Post-Investment Information Asymmetry in Venture Capital Investing: Venture Capitalist’s Legal Mitigation Strategies

Abstract

During recent years, venture capital investing has become an established funding source with a crucial role in supporting economic growth by stimulating innovation. The venture capital indus-try has developed the tools needed in order to take on the challenging task of nurturing high-risk, promising new ideas but it is a business marked by uncertainty and gaps in the information shar-ing with their entrepreneurial contracting parties.

The information asymmetry is a major challenge for venture capital firms, as it makes it difficult to assess a firm and enables opportunistic behaviour by entrepreneurs after the financing has been received. Previous research has to a great extent focused on information asymmetry occur-ring prior to the investment decision, whereas this dissertation has explored the less researched topic of post-investment information asymmetry.

The purpose of the study is to identify, define and evaluate legal mitigation strategies succeeding the investment decision from the venture capitalist’s point of view. The research findings are that the venture capitalist can through agent constraints, affiliation terms, appointment rights, deci-sion rights and agent incentives as well as other contractual strategies mitigate post-investment risks. The analysis however shows that, while the implications of information asymmetry in ven-ture capital investments are well understood, there are still no mechanism that can reduce the implications to a complete extent.

The main conclusion derived from the thesis is that a combination of different mitigation actions is the most efficient strategy to target post-investment risks. A combination would secure that all post-investment risks are addressed and would, at the same time, reduce the net value of the negative consequences that the shortfalls associated with each mechanism potentially causes.