The Impact of Law and Corruption on Venture Capital and Private Equity Fees and Returns

By Douglas Cumming, Grant Fleming, Sofia Johan & Dorra Najar

This article summarises recent research on the role of law, culture and corruption on venture capital and private equity fund structures, governance and performance. The authors focus on the role of law and corruption on two aspects of venture capital and private equity investment: the structure of manager compensation, and performance outcomes. 

Since the 2007 financial crisis, there has been significant and growing concern in the venture capital and private equity industries worldwide of the role of corruption in influencing venture capital and private equity fund manager activities. For example, the high profile law firm S.J. Berwin noted in their Private Equity Comment1 that regulators are paying significantly more attention to venture capital fund manager corruption, particularly with respect to bribery, and environmental, social and governance issues. As they commented, ‘[i]t makes good business sense, therefore, for [fund] managers to understand the legal issues in every country in which the fund does business, and to take active steps to ensure that responsible business practices are adopted throughout the portfolio’. Indeed, a lack of understanding by the private equity industry on differences in legal practices, corruption and cultural norms around bribery could result in longer term (negative) effects for the industry. S.J. Berwin expressed particular concern with international venture capital and private equity transactions where exposure to firms could result in ‘corrupt linkages’  to local, regional and national governments.


The Role of Corruption, Culture and Law on Fund Manager Compensation

Venture capital and private equity fund managers are financial intermediaries between institutional investors and entrepreneurial firms. Venture capital and private equity funds are typically set up as limited partnerships whereby the institutional investors are the limited partners and the fund manager is the general partner.2Institutional investors include pension funds (which are most common across countries), insurance companies, banks and endowments, etc.  Venture capital and private equity funds typically have a finite life of 10-13 years. This life-span enables fund managers time to select appropriate investees and manage such investments to fruition. A typical investment in an entrepreneurial firm can take from 2-7 years from first investment to the exit date. Entrepreneurial firms typically lack income, revenue and/or cash flows to pay interest on debt and dividends on equity; hence, returns to institutional investors are in the form of capital gains upon exit (such as an IPO or acquisition for successful entrepreneurial firms, or a write-off for unsuccessful firms).

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The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.