Understanding Venture Capital Structure: A Tax Explanation for Convertible Preferred Stock

The capital structures of venture capital-backed U.S. companies share a remarkable commonality: overwhelmingly, venture capitalists make their investments through convertible preferred stock.[1 ] Not surprisingly, a large part of the academic literature on venture capital has sought to explain this peculiar pattern.[2] Financial economists have developed models showing, for example, that convertible securities allocate control depending on the portfolio company’s success,[3] operate as a signal to overcome various kinds of…