Yifat Aran (University of Haifa – Faculty of Law) has posted The Optional Firm: The Silicon Valley Model of Startup Organization (European Business Organization Law Review, forthcoming) on SSRN. Here is the abstract:
Venture-backed startups allocate equity among founders, investors, employees, and other stakeholders through preferred and common stock, warrants, and options. This structure creates a fragmented residual claim whose value is realized only upon exit. In intangible-intensive firms, where contracts cannot fully protect key assets such as human capital, equity ownership aligns incentives and limits knowledge spillovers. Venture-backed startups therefore function as “optional firms.” Participation is voluntary, and optionality runs throughout the capital structure: staged financing and preemptive rights give investors the option to commit additional capital; convertible preferred stock allows a shift between debt- and equity-like payoffs; liquidation preferences turn the common-stock claim into a call option on the firm’s residual value; and founder reverse vesting, together with employee stock-option vesting, ties human-capital retention to that same residual. Although these arrangements reflect distinct forms of optionality, each derives at least part of its value from a direct or contingent claim on the value of the common stock.
The Article develops the concept of “contingent shared ownership” as a unified framework for startup governance that synthesizes principal-agent and team-production theories. By treating the capital structure as a single ownership architecture, it argues that protecting the common-stock residual claim sustains a dual selection process through which both financial capital and human capital are continuously reallocated toward higher-value firms. The Article further identifies the startup board’s central task as allocating residual claims between financial investors and human-capital providers and interprets corporate law’s protection of the residual claim as essential to maintaining this selection process.
Recommended!
To receive new posts from Legal Theory Blog by email, get a free subscription to Legal Theory Stack.
Lawrence Solum