Top-tier law firms frequently assert their ability to create additional value for their venture capital (VC) clients. Information asymmetry stands as a significant hurdle to the success of VC deals, potentially hindering capital provision transactions and leading to less-than-ideal results. Law firms play a key role in offering legal counsel and contract design for VC deal agreements, influencing communication and coordination between VC investors and their portfolio companies. Thus, it is expected that the expertise of the law firms should facilitate information flows among the parties, addressing the information asymmetry inherent in VC deals. Yet, the effect of top-tier law firm involvement on VC deal outcomes remains unexplored.
There are two main arguments, which yield conflicting predictions with respect to the economic value of aligning VC deals with high-quality legal services. On one hand, if top-tier law firms engage in VC deals primarily to safeguard their interests and prevent opportunistic behaviours by the counterparty, this could lead to excessive formality and tension. This atmosphere could potentially undermine the overall success of VC deals. Conversely, if top-tier law firms mitigate information asymmetry in VC investments – for instance, by providing robust legal advice on fiduciary responsibilities, lowering communication expenses, building greater trust through thorough due diligence, formulating efficient contract terms, and acting as essential negotiators between VCs and portfolio companies – the involvement of legal services could indeed augment investment success. Therefore, whether the participation of top-tier law firms leads to better deal outcomes is the central empirical question in our recent research paper titled “Top-tier law firm expertise and VC investments: Global evidence”.
Leveraging insights from a comprehensive dataset encompassing nearly 182,000 global VC deals spanning the period from 2005 to 2020, our research underscores the multifaceted impact of top-tier law firms on deal success and performance. While diverse in their roles, top-tier law firms exert significant influence within the VC legal advisory market. The study documents the increasing prevalence of top-tier law firms’ participation in VC deals over time.
“We document that top-tier law firms’ participation is associated with a reduction in the likelihood of deal failure.”
Second, VC deals involving top-tier law firms attract larger investments, resulting in a larger ownership stake in portfolio companies. Cross-sectional analysis reveals that the influence of top-tier law firms varies across different attributes of the legal system.
“Countries with more robust civil justice systems, well-structured courts, and strong property rights experience a less pronounced impact.”
Our study also investigates the relationship between the participation of top-tier law firms and subsequent VC deal performance. We identify a positive connection between the participation of top-tier law firms and subsequent financing rounds or successful exits.
“Deals involving top-tier law firms yield higher returns from one financing round to the next, substantiating their positive influence on post-deal financial performance.”
This study paves the way for a deeper understanding of the role of top legal advisory services in the unique market of private equity investments. Specifically, by demonstrating that the involvement of top law firms is associated with increased investment amount, a reduced likelihood of failure, higher deal valuations, and superior returns in subsequent financing rounds, we highlight the pivotal role that legal expertise plays in shaping the financial structure and success of private equity investments. Furthermore, we illustrate that the effect of institutional legal framework substitutes that of top law firms. This offers a fresh perspective on the broader institutional context and the specific legal advisory services involved in VC investment process.
To summarise, this study advances our comprehension of the role of legal advisors in VC investments. It demonstrates a positive impact of top law firms’ involvement on deal outcomes, including deal completion, investment returns, and successful exits, regardless of the party they represent. Our research also emphasizes the significance of legal institutions, with the impact of top-tier law firms being more pronounced in countries with less developed legal systems. This research enriches our insights into the intricate dynamics of VC deals and the valuable contribution of top-tier law firms to their success.
By Douglas Cumming, the DeSantis Distinguished Professor of Finance and Entrepreneurship at the College of Business, Florida Atlantic University.
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