15 - Contracts and Effort

Abstract

This chapter provides empirical insights into the role of contracts and legal systems for managing investor–investee relationships along two dimensions: providing advice and addressing conflict. We examine a new detailed dataset from European venture capital (VC) funds. We match very specific contractual terms in VC contracts with the effort (total time spent) and advice that VCs provide to their entrepreneurial investee firms. We also analyze VC–entrepreneur conflicts. We compare the importance of contractual versus noncontractual governance mechanisms as well as the role of legal systems in different countries for facilitating VC–entrepreneur relationships. The data indicate VC cash flow and control rights significantly facilitate effort and advice that VCs provide to entrepreneurs. VC–entrepreneur conflicts are closely tied to the quality of laws in which the entrepreneur resides: higher quality legal systems mitigate VC–entrepreneur conflicts. The data further indicate that noncontractual governance mechanisms significantly facilitate VC advice and mitigate VC–entrepreneur conflicts. The results provide a unique unifying look into the role of actual VC contracts and legal settings versus noncontractual governance mechanisms, risk, and success potential on VC–entrepreneur relationships in an international context.