OLA BENGTSSON

Papers

Working Papers on Venture Capital Contracts

The Geography of Venture Capital Contracts
Joint with Avri Ravid
This paper shows that geographical elements can form an essential component of contract design in addition to more traditional ingredients such as information problems, moral hazard and legal institutions. We analyze how investor-friendly cash flow contingencies are included in 1,804 contracts between U.S. venture capitalists (VCs) and U.S. startup companies. These contingencies affect both the pricing of the VC investment and the entrepreneur’s monetary incentives. Our main finding is that contracts include considerably fewer such contingencies if the startup is located in California, and in particular in Silicon Valley. Indeed, this “California effect” has a greater impact on contract design than any other observable company, VC or founder characteristic. The effect also carries over between markets. Contracts are less investor-friendly if a VC is located in California or if a non-California VC has had large exposure to investments in California. We further show that contracts are also less investorfriendly if the startup is located in a region with a larger VC market, or if the geographical distance between the VC and the company is shorter. This latter finding supports the view that parties who are geographically close can contract more efficiently due to lower monitoring costs and better soft information. However, the “California effect” remains large and significant even after we control for these other factors. Finally, we present evidence that the effect cannot be explained by a substitution between control rights and cash flow contingencies. In fact, California contracts are less investor-friendly on both counts. We discuss how our findings are consistent with arguments on how regional culture can affect the nature of local VC markets.


Investor Abilities and Financial Contracting: Evidence from Venture Capital
Joint with Berk Sensoy
We investigate how investors’ abilities to mitigate agency problems in non-contractual ways impacts contract design. Our empirical setting is the venture capital (VC) industry, in which there are substantial agency problems, considerable flexibility in contract design, and wide variation in the abilities of VCs to monitor and add value to their portfolio companies. Using a large, new database of VC contracts, we find that more experienced VCs, who likely have better monitoring abilities and whose withdrawal as active, value-added investors is more costly to entrepreneurs, obtain weaker downside-protecting cash flow rights than less experienced VCs. This result survives a battery of controls for company characteristics, including valuation, as well as specifications that control for endogenous selection effects. The relation between VC experience and downside protections is weaker when entrepreneurial agency problems are less severe, and stronger when the VC equity stake is larger, suggesting that our main result is more likely due to the entrepreneur’s incentive problem rather than the VC’s.


Intermediaries in Negotiations of Complex Contracts: The Role of Attorneys in Venture Capital Transactions

I show that intermediaries can affect the design of financial contracts by reducing asymmetry in contracting parties’ knowledge about complicated and interrelated contract contingencies. Across 908 contracts used in venture capital (VC) transactions, entrepreneurs counseled by attorneys with high VC expertise sign contracts with fewer investor-friendly cash flow contingencies, particularly entrepreneurs with less knowledge of such contracts. This finding does not hold for attorneys with high general expertise, which underscores the intermediary’s role of providing information about a specific type of complex contract. The results are likely to reflect a causal association because I do not observe that law firms with more VC expertise systematically counsel venture-backed companies of higher quality.


Restrictive Covenants in Venture Capital Contracts

I show that VCs frequently have the right to veto specific operational and financial decisions even though they are equity investors with access to other powerful governance mechanisms. Across 182 first-round U.S. venture capital investments, restrictive covenants are commonplace with 92 percent of all contracts including at least one covenant. I exploit the considerable observed variation in the basic design of venture capital contracts to test the underlying motivation in investor demand for restrictive covenants. Consistent with the thesis of Jensen and Meckling (1976), Myers (1977), and Smith and Warner (1979), my results show that covenants are more prevalent for contracts that give VCs a higher debt-like payoff and no control over boards of directors. Restrictive covenants are also more common for older companies and when fewer VCs invest in the round.


