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Venture Capital and Private Equity Contracting

Name: Venture Capital and Private Equity Contracting
ISBN: 9780121985813

by Douglas J. Cumming, Sofia A. Johan

April 2009

Intermediate to advanced

792 pages

29h 26m

English

Academic Press

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Brief Table of Contents
Table of Contents
Dedication
Preface
Part One. Introduction
Chapter 1. Introduction and Overview
1.1. What Are Venture Capital and Private Equity?1.2. How Do Venture Capital and Private Equity Differ from Alternative Sources of Capital?1.3. How Large Is the Market for Venture Capital and Private Equity?1.4. What Issues Are Relevant to the Study of Venture Capital and Private Equity?1.4.1. Information Asymmetries and Agency Problems1.4.2. International Institutional and Legal Context, and Empirical Methods1.4.3. How Do You Attract Institutional Investors?1.4.4. How Are Funds Structured?1.4.5. How Well Are Fund Managers Compensated?1.4.6. Does Regulation Matter for Limited Partners and General Partners?1.4.7. Why Are Specialized Investment Mandates Necessary?1.4.8. What Role Does Government Play?1.4.9. Time to Invest: The Process1.4.10. What Security Is Necessary?1.4.11. What Is Distinct about Corporate Venture Capital Investment?1.4.12. How Do Exit Expectations Influence Financial Contracts?1.4.13. What Influences Investor Effort?1.4.14. Do Contracts Ensure Effort?1.4.15. Where Should You Invest?1.4.16. How Many Investments Should You Have?1.4.17. Time to Divest: The Process1.4.18. What Exit Vehicle Should You Use?1.4.19. Valuation and Disclosure
Chapter 2. Overview of Agency Theory
2.1. Introduction and Learning Objectives2.2. Forms of Finance2.2.1. Debt2.2.2. Preferred Equity2.2.3. Common Equity2.2.4. Warrants2.3. Agency Problems2.3.1. Moral Hazard2.3.2. Bilateral Moral Hazard2.3.3. Multitask Moral Hazard2.3.4. Adverse Selection2.3.5. Free Riding2.3.6. Hold-up2.3.7. Trilateral Bargaining2.3.8. Window Dressing2.3.9. Underinvestment2.3.10. Asset Stripping2.3.11. Risk Shifting2.4. Does Mitigating Agency Problems Enhance Firm Value?2.5. Summary and Steps Forward in Remaining ChaptersKey TermsDiscussion Questions
Chapter 3. Overview of Institutional Contexts, Empirical Methods
3.1. Introduction and Learning Objectives3.2. An Overview of the International Institutional and Legal Context3.3. Statistics and Econometrics Used in This Book3.3.1. Why Use Statistics and Econometrics and Not Case Studies?3.3.2. What Are the Steps for Analyzing Data?3.4. SummaryKey TermsKey Statistical and Econometric TermsDiscussion Questions
Part Two. Fund Structure and Governance
Chapter 4. What Should Fund Managers Care About? Perspectives from Institutional Investors
4.1. Introduction and Learning Objectives4.2. Institutional Investor Objectives from Investment in Private Equity4.3. SummaryKey TermsDiscussion Questions

