SOCIETÀ ITALIANA DI DIRITTO ED ECONOMIA
Alvaro Pereira (Georgia State University)
Abstract
The development of the venture capital (VC) industry and the proliferation of billion-dollar private companies known as Unicorns raises important legal questions about the governance and finance of startup companies worldwide. A growing body of literature has identified and analyzed some of these questions, although mainly focusing on US law. These include new agency problems, uncertainty over duties and liability of investor-appointed directors, exacerbated risks for employees with stock-based compensation packages, and shadow governance structures facilitated by shareholders’ agreements. Despite increasing interest in promoting startups and VC outside the US, it is unclear whether the distinctive governance and financial arrangements observed in US VC-backed firms should be facilitated through corporate law reform and how to address the issues associated with them.
To assess the pertinence and perils of promoting VC-style governance and financial structures through corporate law reform, this paper introduces the Startup Corporate Law (SCL) Index for 12 jurisdictions in Europe and Latin America. The SCL index comprises 26 variables, each representing a corporate law rule governing startups’ boards, shares, and shareholders’ agreements. The Index provides the first comprehensive map of how corporate law rules that determine startups’ financial and governance structures have evolved in the twenty-first century.
Broadly, the Index reveals a trend toward higher flexibility or deregulation. These findings are in sharp contrast to what has been observed in dominant rankings of favorable legal environments for investment, such as shareholder protection, where there is evidence of a decades-long trend towards less flexibility. The observed contrast corroborates that corporate law is not universally enabling and favorable for VC (at least, not yet), and that differences between the regulation of listed and non-listed firms are relevant. For example, several jurisdictions that have aggressively promoted VC by enabling the issuance of multiple-voting shares, preserve hidden restrictions to startup boards’ powers, e.g., to issue and determine privileges to preferred stock. The range of legal boundaries to boards’ powers, unaccounted for by comparative and empirical studies, directly determines the relevance of VC board representation as a control and monitoring mechanism. These and similar findings shed light on how the regulation of private firms’ boards may be helpful to policymakers interested in promoting good governance in VC-backed firms.
The paper identifies and discusses the determinants of relevant trends in the evolution of SCL and considers their potential impact on VC from two perspectives. On the one hand, how such changes may contribute to the development of VC and the rise of Unicorns across the sampled jurisdictions by facilitating VC-style governance and financial structures. On the other hand, how differences in corporate law doctrines across jurisdictions may assist or make it more challenging to address emerging issues associated with VC-style agreements—i.e., new agency problems, duties of constituency directors, risks derived from stock-based compensation packages, and shadow governance structures relying on shareholders’ agreements.