Ethnic Enclave and Entrepreneurial Financing: Asian Venture Capitalists in Silicon Valley

• Date: 01 September 2016
• Published date: 01 September 2016
• DOI: http://doi.org/10.1002/sej.1230
• Author: Poh Kam Wong,Jing Zhang,Yuen Ping Ho

ETHNIC ENCLAVE AND ENTREPRENEURIAL

FINANCING: ASIAN VENTURE CAPITALISTS IN

SILICON VALLEY

JING ZHANG,

1

* POH KAM WONG,

2,3

and YUEN PING HO

3

1

Department of Management, Strome College ofBusiness, Old Dominion University,

Norfolk, Virginia, U.S.

2

NUS Business School, National University of Singapore, Singapore

3

NUS Entrepreneurship Centre, National University of Singapore, Singapore

Researchsummary: We examinethe dilemma of ethnic investorsin using ethnic network ties to

invest by extendingthe ‘ethnic enclave’conceptto incorporate two dimensions:social network

and social status. Our analysis of the first round of venture capital funding in Silicon Valley

from 1976 to 2004 shows a higher likelihood of Asian venture capitalists (VCs) investing in

Asian-led ventures th an mainstream VCs. In a ddition, the valua tion of their inves tments in

mainstreamventures is higher thanthose by mainstream VCsin such ventures. In contrast,this

premium effect is not observed when mainstream VCs invest in Asian ventures. These

asymmetrical findings suggest the premium Asian VCs pay to compete in the mainstream

venture market is due to their lower social status rather than their social network

disadvantages.

Managerial summary: Do ethnic minority investors behave differently from more mainstream

investors? We examine this questionby studying the venture capital industry in Silicon Valley

over the period 1976to 2004. We found that Asian venture capitalists (VCs) were more likely

to invest in immigrant Asian entrepreneurs than mainstreamVCs, and when they did invest in

mainstream ventures, the y paid higher val uations than mai nstream VCs. In contr ast,

mainstream VCs did not pay higher average valuations compared to Asian VCs when they

invested in Asian ventures. We show that two social factors—the ethnic min ority VCs’social

network ties and their lower social status—could have contributed to such behavioral

differences.Copyright © 2016 Strategic Management Society.

INTRODUCTION

Ethnic minority entrepreneurs are over-represented

among innovation-based founders in theUnited States

(Saxenian, 2006). Compared to a foreign–born

population of 12 percent in 2000, 25 percent of

founders of venture capital (VC)-backed U.S.

companies from 1990 to 2005 were immigrants

(Anderson and Platzer, 2006), as were founders of

25 percent of technology and engineering ventures

with more than $1 million in sales in 2006 (Wadhwa

et al., 2007). The largest U.S. VC-backed public

companies started by immigrants include Intel,

Sanmina-SCI, Sun Microsystems, eBay, Yahoo!,

and Google, to namea few (Ndoforand Priem, 2011).

While immigrant entrepreneurs contribute

significantly to job creation and innovation in the

United States, they generally face greater challenges

in acquiring financial capital than do their mainstream

peers (Kushnirovich and Heilbrunn, 2008). The

literature on sociology (Aldrich and Waldinger, 1990;

Fisman, 2003; Nielsen, 1985) and entrepreneurship

(Bates, 1997; Brüderl and Preisendörfer, 1998;

Masurel et al., 2002) have long recognized the

Keywords: venture capital; ethnic enclave; entrepreneurial

financing; Silicon Valley; social network

*Correspondence to: Jing Zhang, Strome College of Business,

Old Dominion University, 2038 Constant Hall, Norfolk, VA

23529, U.S.A. E-mail: j3zhang@odu.edu

Strategic Entrepreneurs hip Journal

Strat. Entrepreneurship J.,10:318–335 (2016)

Published onlinein Wiley Online Library (wileyonlinelibrary.com).DOI: 10.1002/sej

Copyright © 2016 Strategic Management Society

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importance of the social network of co-ethnics in

funding new businesses. For instance, Light (1972)

argues that a cultural proclivity toward business

partnerships and the institution of rotating credit unions

enabled Chinese and Japanese immigrants to start

small businesses. Very recent studies find that co-

ethnicity between innovation-based entrepreneurs and

their VC investors facilitates the funding process

through increased trust (Bengtsson and Hsu, 2015;

Hegde and Tumlinson, 2014).

