1、Review of Economic Studies (2002) 00, 135 0034-6527/02/00000001$02.00c 2002 The Review of Economic Studies LimitedFinancial Contracting Theory Meetsthe Real World: An EmpiricalAnalysis of Venture CapitalContractsSTEVEN N. KAPLAN and PER STR OMBERGUniversity of ChicagoFirst version received March 200
2、0; final version accepted March 2002 (Eds.)We compare the characteristics of real world financial contracts to their counterparts in financialcontracting theory. We do so by studying the actual contracts between venture capitalists (VCs) andentrepreneurs. The distinguishing characteristic of VC fina
3、ncings is that they allow VCs to separatelyallocate cash flow rights, board rights, voting rights, liquidation rights and other control rights. We describeand measure these rights. We then interpret our results in relation to existing financial contracting theories.We also describe the interrelation
4、 and the evolution across financing rounds of the different rights. Query 1Query 21. INTRODUCTIONThere is a large academic literature on the principal-agent problem in financial contracting.1The papers in this literature often begin with a situation in which an investor negotiates withan entrepreneu
5、r over the financing of a project or company. Despite the large volume of theory,relatively little empirical work exists that compares the characteristics of real world financialcontracts to their counterparts in financial contracting theory.2 In this paper, we attempt to informtheory by describing
6、in detail the contracts between VCs and entrepreneurs. We compare theactual contracts to the assumed and predicted ones in different financial contracting theories.In doing this, we assume that VCs are real world entities who closely approximate theinvestors of theory. VCs invest in entrepreneurs wh
7、o need financing to fund a promising venture.VCs have strong incentives to maximize value, but, at the same time, receive few or no privatebenefits of control. Although they are intermediaries, VCs typically receive at least 20% of theprofits on their portfolios.3We study 213 VC investments in 119 p
8、ortfolio companies by 14 VC firms. Each VCfirm provided the contractual agreements governing each financing round in which the firmparticipated. The VC firm also provided (if available) the companys business plan, internalanalyses evaluating the investment, and information on subsequent performance.
9、We find that VC financings allow VCs to separately allocate cash flow rights, board rights,voting rights, liquidation rights, and other control rights. These rights are often contingent on1. For a recent summary, see Hart (2001). Extensive theoretical overviews can be found in Allen and Winton(1995)
10、, Harris and Raviv (1992) and Hart (1995).2. For earlier, related work, see Sahlman (1990), Gompers (1998), Black and Gilson (1998) and Baker andGompers (1999, 2000). Kaplan and Stromberg (2001) discuss other ways that venture capitalists (VCs) mitigateprincipal/agent problems.3. See Gompers and Ler
11、ner (1999).12 REVIEW OF ECONOMIC STUDIESobservable measures of financial and non-financial performance. In general, board rights, votingrights, and liquidation rights are allocated such that if the firm performs poorly, the VCs obtainfull control. As performance improves, the entrepreneur retains/ob
12、tains more control rights. Ifthe firm performs very well, the VCs retain their cash flow rights, but relinquish most of theircontrol and liquidation rights.We also report that it is common for VCs to include non-compete and vesting provisionsthat make it more expensive for the entrepreneur to leave
13、the firm, thus mitigating the potentialhold-up problem between the entrepreneur and the investor.Finally, the cash flow incentives, control rights and contingencies in these contracts areused more as complements than as substitutes. Ventures in which the VCs have voting andboard majorities are also
14、more likely to make the entrepreneurs equity claim and the releaseof committed funds contingent on performance milestones.Our results have the following implications. First, cash flow rights matter in a way that isconsistent with the principal-agent theories of Holmstrom (1979), Lazear (1986) and ot
15、hers. Forexample, the entrepreneurs equity compensation function is more sensitive to performance whenincentive and asymmetric information problems are more severe.Second, the allocation of control rights between the VC and the entrepreneur is a centralfeature of the financial contracts. This strong
16、ly suggests that despite the prevalence of contingentcontracting, contracts are inherently incomplete. This finding gives support to the incompletecontracting approach pioneered by Grossman and Hart (1986) and Hart and Moore (1990).Third, cash flow rights and control rights can be separated and made
