Do VCs Use Inside Rounds to Dilute Founders? Some Evidence from Silicon Valley
51 Pages Posted: 27 Jun 2011 Last revised: 3 Mar 2014
Date Written: June 27, 2012
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
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