Common Stock Carveouts In Acquisitions

If you read our term sheet series, you know that we spent a fair amount of time discussing liquidation preferrences.  Jesse Fried and Brian Broughman, a professor and graduate student at Berkeley, respectively, recently published a paper about the emergence of common stock carveouts and some of the reasons why they belive venture capitals are not getting the liquidation preferences that the VCs originally bargained for.

It’s an interesting read.  I agree with most of their conclusions, but am not sure that state law plays as big of a factor as they think.  Jesse and I are shooting emails back and forth about this and I have found the discussion robust and intelligent.

The abstract of the paper:  

The literature on venture capital contracting implicitly assumes that VCs’ cash flow rights – including their liquidation preferences – are fully respected. Using a hand-collected dataset of Silicon Valley firms sold in 2003 and 2004, this paper is the first to document that common shareholders often receive payment before VCs’ liquidation preferences are satisfied. We show these carveouts are larger when governance arrangements give common shareholders more power to impede the sale. Our study shows how VCs’ control rights and cash flow rights interact to affect VCs’ cash flow outcomes, and contributes to a better understanding of VC exits.

You can find the paper here, it’s downloadable from bottom of the page.

Jesse’s bio is here.