Chapter 5. Limited Partnership Agreements
5.1. Introduction and Learning Objectives5.2. Types of Restrictive Covenants5.2.1. Category 1: Authority of Fund Manager Regarding Investment Decisions5.2.2 Category 2: Restrictions on Fund Manager's Investment Powers5.2.3. Category 3: Covenants Relating to the Types of Investment5.2.4. Category 4: Fund Operation5.2.5. Category 5: Limitation of Liability of the Fund Manager5.3. What Affects the Frequency of Use of Limited Partnership Covenants?5.3.1. Human Capital Factors Influencing the Use of Fund Covenants5.3.2. Legal and Institutional Factors Influencing the Use of Fund Covenants5.3.3. Fund-specific Factors Influencing the Use of Fund Covenants5.3.4. Market Conditions and the Use of Fund Covenants5.4. Survey of Private Equity Funds5.4.1. Methods and Survey Instrument5.4.2. Potential Sample Selection Bias5.4.3. Summary Statistics5.4.4. Correlation Matrix5.5. Econometric Tests5.6. Limitations, Alternate Explanations, and Future Research5.7. ConclusionsKey TermsDiscussion Questions
Chapter 6. Compensation Contracts
6.1. Introduction and Learning Objectives6.2. Compensation Contracts in Limited Partnerships6.3. What Affects the Design of Limited Partnership Compensation Contracts?6.3.1. Human Capital Factors Influencing the Design of Compensation Contracts6.3.2. Legal and Institutional Factors Influencing the Design of Compensation Contracts6.3.3. Fund Specifics That Influence the Design of Compensation Contracts6.3.4. Market Factors That Influence the Design of Compensation Contracts6.4. Data6.4.1. Data6.4.2. Summary Statistics6.4.3. Correlation Matrix6.5. Econometric Tests6.5.1. Econometric Methods6.5.2. Regression Results6.6. Limitations, Alternate Explanations, and Future Research6.7. ConclusionsKey TermsDiscussion Questions
Chapter 7. Fundraising and Regulation
7.1. Introduction and Learning Objectives7.2. Regulation of Institutional Investors and Fund Managers7.3. Legal and Institutional Details and Testable Hypotheses7.3.1. Regulatory Harmonization of Institutional Investors7.3.2. The Dearth of Private Equity Fund Regulation7.4. Data7.4.1. Methods and Survey Instrument7.4.2. Potential Sample Selection Bias7.4.3. Summary Statistics7.4.4. Difference of Means and Medians Tests and Correlation Matrix7.5. Multivariate Analyses7.5.1. The Impact of Institutional Investor Regulatory Harmonization on Institutional Investor Allocations to Private Equity7.5.2. The Impact of a Dearth of Private Equity Fund Regulations on Institutional Investor Allocations to Private Equity7.5.3. The Impact of Nonregulatory Factors on Institutional Investor Private Equity Allocations7.5.4. Summary7.6. Extensions and Future Research7.7. ConclusionsKey TermsDiscussion Questions
Chapter 8. Specialized Investment Mandates
8.1. Introduction and Learning Objectives8.2. Why Socially Responsible Investments in Private Equity? Testable Hypotheses8.2.1. Other Factors Relevant to Socially Responsible Private Equity Investments8.3. Data8.3.1. Methods and Survey Instrument8.3.2. Potential Sample Selection Bias8.3.3. Summary Statistics8.4. Multivariate Empirical Analyses8.5. Extensions and Future Research8.6. ConclusionsKey TermsDiscussion Questions
Chapter 9. The Role of Government and Alternative Policy Options
9.1. Introduction and Learning Objectives9.2. Taxation9.3. Securities Laws9.4. Regulation Pertaining to the Demand for Entrepreneurial Capital9.5. Regulations Pertaining to the Supply of Entrepreneurial Capital9.6. Direct Government Investment Programs9.6.1. United States9.6.2. Israel9.6.3. Canada9.6.4. United Kingdom9.6.5. Australia9.6.6. Summary and Other Possible Design Mechanisms for Government Venture Capital Funds9.7. SummaryKey TermsDiscussion Questions
Part Three. Financial Contracting between Funds and Entrepreneurs
