the contracting universe: law firms and the evolution of

The Contracting Universe:

Law Firms and the Evolution of Venture Capital Financingin Silicon Valley

Mark C. SuchmanDepartment of Sociology

University of Wisconsin - Madison

January 2006

[DRAFT: Please do not cite or circulate without permission]

The research reported herein was supported in part by dissertation fellowships from the USNational Science Foundation and the American Bar Foundation. The author wishes to thank W.Richard Scott, Robert Gordon, Nancy Tuma and Teresa Scheid for their numerous commentsand suggestions on previous drafts.

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The Contracting Universe:Law Firms and the Evolution of Venture Capital Financing

in Silicon Valley

Mark C. SuchmanDepartment of Sociology/School of Law

University of Wisconsin - Madison

ABSTRACT

This project examines the contribution of local law firms to the development of California's SiliconValley. By synthesizing prominent themes from organizational ecology, institutional theory, and thesociology of the legal profession, the analysis suggests that Silicon Valley law firms act as"interorganizational pollinators." In this capacity, lawyers exploit a distinctive structural position withinthe start-up process, in order to formulate and disseminate standardized blueprints for organizationalstructure. These activities exert both micro and macro effects, simultaneously promoting the founding ofnew firms and the structuration of the larger community. Support for this analysis comes from bothqualitative and quantitative evidence. Interviews with lawyers, entrepreneurs and venture capitalistssuggest that local attorneys act, in part, as business counselors, drawing on their experiences withrecurrent start-up problems in order to develop and diffuse constitutive templates for commonorganizational activities. Statistical analyses of venture capital financing contracts (VCFCs) confirm thisfinding, revealing not only that these foundational contracts became increasingly standardized during theearly years of Silicon Valley, but also that the level and form of standardization were significantlycorrelated with the involvement of particular law firms. These findings illustrate the complex co-evolution of resource and information flows in new organizational communities. In Silicon Valley, atleast, the development of community-sustaining institutions results neither from the impact of adisembodied zeitgeist nor from the ministrations of an impervious external actor. Rather, thestructuration of Silicon Valley reflects the mundane, day-to-day activities of specific intermediaryorganizations located within the community itself.

VENTURE CAPITAL FINANCING CONTRACTS MARK C. SUCHMAN

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Contracts are, first and foremost, social artifacts. Like most artifacts, they often emerge

from the labors of specific artisans; but also like most artifacts, they necessarily bear the

markings of broader social contexts. Some of these markings are technical, since contracts fall

into the general category of ostensibly useful artifacts; but other markings are cultural, since the

uses to which contracts are put involve substantial symbolic, narrative and even ceremonial

components. Thus, contracts are at once both communicative gestures and marketable

commodities, and to understand a contractual regime, one must understand both the cultural and

the economic environment that gave it birth. At the same time, one must also recognize that

contracts, like any artifacts, are themselves capable of transforming their environments, both

culturally and materially. Thus, the sociological study of contracts must attend to several

distinct but intertwined historical dynamics: It must study both the private parties who use

contracts and the professionals who produce contracts; it must study both individual transactions

and larger social systems; it must study both the influence of social environments on contractual

practices and the reciprocal influence of contractual practices on social environments.

This paper is not so bold as to attempt all of these tasks at once. For the most part, it

offers a relatively modest preliminary study of the emergence of distinctive contractual practices

in one particular locale. Informed by the foregoing sociological perspective, however, it strives

to address the role of legal professionals, as well as contracting parties; to attend to systemic

processes, as well as specific transactions; and to recognize that contractual regimes shape

professions and business communities, as well as that professions and business communities

shape contractual regimes.

