Venture Capital and Private Equity Contracting

Venture Capital and Private Equity Contracting

by Douglas J. Cumming, Sofia A. Johan
Released April 2009
Publisher(s): Academic Press
ISBN: 9780121985813

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Book description

Other books present corporate finance approaches to the VC/PE industry, but many key decisions require an understanding of the ways that law and economics work together. This book is better than straight corporate finance textbooks because it offers broad perspectives and principles that enable readers to deduce the economic implications of specific contract terms. This approach avoids the common pitfalls of implying that contractual terms apply equally to firms in any industry anywhere in the world.

• Explores the economic implications of contract terms for start-up firms in various industries
• Pairs international data with explanations and examples about differences in VC and PE national and regional markets
• Contains sample contracts, including limited partnership agreements, term sheets, shareholder agreements, and subscription agreements
• Presents international datasets on limited partnership agreements between institutional investors and VC and PE funds

Table of contents

  1. Brief Table of Contents
  2. Table of Contents
  3. Dedication
  4. Preface
  5. Part One. Introduction
    1. Chapter 1. Introduction and Overview
      1. 1.1. What Are Venture Capital and Private Equity?
      2. 1.2. How Do Venture Capital and Private Equity Differ from Alternative Sources of Capital?
      3. 1.3. How Large Is the Market for Venture Capital and Private Equity?
      4. 1.4. What Issues Are Relevant to the Study of Venture Capital and Private Equity?
        1. 1.4.1. Information Asymmetries and Agency Problems
        2. 1.4.2. International Institutional and Legal Context, and Empirical Methods
        3. 1.4.3. How Do You Attract Institutional Investors?
        4. 1.4.4. How Are Funds Structured?
        5. 1.4.5. How Well Are Fund Managers Compensated?
        6. 1.4.6. Does Regulation Matter for Limited Partners and General Partners?
        7. 1.4.7. Why Are Specialized Investment Mandates Necessary?
        8. 1.4.8. What Role Does Government Play?
        9. 1.4.9. Time to Invest: The Process
        10. 1.4.10. What Security Is Necessary?
        11. 1.4.11. What Is Distinct about Corporate Venture Capital Investment?
        12. 1.4.12. How Do Exit Expectations Influence Financial Contracts?
        13. 1.4.13. What Influences Investor Effort?
        14. 1.4.14. Do Contracts Ensure Effort?
        15. 1.4.15. Where Should You Invest?
        16. 1.4.16. How Many Investments Should You Have?
        17. 1.4.17. Time to Divest: The Process
        18. 1.4.18. What Exit Vehicle Should You Use?
        19. 1.4.19. Valuation and Disclosure
    2. Chapter 2. Overview of Agency Theory
      1. 2.1. Introduction and Learning Objectives
      2. 2.2. Forms of Finance
        1. 2.2.1. Debt
        2. 2.2.2. Preferred Equity
        3. 2.2.3. Common Equity
        4. 2.2.4. Warrants
      3. 2.3. Agency Problems
        1. 2.3.1. Moral Hazard
        2. 2.3.2. Bilateral Moral Hazard
        3. 2.3.3. Multitask Moral Hazard
        4. 2.3.4. Adverse Selection
        5. 2.3.5. Free Riding
        6. 2.3.6. Hold-up
        7. 2.3.7. Trilateral Bargaining
        8. 2.3.8. Window Dressing
        9. 2.3.9. Underinvestment
        10. 2.3.10. Asset Stripping
        11. 2.3.11. Risk Shifting
      4. 2.4. Does Mitigating Agency Problems Enhance Firm Value?
