Joint Control and Redemption Rights in Venture Capital Contracts

In most venture capital financed firms, neither the VC nor the manager has exclusive authority over some of the key corporate decisions. For example: the decision whether the firm should undertake an IPO or be sold to a larger rival usually requires the approval of both the manager and the VC. This contradicts a strong prediction in the theoretical literature that joint control is suboptimal. In this paper, I show that assigning control jointly to both the agents, and specifying a harsh penalty (such as liquidation) if they fail to reach an agreement, is sometimes better than assigning control exclusively to one of the agents. A key factor is the firm's "financial slack" - the difference between its expected cash flows and its required investments and monitoring costs. Joint control is the optimal control allocation when the firm has low financial slack and a reasonable collateral value, and when the VC's liquidity constraints and cost of monitoring the firm are high. Most VC-financed firms fit this description.