The Impact of Litigation on Venture Capitalist Reputation

56 Pages Posted: 30 Nov 2007 Last revised: 10 Oct 2022

Multiple version iconThere are 2 versions of this paper

Date Written: November 2007

Abstract

Venture capital contracts give VCs enormous power over entrepreneurs and early equity investors of portfolio companies. A large literature examines how these contractual terms protect VCs against misbehavior by entrepreneurs. But what constrains misbehavior by VCs? We provide the first systematic analysis of legal and non-legal mechanisms that penalize VC misbehavior, even when such misbehavior is formally permitted by contract. We hand-collect a sample of over 177 lawsuits involving venture capitalists. The three most common types of VC-related litigation are: 1) lawsuits filed by entrepreneurs, which most often allege freezeout and transfer of control away from founders; 2) lawsuits filed by early equity investors in startup companies; and 3) lawsuits filed by VCs. Our empirical analysis of the lawsuit data proceeds in two steps. We first estimate an empirical model of the propensity of VCs to get involved in litigation as a function of VC characteristics. We match each venture firm that was involved in litigation to otherwise similar venture firm that was not involved in litigation and find that less reputable VCs are more likely to participate in litigation, as are VCs focusing on early-stage investments, and VCs with larger deal flow. Second, we analyze the relationship between different types of lawsuits and VC fundraising and deal flow. Although plaintiffs lose most VC-related lawsuits, litigation does not go unnoticed: in subsequent years, the involved VCs raise significantly less capital than their peers and invest in fewer deals. The biggest losers are VCs who were defendants in a lawsuit, and especially VCs who were alleged to have expropriated founders.

Suggested Citation

Atanasov, Vladimir A. and Ivanov, Vladimir and Litvak, Kate, The Impact of Litigation on Venture Capitalist Reputation (November 2007). NBER Working Paper No. w13641, Available at SSRN: https://ssrn.com/abstract=1037165

Vladimir A. Atanasov (Contact Author)

William and Mary - Raymond A. Mason School of Business ( email )

P.O. Box 8795
Williamsburg, VA 23187-8795
United States

Vladimir Ivanov

US Securities & Exchange Commission ( email )

Washington, DC
United States
202-551-5307 (Phone)

Kate Litvak

Northwestern University - Pritzker School of Law ( email )

375 E. Chicago Ave
Chicago, IL 60611
United States

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