Power and Payouts in the Sale of Startups

Researchers have extensively analyzed VCs’ cash flow rights in venture-backed startups, including the right to be paid liquidation preferences ahead of common shareholders when the startup is sold. However, common shareholders have various ways of impeding these preference-triggering transactions, and may use their holdup power to capture part of the VCs’ preferences. Little is known about VCs’ cash flow outcomes: whether VCs receive their full liquidation preferences when startups are sold. Using a hand-collected dataset of VC-backed startups, we find that VCs frequently “carve out” part of their preferences for common shareholders. We also find that the expected value of these carveouts is larger when the common have more holdup power. For example, carveouts are more likely to occur and larger when VCs do not control the board and when the corporate law governing the firm gives common more leverage over the VCs. Our study highlights the distinct role of common shareholders in late-stage startup governance, and shows how VCs’ control rights and cash flow rights interact to affect VCs’ cash flow outcomes. Our results also suggest that the choice of corporate law in private companies matters.