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The impact of insolvency laws on venture capital

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  • Bhatia, Jai

Abstract

The venture capital (VC) industry supports innovation in an economy, and has seen much success over the last few years. However, with the inherent risk in any start-up business, the venture capitalist is bound to see some failures. This paper explores the effects of corporate and personal insolvency laws on financially distressed VC funded firms. It also compares the contract driven bankruptcy system to the court driven system, and their implications for failed VC funded firms. This paper relies upon qualitative analysis and draws upon interviews with academic experts, industry practitioners and secondary data. In the light of corporate insolvency, the research concludes that entrepreneurial firms are often ‘wound up’ rather than put into the bankruptcy system for liquidation/ reorganization because the realized value from the small firms often do not cover the cost of the bankruptcy process. Consequently, it is difficult to ascertain the impact of corporate insolvency laws on small businesses. On the contrary, it has been observed that the severity of the personal insolvency law does not affect venture capital financed entrepreneurs. The venture capitalists provide equity finance and the entrepreneurs do not need to risk their personal assets for collateral to acquire bank finance. The comparison between the US and UK systems of bankruptcy revealed that for small entrepreneurial firms, both systems are convergent to a greater degree than they are for larger firms i.e., the smaller the firm the more similar both the systems seem in relation to efficiency and the ability to salvage value from financially distressed firms.

Suggested Citation

  • Bhatia, Jai, 2009. "The impact of insolvency laws on venture capital," MPRA Paper 21346, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:21346
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    File URL: https://mpra.ub.uni-muenchen.de/21346/1/MPRA_paper_21346.pdf
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    References listed on IDEAS

    as
    1. Oliver Hart & John Moore, 1998. "Default and Renegotiation: A Dynamic Model of Debt," The Quarterly Journal of Economics, Oxford University Press, vol. 113(1), pages 1-41.
    2. John Armour & Douglas Cumming, 2008. "Bankruptcy Law and Entrepreneurship," American Law and Economics Review, Oxford University Press, vol. 10(2), pages 303-350.
    3. Paul A. Gompers & Josh Lerner, 1999. "What Drives Venture Capital Fundraising?," NBER Working Papers 6906, National Bureau of Economic Research, Inc.
    4. John Armour & Douglas Cumming, 2004. "The Legal Road To Replicating Silicon Valley," Working Papers wp281, Centre for Business Research, University of Cambridge.
    5. Sergei A. Davydenko & Julian R. Franks, 2008. "Do Bankruptcy Codes Matter? A Study of Defaults in France, Germany, and the U.K," Journal of Finance, American Finance Association, vol. 63(2), pages 565-608, April.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Insolvency Law; Bankruptcy; Venture Capital; Entrepreneurship; Administration; Liquidation; Personal insolvency; Corporate Insolvency;

    JEL classification:

    • K35 - Law and Economics - - Other Substantive Areas of Law - - - Personal Bankruptcy Law
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • M13 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - New Firms; Startups

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