      5. 2.5. Summary and Steps Forward in Remaining Chapters
        1. Key Terms
        2. Discussion Questions
    3. Chapter 3. Overview of Institutional Contexts, Empirical Methods
      1. 3.1. Introduction and Learning Objectives
      2. 3.2. An Overview of the International Institutional and Legal Context
      3. 3.3. Statistics and Econometrics Used in This Book
        1. 3.3.1. Why Use Statistics and Econometrics and Not Case Studies?
        2. 3.3.2. What Are the Steps for Analyzing Data?
      4. 3.4. Summary
        1. Key Terms
        2. Key Statistical and Econometric Terms
        3. Discussion Questions
  6. Part Two. Fund Structure and Governance
    1. Chapter 4. What Should Fund Managers Care About? Perspectives from Institutional Investors
      1. 4.1. Introduction and Learning Objectives
      2. 4.2. Institutional Investor Objectives from Investment in Private Equity
      3. 4.3. Summary
        1. Key Terms
        2. Discussion Questions
    2. Chapter 5. Limited Partnership Agreements
      1. 5.1. Introduction and Learning Objectives
      2. 5.2. Types of Restrictive Covenants
        1. 5.2.1. Category 1: Authority of Fund Manager Regarding Investment Decisions
        2. 5.2.2 Category 2: Restrictions on Fund Manager's Investment Powers
        3. 5.2.3. Category 3: Covenants Relating to the Types of Investment
        4. 5.2.4. Category 4: Fund Operation
        5. 5.2.5. Category 5: Limitation of Liability of the Fund Manager
      3. 5.3. What Affects the Frequency of Use of Limited Partnership Covenants?
        1. 5.3.1. Human Capital Factors Influencing the Use of Fund Covenants
        2. 5.3.2. Legal and Institutional Factors Influencing the Use of Fund Covenants
        3. 5.3.3. Fund-specific Factors Influencing the Use of Fund Covenants
        4. 5.3.4. Market Conditions and the Use of Fund Covenants
      4. 5.4. Survey of Private Equity Funds
        1. 5.4.1. Methods and Survey Instrument
        2. 5.4.2. Potential Sample Selection Bias
        3. 5.4.3. Summary Statistics
        4. 5.4.4. Correlation Matrix
      5. 5.5. Econometric Tests
      6. 5.6. Limitations, Alternate Explanations, and Future Research
      7. 5.7. Conclusions
        1. Key Terms
        2. Discussion Questions
    3. Chapter 6. Compensation Contracts
      1. 6.1. Introduction and Learning Objectives
      2. 6.2. Compensation Contracts in Limited Partnerships
      3. 6.3. What Affects the Design of Limited Partnership Compensation Contracts?
        1. 6.3.1. Human Capital Factors Influencing the Design of Compensation Contracts
        2. 6.3.2. Legal and Institutional Factors Influencing the Design of Compensation Contracts
        3. 6.3.3. Fund Specifics That Influence the Design of Compensation Contracts
        4. 6.3.4. Market Factors That Influence the Design of Compensation Contracts
      4. 6.4. Data
        1. 6.4.1. Data
        2. 6.4.2. Summary Statistics
        3. 6.4.3. Correlation Matrix
      5. 6.5. Econometric Tests
        1. 6.5.1. Econometric Methods
        2. 6.5.2. Regression Results
      6. 6.6. Limitations, Alternate Explanations, and Future Research
      7. 6.7. Conclusions
      8. Key Terms
      9. Discussion Questions
    4. Chapter 7. Fundraising and Regulation
      1. 7.1. Introduction and Learning Objectives
      2. 7.2. Regulation of Institutional Investors and Fund Managers
      3. 7.3. Legal and Institutional Details and Testable Hypotheses
        1. 7.3.1. Regulatory Harmonization of Institutional Investors
        2. 7.3.2. The Dearth of Private Equity Fund Regulation
      4. 7.4. Data
