Thursday, July 12, 2007
No field of contract practice offers more opportunity for information asymmetry, differences in bargaining power, opportunism, and simple uncertainty than the world of the so-called "angel" investor. Angels are investors who provide money to would-be entrepreneurs at an early stage of the business. Darian Ibrahim (Arizona) has been studying these contracts, and has come up with some surprising conclusions in The (Not So) Puzzling Behavior of Angel Investors. Here's the abstract:
Angel investors fund start-ups in their earliest stages, which creates a contracting environment rife with uncertainty, information asymmetry, and agency costs in the form of potential opportunism by entrepreneurs. Venture capitalists also encounter these problems in slightly later-stage funding, and use a combination of staged financing, preferred stock, board seats, negative covenants, and specific exit rights to respond to them. Curiously, however, traditional angel investment contracts employ none of these measures, which is a marked departure from what financial contracting theory would predict. This article explains this (not so) puzzling behavior on the part of angel investors, and also explains why some angels are moving toward venture capital-like organization and adopting venture capital-like contracts in the process.