Working Paper: NBER ID: w26115
Authors: Michael Ewens; Alexander S. Gorbenko; Arthur Korteweg
Abstract: We estimate the impact of venture capital (VC) contract terms on startup outcomes and the split of value between the entrepreneur and investor, accounting for endogenous selection via a novel dynamic search and matching model. The estimation uses a new, large data set of first financing rounds of startup companies. Consistent with efficient contracting theories, there is an optimal equity split between agents, which maximizes the probability of success. However, VCs use their bargaining power to receive more investor-friendly terms compared to the contract that maximizes startup values. Better VCs still benefit the startup and the entrepreneur, due to their positive value creation. Counterfactuals show that reducing search frictions shifts the bargaining power to VCs and benefits them at the expense of entrepreneurs. The results show that selection of agents into deals is a first-order factor to take into account in studies of contracting.
Keywords: venture capital; contract terms; startup outcomes; dynamic search; matching model
JEL Codes: C78; D86; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| quality of the VC (L15) | startup success (M13) |
| search frictions (F12) | contract terms (K12) |
| contract terms (K12) | startup's value (M13) |
| search frictions (F12) | outcomes (P47) |
| participation rights (J54) | firm value (G32) |
| cash flow rights + control rights (G39) | outcomes (P47) |
| quality of the investor + quality of the entrepreneur (L26) | negotiated contract terms (L14) |