Abstract

Using a unique, hand-collected data set of lawsuits in which venture capitalists are named as co-defendants, we examine the relationship between venture capitalist litigation risk, on the one hand, and their reputation and monitoring intensity, on the other. We hypothesize that the likelihood of litigation will be decreasing with VC reputation and monitoring intensity. Further, we examine two measures of the merits of litigation, namely, lawsuit dismissal and the likelihood of a VC's continued financing of the firm after litigation. Finally, we examine the existence of reputational penalties for venture capitalists by studying the post-litigation fundraising by sued venture capitalists. We find a significant positive relationship between venture capitalist reputation and the likelihood of litigation, the finding consistent with deep pocket theory. At the same time, we also find some evidence that lawsuits are merited. In particular, we find that lawsuits against firms backed by more reputable venture capitalists are less likely to be dismissed and that sued venture-backed firms are less likely to continue receiving venture financing after the litigation. Also, venture capitalists named as co-defendants are less likely to maintain their rank in the fundraising hierarchy. Finally, we also find some evidence that more intensive monitoring by venture capitalists seems to decrease the likelihood of litigation