Empirically, this paper reports early results from an ongoing research project on the role

of law firms (and, to a lesser extent venture capital funds) in the growth and development of

California's "Silicon Valley." Lying along the San Francisco peninsula between Palo Alto and

Los Gatos, Silicon Valley boasts one of the fastest growing industrial communities in the United

States, and the region's distinctive indigenous business practices offer an excellent opportunity to


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examine how contracts and organizational environments emerge in tandem. Social scientists

have, of course, devoted a substantial amount of attention to Silicon Valley in recent years (see,

e.g., Rogers & Larsen 1984; Saxenian 1994): Many researchers have studied the regions' core

technologies -- semiconductors, computer equipment, software, telecommunications and

biotechnology -- and the industries that have grown up around them. Others, especially within

legal academia, have examined the public laws governing these new technologies, most notably

those aspects of intellectual property law that deal with computer hardware and software or with

genetic engineering. The project reported here, however, grows out of a somewhat different set

of concerns.

Rather than focussing on Silicon Valley's distinctive "high technology" innovations, the

present investigation addresses Silicon Valley's more generic characteristics as an emerging

business community. The question then becomes not "What can Silicon Valley teach us about

the high-tech economy?" but rather, "What can Silicon Valley teach us about the emergence of

governance structures in changing economic environments, regardless of those environments'

underlying industrial technologies?" Drawing on theories from the sociology of organizations

and the sociology of the legal profession, the following pages examine a significant but often

overlooked aspect of industrial governance: the routinization of transactional practices within a

developing organizational community. To this end, the paper offers a detailed empirical portrait

of the emergence and institutionalization of one particular set of such practices, the standardized

venture capital financing contracts (VCFCs) that structure new-company investments in Silicon

Valley.

The introductory section of this paper outlines the multiple theoretical concerns that

motivate this research project, both from the sociology of organizations and from the sociology

of law. Section two then presents some preliminary empirical results, illustrating the

standardization of venture capital financing contracts, the emergence of distinct contractual

archetypes, and the temporal and social dynamics driving choice among those archetypes.


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Finally, section three briefly returns to re-examine the implications of these findings for the

theoretical traditions that motivated the investigation.

Theoretical Framework

Organizational Communities:

Today's Silicon Valley exemplifies a phenomenon that organizational researchers have

termed an "organizational field" (DiMaggio and Powell 1983) or an "organizational community"

(Astley 1985): "organizations that, in the aggregate, constitute a recognized area of institutional

life: key suppliers, resource and product consumers... and other organizations that produce

similar services and products" (Dimaggio and Powell 1983:148). As a practical matter,

organizational communities (and, particularly, new organizational communities) are often

associated with specific geographic locales: The Pittsburgh steel industry, the Detroit automotive

industry, the Hollywood film industry and, of course, the Silicon Valley computer industry. In

theory, however, these units have no necessary geographic limits; they occupy fields in social,

not physical, space. What defines an organizational community such as Silicon Valley is its high

level of internal interaction and interdependence, its distinctive normative and behavioral style,

its collective identity and, ultimately, its pervasive sense of "entity-ness." As one local

chronicler observed, somewhat hyperbolically:

[M]ore than any industry in history, [Silicon Valley] is a self-contained, livingentity....It has defined boundaries, is self-perpetuating and reproducing and haspredictable behavior -- including the instinct for self-preservation. Even in theelectronics industry, there is a tendency to speak of "Silicon Valley" as though itwere a sensate being. (Malone 1985:8)

Although several of Santa Clara County's leading industrial firms date back to the 1930s

or earlier, the region has only recently developed these crucial community attributes of structure,

culture and identity. Until the advent of the microcomputer era, few local residents had much

sense of participating in a distinctive industrial phenomenon. As recently as 1950, the area that


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was to become "Silicon Valley" still touted itself more modestly as "the Prune Capital of

America." Less than 0.25% of Santa Clara's population held manufacturing jobs (800 workers),

and half of these were in canneries and food processing plants (Rogers & Larsen 1984:28).

Although several electronics companies already operated in the area, neither their numbers nor

their product lines distinguished them from electronics manufacturers in other parts of the

country. In public discourse, the activities of the region were identified by their particular

geographic locales -- Palo Alto, Sunnyvale, Santa Clara County -- rather than as part of a larger

social system.

