Working Paper: CEPR ID: DP3462
Authors: Giacinta Cestone
Abstract: This Paper develops a theory of the joint allocation of control and cash-flow rights in venture capital deals. I argue that when the need for investor support calls for very high-powered outside claims, entrepreneurs should optimally retain control in order to avoid undue interference. Hence, I predict that risky claims should be negatively correlated to control rights, both along the life of a start-up and across deals. This challenges the idea that control should always be attached to more equity-like claims, and is in line with contractual terms used in venture capital, in corporate venturing and in partnerships between biotech start-ups and large corporations. The Paper also rationalizes the evidence, documented in Gompers (1999) and Kaplan and Stromberg (2000), that venture capital contracts include contingencies triggering both a reduction in VC control and the conversion of VC's preferred stock into common stock.
Keywords: control rights; corporate governance; security design; venture capital
JEL Codes: G30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high need for investor support (G24) | retain control rights (G34) |
| risky claims (D81) | control rights (P14) |
| high-powered outside claims (G24) | control rights (P14) |
| control rights (P14) | risky claims (D81) |