Board Dynamics Over the Startup Life Cycle

Abstract

Venture capital (VC) backed firms face neither the governance requirements nor a major separation of ownership and control of their public peers. These differences suggest that independent directors could play a unique role on private firm boards. This paper explores the dynamics of VC-backed startup boards using new data on board member entry, exit, and individual director characteristics. We document several new facts about board size, the allocation of control, and composition dynamics. At formation, a typical board has four members and is entrepreneur-controlled. Independent directors are found on the median board after the second financing event, when control over the board becomes shared, with independent directors holding the tie-breaking vote. These patterns are consistent with independent directors playing both a mediating and advising role over the startup life cycle, and thus representing another potential source of value-add to entrepreneurial firm performance.

The Rise of Dual-Class Stock IPOs

“…We also document a decrease in VC firms' aversion to dual-class structures and attribute it-at least in part-to the reduction in the costs of doing business due to technological advances in the software and service industries. This finding is consistent with the idea that when there is a lower need for financing, founders are less likely to relinquish their power to VC firms (Ewens, Nanda, and Rhodes-Kropf, 2018;Ewens and Malenko, 2020).…”

“…In particular, in examining the certificates of incorporation of a sample of 56 large startups from the Private Capital Research Institute, we find that dual-class structures were created prior to the IPO negotiation process in about 80 percent of these firms. In addition, using data from Ewens and Malenko (2020), we find that pre-IPO board control of VC-backed firms does not predict control at the IPO stage. This supports the notion that the availability of VC financing in the year prior to the IPO affects founders' bargaining power for control rights at the IPO.…”

“…V C Rounds is the number of VC financing rounds a firm undergoes prior to the IPO. In each round of financing, VC firms tend to negotiate for control through contractual rights and the appointment of board members Stromberg, 2001, 2003;Ewens and Malenko, 2020). V C F irms is the number of VC firms that provided financing to the firm.…”

“…Our article extends these studies by focusing on how changes in the relative bargaining power of founders and VCs have affected the most extreme entrenchment device, the dual-class stock structure. Moreover, we not only identify the impact of VC financing at the firm and industry levels, but also document the changes in VC firms' attitudes towards governance over time (Ewens et al, 2018;Ewens and Malenko, 2020).…”

Enterprise survival in the high-tech community: persuasion and power in board decisions

“…Board size at the time of the venture's formation is typically four members and is controlled by the entrepreneur. After the second financing round, the control over the board tends to be shared with independent directors who hold the tie-breaking vote (Ewens and Malenko, 2020). Therefore, board size is expected to grow over time.…”