Venture Capital Contracts

67 Pages Posted: 22 Jul 2019

See all articles by Michael Ewens

Michael Ewens

California Institute of Technology - Division of the Humanities and Social Sciences; National Bureau of Economic Research (NBER)

Alexander S. Gorbenko

University of Southern California - Marshall School of Business

Arthur G. Korteweg

University of Southern California - Marshall School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: July 19, 2019

Abstract

We estimate the impact of venture capital (VC) contract terms on startup outcomes and the split of value between the entrepreneur and investor, accounting for endogenous selection via a novel dynamic search and matching model. The estimation uses a new, large data set of first financing rounds of startup companies. Consistent with efficient contracting theories, there is an optimal equity split between agents that maximizes the probability of success. However, VCs use their bargaining power to receive more investor-friendly terms compared to the contract that maximizes startup values. Better VCs still benefit the startup and the entrepreneur, due to their positive value creation. Counterfactual exercises show that eliminating certain contract terms benefits entrepreneurs and enables low-quality entrepreneurs to finance their startups more quickly, increasing the number of deals in the market. Lowering search frictions shifts the bargaining power to VCs and benefits them at the expense of entrepreneurs. The results show that selection of agents into deals is a first-order factor to take into account in studies of contracting.

Keywords: venture capital, contracts, entrepreneurship, matching, structural

JEL Classification: G24, D86, C78

Suggested Citation

Ewens, Michael and Gorbenko, Alexander S. and Korteweg, Arthur G., Venture Capital Contracts (July 19, 2019). Available at SSRN: https://ssrn.com/abstract=3423155 or http://dx.doi.org/10.2139/ssrn.3423155

Michael Ewens (Contact Author)

California Institute of Technology - Division of the Humanities and Social Sciences ( email )

1200 East California Blvd.
Pasadena, CA 91125
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National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
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Alexander S. Gorbenko

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA 90089
United States

Arthur G. Korteweg

University of Southern California - Marshall School of Business ( email )

3670 Trousdale Parkway
Los Angeles, CA 90089
United States

HOME PAGE: http://www-bcf.usc.edu/~korteweg/

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