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Essays in Entrepreneurial Finance and Strategy


This dissertation analyzes contracts and organizational form decisions in the empirical setting of venture capital investments. The first chapter asks how entrepreneurs and venture capital investors are affected by a specific design feature of investment contracts. Participating preferred rights, which are venture capital contract terms that give investors returns greater than their intrinsic ownership, are used extensively despite possible deleterious effects on founder incentives. Using a novel data set of venture capital investment contracts from 2004-2009, I ask three fundamental questions about these rights: when are they used, who uses them, and what are their consequences? The findings indicate that (i) lower inflows of venture capital funding increase the use of participating preferred rights; (ii) less experienced investors and certain industry sectors utilize participating preferred rights more often; and (iii) firms with participating preferred rights are less likely to raise a subsequent financing at a higher valuation and less likely to exit through an IPO or acquisition, suggesting that the incentive implications of these rights may affect firm performance. These results are robust to specifications that attempt to control for the endogeneity of the contract right. The findings provide important insights for entrepreneurs and investors who are weighing the consequences of certain contractual forms.

The second chapter broadens the analysis to other contractual rights to asks how investors and entrepreneurs allocate ownership and venture capital investment rights in competitive markets. Using the same data set of venture capital financings from 2004-2009, I find that changes in market competition, or venture capital supply, affect contractual terms in significant ways. Competition not only affects firm valuations, but how actual firm ownership is divided between entrepreneurs and investors. Additionally, certain contractual rights shift in response to venture capital scarcity. Specifically, the results suggest that (i) entrepreneurs own more of the firm in periods of high venture capital inflows, (ii) entrepreneurs give up cash flow rights in periods of low venture capital inflows, and (iii) the incidence of control rights are not significantly affected by venture capital inflows. Similarly, the results are robust to specifications that attempt to control for the endogeneity of venture capital inflows.

The third chapter (co-authored with Eric J. Allen) focuses on a potential inefficiency of organizational design, specifically when a startup chooses to organize as a C-corporation rather than as a limited liability company (LLC). We examine the previously documented anomaly of loss-generating startup firms organizing as C-Corporations, as opposed to the theoretically more tax efficient alternative - the LLC. While prior research examines the potential reasons for this divergence between theory and practice, this is the first study that actually attempts to quantify the foregone tax benefits incurred by the current system. We examine a sample of venture backed firms that reached the Initial Public Offering stage between 1996 and 2008. We find that the vast majority of these firms have accumulated tax losses at issuance, on average $33 million, and that the associated potential tax benefit is significant. We also examine a subsample of firms that were, at one time, organized as pass-through entities prior to going public. We find that, while the majority switched to the C-Corporate form upon the entrance of a venture capital investor, a small number were allowed to retain their pass-through status until issuance. Their existence provides further evidence that the alternative form's lack of adoption must be attributable to some aspect other than technical limitations that would prevent venture capital investment.

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