        1. 7.4.1. Methods and Survey Instrument
        2. 7.4.2. Potential Sample Selection Bias
        3. 7.4.3. Summary Statistics
        4. 7.4.4. Difference of Means and Medians Tests and Correlation Matrix
      5. 7.5. Multivariate Analyses
        1. 7.5.1. The Impact of Institutional Investor Regulatory Harmonization on Institutional Investor Allocations to Private Equity
        2. 7.5.2. The Impact of a Dearth of Private Equity Fund Regulations on Institutional Investor Allocations to Private Equity
        3. 7.5.3. The Impact of Nonregulatory Factors on Institutional Investor Private Equity Allocations
        4. 7.5.4. Summary
      6. 7.6. Extensions and Future Research
      7. 7.7. Conclusions
        1. Key Terms
        2. Discussion Questions
    5. Chapter 8. Specialized Investment Mandates
      1. 8.1. Introduction and Learning Objectives
      2. 8.2. Why Socially Responsible Investments in Private Equity? Testable Hypotheses
        1. 8.2.1. Other Factors Relevant to Socially Responsible Private Equity Investments
      3. 8.3. Data
        1. 8.3.1. Methods and Survey Instrument
        2. 8.3.2. Potential Sample Selection Bias
        3. 8.3.3. Summary Statistics
      4. 8.4. Multivariate Empirical Analyses
      5. 8.5. Extensions and Future Research
      6. 8.6. Conclusions
      7. Key Terms
      8. Discussion Questions
    6. Chapter 9. The Role of Government and Alternative Policy Options
      1. 9.1. Introduction and Learning Objectives
      2. 9.2. Taxation
      3. 9.3. Securities Laws
      4. 9.4. Regulation Pertaining to the Demand for Entrepreneurial Capital
      5. 9.5. Regulations Pertaining to the Supply of Entrepreneurial Capital
      6. 9.6. Direct Government Investment Programs
        1. 9.6.1. United States
        2. 9.6.2. Israel
        3. 9.6.3. Canada
        4. 9.6.4. United Kingdom
        5. 9.6.5. Australia
        6. 9.6.6. Summary and Other Possible Design Mechanisms for Government Venture Capital Funds
      7. 9.7. Summary
      8. Key Terms
      9. Discussion Questions
  7. Part Three. Financial Contracting between Funds and Entrepreneurs
    1. Chapter 10. The Investment Process
      1. 10.1. Introduction and Learning Objectives
      2. 10.2. Due Diligence
      3. 10.3. Stage of Development and Industry
      4. 10.4. Staging
      5. 10.5. Fund Flows and Valuations
      6. 10.6. Syndication
      7. 10.7. Board Seats
      8. 10.8. Contract Terms
      9. 10.9. Summary
      10. Key Terms
      11. Discussion Questions
    2. Chapter 11. Security Design
      1. 11.1. Introduction and Learning Objectives
      2. 11.2. Theory and Hypotheses
        1. 11.2.1. Agency Costs
        2. 11.2.2. Taxation
        3. 11.2.3. Sophistication and Learning
        4. 11.2.4. Economic Conditions
        5. 11.2.5. Summary
      3. 11.3. Data
      4. 11.4. Empirical Tests
        1. 11.4.1. Methodology
        2. 11.4.2. Empirical Results
      5. 11.5. Limitations, Alternative Explanations, and Future Research
        1. 11.5.1. Securities Regulation
        2. 11.5.2. Other Control Rights
        3. 11.5.3. Behavioral Finance Factors
      6. 11.6. Conclusions
      7. Appendix
        1. Case A Fixed-fraction contract without effort-related moral hazard
        2. Case B Fixed-fraction contract with effort-related moral hazard
        3. Case C The proposed contractual arrangement
      8. Key Terms
    3. Chapter 12. Security Design and Adverse Selection
      1. 12.1. Introduction and Learning Objectives
      2. 12.2. Adverse Selection, Capital Structure, Firm Characteristics, and Syndication
