Syndication of Venture Capital Deals

This article develops a model of venture capital syndication to study the relationship between widely used financial and legal arrangements and potential moral hazard (in team) problems of investors. We endogenously derive the critical thresholds for early project termination, single VC finance, and syndicated VC finance for environments in which first-best contracting outcomes are unattainable. The central tradeoff is that commonly used anti-dilution or option-like clauses, e.g., Rights of First Refusal, ensure better incentives, but inevitably make syndication less likely. The use of convertible securities may have similar undesirable effects. These distortions arise because equilibrium follow-up financing rounds at times require an allocation of too many shares to early investors, which may deter new investors. Extensions to correlated valuations and investor bargaining are discussed.