Agency Costs, Institutions, Learning, and Taxation in Venture Capital Contracting

Posted: 10 Nov 2009

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Date Written: 2005


The conventional wisdom is that convertible preferred equity is the optimal form of finance; however, empirical support has been offered only for U.S. firms. This study examines 12,363 Canadian venture capital transactions between 1991 and 2003. Data clearly indicate that convertible preferred equity is not the dominant security for all types of venture capital funds and entrepreneurial firms. Frequency of use was common equity (28.66 percent), straight debt (15.34 percent), convertible debt (14.63 percent), convertible preferred equity (10.77 percent), straight (nonconvertible) preferred equity (9.25 percent), followed by other combinations and types of common equity and debt. There have also been changes in the intensity of use of different forms of finance over time. Four main explanations for the patterns of forms of finance are proposed: (1) economic agency costs explanations, (2) tax explanations, (3) institutional sophistication and learning explanations, and (4) market conditions. Market conditions in the aftermath of the Internet bubble have drastically reduced the use of common equity and increased the use of securities involving priority in bankruptcy for the investor. Venture capital financing in Canada is not found to be evolving to resemble the U.S. market. U.S. venture capital funds do not use convertible preferred shares more frequently to finance Canadian entrepreneurs. It is concluded that agency cost is the most compelling explanation for the findings. Securities selected systematically vary depending on the venture capitalist and entrepreneur characteristics in order to mitigate expected agency problems.(TNM)

Keywords: Ownership structures, Debt financing, Equity financing, Financing, Moral hazard problem, Startups, Venture capital

Suggested Citation

Cumming, Douglas J., Agency Costs, Institutions, Learning, and Taxation in Venture Capital Contracting (2005). Journal of Business Venturing, Vol. 20, Issue 5, p. 573-622 2005. Available at SSRN:

Douglas J. Cumming (Contact Author)

Florida Atlantic University ( email )

777 Glades Rd
Boca Raton, FL 33431
United States


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