Although intriguing and important, the existing

literature on ethnic entrepreneurship has not fully

examined the ethnicity-driven behavior of investors.

Theoretically, while these prior studies have

recognized the roles of ethnic solidarity (Nielsen,

1985) and social homophily in ethnic social networks

(Hegde and Tumlinson, 2014), they have not fully

explored the complex impacts of one fundamental

feature of ethnicity—the social status of minority

groups (Wang and Altinay, 2012). In the particular

context of VC investment, minority ethnic investors

may suffer from lower social status and, hence, face

barriers to investing in the mainstream venture

market. Thus, while co-ethnic social network ties

may facilitate investment by ethnic investors in ethnic

ventures, they mayat the same time also reinforce the

lower social status of the ethnic investors, causing

them to have to pay a premium compared to

mainstream investors when they invest in the

mainstream market. This social status effect can be

distinguished from the social network effect, as it is

asymmetrical, i.e., while the investors with lower

social status need to pay a premium to invest outside

their social networks, the mainstream investors do

not similarly pay a premiumwhen they invest outside

their mainstream networks.

In this article, we exploit these insights on both the

advantages and disadvantages of using co-ethnic ties

to study co-ethnic VC investment in Silicon Valley.

In particular, we propose to disentangle the traditional

construct of the ‘ethnic enclave’(Portes, 1981) into

two distinct dimensions: the social network ties among

co-ethnics and the social status of an ethnic minority

group in a host society. While the original ethnic

enclave concept focuses only on entrepreneurs and

employment (Sanders and Nee, 1987), we extend it to

study the behavior of venture investors. In essence,

we hypothesize that ethnic investors are driven by

two competing forces when funding co-ethnic

entrepreneurs. On the one hand, an ethnic social

network reduces information asymmetry and increases

trust and solidarity between entrepreneurs and

investors; ethnic investors would then have a higher

ability and, hence, likelihood to invest in co-ethnic

entrepreneurs compared to non-ethnic investors. On

the other hand, according to social status logic, a high

reliance on ethnic ties may lead to a vicious circle,

whereby ethnic investors’lower social status as an

immigrant community will be reinforced, thus

constraining their ability to compete on equal footing

in the mainstream business world (Rudman, Feinberg,

and Fairchild,2002; Tajfel, 1978). To break out of this

social status constraint, ethnic investors would have to

pay a premium when they do invest outside their ethnic

networks. In contrast, mainstream investors do not pay

a premium above what is paid by Asian investors when

they invest in Asian ventures. These hypotheses are

tested and supported by the data on the first round of

VC investment in innovation-basedventuresinSilicon

Valley over the period 1976 to 2004.

This study makes an important theoretical

contribution to the ethnic entrepreneurship literature

by developing the ‘ethnic enclave’concept to

incorporate both the social network and social status

dimensions and showing the need for ethnic investors

to trade-off between investing within their ethnic

networks and in mainstream ventures. By combining

the logics of social network and social status, this

study also contributes to the entrepreneurial financing

literature that is traditionally grounded only on

network-based entrepreneurship studies. The

combination offers more insights than either

network-based entrepreneurship studies (Hoang and

Antoncic, 2003) or social status studies (Hsu, 2004)

could offer ontheir own. In particular, by highlighting

how an ethnic network can reinforce entrapment in

lower social status, this study answers the call for

more research on the drawbacks of using social

networks in the entrepreneurial process (Hoang and

Antoncic, 2003; Zhang, 2010).

RESEARCH CONTEXT

In this study, we investigate the behavior of minority

ethnic VCs versus their ‘mainstream’counterparts in

Silicon Valley. We chose Silicon Valley because it is

the dominant center in the world in terms of the size

of VC investment made (Kenney, 2000). Despite a

sharp meltdown of VC investing after the dot-com

crash in 2000, Silicon Valley has rebounded and

continues to garner the largest share of VC

investments. According to the latest PwC/NVCA

survey (PwC/NVCA, 2016), Silicon Valley accounted

Ethnic Entrepreneurial Financing in Silicon Valley 319

Copyright© 2016 Strategic Management Society Strat. Entrepreneurship J.,10:318–335 (2016)

DOI: 10.1002/sej