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Changing the Nexus: The Evolution and Renegotiation of Venture Capital Contracts

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  • Bengtsson, Ola

    (University of Illinois at Urbana-Champaign)

  • Sensoy, Berk A.

    (Ohio State University)

Abstract

We study empirically how financial contracts evolve and are renegotiated as venture capital (VC)-backed companies secure new rounds of financing. Because VC contract designs vary considerably between companies according to their economic circumstances, it is plausible to expect that the contracts governing successive financing rounds of a quickly-evolving company should often be dissimilar. The data offer little support for this intuitive hypothesis. In fact, the majority of cash flow provisions in a new round contract are recycled from the previous round contract, even when the company has evolved substantially. Such recycling may be beneficial in typical situations because it alleviates information problems in negotiations and reduces the complexity of the company's nexus of financial contracts (Fama, 1980). However, in some situations restructuring contract design may be necessary to entice investors to provide new capital. Consistent with debt overhang arguments (Myers, 1977), we show that venture capital contracts evolve to include more investor-friendly cash flow provisions when the valuation of the company has not increased since the previous round, when new investors join the new round, or when new round investors hold larger debt-like claims. Although major renegotiations of previous round contracts are rare, minor renegotiations appear to be more common and almost uniformly result in making the previous round contract more similar to the new round contract. Overall, our findings suggest that the tradeoff relevant for changing a company's nexus of financial contracts is different from the tradeoffs relevant for the initial structuring of this nexus.

Suggested Citation

  • Bengtsson, Ola & Sensoy, Berk A., 2009. "Changing the Nexus: The Evolution and Renegotiation of Venture Capital Contracts," Working Paper Series 2009-19, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    • Handle: RePEc:ecl:ohidic:2009-19
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    Cited by:

    1. Hui Fu & Jun Yang & Yunbi An, 2019. "Contracts for venture capital financing with double-sided moral hazard," Small Business Economics, Springer, vol. 53(1), pages 129-144, June.
    2. Broughman Brian, 2013. "Independent Directors and Shared Board Control in Venture Finance," Review of Law & Economics, De Gruyter, vol. 9(1), pages 41-72, June.
    3. Ewens, Michael & Gorbenko, Alexander & Korteweg, Arthur, 2022. "Venture capital contracts," Journal of Financial Economics, Elsevier, vol. 143(1), pages 131-158.
    4. Mayer, Simon, 2022. "Financing breakthroughs under failure risk," Journal of Financial Economics, Elsevier, vol. 144(3), pages 807-848.
    5. Julian Kaboth & Arnd Lodowicks & Maximilian Schreiter & Bernhard Schwetzler, 2023. "Same same but different: how preferential claims trigger valuation discounts in equity tranches of VC-backed firms," Review of Quantitative Finance and Accounting, Springer, vol. 60(3), pages 877-914, April.
    6. Kang, Jun-Koo & Li, Yingxiang & Oh, Seungjoon, 2022. "Venture Capital Coordination in Syndicates, Corporate Monitoring, and Firm Performance," Journal of Financial Intermediation, Elsevier, vol. 50(C).
    7. Nahata, Rajarishi, 2019. "Success is good but failure is not so bad either: Serial entrepreneurs and venture capital contracting," Journal of Corporate Finance, Elsevier, vol. 58(C), pages 624-649.
    8. Wang, Pengfei, 2020. "Broadening versus reinforcing investor portfolios: Social structure and the search for venture capital investors," Journal of Business Venturing, Elsevier, vol. 35(1).
    9. Tereza Tykvová, 2018. "Venture capital and private equity financing: an overview of recent literature and an agenda for future research," Journal of Business Economics, Springer, vol. 88(3), pages 325-362, May.

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