Agency Costs of Venture Capitalist Control in Startups

Jesse M. Fried and Mira Ganor

Berkeley Olin Program in Law & Economics, Working Paper Series from Berkeley Olin Program in Law & Economics

Abstract: Venture capitalists investing in U.S. startups typically receive preferred stock and extensive control rights. Various explanations for each of these arrangements have been offered. However, scholars have failed to notice that these arrangements, when combined, often lead to a highly unusual corporate governance structure: one where preferred shareholders, rather than common shareholders, control the board and therefore the firm itself. The purpose of this Article is threefold: (1) to highlight the unusual governance structure of these VC-backed startups; (2) to show that preferred shareholder control can give rise to potentially large agency costs; and (3) to suggest legal reforms that may help VCs and entrepreneurs reduce these agency costs and improve corporate governance in startups.

Date: 2006-05-08
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