Venture capitalists (VCs) play a significant role in the financing of high-risk, technology-based business ventures. VC exits usually take one of three forms: an initial public offering (IPO) of a portfolio company’s shares, followed by the sale of the VC’s shares into the public market; a “trade sale” of the company to another firm; or dissolution and liquidation of the company.

Of these three types of exits, IPOs have received the most scrutiny. This attention is not surprising. IPO exits tend to involve the largest and most visible VC-backed firms. And, perhaps just as importantly, the IPO process triggers public-disclosure requirements under the securities laws, making data on IPO exits easily accessible to researchers.

But trade sales are actually much more common than IPOs and, in aggregate, are more financially important to VCs. Unlike IPOs, however, trade sales do not trigger the intense public-disclosure requirements of the securities laws; they take place in the shadows. Thus, although trade sales play a critical role in the venture capital cycle, relatively little is known about them.

In our paper, Carrots & Sticks: How VCs Induce Entrepreneurial Teams to Sell Startups recently made public on SSRN, Brian Broughman and I seek to shine more light on intra-firm dynamics around trade sales. In particular, we investigate how VCs induce the “entrepreneurial team” – the founder, other executives, and common shareholders – to go along with a trade sale that they might have an incentive to resist.

…continue reading: Carrots & Sticks: How VCs Induce Entrepreneurial Teams to Sell Startups

Delaware courts frequently are called upon to determine the “fair value” of a company’s stock. For a company whose capital structure includes preferred stock with a liquidation preference, there is the question of how to treat that liquidation preference when determining the per-share “fair value” of the common, the preferred, or some other specific class of the company’s stock.

Two recent Delaware Court of Chancery decisions by Chancellor Leo E. Strine Jr. demonstrate that the answer depends on whether the liquidation preference actually has been triggered (or otherwise represents a non-speculative payment obligation), or whether the payout of the liquidation preference is a matter of speculation. Importantly, that determination depends on the specific rights defining the liquidation preference, as set forth in the charter or certificate of designations, and does not necessarily depend on “market realities” that might suggest a discount for common stock relative to the preferred.

…continue reading: Common Stock Under Delaware’s Fair Value Standard

I would like to take the opportunity to discuss one of those challenging issues – the orderly resolution of systemically important financial institutions ( SIFIs). The Dodd-Frank Act provided important new authorities to the FDIC to resolve SIFIs. Prior to the recent crisis, the FDIC’s receivership authorities were limited to federally insured banks and thrift institutions. There was no authority to place the holding company or affiliates of an insured institution or any other non-bank financial company into an FDIC receivership to avoid systemic consequences. The lack of this authority severely constrained the ability of the government to resolve a SIFI.

This authority has now been provided to the FDIC under the Dodd-Frank Act. The question is whether the FDIC can develop the operational capability to utilize this authority effectively and a credible strategy under which an orderly resolution of a SIFI can be carried out without putting the financial system itself at risk. These key challenges have been the focus of the FDIC’s efforts since the enactment of the Dodd-Frank Act in July 2010. I would like to focus my comments today on the progress we have made in meeting these important challenges.

…continue reading: FDIC’s Orderly Liquidation Authority

My paper “Liquidation Values and the Credibility of Financial Contract
Renegotiation: Evidence from U.S. Airlines” co-written with Nittai Bergman, which is forthcoming in the Quarterly Journal of Economics, documents empirically the conditions under which airlines renegotiate aircraft leases in the United States. The control rights that financial contracts provide over firms’ underlying assets play a fundamental role in the incomplete contracting literature since the threat of asset liquidation motivates debtors to avoid default. Thus, in the incomplete contracting literature, asset liquidation values play a key role in the ex-post determination of debt payments. To date, there is little empirical evidence analyzing the ability of firms to renegotiate their financial liabilities and the role asset values play in such renegotiations. This paper attempts to fill this gap.

We develop an incomplete-contracting model of financial contract renegotiation and estimate it using data on the airline industry in the United States. Our model has two testable implications. First, firms will be able to credibly renegotiate their financial commitments only when their financial situation is sufficiently poor. Second, when a firm’s financial position is sufficiently poor, and hence its renegotiation threat is credible, a reduction in the liquidation value of assets increases the concessions that the firm obtains in renegotiation.

Our empirical analysis examines renegotiation of leases amongst U.S. airlines. We collect data on all publicly traded, passenger-carriers and construct a dataset which includes information about contracted lease payments, actual lease payments, and fleet composition by aircraft type.

In addition, we construct four different measures of the ease of overall re-deployability of an airline’s leased aircraft. We find that publicly traded airlines often renegotiate their lease contracts. Furthermore, we show that aircraft lease renegotiations take place when liquidation values are low and airlines’ financial condition is poor. We supplement our analysis by studying lease renegotiation out of bankruptcy. We find that, even out of bankruptcy, airlines in poor financial condition can reduce their lease payments and that lower fleet re-deployability enables these airlines to extract greater concessions from their lessors.

The full paper is available for download here.