Venture capital (VC) is a key driver of economic growth. A substantial body of legal and financial scholarship has examined the institutional factors that shape VC activity. In the first of two papers, we build on the idea that the flexibility of corporate law plays a critical role in enabling VC investments. Specifically, we offer a conceptual framework for understanding how corporate law affects negotiations between venture capitalists and entrepreneurs, particularly when corporate law is rigid, i.e., imposes a range of mandatory requirements. We illustrate the relevance of this framework by comparing how VC contracting operates under U.S. (Delaware) law and European corporate laws, focusing on Germany and Italy.

Our analysis shows that the rigidity of German and Italian corporate law forces parties to adopt contractual structures that are less effective than those commonly used in the U.S. Importantly, we find that the rigidity of German and Italian corporate law stems less from blackletter provisions and more from how those provisions are interpreted by scholars and then applied by practitioners and courts in their respective capacities. We argue that these impediments to private ordering negatively affect the value of VC contracts, thereby constraining financing opportunities for innovative startups.

In a second paper, we address two potential objections to the practical significance of our findings and explore their policy implications.

First, it might be argued that VC firms and entrepreneurs in Germany and Italy can simply incorporate abroad to sidestep restrictive domestic corporate laws. However, we show that especially for early-stage ventures, this is impractical because of legal uncertainties, ongoing compliance costs, and the inability to fully avoid the application of domestic corporate law.

Second, some might contend that formal contracting is of limited importance in the VC world, as relationships there are based on reputation and social bonds, with litigation being seldom used by market players. We counter this view by demonstrating that formal contracts prove essential – especially during downturns – when a breakdown of the relationship between the VC firm and the entrepreneur looms.

Regarding policy implications, we start from the premise that the problems associated with German and Italian corporate laws’ rigidity are the function of how corporate law is made in these jurisdictions: The constraints arise from implicit rules and standards developed by scholars and implemented by practitioners and courts, who share a general skepticism about private ordering. Consistent with this finding, we advance two recommendations to expand the scope for welfare-enhancing private ordering in VC contracting.

Our first recommendation is to enact statutory provisions that explicitly shield typical U.S. contractual arrangements from undue interference by practitioners and courts rooted in private ordering-hostile doctrinal scholarship. Second, we propose the introduction of a model charter – its contents aligned with U.S. VC contracts – that would be declared fully enforceable by the law, thus again protecting VC contracts from any undue ex post intervention. Both proposals would ultimately prove key to invigorate European venture capitalists’ and entrepreneurs’ ability to rely on their contract to conclusively define the governance structure and risk allocation of their business relationships.

These suggestions align with EU policymakers’ proposals for a 28th regime for innovative enterprises (as first set out in the Letta Report and recently endorsed by the European Commission) and may be especially relevant in this context. Our findings demonstrate that such a regime requires two essential features to succeed. First, it must be established as an independent and conclusive EU legal instrument, eliminating any role for national corporate law in areas not covered by the EU regulation – a departure from the European Company Statute model. Second, it should explicitly protect VC deals’ private ordering solutions from judicial interference, potentially through the shielded model charter we propose.

This post comes to us from Luca Enriques, a professor of business law at Bocconi University, Casimiro A. Nigro, a business law lecturer at Leeds University, and Tobias H. Tröger, a  professor of law and finance at Goethe University and the Leibniz Institute SAFE. It is based on their recent paper, “Mandatory Corporate Law as an Obstacle to Venture Capital Contracting in Europe: Implications for Markets and Policymaking,” available here. A version appeared on the Oxford Business Law Blog, here.