Volume 40 Number 2

In Pursuit of Good & Gold: Data Observations of Employee Ownership & Impact Investment

A startup’s path to self-sustaining profitability is risky and hard, and most do not make it. Venture capital (VC) investors try to improve these odds with contractual terms that focus and sharpen employees’ incentives to pursue gold. If the employees and investors expect the startup to balance the goal of profitability with another goal—the goal of good—the risks are likely to both grow and multiply. They grow to the extent that profits are threatened, and they multiply to the extent that balancing competing goals adds a dimension to the incentive problem. In this Article, we explore contracting terms specific to impact investing funds and their portfolio companies. We observe one possible private ordering mechanism to balance and align interests to serve both goals: employee ownership.

Traditional VC investments confront contracting challenges as the portfolio companies and investors balance their interests, which may not align. Additionally, portfolio companies are contracting with their own employees. The VC contracting literature identifies several agency costs that contractual terms can address. Contracts can help attract the right employees, then encourage them to work, stay, and share their best ideas. But, the existing literature addresses traditional agency costs with respect to the pursuit of a single monetary goal. Impact investment funds that balance monetary goals, short-term or long, with other goals may strike a different balance in negotiating with companies. We examine how the introduction of new motivations and interests into a precarious negotiation process shapes contracting outcomes.

We address this question empirically by analyzing the role of employee stock ownership in impact investment fund contracts when investing in targeted portfolio companies. That a startup’s employees might receive shares and options is uncontroversial. Indeed, this appears in many ways to be fundamental to today’s startup culture. Might impact investors mandate that employees own shares as a means to balance dual goals? That is the key question for our analysis.

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