Why do contracts differ between venture capital types?
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Why do contracts differ between venture capital types? Julia Hirsch • Uwe Walz
Accepted: 11 October 2011 / Published online: 4 November 2011 Ó Springer Science+Business Media, LLC. 2011
Abstract The main objective of the present paper is to investigate differences in the design of contracts between venture capitalists and their portfolio firms across venture capital (VC) types. By controlling for selection effects, we focus on contract design differences which reflect differences in corporate governance approaches across VC types. To address this issue, we use a unique, hand-collected German data set consisting of all contractual details of VC investments into 290 entrepreneurial firms in the period 1990–2004. By employing various matching procedures, we show that VC types differ in their corporate governance approach vis-a`-vis their portfolio firms. It turns out that independent VCs, when compared to captive VCs, use significantly more contract mechanisms which induce active intervention. Keywords Venture capital Corporate governance Matching Contract design JEL Classifications
G24 G32 G34
J. Hirsch Universidad Iberoamericana Mexico City, Prolongacio´n Paseo de la Reforma 880, Mexico City 01219, Mexico e-mail: [email protected] U. Walz (&) Center for Financial Studies, Goethe University Frankfurt, Postfach 54, Gru¨neburgplatz 1, 60629 Frankfurt, Germany e-mail: [email protected]
1 Introduction The contractual relation between venture capitalists (VCs) and their portfolio firms has received growing attention in recent years (see, for example, Gompers 1997; Cumming 2005a, b; and Kaplan and Stro¨mberg 2003, 2004 for early studies), in particular, because it offers the possibility to study the role of explicit contracts in an environment of complex informational asymmetries and control problems. A predominant concern has always been the search for the prototype VC contract. Nevertheless, it is unclear if such a prototype corporate governance approach really exists or if there are not instead persistent differences across VC types (i.e. VCs with different types of main investors) and countries which prevail over time. The aim of this paper is to explore potential differences in corporate governance and contract design across different VC types using a German data set with a large variety of different VC types and all the contractual details of VC investments into 290 entrepreneurial firms during the period from 1990 to 2004. We thereby distinguish between independent VCs (i.e. VCs with many different institutional and private investors) and captive VCs (those with one main investor, e.g. a bank or a public entity). Observing, however, different contract approaches between different VC types does not necessarily imply that different types of VCs apply different corporate governance approaches. Observed differences may also be due to a selection effect. Different VC types finance different types of firms and
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thus need to use different types of contracts. Hence, it is crucial to disen
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