The Funding Gap Contractual Drivers of Risk in Private Venture Capital

Abstract

The Swedish private venture capital sector is one of the key providers of funds and knowledge to emerging firms and thus crucial for these start-up firms success. However, due to a recent increase in perceived investment risk related to this segment, venture capitalists operating in the Swedish market are deserting the start-ups in favor of other segments. This has caused the overall private venture capital start-up investments and prospects made in the since 2011 to decrease severely, leaving the entrepreneurs with more unattractive funding options. In cases of similar shifts in the market, fund managers who address the phenomenon suggest a potential coherence between the drivers of incomplete contractual obligations and the direct risks of the funds. The potential coherence is said to be more significant in the case of innovative firms, which would explain the shift to some extent. The idea of coherence has also been addressed by previous research, however, a real connection has yet to be proven. This thesis aims to examine the presence as well as the strength of this potential coherence, which in turn may offer explanatory value to what extent contractual agreements could aid managers of both venture capital funds as well as entrepreneurs in their efforts to negate risks. In order to address the purpose of the study, we chose to conduct an inductive case study of a number of investments made in the Swedish start-up segment by private venture capital from 2010 to 2013. The case study resulted in eight primary arguments, three of which addressed contractual agreement and five related to the funds’ investment risk. These arguments were structured and analyzed based on contractual- and agency theory. The analysis revealed that there was a strong coherence between the drivers of incomplete contracts and risks experienced by the funds post-investment. We argue that this coherency might offer explanatory value to events like the previously mentioned drop in investments on the Swedish market. Lending support to both venture capital managers and entrepreneurs in creating more viable contractual agreements, which will also reduce risk and increase the willingness to invest in this sector.