Stanford Law School
John M. Olin Program in Law and Economics

WHAT ECONOMISTS HAVE TAUGHT US ABOUT VENTURE CAPITAL CONTRACTING
Michael Klausner and Kate Litvak
Stanford Law School

What Economists Have Taught Us About Venture Capital Contracting MICHAEL KLAUSNER AND KATE LITVAK
Venture capital investments are made under conditions of potentially extreme information asymmetry and agency cost among three sets of parties: the ultimate investors in venture capital funds, the venture capitalist (VC), and the entrepreneur. Individuals and institutions are the ultimate investors in entrepreneurial ventures. These parties invest blindly — they invest in a venture capital fund before the VC selects its investments, they delegate all investment and monitoring decisions to the VC, and they have no control and few monitoring rights over the VC’s actions.1
The VC, in turn, invests the investors’ funds in entrepreneurial firms whose prospects are highly uncertain, whose cash flow will often be negative for years, and whose liquidation value is commonly low. Moreover, the entrepreneurs to whom the VC entrusts this investment will have superior information regarding the firms’ operations and prospects, they will have control of day-to-day decisionmaking, and under some circumstances, they will have interests that conflict with those of investors.