Does Reputation Limit Opportunistic Behavior in the VC Industry? Evidence from Litigation against VCs

Abstract

We provide the first systematic analysis of the role of reputation in limiting opportunistic behavior by venture capitalists towards four types of counterparties: entrepreneurs, investors, other VCs, and buyers of VC-backed startups. Using a hand-collected database of lawsuits, we document that more reputable VCs (i.e., VCs that are older, have more deals, more funds under management, and syndicate with larger networks of venture capitalists) are less likely to be litigated. We also find that litigated VCs suffer declines in future business relative to carefully selected peers. These negative effects are stronger for more reputable VCs, and when VCs are defendants to multiple lawsuits or sued by entrepreneurs. Our results suggest that reputational mechanisms help deter VC opportunism.

Keywords: venture capital, litigation, reputation markets

JEL Classification: G24, G33