THE USE OF COVENANTS - AN EMPIRICAL-ANALYSIS OF VENTURE PARTNERSHIP AGREEMENTS

This article examines covenants in 140 partnership agreements establis hing venture capital funds. Despite the similar objectives and structu res of these funds and the relatively limited number of contracting pa rties, the agreements are quite heterogenous in their inclusion of cov enants. We examine two complementary hypotheses that suggest when cove nants will be used. Covenant use may be determined by the extent of po tential agency problems: because covenants are costly to negotiate and monitor, they will be employed only when these problems are severe. A lternatively, covenant use may reflect the supply and demand condition s in the venture capital industry. The price of venture capital servic es may shift if the demand for venture funds changes while the supply of fund managers remains fixed in the short nm. The evidence suggests that both factors are important. This is in contrast to previous studi es which have either focused exclusively on costly contracting or prov ided only weak support for the effects of supply and demand on contrac ts.