Do VCs Use Inside Rounds to Dilute Founders? Some Evidence from Silicon Valley

51 Pages Posted: 27 Jun 2011 Last revised: 3 Mar 2014

Brian J. Broughman

Indiana University Maurer School of Law

Jesse M. Fried

Harvard Law School; European Corporate Governance Institute (ECGI)

Date Written: June 27, 2012

Abstract

In the bank-borrower setting, a firm’s existing lender may exploit its positional advantage to extract rents from the firm in subsequent financings. Analogously, a startup’s existing venture capital investors (VCs) may dilute the founder through a follow-on financing from these same VCs (an “inside” round) at an artificially low valuation. Using a hand-collected dataset of Silicon Valley startup firms, we find little evidence that VCs use inside rounds to dilute founders. Instead, our findings suggest that inside rounds are generally used as “backstop financing” for startups that cannot attract new money, and these rounds are conducted at relatively high valuations (perhaps to reduce litigation risk).

Keywords: Venture capital, dilution, corporate governance, inside rounds, opportunism, corporate law, inside financing, adverse selection

JEL Classification: G24, G32, G33, G34, K12, K20, K22, M13

Suggested Citation

Broughman, Brian J. and Fried, Jesse M., Do VCs Use Inside Rounds to Dilute Founders? Some Evidence from Silicon Valley (June 27, 2012). Journal of Corporate Finance, Volume 18, 1104-1120 (2012) . Available at SSRN: https://ssrn.com/abstract=1873089 or http://dx.doi.org/10.2139/ssrn.1873089

Brian J. Broughman

Indiana University Maurer School of Law ( email )

211 S. Indiana Avenue
Bloomington, IN 47405
United States

Jesse M. Fried (Contact Author)

Harvard Law School ( email )

1575 Massachusetts
Griswold Hall 506
Cambridge, MA 02138
United States
617-384-8158 (Phone)

HOME PAGE: http://www.law.harvard.edu/faculty/directory/10289/Fried

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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