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Do VCs use inside rounds to dilute founders? Some evidence from Silicon Valley

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  • Broughman, Brian J.
  • Fried, Jesse M.
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    Abstract

    In the bank-borrower setting, a firm's existing lender may exploit its positional advantage to extract rents from the firm in subsequent financings. Analogously, a startup's existing venture capital investors (VCs) may dilute the founder through a follow-on financing from these same VCs (an “inside” round) at an artificially low valuation. Using a hand-collected dataset of Silicon Valley startup firms, we find little evidence that VCs use inside rounds to dilute founders. Instead, our findings suggest that inside rounds are generally used as “backstop financing” for startups that cannot attract new money, and these rounds are conducted at relatively high valuations (perhaps to reduce litigation risk).

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Corporate Finance.

    Volume (Year): 18 (2012)
    Issue (Month): 5 ()
    Pages: 1104-1120

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    Handle: RePEc:eee:corfin:v:18:y:2012:i:5:p:1104-1120

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    Web page: http://www.elsevier.com/locate/jcorpfin

    Related research

    Keywords: Venture capital; Dilution; Corporate governance; Inside rounds; Corporate law; Inside financing;

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    References

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    Cited by:
    1. Humphery-Jenner, Mark & Suchard, Jo-Ann, 2013. "Foreign VCs and venture success: Evidence from China," Journal of Corporate Finance, Elsevier, vol. 21(C), pages 16-35.

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