        1. 12.2.1. Theoretical Principles on Adverse Selection and Capital Structure
        2. 12.2.2. Adverse Selection Risks in Venture Capital Finance
      3. 12.3. Data
      4. 12.4. Empirical Evidence
        1. 12.4.1. The Determinants of Forms of Venture Capital Finance
        2. 12.4.2. Do Different Types of Investors Select Different Types of Entrepreneurial Firms?
        3. 12.4.3. Adverse Selection, Forms of Finance, and Firm Characteristics: Empirical Evidence
        4. 12.4.4. Robustness Checks on the Adverse Selection Tests
        5. 12.4.5. Limitations and Future Research
      5. 12.5. Conclusions
      6. Key Terms
      7. Discussion Questions
    4. Chapter 13. Corporate Venture Capital Fund Contracts
      1. 13.1. Introduction and Learning Objectives
      2. 13.2. Financial Contracting in Venture Capital
        1. 13.2.1. A Brief Review of the Issues in Venture Capital Financial Contracting
        2. 13.2.2. Why Might Corporate Venture Capital Fund Contracts Differ from Limited Partnership Venture Capital Fund Contracts?
        3. 13.2.3. Is Convertible Preferred Equity Optimal in Venture Capital Finance?
      3. 13.3. U.S. and Canadian Corporate and Limited Partnership Venture Capital Fund Investments in Canadian Entrepreneurial Firms
      4. 13.4. European Corporate Venture Capital Fund Investments
      5. 13.5. Venture Capital Fund Contracts, Exits, and Returns Performance
      6. 13.6. Lessons for Corporations Setting Up Venture Capital Funds
      7. 13.7. Concluding Remarks and Future Research
      8. Key Terms
      9. Discussion Questions
    5. Chapter 14. Preplanned Exits and Contract Design
      1. 14.1. Introduction and Learning Objectives
      2. 14.2. Hypotheses
        1. 14.2.1. Preplanned Exits and Venture Capital Contracts
        2. 14.2.2. Law Quality and Bargaining Power in Contract Formation
      3. 14.3. Data
      4. 14.4. Multivariate Tests
        1. 14.4.1. Veto and Control Rights
        2. 14.4.2. Security Design
      5. 14.5. Limitations and Future Research
      6. 14.6. Conclusions
      7. Key Terms
      8. Discussion Questions
  8. Part Four. Investor Effort
    1. Chapter 15. Investor Value-added
      1. 15.1. Introduction and Learning Objectives
      2. 15.2. Innovation and Efficiency
      3. 15.3. Do Contract Terms Facilitate Investor Effort?
      4. 15.4. Location
      5. 15.5. Portfolio Size
      6. 15.6. Investment Duration
      7. 15.7. Summary
      8. Key Terms
      9. Discussion Questions
    2. Chapter 16. Contracts and Effort
      1. 16.1. Introduction and Learning Objectives
      2. 16.2. Hypotheses
        1. 16.2.1. Allocation of Cash Flow Rights
        2. 16.2.2. Allocation of Control Rights
        3. 16.2.3. Quality of Legal System
      3. 16.3. Methodology
        1. 16.3.1. Dependent Variables: Hours per Month, Advice, and Conflict
        2. 16.3.2. Explanatory Variables to Test Hypotheses 16.1 to 16.3
        3. 16.3.3. Other Governance Mechanisms, Risk, and Controls for Other Factors
      4. 16.4. The Dataset
        1. 16.4.1. Data Collection
        2. 16.4.2. Data Summary
      5. 16.5. Econometric Analysis
        1. 16.5.1. Hypotheses 16.1 to 16.3: The Impact of Contracts and Laws on Venture Capital Fund Manager-Entrepreneur Relationships
        2. 16.5.2. Other Governance Mechanisms, Risk, and Control Variables
      6. 16.6. Limitations, Alternative Explanations, and Future Research
      7. 16.7. Conclusions
      8. Key Terms
      9. Discussion Questions
    3. Chapter 17. Home Bias
