Same, Same but Different: How Preferential Claims Skew Returns of Venture Capital Investments

by Julian Kaboth, HHL Leipzig Graduate School of Management / Arnd Lodowicks, Freie Universität Berlin / Maximilian Schreiter, Handelshochschule Leipzig (HHL) / Bernhard Schwetzler, HHL Leipzig Graduate School of Management – Department of Finance.

Venture capital often involves complex equity contracts, which affect the allocation of cash flows among shareholdings at an exit liquidation. To facilitate economic impact analysis, we structure exit relevant preferential rights by their economic impact in a two-dimensional framework.

Based hereon, we provide a model that allows to assess ex-ante value of such shares. We apply our model to a selected sample of ventures and find an average overvaluation on a share class basis of 22:1% (median 23:9%), where overvaluation is particularly severe for common and early-on investments.

Link to the paper.