Kaplan and Stromberg compare real-world venture capital contracts against financial contracting theory, arguing VCs function as the closest real-world approximation to the idealized theoretical investor since VC financings allow cash flow rights, voting rights, board rights, liquidation rights, and other control rights to be allocated separately rather than bundled together. While convertible securities are the most common instrument, VCs achieve a similar separation of rights using combinations of multiple share classes and straight preferred stock, and cash flow, voting, control, and future financing terms are frequently made contingent on observable financial and non-financial performance benchmarks. When a company performs poorly, VCs obtain full control, but as performance improves the entrepreneur regains more control rights, and if performance is very strong, VCs keep cash flow rights while relinquishing most control and liquidation rights, a structure the authors find most consistent with Aghion and Bolton and Dewatripont and Tirole's theoretical work and with screening theories, noting VCs commonly add non-compete and vesting provisions to mitigate hold-up risk.

This is one of the most foundational and widely cited empirical papers on VC contract design in the entire field, giving researchers a rigorous, real-world test of financial contracting theory that directly connects to and helps explain the mechanics behind several other VC term sheet and staged financing resources already cataloged in this archive. Founders negotiating a term sheet get a genuinely important structural insight, that control rights, not just economic rights, shift with company performance, so a strong operating quarter can meaningfully change how much board and voting control a founder actually holds, distinct from the equity percentage alone that many founders focus on exclusively. The explicit connection to non-compete and vesting provisions as tools for mitigating hold-up risk gives founders and investors alike a clearer rationale for why these otherwise restrictive-feeling clauses exist, framing them as solutions to a specific, well-documented contracting problem rather than arbitrary investor demands.