Deal Completion: Inequitable Agreements in Venture Capital Contracting

Abstract

Financial contracts in the venture capital ecosystem are often incomplete, imperfect, and defective. Most financial contracts aim to “overcompensate” for venture capitalists’ inabilities and lack of expertise. Venture capitalists seek disproportionate, one-sided, and asymmetric protections. Two of the most draconian clauses and provisions sought by venture capitalists include the “voting flip-over event” provision (venture capitalists terminate the founding entrepreneur as CEO) and “drag-along” rights (venture capitalists implement a forced disposal of the entrepreneurial venture). Moreover, venture capitalists often bring a “uniform” approach to financial contacting that is unlikely to reflect the actual risk profile of the unique entrepreneurial firm. This standardized approach to financial contracting may highlight venture capitalists’ inability to properly understand the strengths and weaknesses of their underlying investee firms.