Venture Capital Meets Contract Theory: Risky Claims or Formal Control?

Cestone, G. (2014). Venture Capital Meets Contract Theory: Risky Claims or Formal Control?. Review of Finance, 18(3), pp. 1097-1137. doi: 10.1093/rof/rft021

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Abstract

This article develops a theory of the joint allocation of control and cash-flow rights in venture capital (VC) deals. When the need for VC advice and support calls for a high-powered outside claim, the entrepreneur should optimally retain control in order to avoid undue interference. Hence, I predict that more high-powered claims should be associated with fewer control rights. This challenges the idea that control should always be attached to equity-like claims and is in line with contractual terms used in venture capital, corporate venturing, and partnerships between biotech start-ups and large corporations. The article also rationalizes evidence that venture capital contracts include contingencies triggering both a reduction in VC control and the automatic conversion of VC’s preferred stock into common.

Item Type: Article
Additional Information: This is a pre-copyedited, author-produced PDF of an article accepted for publication in Review of Finance following peer review. The version of record Cestone, G (2014). Venture Capital Meets Contract Theory: Risky Claims or Formal Control?. REVIEW OF FINANCE, 18(3), pp. 1097-1137, is available online at: http://dx.doi.org/10.1093/rof/rft021
Uncontrolled Keywords: Control Rights, Cash-Flow Rights, Security Design, Venture Capital
Subjects: H Social Sciences > HG Finance
Divisions: Cass Business School > Faculty of Finance
URI: http://openaccess.city.ac.uk/id/eprint/7010

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