Venture Capital Contracting: A Case Study

2 Venture Capital Contracting
2.1 The Investment Process
The investment process may be viewed as involving the following issues:
1. Due diligence (screening potential investee firms)
2. Selecting the stage of entrepreneurial firm development at which to invest and industry in which to invest (e.g., biotech, computers, etc.)
3. Staging (number of financing rounds)
4. Valuation
5. Syndication (number of investors)
6. Board seats
7. Contracts between the fund and its investee firms, which includes decisions over matters that include, but are not limited to the following:
a. Security (debt, preferred equity, common equity, etc.)
b. Control rights (such as the right to replace the founding entrepreneur as the CEO, among other rights)
c. Veto rights (such as over asset sales and purchases)

1. Due diligence
The process of due diligence is a natural place to start because it involves the screening of potential investee firms. Academic evidence indicates that a typical venture capital fund will receive more than 1,000 business plans per year, but many will not even seriously consider business plans unless they are referred by someone known to the fund manager. Fund managers may look at 50 of these plans but

Financial contracts are vitally important to the venture capital investment process because contracts minimize information asymmetries and agency problems and appropriately provide incentives for both the entrepreneur and value-added venture capital fund manager to add value to the enterprise. Financial contracts also facilitate the exit of venture capital fund investments in entrepreneurial firms. Given the high risk and uncertainty facing venture capital investments, financial contracts have emerged as highly sophisticated instruments that are a vital part of the venture capital