Entrepreneurial Litigation and Venture Capital Finance

Abstract

This paper empirically examines the impact of entrepreneurial firm plaintiff litigation on the ability of entrepreneurial firms to obtain venture capital (VC), and the subsequent effect on VC exit outcomes. This empirical context is important, as both the costs of litigation and potential benefits are arguably more pronounced for start-ups relative to established firms. We consider cases of litigation being initiated both before and during VC financing. The data indicate (1) plaintiff firms are more likely to obtain financing by less reputable VCs, (2) VCs provide more oversight of plaintiff firms relative to non-plaintiff firms in their portfolio, (3) plaintiff firms are more likely to exit by an IPO (versus acquisition), and less likely to be defunct at the end of the investment period; these exit outcomes are more pronounced for successful plaintiff firms, and (4) underpricing is reduced when PCs win or lose cases but is increases when cases are settled. For all results, implications are less severe for litigants who begin their suit after VC suggesting these entrepreneurial litigants have the backing of the VC.