The venture capital industry

1
The venture capital industry
Portfolio firm (Subchapter C corporation)
General partner
VC preferred stock
Limited partnership agreement
Limited partners
Entrepreneur common stock
Venture capital partnership
2
Venture capital contracts

• Limited partnership agreements (Gompers/ Lerner)
• GP agency costs the role of private benefits
• Supply and demand
• Costly contracting
• Covenants vs. compensation
• Factors affecting costs and benefits of controls
• VC firm and portfolio company (Smith)
• Conflicts between entrepreneurs and investors

3
The VC industry

• The limited partnership
• Separation of ownership and control
• Change in liability rule
• Supply and growth of VC firms
• Effect of prudent man rule change (Sitkoff)

4
Costs and benefits of covenants

• Fund size
• VC reputation
• Pay/performance sensitivity
• Fund stage and type

5
Types of covenants

• Fund management
• Concentration of investments
• Use of debt
• Coinvestment with vcs other funds
• Reinvestment of profits
• General partner activities
• Investment of personal funds
• Sale of partnership interests
• Fund-raising
• Outside activities
• New partners
• Limits on investments
• Public securities
• Debt

6
Factors determining covenants

• Agency problems
• Fund focus early stage, high-tech
• Fund size
• Pay sensitivity
• Supply and demand conditions
• Inflow of capital
• Investment managers
• VC compensation
• Age of VC organizations

7
Regression analysis

• Demand vs. costly contracting
• Costly contracting
• Importance of fund size to covenants re
  management and type of investment

8
VCs and portfolio firms

• Entrepreneurs private benefits
• VCs liquidity preference

9
Agency cost control devices protecting VCs

• Staged financing
• Preferred stock and covenants
• Board composition provisions
• Specified number to each series
• Specified seats for common shareholders
• Remaining seats filled by combined vote
• Control types investor, entrepreneur, combined

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Alternative agency cost strategies

• Shared control
• Risk to vc
• Deadlock and holdup
• Transfer and contingent control
• Negative covenants
• Business combinations
• Charter amendments
• Redemptions and dividends
• Preferred stock issuance
• Liquidation preferences and participations
• Redemption rights calls and puts
• Registration demands the role of deadlines
• Convertible preferred
• Conclusion early vs. late stage

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Protecting entrepreneurs

• Convertible preferred owners may gain less from
  gains than they lose from losses (Fried Ganor)
• Tax incentives for all-common structure
• Weak fiduciary duty protection

12
Implications

• Fiduciary duties
• Executive compensation
• Choice of form and closely held firms
• Theory of the firm and governance contracts
• Role of tax and other legal rules