By the 1970s, however, the population of interrelated spin-off firms had blossomed, and

previously isolated start-ups were beginning to perceive themselves as participants in a common

endeavor. In 1971, Microelectronics News coined the phrase "Silicon Valley" to describe this

new regional entity. Use of this community label grew rapidly in the late 1970s and early 1980s,

as local organizations developed a growing sense of collective identity, built around the region's

emerging high-technology industries. This heightened commonality corresponded with a

marked increase in intra-communal business relations and with a progressive standardization of

local business practices.

In the lexicon of organizational sociology, Silicon Valley's experience since the late

1960s falls under the ungainly rubric of "community structuration." Structuration refers to the

development of coherent and consistent social relations -- shared meanings, stable interaction

patterns, consensually defined roles -- within a group of previously isolated firms (DiMaggio &

Powell 1983:148). Increasingly, organizations theorists identify this transition from quasi-

randomness to systematicity as a crucial but only partially understood "phase change" in

organizational life. Among other things, the trajectory that organizational communities follow in

their early history often determines the fate of new technologies and "locks in" many

environmental characteristics for years to come (Arthur 1989). Thus, the task of explaining how

viable organizational communities coalesce over time poses an intriguing puzzle in the analysis


1Suchman (forthcoming:18) defines "constitutive information" as "fundamental rules abouthow to produce an organizational structure, operational procedure or behavioral pattern."

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of organizational environments, and the solution of this "structuration puzzle" promises

substantial theoretical and practical dividends.

Clues to the resolution of this puzzle come from two distinct traditions in organizational

sociology, one known as "institutional theory" and the other known as "organizational ecology."

Institutional theorists, who focus primarily on the cultural features of organizational

environments, argue that community structuration represents an important step in the

institutionalization of a coherent industrial culture (see generally, Powell & DiMaggio 1991

[anthology of readings in institutional theory]). The concomitant standardization of local

business practices is, thus, simply one element of the social construction of cultural norms, roles,

definitions, and routines within the emerging industrial system. In contrast, organizational

ecologists, who focus primarily on the material features of organizational environments, argue

that community structuration reflects the consolidation of a coherent industrial ecosystem (see

generally, Baum & Singh 1994 [anthology of readings in organizational ecology]). In this view,

the standardization of business practices stems from the routinization of inter-organizational

resource flows and the corresponding co-evolution of stable environmental niches and

interconnected organizational populations.

Together, these two apparently divergent models suggest that although standardized

business practices may be socially-constructed cultural artifacts, the social construction process

that produces them may nonetheless stem in large part from the activities and experiences of

concrete organizational populations -- populations who are, themselves, subject to competitive

pressures and material resource constraints. Among other things, this depiction raises the

intriguing possibility that certain communities may include ecological niches for organizations

that specialize in the transmission of basic constitutive information1 among the members of other

local populations. In action, such "inter-organizational pollinators" would channel the


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development of business standards while, themselves, remaining profoundly enmeshed in (and

vulnerable to) material and cultural forces within the larger community.

Legal Practitioners:

This, of course, is where the sociology of the legal profession comes in. In recent years,

a substantial body of research has emerged around the question of what, exactly, corporate

lawyers do. Despite persistent lay sentiment that attorneys amount to nothing more than a

parasitic drain on the productive economy (Galanter 1994), socio-legal scholars have articulated

a number of accounts in which corporate lawyers appear to be earning their fees in a somewhat

more productive manner (see e.g., Suchman & Cahill 1996). In particular, several researchers

have recently argued that lawyers may actually be creating value for their clients, by

"engineering" complex transactions and by "inventing" useful legal "devices" (see, generally,

Oregon Law Review 1995). In these accounts, standard-form contracts occupy a prominent

position on the list of efficiency-enhancing inventions produced by the business lawyer qua

transaction-cost engineer (Gilson 1983 [describing business lawyers as transaction-cost

engineers]; Klausner 1995 [outlining benefits of standardized contracts]).

