Joint Control and Redemption Rights in Venture Capital Contracts

38 Pages Posted: 25 Feb 2004  

Vijay Yerramilli

University of Houston, C. T. Bauer College of Business

Multiple version iconThere are 2 versions of this paper

Date Written: March 2004

Abstract

In most venture capital financed firms, neither the VC nor the manager has exclusive authority over some of the key corporate decisions. For example: the decision whether the firm should undertake an IPO or be sold to a larger rival usually requires the approval of both the manager and the VC. This contradicts a strong prediction in the theoretical literature that joint control is suboptimal. In this paper, I show that assigning control jointly to both the agents, and specifying a harsh penalty (such as liquidation) if they fail to reach an agreement, is sometimes better than assigning control exclusively to one of the agents. A key factor is the firm's "financial slack" - the difference between its expected cash flows and its required investments and monitoring costs. Joint control is the optimal control allocation when the firm has low financial slack and a reasonable collateral value, and when the VC's liquidity constraints and cost of monitoring the firm are high. Most VC-financed firms fit this description.

Keywords: Joint control, venture capital, redemption rights

JEL Classification: G30, G24

Suggested Citation

Yerramilli, Vijay, Joint Control and Redemption Rights in Venture Capital Contracts (March 2004). ECGI - Finance Working Paper No. 37/2004. Available at SSRN: https://ssrn.com/abstract=481362 or http://dx.doi.org/10.2139/ssrn.481362

Vijay Yerramilli (Contact Author)

University of Houston, C. T. Bauer College of Business ( email )

Houston, TX 77204
United States
713-743-2516 (Phone)

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