How Do Financial Contracts Evolve for New Ventures

While previous papers have characterized various features of the financial contracts between entrepreneurs and venture capitalists, little is known about how the equity contracts evolve over the life of new ventures. Using the novel data set containing financial contract terms applying to different classes of stock, this paper is the first to focus on exploring the how the equity contract terms granted by the same investee private firms may vary across time, and determining the possible influencing factors. We find that there exists a default contract, for the terms adopt by different companies or used by the same companies in different funding rounds are surprisingly similar. Further, we notice, by analyzing the evolution patterns, that equity contracts change asymmetrically across different terms and at different stages of the investee firms. We also provide insights into the discussion on whether employing post-money valuation will definitely result in the over-valuation of start-ups. Our preliminary regression results show that the headroom, the new measure we developed as a proxy for the company's financial flexibility, be negatively related to the dilution of common stockholders' ownership of the company