The Allocation of Control Rights in Venture Capital Contracts

1995| Working Paper No. 1362

Venture Capitalists hold extensive control rights over entrepreneurial companies, includingthe right to fire the entrepreneurs with little severance. I examine why, and under what circumstances, entrepreneurs would voluntarily choose to relinquish control. I show that control may be necessary for the venture capitalists to have incentives to add value to their companies. Entrepreneurs may give up control and risk being replaced, even if the loss of private benefits under replacement outweighs the monetary benefit to the company. The model is also used to explain further stylized facts about governance and financial structure in venture capital contracts.