A Study On The Mechanism And Contract Terms Of Preference Shares In Venture Capital

This paper systemically analyzed the investment term sheet which had widely practiced in the U.S. From the perspective of the functions of enterprise value split and control right split, this paper analyzed the mechanism of preferred stock, a tool which have been commonly used in venture capital investments. Under the description of enterprise value split function, this section emphasized on the individual and combined actions of liquidation preference, preferred dividends, anti-dilution provisions and conversion right. A real option approach was used in analyzing the comparisons of participating preferred stock and non-participating preferred stock. The impact of other provisions on participating preferred stock was also considered in this section. Under the description of control right spilt, the section introduced a combined investor right protective system through ex-ante prevention and post hoc remedies. Through a real case study, the section showed how the system worked when a moral hazard problem occurred. Then, the paper introduced the current practice of China venture capital industry and analyzed an advanced local term sheet model. Finally, through the comparison of preferred stock legislation in different countries and regions, especially Taiwan, this paper provided specific guidance to China preferred stock legislation.