Team Production in Venture Capital Investing

I. INTRODUCTION The relationship between entrepreneur and venture capitalist has often been analyzed as an agency relationship, with the entrepreneur as the agent and the venture capitalist as the principal,1 but this characterization is too simple to capture the venture capital relationship.2 Although the relationship between entrepreneur and venture capitalist has elements of hierarchy, it is not a "pure agency relationship."3 In some ways, it is more like a partnership than a principal-agent relationship, with each contributing resources and expecting a share of the value generated by their joint effort.4 In the language of this symposium, entrepreneur and venture capitalist sometimes engage in "team production."5 The task of analyzing venture capital contracts through the lens of team production is complicated by the fact that the relationship between entrepreneur and venture capitalist does not fit easily into existing economic models of team production. In short, their relationship is not "pure" team production,6 and relatively few attempts have been made to analyze relationships that combine elements of hierarchy and team.7 Rather than attempting to capture the complex interactions of entrepreneur and venture capitalist through an economic model, this Article will describe the team nature of the venture capital relationship using the rich set of facts provided by the book Startup: A Silicon Valley Adventure,8 which recounts how entrepreneur Jerry Kaplan and his venture capitalists at Kleiner Perkins Caufield & Byers, the most prominent venture capital firm in Silicon Valley, formed and operated GO Corporation.9 Kaplan's account provides a highly textured picture of the ways in which entrepreneurs and venture capitalists build a company and the mechanisms they use to ensure that their relationship is productive. The Article begins in Part II with a description of the Venture Capital Team, which is comprised of the "Entrepreneur" and the "Venture Capitalist." Both are referred to in the singular for purposes of simplification, even though the Entrepreneur is usually a team of individuals and the Venture Capitalist often might include several venture capital firms and perhaps more than one person per firm. Part III briefly describes the team production problem in terms of moral hazard (more specifically, "shirking"). Although adverse selection may also be problematic in team production, especially because it interacts with moral hazard in affecting the output of the team,10 the initial work on team production focused on the moral hazard problem, and that is where the primary challenges lie.11 With the nature of the problem firmly fixed, Part IV proceeds to review the approaches to resolving the team production problem in three economic models: the monitoring model; the budget breaking model; and the bonding model. As already noted, the existing economic models are inadequate, standing alone, to explain the structure of venture capital contracting, but they provide useful insights about how contractual mechanisms might address the team production problems in venture capital financing. Finally, Part V concludes by examining the role of staged financing in addressing the team production problem. The terms of venture capital contracts exhibit great variety, but staged financing is nearly universal in these transactions, and it seems to provide at least a partial solution to the moral hazard problem. II. THE VENTURE CAPITAL TEAM In most emerging companies, a team of entrepreneurs forms the core operational group, and that group may contain multiple overlapping teams and principal-agent relationships. The relationship between the team of entrepreneurs ("Entrepreneur") and the venture capitalists ("Venture Capitalist") typically is designed to deal with strategic issues that reside at a higher level of abstraction than most operational issues. The Entrepreneur and Venture Capitalist comprise the Venture Capital Team, and the goal of this section is to describe their respective inputs into the team production process, using the history of GO Corporation as described in Startup: A Silicon Valley Adventure. …