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Legal Issues In U.S. Venture Capital Contract And Corporate Governance Of Start-up

Posted on:2013-02-22Degree:DoctorType:Dissertation
Country:ChinaCandidate:L PanFull Text:PDF
GTID:1116330371982888Subject:Civil and Commercial Law
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Venture capital aims to link capital and innovation thus break the dilemma offundraising in the development of small and media businesses especially high risk,high technology and high growth enterprises. Venture capital contract refers to aseries of agreements between venture capitalists and entrepreneurs dealing withseveral issues including the infusion of equity investment, the participation in thegovernance of start-ups as well as the realization of returns. It breaks the standardpattern of control allocation as well as returns distribution in corporations and shapesthe unique corporate governance structure of start-ups. Venture capital contract andthe corporate governance of start-up it erects respond to the innate problems ofextreme uncertainty, information asymmetry as well as agency cost in venture capitalcycle.U.S. is where the venture capital flourishes and its experience is what ourventure capital practice is learning from. This dissertation aims to analyze thearrangement and design of venture capitalists and entrepreneurs in U.S. venturecapital contract provisions, evaluates the function and role of corporate law, contractlaw and judicial judgment from the perspectives of toleration, facilitation andprotection of such arrangements and design of venture capital participants, andexplores the best approach to settle the conflicts among shareholders in start-ups thusattempt to discover the unique institutional demands as well as corporate legalresearch perspectives, which are different from large corporations, of start-upscharacterized by high risk and extreme uncertainty.This dissertation is divided into four parts.The Character of U.S. Venture Capital Contract: Adaptive Efficiency. Venturecapital contract is a product of the bond of entrepreneurs' financial demand withventure capitalists' risk appetite. And there is usually more than one venturecapitalist in a same start-up because of the syndication strategy in venture capital. The start-ups are generally in the form of close corporation. Venture capitalflourishes in America whose success could be attributed to risk tolerance achievedby its corporate legal system and the institutional environment. The character ofencouraging and promoting trial as well as venture corresponds with the institutionaldemand of start-ups. Different from agency cost theory, adaptive efficiency theorydynamically explains and evaluates how corporate legal system fits the uncertaintyarises from the development of corporation business and how to facilitate ventureand innovation.The Carrier of U.S. Venture Capital Contract Provisions: Preferred StockSystem and Start-ups. Preferred stock to which the venture capital contractprovisions attached is the universally used financial instrument in U.S. venturecapital practice. As to the tax explanation for the widely usage of preferred stock inU.S. venture capital, its foundation is contrary-to-fact. What's more, its observationof the function of preferred stock in start-ups is one-sided. Preferred stock systemaccords with adaptive efficiency perfectly. The flexibility it provides accommodatesthe differences of investment properties in the financing process, caters to the diverserisk preferences of investors, realizes control transfer between the raisers andinvestors and offers necessary tension for the power allocation among investors in anenterprise, thus facilitates the bond of capital and ideas. The rule for creatingdifferent classes or series of stock in U.S. which breaks the limitation of titles andconcepts and helps to bring about the utmost flexibility and adaptability in corporatefinancing is an important reference for us.U.S. Venture Capital Contract Provisions: A Web of Provisons. Director electioncould be realized by voting agreement in China. The voting agreement to allocateboard seats between venture capitalists and entrepreneurs is valid as well asspecifically enforceable. Protective provision provides venture capitalists with vetopower which adjusts the majority rule in start-ups and makes the investment fromventure capitalists possible. The information barrier is severe when evaluate venturecapitalists' investment in start-ups and anti-dilution provision responds to thisproblem. Its price adjustment mechanism corrects evaluation deviation caused by information problem and thus facilitates investors' efficient risk managementaccording to the performance of start-ups. The doctrine of capital maintenance aswell as the capital system based on it in our country makes the operation ofredemption provision very hard and could not satisfy the reasonable business needsof participants in venture capital. Drag-along provision essentially embodies the freedisposition of property which is a principle in private law and should be deemedvalid. Negating the selfish acts of the drag along obligee and imposing them absolutefiduciary duty towards the other shareholders is not desirable. Valuation adjustmentmechanism creates social value and of which the two parties share identical interests.As an aleatory contract, it should be deemed valid. Empirical analysis is animportant or even dominant method in the research of venture capital contract in U.S.On one hand, these data could also be used here. On the other hand, they havemethodological implications from the perspectives of sample collection andcomposition. The web composed of director election provision, voting rightsprovision, staged-financing provision and redemption provision facilitate controltransfer to the right party with proper incentive based on different circumstancesunder control theory. Protective provision, redemption provision and drag-alongprovision play a key role in balancing incentive for the investor to provide effectivesupervision and guarantee of their liquidity.U.S. Venture Capital Contract Disputes: Ways to Resolve Conflicts amongShareholders in U.S. Start-ups. The high risk of start-ups and the relationshipbetween entrepreneurs and venture capitalists inevitably cause conflicts betweenthem which could be intensified when it is a hard time for the start-ups. On one hand,American courts'"obedience" to the controlling shareholders corresponds to thesubstance of fiduciary duty and the characters of start-ups. On the other hand, itillustrates the limits of judicial decisions to resolve conflicts among shareholders instartups. Adaptive efficiency theory provides guidance for courts as to balancingrestraint and activeness in dealing with private order thus protect anticipation andadvance the cause of venture. Making innovations in corporate governancemechanism is the fundamental approach to solve this problem. Different from those of public corporations, independent directors in start-ups play a role of tie-breakingand disputes arbitration. Independent directors which are common in publiccorporations can be a more effective internal mechanism with lower cost to resolvesuch conflicts within start-ups. And the appointment provision as well as thereputation restraint makes the mechanism of independent director work effectively.
Keywords/Search Tags:venture capital, start-up, venture capital contract, corporate governance, adaptiveefficiency
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