Changing the Nexus: The Evolution and Renegotiation of Venture Capital Contracts

We study empirically how financial contracts evolve and are renegotiated as venture capital (VC)-backed companies secure new rounds of financing. Because VC contract designs vary considerably between companies according to their economic circumstances, it is plausible to expect that the contracts governing successive financing rounds of a quickly-evolving company should often be dissimilar. The data offer little support for this intuitive hypothesis. In fact, the majority of cash flow provisions in a new round contract are recycled from the previous round contract, even when the company has evolved substantially. Such recycling may be beneficial in typical situations because it alleviates information problems in negotiations and reduces the complexity of the company’s nexus of financial contracts (Fama, 1980). However, in some situations restructuring contract design may be necessary to entice investors to provide new capital. Consistent with debt overhang arguments (Myers, 1977), we show that venture capital contracts evolve to include more investor-friendly cash flow provisions when the valuation of the company has not increased since the previous round, when new investors join the new round, or when new round investors hold larger debt-like claims. Although major renegotiations of previous round contracts are rare, minor renegotiations appear to be more common and almost uniformly result in making the previous round contract more similar to the new round contract. Overall, our findings suggest that the tradeoff relevant for changing a company’s nexus of financial contracts is different from the tradeoffs relevant for the initial structuring of this nexus.

Working Papers on How Entrepreneurs Evaluate and Select Venture Capitalists

Relational VC Financing of Serial Founders
This study examines how often and why a serial founder receives financing for his new company from a venture capital (VC) firm that also invested in his previous company. Only one in ten VC investments leads to a repeated relationship and only one in three serial founders enters into a repeated relationship with any previous VC firm. A repeated relationship is more likely when the relational VC firm has acquired more private information about the founder, but less likely if the founder’s new venture has a bad fit with the VC firm’s geographic or industry focus. My findings add to the literature on relational financing by showing that the preservation of information is an important motivation for relational financing when screening and monitoring costs are high. Yet, repeated relationships appear to be relatively uncommon partly because investors also respond to information problems by specializing in certain types of firms.


What Matters in Venture Capital? Evidence from Entrepreneurs’ Stated Preferences
Joint with Frederick Wang
We study how entrepreneurs evaluate the ability of different U.S. venture capitalists (VCs) to add value to start-up companies. Analyzing a large dataset on entrepreneurs’ stated preferences on VCs, we show that entrepreneurs view independent partnership VCs more favorably than other VC types (e.g. corporate, financial, and governmentsponsored VCs). Although entrepreneurs are able to correctly identify the VCs with better track record, they do not believe that such VCs have a higher ability to add value. We also find that an entrepreneur’s rankings are affected by his or her overall exposure to VCs, emphasizing the role of experiential learning in the venture capital market.


How Do Venture Capital Partners Match with Startup Founders?
Joint with David Hsu
The venture capital market is characterized by personal interactions between VC firms and the startups they finance. Yet we have little systematic evidence of how startup founders get matched with partners at VC firms. By assembling data at the individual partner and founder level, we compare personal similarity-based rationale with resource complementarity-based reasons explaining the likelihood of an investment match. We find that a match is more likely if the two parties share a common ethnicity or have both attended a top ranked university, and particularly so when information problems are more severe. With such similarities, the VC’s investment also represents a larger fraction of her total investments. We interpret personal similarity as reducing transactions costs in VC matching rather than proxying quality-based matching. Matching based on VC partner’s professional expertise appears to be less determined by their complementarity with the founder’s background and more by the current lifecycle stage of the startup. In particular, VC partners with finance or operational capabilities are more likely to match with mature ventures. Our findings shed new light on how personal characteristics and professional expertise can be important in financing situations where informational frictions are severe and investors are actively involved with their borrowers.

Working Papers on How Entrepreneurs Are Compensated

CEO Compensation in Venture Capital Markets
Joint with John Hand, (forthcoming, Journal of Business Venturing)
We hypothesize that because fast-growing young companies must raise money in private capital markets that contain significant financing frictions, the CEOs of such firms will be compensated for successful fundraising. Using a sample of 1,585 private venture-backed U.S. firms, we find that the cash pay of entrepreneur-CEOs is increasing in both the quantity and quality of financing secured and is more sensitive to successful fundraising the more challenging and difficult is the fundraising task. Successful fundraising also increases the gap between the pay of CEOs and other executives. Finally, we show that while VC financing dilutes the CEO’s fractional equity ownership, it increases the dollar value of that ownership.

Work in Progress

Pay-to-Play or Paid-to-Pay. Employee Compensation in Entrepreneurial Companies
Joint with John Hand

Investment Screening and Market Conditions: Evidence From Venture Capital
Steven Kaplan, Frederic Martel, and Per Strömberg

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