Renegotiation of Cash Flow Rights in the Sale of VC-Backed Firms

Abstract

Incomplete contracting theory suggests that VC cash flow rights - including liquidation preferences - may be subject to renegotiation. Using a hand-collected dataset of sales of Silicon Valley firms, we find common shareholders do sometimes receive payment before VCs' liquidation preferences are satisfied. However, such deviations tend to be small. We also find that renegotiation is more likely when governance arrangements, including the firm's choice of corporate law, give common shareholders power to impede the sale. Our study provides support for incomplete contracting theory, improves understanding of VC exits, and suggests that choice of corporate law matters in private firms.

Keywords: Venture capital, preferred stock, liquidation preferences, corporate governance, incomplete contracting

JEL Classification: G24, G32, G33, G34, K12, K20, K22, M13