Significantly, however, the existing literature offers remarkably few empirical studies of

the actual emergence of specific legal devices over time (but see Powell 1993 [describing role of

lawyers in the emergence of "poison pill" takeover defenses]). Rarer still are sustained efforts to

situate the creative activities of corporate lawyers within a model of the larger inter-

organizational environment. In reality, though, both history and context always matter.

Marketable devices never spring fully-formed from the minds of their inventors, and new

contractual governance structures are no exception. At the same time, law firms never invent on

their own, in isolation from their social and economic context. Environmental dynamics

necessarily structure and condition these organizations' every move, and the technologies that

these firms produce often, in turn, reconfigure the organizational environment. Thus, if socio-

legal scholars wish to reconceptualize corporate lawyers as entrepreneurial inventors who


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construct and peddle novel legal devices, research must move beyond the economic exegesis of

legal technology, to look empirically at the ways in which law firm activities mesh with the

development of concrete organizational communities. What looks like technical transaction-cost

engineering when viewed on a case-by-case basis may more closely resemble "paradigm

pushing" when viewed across a longer time-span. And if law firms are, in fact, actively

promulgating distinct, constitutive models of organizational structure, then it might make sense

to view them as a species of inter-organizational pollinator, and to link socio-legal studies of

corporate law with organizational studies of this particular pollinator niche.

In applying this perspective to the case of Silicon Valley, one might hypothesize that

during the early years of the community's development, law firms were among a small class of

organizations whose activities provided regular contact with significant numbers of new high-

technology enterprises. This network centrality created an opportunity for Silicon Valley

lawyers to perceive, to foster and to promote hidden commonalities between otherwise isolated

start-ups. In exploiting this privileged structural position, however, local law firms were not

simply crafting technical devices that minimized transaction costs for individual clients in

isolated instances. Rather, by assembling a standardized cultural tool-kit, the lawyers of Silicon

Valley were playing an important role in developing the taken-for-granted business practices --

including the distinctive contractual artifacts -- of the community as a whole.

Empirical Evidence on Venture Financing

Read in conjunction, theories of organizational environments and accounts of corporate

legal practice provide strong reason to believe that the structuration of new industrial

communities may reflect the influence of law firms, as inter-organizational pollinators, on the

construction and transmission of basic business routines -- and, in particular, on the

institutionalization of standardized contractual practices. To explore these theoretical

suspicions, the present study gathered a range of qualitative and quantitative evidence on the role


2The empirical evidence presented below draws heavily on the author's prior studies of therole of law firms in the development of Silicon Valley. Readers who are interested inmethodological and/or computational details beyond those reported here should refer toSuchman (1994).

3Generically, the term "venture capital" refers to a wide range of high-risk investmentactivities, including -- but not limited to -- new company finance. Most Silicon Valley venturecapitalists, however, specialize almost exclusively in emerging-growth start-ups, andconsequently, within this particular community, the primary social significance of venturecapital lies in its role in supporting such early-stage entrepreneurship. (See, generally, Bygrave& Timmons 1992).

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of law firms in the formation of new high-technology start-up companies in Silicon Valley. The

goals of these investigations were to determine: (a) what, roles Silicon Valley's corporate

lawyers were playing in the start-up process; (b) whether those roles involved the construction

and transmission of constitutive information; and (c) what impact such activities had on the

structuration of the organizational community as a whole.

