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
Suggested Citation: 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
By Mark Roe