      1. 17.1. Introduction and Learning Objectives
      2. 17.2. Institutional Structure, Prior Research, and Testable Hypotheses
        1. 17.2.1. Agency Impediments to Interprovincial Investment
        2. 17.2.2. Institutional Impediments to Interprovincial Investment
      3. 17.3. Data
      4. 17.4. Multivariate Logit Tests
      5. 17.5. The Scope of the Data and Generalizations That Can Be Drawn from the Empirical Analysis
      6. 17.6. Conclusions and Implications
      7. Key Terms
      8. Discussion Questions
    4. Chapter 18. Portfolio Size
      1. 18.1. Introduction and Learning Objectives
      2. 18.2. Comparative Statistics and Hypotheses
        1. 18.2.1. Venture Capital Fund Characteristics
        2. 18.2.2. Entrepreneurial Firm Characteristics
        3. 18.2.3. Nature of the Financing Arrangement
        4. 18.2.4. Market Conditions
      3. 18.3. Data
        1. 18.3.1. Description of the Data
        2. 18.3.2. Comparison Tests and Correlation Matrix
      4. 18.4. Empirical Evidence
        1. 18.4.1. Empirical Methods
        2. 18.4.2. Empirical Results
        3. 18.4.3. Further Robustness Checks, Limitations, and Alternative Explanations
      5. 18.5. Conclusions
      6. Appendix
      7. Key Terms
      8. Discussion Questions
  9. Part Five. Divestment
    1. Chapter 19. The Divestment Process
      1. 19.1. Introduction and Learning Objectives
      2. 19.2. The Economics of Initial Public Offerings
        1. 19.2.1. Short-run Performance
        2. 19.2.2. Long-run Performance
      3. 19.3. Investment Duration and Time to Exit
      4. 19.4. The Mode of Exit
      5. 19.5. International Exit Statistics
      6. 19.6. Summary
      7. Key Terms
      8. Discussion Questions
    2. Chapter 20. Exit Outcomes
      1. 20.1. Introduction and Learning Objectives
      2. 20.2. Hypotheses
        1. 20.2.1. Venture Capitalist Characteristics
        2. 20.2.2. Entrepreneurial Firm Characteristics
        3. 20.2.3. Venture Capitalist-Entrepreneur Contracts
        4. 20.2.4. Market and Regulatory Control Variables
        5. 20.2.5. Summary
      3. 20.3. Data
      4. 20.4. Regression Analyses
        1. 20.4.1 Additional Robustness Checks
      5. 20.5. Conclusions
      6. Key Terms
      7. Discussion Questions
    3. Chapter 21. Contracts and Exits
      1. 21.1. Introduction and Learning Objectives
      2. 21.2. Hypotheses
        1. 21.2.1. VC Control Rights
        2. 21.2.2. Other Factors Relevant to the Choice between IPOs versus Acquisitions
      3. 21.3. Variables in the Econometric Specifications
      4. 21.4. Data
        1. 21.4.1. Sample Description
        2. 21.4.2. Summary Statistics
      5. 21.5. Multivariate Regressions
        1. 21.5.1. Base Regression Models
        2. 21.5.2. Endogeneity
        3. 21.5.3. Additional Robustness Checks
      6. 21.6. Conclusions
      7. Key Terms
      8. Discussion Questions
    4. Chapter 22. Valuation, Returns, and Disclosure
      1. 22.1. Introduction and Learning Objectives
      2. 22.2. Venture Capital Valuation Method
      3. 22.3. Factors That Affect Venture Capital Realized Returns and Reported Unrealized Returns
      4. 22.4. Conclusions and Remarks
        1. Key Terms
        2. Discussion Questions
  10. Part Six. Conclusion
    1. Chapter 23. Summary and Concluding Remarks
  11. Appendix Online Appendices
  12. Bibliography
    1. References

Product information

  • Title: Venture Capital and Private Equity Contracting
  • Author(s): Douglas J. Cumming, Sofia A. Johan
  • Release date: April 2009
  • Publisher(s): Academic Press
  • ISBN: 9780121985813