Location Specific Styles and US Venture Capital Contracting

Abstract

This paper shows that several contractual equilibria coexist in the US venture capital (VC) contracts. Our database is larger than that of previous studies and includes 1,804 contracts. Our main finding is that California-based entrepreneurs receive less harsh contract terms. In particular, investors subject to California-based or California style contracts have less downside protection. This “California effect” remains large and significant even after we include all the previously discovered controls which determine contract design. We find a similar effect if the VC is located in California, or if a non-California VC had a large exposure to the California market. We do not find evidence that VCs are substituting cash flow contingencies for control rights or for performance-based CEO compensation contracts. We also document several other new contractual features of VC contracts. In particular, we find that better companies and more experienced VCs receive better contract terms, whereas older companies receive harsher contracts. We also confirm the role of concentration and proximity in financial contracts.