This Article examines a third exit option in venture capital to supplement IPOs and trade sales: secondary markets for the sale of individual ownership interests in start-ups and venture capital (VC) funds. While investors can readily buy shares in publicly-traded companies, until recently they have been unable to own a piece of private start-ups like Facebook or Twitter without working there or investing in exclusive VC funds. Now that venture capital has become a $400 billion worldwide asset class, however, start-up stock and limited partnership interests in VC funds have begun trading in private secondary markets. These secondary markets offer initial investors a new path to liquidity, offer buyers access to a previously untapped class of assets, and produce governance benefits for traded firms. The realization of these benefits in venture capital should lead to a net increase in the total amount of entrepreneurial activity. Given the surplus that entrepreneurial activity produces for society, VC secondary markets should be studied by academics and encouraged by policy makers. This Article is the first to study VC secondary markets and the issues they implicate in law and economics analysis. The Article examines VC secondary markets in their present state and contemplates their further development.
Venture debt, or loans to rapid-growth start-ups, is a puzzle. How are start-ups with no track records, positive cash flows, tangible collateral, or personal guarantees from entrepreneurs able to attract billions of dollars in loans each year? And why do start-ups take on debt rather than rely exclusively on equity investments from angel investors and venture capitalists (VCs), as well-known capital structure theories from corporate finance would seem to predict in this context? Using hand-collected interview data and theoretical contributions from finance, economics, and law, this Article solves the puzzle of venture debt by revealing that a start-up’s VC backing and intellectual property substitute for traditional loan repayment criteria and make venture debt attractive to a specialized set of lenders. On the firm side, venture debt helps entrepreneurs, angels, and VCs avoid dilution, improves VC internal rate of return, assists VCs in monitoring entrepreneurs, and follows from capital structure theories after the first round of VC funding.
Silicon Valley's success has led other regions to attempt their own high-tech transformations, yet most imitators have failed. Entrepreneurs may be in short supply in these "non-tech" regions, but some non-tech regions are home to high-quality entrepreneurs who relocate to Silicon Valley due to a lack of local financing for their start-ups. Non-tech regions must provide local finance to prevent entrepreneurial relocation and reap spillover benefits for their communities. This Article compares three possible sources of entrepreneurial finance - private venture capital, state-sponsored venture capital, and angel investor groups - and finds that angel groups have distinct advantages when it comes to funding innovation in non-tech regions. This entrepreneurial finance story is then supplemented by a "law and entrepreneurship" story - specifically, a look at securities laws that might impede optimal levels of angel group financing.
Angel investors fund start-ups in their earliest stages, which creates a contracting environment rife with uncertainty, information asymmetry, and agency costs in the form of potential opportunism by entrepreneurs. Venture capitalists also encounter these problems in slightly later-stage funding, and use a combination of staged financing, preferred stock, board seats, negative covenants, and specific exit rights to respond to them. Curiously, however, traditional angel investment contracts employ none of these measures, which appears inconsistent with what financial contracting theory would predict. This article explains this (not so) puzzling behavior on the part of angel investors, and also explains the recent move toward venture capital-like contracts as angel investing becomes more of a professional endeavor.