and connections in that country. If I’m a venture capitalist and invest in a startup that an entrepreneur from India or China or Israel has founded, then over time, just because I interact with that individual, I become exposed to the knowledge and connections of that person.

K@W: What were the results of this study?

Hernandez: In our study, we had data on the investments of U.S.-based venture capital firms in Indian startups. What we found is that the more a U.S. venture capitalist invested in startups in the U.S. that were founded by Indian entrepreneurs, the more it later invested in startups in India, or the greater the count of investments in India. But what’s really important is that we found that this effect only happened if the Indian entrepreneurs in the U.S. were first-generation immigrants, meaning they came directly from India. There was no effect for second- or later-generation Indians. We also found some very specific results that are interesting. For example, we found that if a venture capitalist is exposed to Indians from a certain region of India — say, West India — it will make more investments in West India than in other parts of India. So it seems to be that the exposure is very specific to the region — that the knowledge and connections of these immigrants are very specific to where they spent time in India growing up. The other result we found is that if you make an investment in India because you’re exposed to Indian entrepreneurs in the U.S., you’re less likely to co-invest with a local Indian venture capitalist. You kind of go it alone, probably because you’re willing to take on a little bit more risk. Perhaps the entrepreneurs gave you information and make it so that you don’t feel it’s as risky to go it alone.

“Immigration plays an important role in the diffusion and allocation of capital across countries,” says professor Zeke Hernandez.

K@W: Unlike previous studies in this area, you looked at firms’ interactions with individual immigrants, as opposed to the broader immigrant population. Why is that important?

Hernandez: It’s important because there are previous papers that have looked at how immigrants affect the foreign investments of companies in general. I’m not talking about venture capital, but just direct investment. Think of a multinational firm setting up a subsidiary somewhere. I’ve done some of that work. Others have done some of that work. One of the things that all those previous papers have in common is that they looked at exposure to the population of immigrants from a certain country. Let’s stay with Indians as our example. If I’m in a place like New Jersey or California that has a lot of Indian immigrants, that might stimulate investment in India. But that exposure at the population level doesn’t really explain why two firms headquartered in the same location and exposed to the same number of Indian immigrants at the population level might behave differently. We observe one firm investing in India and another firm not investing. We need a setting where we can observe a firm interacting with individual Indians. Venture capital was really great in that sense because we can observe this. It’s that exposure at the individual level that allows me to know if you were, to use a medical term, infected with the knowledge and connections in a way that’s going to influence you later.

K@W: What implications does your study have for immigration policy?

Hernandez: Perhaps the broadest implication is that immigration plays a really important role in the diffusion and the allocation of capital across countries. To put it differently, migration is a leading indicator of where firms are going to invest capital many years later. And the reason that matters is because if you’re a country or a city or a jurisdiction that wants to increase capital investment — I think this is a concern of most mayors and governors and presidents — then one of the best things you can do is have immigrants. It takes time for this to happen, so it’s not an investment with an immediate payoff. But it matters because in policy discussions, when we talk about how immigrants affect the economy, most of the debate circles around questions of jobs and labor. We don’t usually talk about capital. But if we think about the economy, it doesn’t just grow because of labor issues. It also grows because there’s capital that’s productively invested. Immigrants play a role in that huge part of the economy that is increasing the stock of capital. That’s a very broad implication.


Published as “Betting on Business Abroad” in the Spring/Summer 2020 issue of  Wharton Magazine.