The Structure and Governance of Venture-Capital Organizations

Abstract

Provides an in-depth examination of venture capital firms, including their structures and contractual relationships, using data from such sources as the Venture Capital Journal and field research. These firms use the money of their investors to invest at reasonably well-defined stages in high risk firms that offer the potential of high returns. Although the impact of venture capital firms in overall business formation is limited, there have been many success stories. Approximately two-thirds of venture capital firms are organized as limited partnerships, with the venture capitalists serving as general partners and the investors as limited partners. These firms tend to specialize either by industry or by stage of investment. Several factors help to ensure that the venture capitalists will not take advantage of the investors who are the limited partners. Included are the limited length of the firm, the structure of the compensation package for the venture capitalists, and the mandatory distribution policy. Review of the governance structure helps investors distinguish good venture capitalists from the poor ones. There are many important considerations in identifying ventures in which to invest. These investments are governed by the stock-purchase agreement. Descriptions of the various parts of this agreement are provided, including the amount and timing of the investment, registration rights, option pool, information rights, and board structure. Venture capitalists enlist several techniques to address the times when they disagree with the entrepreneurs with whom they invest. Comparisons are made between venture capital firms and both corporations and leveraged buyout funds. (SRD)

Keywords: Venture capital firms, Venture capitalists, Organizational structures, Investment policies, Venture capital portfolios