Many venture capitalists view confidentiality as a core competitive advantage when investing in high-growth companies. They guard not only the sensitive information they obtain from startups, but also the prices they pay, the structure of their deals, and the proprietary strategies they use to find and evaluate investments. In our recent paper, The Value of Privacy and the Choice of Limited Partners by Venture Capitalists, we show that disclosure requirements influence not only how VCs invest, but also which investors they are willing to accept capital from.

Public pension funds and university endowments have historically been among the most important limited partners (LPs) in VC funds, accounting for roughly one-third of reported capital commitments. However, beginning in late 2002, these public LPs faced a major shift in disclosure obligations driven by state-level Freedom of Information Acts (FOIAs). These laws require public institutions to disclose many types of records upon request, although VC data was historically treated as a trade secret and thus exempt from disclosure. That changed with a pivotal court ruling that forced public LPs to release fund-level performance data and raised the prospect of broader disclosure of sensitive portfolio company information. We refer to this change in public LP disclosure requirements as the FOIA shock.

Initial reaction to court rulings

Using a dataset of VC–LP relationships, we examine how venture capital firms responded to the FOIA shock. We explore a range of VC characteristics and find that the highest-performing firms were the most responsive to this shift. In particular, top VCs cut the share of capital coming from public LPs by half. In contrast, we do not find that other characteristics, including investment stage, industry focus, and target geography, are significantly associated with changes in public LP share. These findings support a “supply of capital” interpretation, where top-performing VCs face excess demand from prospective LPs and can therefore replace public investors. Lower-performing VCs, on the other hand, do not have that luxury.

We show that, in response to being excluded from top-performing VC funds, public LPs turned to funds of funds (intermediaries that pool capital and invest in multiple VC funds) with established relationships with leading VCs. Given the persistence of fundraising relationships in VC, these intermediaries could help LPs regain access to top-tier VC funds. This structure allowed public LPs to disclose information about their funds of funds holdings, which shielded the individual VC funds from public LPs’ disclosure requirements. Although these intermediaries add another layer of fees, this reallocation allowed public LPs to maintain exposure to high-performing VCs. Even accounting for these reallocations, we estimate that lost access cost public LPs approximately $1.6 billion, relative to their $14 billion in total VC commitments.

Contractual and regulatory innovation

The FOIA shock prompted changes both in the limited partnership agreements (LPAs) between LPs and VCs and in the FOIA laws themselves. These changes primarily targeted portfolio company data, highlighting that VCs, LPs, and regulators agreed that portfolio company information should remain private.

Based on a sample of investment contracts before and after the FOIA shock, we find that the language of LPAs was overwhelmingly changed to protect portfolio company information. Some VCs included contractual clauses limiting public LPs’ access to fund performance data, while others allowed access and specified what forms of performance data disclosure were permitted. The lack of return information on top VC firms in commonly used databases provides broader evidence that VCs began using contractual tools to restrict the information they shared with public LPs.

Similarly, the FOIA amendments, which were enacted across various states in response to the lawsuits, sought to exclude portfolio company information from the types of data that had to be publicly disclosed, consistent with the idea that portfolio company information was the central point of contention. We find a positive association between the passage of FOIA amendments and top VC investments by public LPs, suggesting that legislation reducing disclosure helped restore relationships.

Implications for investors and regulators

A long-term consequence of these disclosure requirements is a reduction in the amount of information VCs share with their public LPs. While the direct impact of the lawsuits was limited to a portion of each public LP’s portfolio, the broader reduction in fund performance and operational transparency imposed an additional cost: public LPs now had less data to compare fund managers and make reinvestment decisions. As the industry participants have noted, FOIA rules can hinder public pension plans from obtaining the information they need to evaluate fund managers (Pennsylvania’s Public Pension Management and Asset Investment Review Commission, 2018).

The tradeoff between transparency and confidentiality has broader implications for public governance. Regulatory changes meant to increase accountability may inadvertently reduce access to the highest-quality private investments. While the FOIAs improved information sharing from LPs to the public, they reduced information flow from VCs to LPs. The fact that state legislatures later moved to revise their FOIA rules underscores the tensions inherent in government transparency.

The complete article is available here.