Startups’ earliest investors frequently compromise on the extent of control rights they possess. Their investment terms do not afford them the same degree of contractual controls that later-stage investors have, and the securities that they hold often exclude them, at least temporarily, from shareholder status and the statutory control rights and protections it entails. This inclination to cede control contrasts the practices of later-stage startup investors, who rely more heavily on strong-form control rights to mitigate firm-specific risks. This Article introduces a novel framework for understanding early-stage startup governance structures. It emphasizes the distinctive factors that make investor control more costly and less valuable for startups’ earliest investors than their later-stage counterparts despite the greater risks and uncertainties associated with earlier investments. These factors include the substantial information imbalance favoring entrepreneurs during the very early stage and the complex interplay between control and entrepreneurial incentives. Collectively, these elements shape the rationale behind early investors’ tendency to grant entrepreneurs more flexibility and contribute to the widespread utilization of deferred equity instruments in early-stage financing.
* Wagner Fellow in Law & Business, NYU School of Law. This work draws from research conducted towards a J.S.D. degree at Columbia Law School. For conversations and valuable comments on earlier drafts, I thank Zohar Goshen, Jim An, Bobby Bartlett, Nizan Geslevich Packin, Talia Gillis, Assaf Hamdani, Kobi Kastiel, Adi Marcovich-Gross, Saul Levmore, Joshua Mitts, Elizabeth Pollman, Alex Platt, Guy Rub, David Schizer, Michal Shur-Ofry, James Si Zeng, James Fallows Tierney, Andrew Tuch, Ofer Tur-Sinai, and the participants of the 2023 Law & Entrepreneurship Association Annual Meeting; the 2023 Midwestern Law & Economics Association Annual Meeting; the 2023 Next Generation of Scholarship J.S.D. Symposium; the 2024 Conference on Governance of Emerging Technologies and Science (GETS); the 2024 American Law & Economics Association Annual Meeting; workshops and seminars held at Columbia Law School and CUNY Baruch College; and the Spring 2024 University of Illinois Law Review Symposium. My thanks to the University of Illinois Law Review editors for outstanding editorial work. I have previously represented startups and startup investors; any opinions expressed in this paper exclusively reflect my own views.
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