17、 contingent onobservable and verifiable measures of performance. This is most supportive of theories thatpredict shifts of control to investors in different states, such as Aghion and Bolton (1992) andDewatripont and Tirole (1994).Fourth, the widespread use of non-compete and vesting provisions indi
18、cates that VCs careabout the hold-up problem explored in Hart and Moore (1994).Finally, we think our descriptive results suggest fruitful avenues for future theoreticalresearch.The paper proceeds as follows. Section 2 describes our sample. Section 3 describes the VCcontracts. Section 4 compares the
19、empirical results in Section 3 and additional cross-sectionalanalyses to the assumptions and predictions of financial contracting theories. Section 5 presentsadditional descriptive information regarding the contracts that should be of use to future theory.Section 6 summarizes and discusses our resul
20、ts.2. SAMPLEWe analyse 213 VC investments in 119 portfolio companies by 14 VC partnerships.2.1. DescriptionTo obtain this sample, we asked each VC to provide detailed information on as many of theirportfolio company investments as they were willing to provide. For each of these companies, theVCs pro
21、vided the documents that include all the financing terms, the firms equity ownershipinvestors, founders, management, etc.and any contingencies to future financing. The VCs alsoprovided (if available) the portfolio companys business plan at the time of the financing, the VCsinternal analysis of the i
22、nvestment, and the subsequent portfolio company financial performance.Before we present our results, it is worth pointing out that while we have a great deal of data,we do not have complete data on every financing round. As a result, the number of observationsvaries across our analyses according to
23、the availability of the relevant information.KAPLAN and (2) frequently includesecurities in addition to convertible preferred stock. Only 170 of the rounds are financed solelyby convertible preferred stock. Seven of the 213 financing rounds do not use any form ofconvertible security. Instead, they u
24、se multiple classes of common stock or a combination ofstraight preferred and common stock.Panel F also reports that the VCs use a variant of convertible preferred called participatingpreferred in 82 of the financings. Upon the liquidation or exit of a participating convertiblepreferred, investors r
25、eceive both the principal amount of the preferredas they would in aninvestment of straight preferredand the common stock promised under the conversion terms.As a result, participating convertible preferred is better categorized as a position of straightpreferred stock and common stock than as a posi
26、tion of convertible preferred. In some instances,the participating preferred does not receive a return of principal if the company return issufficiently high. This creates a payoff for the VC that looks like straight preferred and commonover some valuation range and then convertible preferred above
27、that range.While the VC financings utilize different types of securities, the financings are similar inthat they allow for different allocations of cash flow, voting, board, and liquidation rights. Inthe financings that use multiple classes of common stock, the VCs receive a different class ofcommon
28、 stock than the founders who receive two or more classes of common stock. The VCclass of common stock has voting, board, and liquidation rights that are different from those ofthe founders classes of common stock. The cash flow rights of the classes of common stock alsodiffer in that the founders st
29、ock classes vest under different conditions from those of the VCclass (which vests immediately).KAPLAN founders, 30%; and others, 20%. This suggests that substantial equity ownership on the partof founders is desirable. On the other hand, it also indicates that founders give up a large fractionof ow
30、nership.Panel A also indicates that there are state-contingencies built into the cash flow rights. TheVC stake is a median of 42% (average of 88%) lower under full vesting and good performancecompared to the minimum vesting, bad performance state. State-contingencies are significantlygreater in firs
31、t VC rounds compared to subsequent ones, with a median of 80% (average 126%).3.3. Board and voting rightsThe rights to control or make corporate decisions are provided in board rights and in votingrights. The board is generally responsible for (1) hiring, evaluating, and firing top management;and (2
32、) advising and ratifying general corporate strategies and decisions. Certain corporateactions are governed or subject to shareholder votes. These vary across firms, but sometimesinclude large acquisitions, asset sales, subsequent financings, election of directors, or any otheractions stipulated by c
33、ontract.Board rights and voting rights can be different from cash flow rights and from each other.The difference is achieved in a number of ways including unvested stock options (which donot have votes), non-voting stock, contracts specifying a change in equity ownership at the IPO(i.e. at the point
