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Covenants in Venture Capital Contracts

Author

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  • Ola Bengtsson

    () (University of Illinois at Urbana-Champaign, Champaign, Illinois 61820)

Abstract

This paper studies how covenants are included in contracts between venture capitalists (VCs) and entrepreneurs. I show that VCs hold covenanted veto rights even though they are shareholders who have access to other powerful governance solutions. Unlike bank loans and bonds, venture capital (VC) contracts exhibit considerable variation in their contractual designs. I exploit this variation to confirm the argument that covenants are in place to overcome a conflict of interest that arises from debt-like contractual features of a venture capitalist's preferred stock. In particular, I find that contracts with higher fixed payoffs include 1.6 more covenants than do contracts with lower fixed payoffs. Similarly, VC contracts with no VC board majority requirement include 0.6 more covenants than do contracts that require a VC board majority. Covenants are also more common with older companies and when fewer VCs invest in a round. My findings contribute to both the debt covenant literature and the entrepreneurial finance literature. This paper was accepted by Brad Barber, finance.

Suggested Citation

  • Ola Bengtsson, 2011. "Covenants in Venture Capital Contracts," Management Science, INFORMS, vol. 57(11), pages 1926-1943, November.
  • Handle: RePEc:inm:ormnsc:v:57:y:2011:i:11:p:1926-1943
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    File URL: http://dx.doi.org/10.1287/mnsc.1110.1409
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Ola Bengtsson & John R. M. Hand, 2013. "Employee Compensation in Entrepreneurial Companies," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 22(2), pages 312-340, June.
    2. Rin, Marco Da & Hellmann, Thomas & Puri, Manju, 2013. "A Survey of Venture Capital Research," Handbook of the Economics of Finance, Elsevier.
    3. repec:spr:jbecon:v:88:y:2018:i:3:d:10.1007_s11573-017-0874-4 is not listed on IDEAS
    4. Kevin Levillain & Blanche Segrestin & Armand Hatchuel, 2014. "Can venture capital foster innovation? A study of the coupling between innovation and finance," Post-Print hal-00969096, HAL.
    5. Ola Bengtsson & Na Dai, 2014. "Financial Contracts in PIPE Offerings: The Role of Expert Placement Agents," Financial Management, Financial Management Association International, vol. 43(4), pages 795-832, December.
    6. Annalisa Croce & Diego D’Adda & Elisa Ughetto, 2015. "Venture capital financing and the financial distress risk of portfolio firms: How independent and bank-affiliated investors differ," Small Business Economics, Springer, vol. 44(1), pages 189-206, January.
    7. Caselli, Stefano & Garcia-Appendini, Emilia & Ippolito, Filippo, 2013. "Contracts and returns in private equity investments," Journal of Financial Intermediation, Elsevier, vol. 22(2), pages 201-217.
    8. Anita Lovas & János Pereczes & Viktória Rába, 2015. "Incentives and restrictions in venture capital contracts," Financial and Economic Review, Magyar Nemzeti Bank (Central Bank of Hungary), vol. 14(3), pages 106-121.
    9. repec:cbh:journl:v:14:y:2015:i:3:p:106-121 is not listed on IDEAS

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