The Geography of Venture Capital Contracts

Abstract

We show that geographical elements and regional culture can play an essential role in contract design in addition to the influence of more "traditional" determinants such as information and agency problems or the nature of legal institutions. Across 1,800 financial contracts written between U.S. entrepreneurial companies and U.S. Venture Capital (VC) investors, we show that contracts include significantly fewer investor-friendly cash flow contingencies if the company is located in California or if the lead VC is more exposed to the California market. The regional differences in contract design can, to some degree, be explained by the level of concentration of local VC markets. We also show that when the geographical distance between a VC and a company is greater, contracts give high-powered incentives to entrepreneurs by including more investor-friendly cash flow contingencies. This latter finding supports the view that geographical proximity enhances monitoring and soft information. However, the "California effect" persists even after we control for distance and VC market concentration.

Keywords: Venture Capital, Entrepreneurship, Financial Contracting, Geography

JEL Classification: G24, L26