34、 when the VC has pre-committed to giving up most control rights), or explicitcontracting on the right to exercise votes depending on performance targets. Board rights, inturn, can be separated from voting rights through explicit agreements on the election of directors.Different securities also can h
35、ave different rights to elect directors. Panels B and C of Table 1describe board and voting rights in our sample.3.3.1. Board rights. We distinguish between three kinds of board membersVCs,founders, and outsiders. VC seats are board seats that are reserved for or controlled by VCs.Founder seats are
36、board seats that are reserved for or controlled by the founders/entrepreneurs.Outsider seats are board seats that are to be filled by individuals mutually agreed upon by theVCs and the founders/entrepreneurs.8 REVIEW OF ECONOMIC STUDIESTABLE 2Distribution of cash flow, control, and liquidation right
37、sA. Residual cash-flow rightsMinimum Max founder Maximum Difference,VC ownership and employee VC ownership min. andcontingency vesting contingency max. VC ownershipMean Median Mean Median Mean Median Mean MedianAll rounds, N = 212VC% 467 473 479 479 555 575 88 42Founders% 311 298 300 271 243 201 68
38、00Others% 222 204 221 204 202 172 20 00First VC rounds only, N = 98VC% 404 410 424 431 530 505 126 80Founders% 395 387 377 376 296 295 99 37Others% 2031 188 199 188 174 132 27 00B. Board rightsMean (median) All rounds, N = 201 First VC rounds, N = 95Normal Adverse state Normal Adverse stateNumber of
39、 board seats 60(60) 63(60) 57(50) 60(50)% VC seats 414(400) 460(429) 370(400) 426(400)% Founder seats 354(375) 329(333) 385(400) 354(400)% Outsider seats 232(200) 210(200) 245(200) 220(200)% VC board majority 254 358 116 274% Founder majority 139 124 200 168% neither board majority 607 517 684 558%
40、of cases with adverse state board provisions 184 211% Seats to cash flow rights, VC 100(089) 109(092)% Seats to cash flow rights, founder 177(112) 127(099)Signed rank test Z-stat P-value VC vs. F 550 059C. Voting rightsMean (median) All rounds, N = 212 First VC rounds, N = 98Minimum Maximum Differen
41、ce Minimum Maximum DifferenceVC votes VC votes min max VC votes VC votes min max% VC votes 536(529) 623(643) 87(16) 463(454) 589(596) 126(64)% Founder votes 337(311) 245(201) 92(15) 429(425) 298(295) 130(62)% Others votes 126(71) 131(91) 05(00) 109(54) 113(55) 04(00)% VC control 528 689 408 612% Fou
42、nder control 236 123 378 214% Neither control 236 189 214 173% Switch in control 178 245% Votes to cash flow:VC 116(113) 115(109) 116(113) 116(107)Founder 108(109) 102(104) 106(108) 098(100)Others 049(049) 061(064) 047(043) 066(072)Signed rank Z, VC vs. F 426 501 314 300D. Liquidation Rights and Red
43、emption RightsAll rounds, N = 213 First VC rounds only, N = 98% of obs. Mean (Med.) % of obs. Mean (Med.)VC liq. rights cum investment 712% 699%Cumulative accruing dividend rate 438% 0081 (0080) 489% 0079 (0080)Participating preferred stock 405% 308%Common/Conv. plus straight preferred 75% 102%Other
44、 cases with liq. rights inv 24% 21%KAPLAN under a weighted-average provision, the conversion price of the current rounddeclines to a value between the current round and the new issue price. First VC rounds differ from subsequent rounds atthe 1%; 5%, and 10% levels.We also distinguish between normal
45、board rights that reflect the board rights or compositionat the completion of the financing from adverse state board rights that reflect board rights orcomposition if the portfolio company performs poorly or reaches an adverse state.Panel B reports that boards have an average of and a median of six
46、members. These boardsare appreciably smaller than those of public companies. Overall, the VC has the majority of the10 REVIEW OF ECONOMIC STUDIESboard seats in 25% of the cases, the founders in 14% of the cases, and neither in 61% of thecases. VC board control is less common for first VC rounds.Stat
47、e-contingent board provisions (i.e. the VC gets control of the board in the bad state)are present in 18% of the cases. This provides an important example of state-contingent controlrights that do not occur simply in case of default on a debt payment. This state-contingencyresult and those that follo
48、w are important in light of several of the financial contracting theorieswe describe in Section 4.3.3.2. Voting rights. Panel C of Table 2 reports post-round voting rights. Voting rightsmeasure the percentage of votes that investors and management have to effect corporatedecisions.In panel C, minimum (maximum) VC votes represents the minimum (maximum) votesthe VCs control based on subsequent management performance and stock vesting milestonesor contingencies. VC%, Founder%, and Neither% control are, respectively, the percentage ofinstances i