Chapter 10. The Investment Process
10.1. Introduction and Learning Objectives10.2. Due Diligence10.3. Stage of Development and Industry10.4. Staging10.5. Fund Flows and Valuations10.6. Syndication10.7. Board Seats10.8. Contract Terms10.9. SummaryKey TermsDiscussion Questions
Chapter 11. Security Design
11.1. Introduction and Learning Objectives11.2. Theory and Hypotheses11.2.1. Agency Costs11.2.2. Taxation11.2.3. Sophistication and Learning11.2.4. Economic Conditions11.2.5. Summary11.3. Data11.4. Empirical Tests11.4.1. Methodology11.4.2. Empirical Results11.5. Limitations, Alternative Explanations, and Future Research11.5.1. Securities Regulation11.5.2. Other Control Rights11.5.3. Behavioral Finance Factors11.6. ConclusionsAppendixCase A Fixed-fraction contract without effort-related moral hazardCase B Fixed-fraction contract with effort-related moral hazardCase C The proposed contractual arrangementKey Terms
Chapter 12. Security Design and Adverse Selection
12.1. Introduction and Learning Objectives12.2. Adverse Selection, Capital Structure, Firm Characteristics, and Syndication12.2.1. Theoretical Principles on Adverse Selection and Capital Structure12.2.2. Adverse Selection Risks in Venture Capital Finance12.3. Data12.4. Empirical Evidence12.4.1. The Determinants of Forms of Venture Capital Finance12.4.2. Do Different Types of Investors Select Different Types of Entrepreneurial Firms?12.4.3. Adverse Selection, Forms of Finance, and Firm Characteristics: Empirical Evidence12.4.4. Robustness Checks on the Adverse Selection Tests12.4.5. Limitations and Future Research12.5. ConclusionsKey TermsDiscussion Questions
Chapter 13. Corporate Venture Capital Fund Contracts
13.1. Introduction and Learning Objectives13.2. Financial Contracting in Venture Capital13.2.1. A Brief Review of the Issues in Venture Capital Financial Contracting13.2.2. Why Might Corporate Venture Capital Fund Contracts Differ from Limited Partnership Venture Capital Fund Contracts?13.2.3. Is Convertible Preferred Equity Optimal in Venture Capital Finance?13.3. U.S. and Canadian Corporate and Limited Partnership Venture Capital Fund Investments in Canadian Entrepreneurial Firms13.4. European Corporate Venture Capital Fund Investments13.5. Venture Capital Fund Contracts, Exits, and Returns Performance13.6. Lessons for Corporations Setting Up Venture Capital Funds13.7. Concluding Remarks and Future ResearchKey TermsDiscussion Questions
Chapter 14. Preplanned Exits and Contract Design
14.1. Introduction and Learning Objectives14.2. Hypotheses14.2.1. Preplanned Exits and Venture Capital Contracts14.2.2. Law Quality and Bargaining Power in Contract Formation14.3. Data14.4. Multivariate Tests14.4.1. Veto and Control Rights14.4.2. Security Design14.5. Limitations and Future Research14.6. ConclusionsKey TermsDiscussion Questions
Part Four. Investor Effort
Chapter 15. Investor Value-added
15.1. Introduction and Learning Objectives15.2. Innovation and Efficiency15.3. Do Contract Terms Facilitate Investor Effort?15.4. Location15.5. Portfolio Size15.6. Investment Duration15.7. SummaryKey TermsDiscussion Questions
Chapter 16. Contracts and Effort
16.1. Introduction and Learning Objectives16.2. Hypotheses16.2.1. Allocation of Cash Flow Rights16.2.2. Allocation of Control Rights16.2.3. Quality of Legal System16.3. Methodology16.3.1. Dependent Variables: Hours per Month, Advice, and Conflict16.3.2. Explanatory Variables to Test Hypotheses 16.1 to 16.316.3.3. Other Governance Mechanisms, Risk, and Controls for Other Factors16.4. The Dataset16.4.1. Data Collection16.4.2. Data Summary16.5. Econometric Analysis16.5.1. Hypotheses 16.1 to 16.3: The Impact of Contracts and Laws on Venture Capital Fund Manager-Entrepreneur Relationships16.5.2. Other Governance Mechanisms, Risk, and Control Variables16.6. Limitations, Alternative Explanations, and Future Research16.7. ConclusionsKey TermsDiscussion Questions
