VCs and the Expropriation of Entrepreneurs
40 Pages Posted: 5 Jun 2006
Date Written: September 25, 2006
We explore the potential for abuse of startup founders and other common stock shareholders by venture capitalists. We first analyze a set of 26 lawsuits involving venture capitalists and entrepreneurs. Our analysis of lawsuits reveals that VC-related litigation is almost always initiated by founders, and most common allegations are dilution and freezeout of founders, followed by expropriation of company assets via related-party transactions. We document that most of the lawsuits that were not promptly settled end up dismissed by judges on procedural grounds, and yet, after winning, the involved VCs have raised significantly less capital than their peers and have syndicated deals with less reputable partners. We next analyze the founder ownership at the going-public stage in a sample of 390 VC-backed IPOs. We find that founders are less likely to be involved in firm governance and have lower ownership in startups backed by less reputable VCs and where VC investment rounds have been insider dominated. The results suggest that the potential for expropriation of equity holders in venture-backed startups has important implications for entrepreneurial activity.
Keywords: Venture Capital, Tunneling, Dilution, IPOs
JEL Classification: G24, G30, K22
Suggested Citation: Suggested Citation