This section will first introduce the particular empirical focus of these investigations, the

venture capital financing process. This brief introduction will be followed by a more extensive

discussion of several qualitative and quantitative analyses bearing on the questions outlined

above. Data sources and methodologies will be addressed (largely in footnotes) as they become

relevant.2

Venture Capital Financing:

Near the core of the start-up process in Silicon Valley lies the phenomenon of venture

capital financing. In essence, venture capital is high-risk external funding, usually directed

toward early-stage equity investments in "emerging growth" companies (Bartlett 1988 [treatise

on venture capital financing]; Halloran et al. 1991 [venture capital financing contract

formbook]).3 This, for example, is the kind of financing that Steven Jobs and Stephen Wozniak

obtained in 1976, when they decided to move the Apple Computer Company out of Jobs' parents'

garage. Entrepreneurs can, of course, raise start-up funds in many ways, including from

traditional bank loans, corporate partnerships, wealthy "angels," and friends and family. Since


4The following pages draw on quotations from a series of roughly 25 semi-structuredinterviews conducted during the summer of 1991 with various participants in the Silicon Valleyorganizational community. Interviews were divided approximately equally between lawyers,venture capitalists and entrepreneurs, as well as including several individuals who had playedmultiple roles over the course of their careers. The analysis was further enriched by informalconversations with a handful of journalists, academics and other informed community-watchers. The sampling frame for these interviews was a systematic, multiple-snowball sample ofindividuals who were active in Silicon Valley during the formative period from 1970 to 1990. Inorder to capture as full a range of accounts as possible, the sample was informally stratifiedalong such dimensions as: industry, seniority, tenure in the community, geographic location, andthe like. In two months of interviewing, the response rate (ratio of interviews to initial contacts)was over 85%.

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the mid-1970s, however, the private venture-capital equity model has increasingly become the

default route for financing new companies in Silicon Valley.

Significantly, for most new Silicon Valley firms, venture capital financing represents

more than simply a financial event (Timmons & Sapienza 1991). Venture capitalists tend to be

extremely active, hands-on investors. Thus, as well as bringing an infusion of fiscal resources,

the initial venture capital round often also represents the first juncture at which a start-up must

integrate a substantial group of new stakeholders, whose interests and contributions differ

significantly from those of the founding entrepreneurs.

In short, not only do venture capital financings represent a central element of Silicon

Valley's inter-organizational culture, but also they mark a crucial governance challenge in the

"gestation" of local start-ups. Consequently, a new company's first funding round offers an ideal

transactional event in which to discern the impact of Silicon Valley lawyers. An initial venture

capital investment is precisely the sort of setting in which one might expect contractual

structures to have an impact on organizational life -- and in which one might wonder whether

and how standardized contracting practices emerge onto the scene.

Qualitative Evidence:

To begin tracing the role of law firms in the Silicon Valley start-up process, I conducted

a number of exploratory interviews with local lawyers, entrepreneurs and venture capitalists.4

Although a detailed discussion of these interviews lies beyond the scope of the present essay, a


5The quotations presented here have been edited for confidentiality, brevity and readability. In order to preserve the flow of the text, most of this material appears without ellipses, bracketsor other diacritical marks. Care has been taken, however, to maintain the substance and tone ofrespondents' remarks, while eliminating some of the more awkward constructions of impromptuspeech.

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few quotations should suffice to convey the general tenor of respondents' comments, regarding

both what Silicon Valley lawyers do and how these activities effect the emerging community

(for more extensive treatments, see Suchman 1994; Suchman & Cahill 1996).

Most strikingly, interviewees frequently described local attorneys as playing what could

be labelled a "counseling" role -- providing start-up clients not only with legal advice, but with

basic business advice, as well. As one senior partner put it:

Good lawyers are a wonderful resource for business advice, because the problemsthat growing companies encounter are similar. And even if a problem is new toan entrepreneur who has never been president of a company before, the outsidecounsel has seen various ways that people have dealt with it.5

The parallel between this account and the inter-organizational pollination model is

readily apparent. As the previous quotation illustrates, Silicon Valley law firms have occupied a

privileged position within the emerging organizational community: Long before the region had

developed an over-arching normative structure, the routine activities of legal representation

brought local attorneys into regular contact with large number of companies facing similar sets

of operational challenges. This exposure, in turn, allowed law firms to monitor wide ranges of

client strategies, to formulate coherent accounts of the determinants of success and failure, and to

impart these accounts to new community entrants.

