Munich Personal RePEc Archive

The impact of insolvency laws on venture capital

Bhatia, Jai (2009): The impact of insolvency laws on venture capital. Published in: Social Science Research Network (2009)

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The venture capital (VC) industry supports innovation in an economy, and has seen much success over the last few years. However, with the inherent risk in any start-up business, the venture capitalist is bound to see some failures. This paper explores the effects of corporate and personal insolvency laws on financially distressed VC funded firms. It also compares the contract driven bankruptcy system to the court driven system, and their implications for failed VC funded firms. This paper relies upon qualitative analysis and draws upon interviews with academic experts, industry practitioners and secondary data.

In the light of corporate insolvency, the research concludes that entrepreneurial firms are often ‘wound up’ rather than put into the bankruptcy system for liquidation/ reorganization because the realized value from the small firms often do not cover the cost of the bankruptcy process. Consequently, it is difficult to ascertain the impact of corporate insolvency laws on small businesses. On the contrary, it has been observed that the severity of the personal insolvency law does not affect venture capital financed entrepreneurs. The venture capitalists provide equity finance and the entrepreneurs do not need to risk their personal assets for collateral to acquire bank finance. The comparison between the US and UK systems of bankruptcy revealed that for small entrepreneurial firms, both systems are convergent to a greater degree than they are for larger firms i.e., the smaller the firm the more similar both the systems seem in relation to efficiency and the ability to salvage value from financially distressed firms.

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