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Lawyers in Venture Capital Contracting: Theory and Evidence

Bengtsson, Ola LU and Bernhardt, Dan (2014) In Economic Inquiry 52(3). p.1080-1102
Abstract
Real-world financial contracts are sometimes so complex that it can be difficult to understand their exact payoff consequences. We develop and test a theoretical model of a venture capitalist (VC) negotiating with an entrepreneur who may overweigh or underweigh the payoff consequences of contractual downside protection (DP). A lawyer with expertise in venture capital can inform the entrepreneur about these consequences, but less expert (but otherwise high quality) lawyers cannot. We determine how a VC's decision to include DP is affected by the expected quality of the entrepreneur's project, the entrepreneur's experience, and the VC expertise of his/her legal counsel. We show that the VC's incentive to include unnecessary DP declines in... (More)
Real-world financial contracts are sometimes so complex that it can be difficult to understand their exact payoff consequences. We develop and test a theoretical model of a venture capitalist (VC) negotiating with an entrepreneur who may overweigh or underweigh the payoff consequences of contractual downside protection (DP). A lawyer with expertise in venture capital can inform the entrepreneur about these consequences, but less expert (but otherwise high quality) lawyers cannot. We determine how a VC's decision to include DP is affected by the expected quality of the entrepreneur's project, the entrepreneur's experience, and the VC expertise of his/her legal counsel. We show that the VC's incentive to include unnecessary DP declines in expected project quality. Indeed, for inexperienced entrepreneurs involved with high-quality projects, VCs prefer that the entrepreneur's counsel has VC expertise. This implies that, when negotiating with inexperienced entrepreneurs, VCs who invest in high-quality companies should be more likely to negotiate with entrepreneurs who employ lawyers with VC expertise. We document broad empirical support for the model, and provide evidence against competing explanations.(JEL L24, G24, K12, L14, L24) (Less)
Please use this url to cite or link to this publication:
author
organization
publishing date
type
Contribution to journal
publication status
published
subject
keywords
Venture Capital, Contracting, Entrepreneurship, Finance
in
Economic Inquiry
volume
52
issue
3
pages
1080 - 1102
publisher
Wiley-Blackwell
external identifiers
  • wos:000335992200008
  • scopus:84899833863
ISSN
1465-7295
DOI
10.1111/ecin.12088
language
English
LU publication?
yes
id
387fc39b-d53b-4c76-ad2e-79d40fead706 (old id 4174152)
date added to LUP
2014-07-17 13:38:55
date last changed
2017-01-01 03:02:15
@article{387fc39b-d53b-4c76-ad2e-79d40fead706,
  abstract     = {Real-world financial contracts are sometimes so complex that it can be difficult to understand their exact payoff consequences. We develop and test a theoretical model of a venture capitalist (VC) negotiating with an entrepreneur who may overweigh or underweigh the payoff consequences of contractual downside protection (DP). A lawyer with expertise in venture capital can inform the entrepreneur about these consequences, but less expert (but otherwise high quality) lawyers cannot. We determine how a VC's decision to include DP is affected by the expected quality of the entrepreneur's project, the entrepreneur's experience, and the VC expertise of his/her legal counsel. We show that the VC's incentive to include unnecessary DP declines in expected project quality. Indeed, for inexperienced entrepreneurs involved with high-quality projects, VCs prefer that the entrepreneur's counsel has VC expertise. This implies that, when negotiating with inexperienced entrepreneurs, VCs who invest in high-quality companies should be more likely to negotiate with entrepreneurs who employ lawyers with VC expertise. We document broad empirical support for the model, and provide evidence against competing explanations.(JEL L24, G24, K12, L14, L24)},
  author       = {Bengtsson, Ola and Bernhardt, Dan},
  issn         = {1465-7295},
  keyword      = {Venture Capital,Contracting,Entrepreneurship,Finance},
  language     = {eng},
  number       = {3},
  pages        = {1080--1102},
  publisher    = {Wiley-Blackwell},
  series       = {Economic Inquiry},
  title        = {Lawyers in Venture Capital Contracting: Theory and Evidence},
  url          = {http://dx.doi.org/10.1111/ecin.12088},
  volume       = {52},
  year         = {2014},
}