Agency Costs of Venture Capitalist Control in Startups

Abstract

Venture capitalists investing in U.S. startups typically receive preferred stock and extensive control rights. Various explanations for each of these arrangements have been offered. However, scholars have failed to notice that when combined these arrangements result in a highly unusual corporate governance structure: one in which preferred shareholders, not common shareholders, control the board and the firm. The purpose of this Article is threefold: (1) to highlight the unusual governance structure of these VC-backed startups; (2) to show that preferred shareholder control can give rise to potentially large agency costs, and (3) to suggest legal reforms that may help VCs and entrepreneurs reduce these agency costs and improve corporate governance in startups.

Keywords: venture capital, start-ups, preferred stock, corporate governance, fiduciary duties

JEL Classification: G24, G32, G34, G38, H25, K22, M13