Chapter 17. Home Bias
17.1. Introduction and Learning Objectives17.2. Institutional Structure, Prior Research, and Testable Hypotheses17.2.1. Agency Impediments to Interprovincial Investment17.2.2. Institutional Impediments to Interprovincial Investment17.3. Data17.4. Multivariate Logit Tests17.5. The Scope of the Data and Generalizations That Can Be Drawn from the Empirical Analysis17.6. Conclusions and ImplicationsKey TermsDiscussion Questions
Chapter 18. Portfolio Size
18.1. Introduction and Learning Objectives18.2. Comparative Statistics and Hypotheses18.2.1. Venture Capital Fund Characteristics18.2.2. Entrepreneurial Firm Characteristics18.2.3. Nature of the Financing Arrangement18.2.4. Market Conditions18.3. Data18.3.1. Description of the Data18.3.2. Comparison Tests and Correlation Matrix18.4. Empirical Evidence18.4.1. Empirical Methods18.4.2. Empirical Results18.4.3. Further Robustness Checks, Limitations, and Alternative Explanations18.5. ConclusionsAppendixKey TermsDiscussion Questions
Part Five. Divestment
Chapter 19. The Divestment Process
19.1. Introduction and Learning Objectives19.2. The Economics of Initial Public Offerings19.2.1. Short-run Performance19.2.2. Long-run Performance19.3. Investment Duration and Time to Exit19.4. The Mode of Exit19.5. International Exit Statistics19.6. SummaryKey TermsDiscussion Questions
Chapter 20. Exit Outcomes
20.1. Introduction and Learning Objectives20.2. Hypotheses20.2.1. Venture Capitalist Characteristics20.2.2. Entrepreneurial Firm Characteristics20.2.3. Venture Capitalist-Entrepreneur Contracts20.2.4. Market and Regulatory Control Variables20.2.5. Summary20.3. Data20.4. Regression Analyses20.4.1 Additional Robustness Checks20.5. ConclusionsKey TermsDiscussion Questions
Chapter 21. Contracts and Exits
21.1. Introduction and Learning Objectives21.2. Hypotheses21.2.1. VC Control Rights21.2.2. Other Factors Relevant to the Choice between IPOs versus Acquisitions21.3. Variables in the Econometric Specifications21.4. Data21.4.1. Sample Description21.4.2. Summary Statistics21.5. Multivariate Regressions21.5.1. Base Regression Models21.5.2. Endogeneity21.5.3. Additional Robustness Checks21.6. ConclusionsKey TermsDiscussion Questions
Chapter 22. Valuation, Returns, and Disclosure
22.1. Introduction and Learning Objectives22.2. Venture Capital Valuation Method22.3. Factors That Affect Venture Capital Realized Returns and Reported Unrealized Returns22.4. Conclusions and RemarksKey TermsDiscussion Questions
Part Six. Conclusion
Chapter 23. Summary and Concluding Remarks
Appendix Online Appendices
Bibliography
References

Content preview from Venture Capital and Private Equity Contracting

Chapter 11. Security Design

11.1. Introduction and Learning Objectives

The academic venture capital literature is dominated by the view that convertible securities are the optimal form of venture capital finance (see, e.g., Bascha and Walz, 2001a; Berglöf, 1994; Bergmann and Hege, 1998; Casamatta, 2003; Cornelli and Yosha, 2003; Gompers, 1998; Gompers and Lerner, 2001; Hellmann, 2006; Kaplan and Strömberg, 2003; Marx, 1998; Sahlman, 1990; Schmidt, 2003; Trester, 1998; and others). The only empirical support for this proposition around the world is found in U.S.-based research comprising hand-collected datasets with up to 213 observations from U.S. venture capital funds (Bergmann and Hege, 1998; Gompers, 1998; Kaplan and Strömberg, 2003; Sahlman, ...

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Venture Capital and Private Equity Contracting

by Douglas J. Cumming, Sofia A. Johan

Chapter 11. Security Design

11.1. Introduction and Learning Objectives

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