Berkeley Program in Law and Economics

The capital structure and governance of venture-backed startups have received significant attention from economists and legal academics. Much of this literature has focused on venture capitalists' use of preferred stock and control rights - including board control- to reduce agency costs. Recently, it has also been suggested that VC's use of preferred stock is tax-driven. However, scholars have failed to notice that these arrangements, whatever their explanation, lead to a highly unusual and perhaps unique corporate governance structure: one in which preferred shareholders, not common shareholders, control the board and the corporation. The purpose of this paper is threefold: (1) to highlight the unusual governance structure of venture-backed startups; (2) to show that this structure leaves common shareholders vulnerable to opportunistic behavior by preferred-holding VC's expecially under current corporate law doctrines; and (3) to consider changes in these doctrines and the tax laws that would reduce common shareholder vulnerability and enlarge the startup pie for all its investors.