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-à-vis their portfolio firms. It turns out that independent VCs, when compared to captive VCs, use significantly more contract mechanisms which induce active intervention.
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Notes
A partial exception to this is Masulis and Nahata (2009) who correct for the selection effect; however, only for a subsample of their corporate VC sample rather than between different VC types in general. Furthermore, they have only limited information about the overall contract design.
See Kaplan and Strömberg (2003) for a general empirical analysis; Kaplan et al. (2007) and Cumming et al. (2010) for related work on an international data set; and Bienz and Walz (2010), Cumming (2008) as well as Cumming and Johan (2008) for detailed studies on the relation between contract design and VC exits.
As the objective of the project was to analyze different aspects of venture capital contracting in Germany, we aimed at getting a representative sample of VC contracts and not at including a preferably high number of different types of VCs.
According to BVK (2003) there were 11,854 seed, start-up and expansion deals by its members in the relevant time period; KfW supported almost 7,100 deals of potential members. This implies a market coverage of approximately 60%.
In order to check this result for robustness, we create a continuous variable DEBTPERC which measures the degree of debt financing by the analyzed VC.
These other decisions embrace decisions against lawsuits on behalf of the firm as well as the veto right against changes in the shareholder’s agreement, the veto that forbids the firm’s dissolution and the veto against changes in the firm’s capital structure such as giving out new shares.
In this step, we do not consider whether syndication takes place or not. Though, in the extension section, we will only include those captive VCs which do not syndicate. We adopt this procedure because we think that it may be the case that a captive analyzed VC syndicates with an independent VC who is really determining the contract design. We do not think that this problem should be crucial for the case of independent analyzed VCs, however.
This is the only German peculiarity of our data set. We account for this in our later analysis.
If we run the probit regression with standard errors clustered by firm year, the results remain almost unaltered.
We check the robustness of our results by using the alternative continuous variable debtperc measuring the degree of debt financing by the analyzed VC. Using this variable yields even stronger results: the mean for independent VCs is only 0.46 whereas it lies at 0.82 (0.77) after nearest neighbor (Gaussian kernel) matching for captive VCs. This means that both variables go in the same direction. Nevertheless, as the IMD variable takes into account the details of the financing instruments (like, for example, conversion), we think that it is better suited.
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Acknowledgments
This paper is part of a larger research cooperation between the Center for Financial Studies and KfW. In that respect, special thanks go to Carsten Bienz and Volker Zimmermann for valuable comments, all KfW employees at KI and especially Andreas Weber (KfW) for their support. We also would like to thank Adrian Schawalder and Sophie Manigart for valuable suggestions. In addition, seminar participants at Université Catholique du Louvain (CORE), the Universidad Iberoamericana Mexico City, Goethe University Frankfurt as well as the participants of the 2007 Annual Meeting of the European Finance Association (Ljubljana), the 2007 Annual Meeting of the European Economic Association (Budapest), the 2007 Annual Meeting of the German Economic Association Meeting (Munich), the 2008 FIRS Conference (Anchorage) and the Workshop “Reassessing the Relationships between Private Equity Investors and Their Portfolio Companies” at Vlerick Leuven Gent Management School (2010) provided helpful comments and suggestions. We are very grateful for the comments and suggestions of two anonymous referees as well as Mike Wright (the guest editor). All errors remain ours. Financial support by the German Research Foundation (DFG) is gratefully acknowledged.
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Hirsch, J., Walz, U. Why do contracts differ between venture capital types?. Small Bus Econ 40, 511–525 (2013). https://doi.org/10.1007/s11187-011-9388-6
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DOI: https://doi.org/10.1007/s11187-011-9388-6