Finance Seminar: Arthur Korteweg, USC
Venture Capital Contracts
Abstract: We develop a dynamic search and matching model to estimate the impact of venture capital contract terms on startup outcomes and the split of value between entrepreneur and investor in the presence of endogenous selection. Using a new data set of over 10,000 first financing rounds of startup companies, we estimate an internally optimal equity split between investor and entrepreneur that maximizes the probability of success. In almost all deals, investors receive more equity than is optimal for the company. In contrast to most theoretical predictions, participation rights and investor board seats reduce company value, while shifting more of it to the investors. Eliminating these terms increases startup values through rematching, making entrepreneurs better off and leaving all but the highest quality investors marginally worse off.
Finance Seminars at Caltech are funded through the generous support of The Ronald and Maxine Linde Institute of Economic and Management Sciences (lindeinstitute.caltech.edu) and Stephen A. Ross.