Over time, it seems likely that these summaries of basic constitutive information could

exert significant pressures on the structure of the developing business community: As clients

come to embody the models compiled by their attorneys, one would predict that the diversity of

organizational structures would fall, and that inter-organizational relations would become more

consistent and more highly routinized. Two additional quotations, from lawyers with substantial


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venture capital experience, nicely capture this structuration dynamic. The first describes the

evolution or, more accurately the institutionalization, of venture capital financing agreements:

If there is a transaction with one of the other Silicon Valley law firms, thetransaction costs tend to be minimal. Very often they've adopted our contractforms or vice versa. I remember one attorney at another firm saying that, a coupleyears ago, he had this whole set of negotiating responses to my firm's forms. Butin the last few deals I did with them, their forms were virtually identical to ours,and there wasn't anything to argue over.

The second quotation goes a bit further in illustrating the role of law firms in this process of

institutionalization:

I think there are law firms out there that have three cookie cutters, and they justask: "Is it A, B, or C?" They are going to force these things into one of thosecookie cutters and just ignore the fact that you may not fit the profiles. They'lljust pretend you do, and they'll just cram you into the structure.

These quotations illustrate a number of significant features of the venture capital

financing process: (a) Silicon Valley lawyers use their broad counseling role to transmit basic

constitutive models between various clients; (b) this social influence is something that lawyers

often consciously acknowledge as being an important part of Silicon Valley legal practice; and

(c) in the aggregate, such pollination activity tends to narrow the range of behavioral variation

within the larger community, and to produce relatively homogeneous sets of standardized and

typified business routines.

Quantitative Evidence:

While generally supportive of the pollination model, the qualitative evidence described

above leaves several questions about the venture capital financing process unresolved. Interview

responses are themselves retrospective cultural narratives, and consequently they tend to be

poorly suited to differentiating mythology from reality or to tracing the finer points of shifting

practice over an extended period of time. To address such concerns, the second stage of the

investigation sought to gather quantitative evidence on a typical Silicon Valley practice that


6One caveat may be in order: Since VCFCs are formally confidential business documents, thedata necessarily reflect access constraints, and the sample is in no sense a random one. Nonetheless, every effort has been made to construct as comprehensive a data set as possible: The two participating funds are widely recognized leaders in the industry, yet they do notmaintain particularly close ties with one another; the coded agreements cover a wide range ofindustry segments (including semiconductors, computer systems, software, telecommunicationsand bio-technology); the time period extends throughout the early years of Silicon Valley; andthe sampling frame does not exclude agreements on the basis of transaction size, geographicfocus, legal representation, or contractual structure. While none of these precautions can entirelyeliminate the possibility that the observed contracts are in some ways atypical, substantialexploratory analysis has failed to uncovered any evidence that the reported results constitutemere artifacts of the data collection procedures. Rather, the data seem to represent a reasonablecross-section of the "state of the art" in venture capital finance during the period underconsideration.

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might plausibly have been affected by pollination processes, if these processes were indeed

taking place.

Data: This phase of the project employed statistical content analysis to examine the provisions

of over 100 actual venture capital financings contracts (VCFCs), produced in transactions

spanning a 15-year period of Silicon Valley's early history. Specifically, the following analyses

employ content-analytic data on 100% of the first-round, high-technology VCFCs entered into

by two of Silicon Valley's leading venture capital funds, between 1975 and 1990. The resulting

data set contains a total of 108 contracts, spanning much of the organizational community's

formative period.

Each of these agreements was coded on over 400 elements of contractual structure.

Measured items included: (a) formal issues, such as the length of the agreement and the number

of separate contractual instruments involved; (b) substantive issues, such as stock redemption

provisions, antidilution protections, dividend structures, etc.; and (c) "exogenous" information,

such as the age, industry and valuation of the company, the structure of the investor syndicate,

and the identity of the lead investor and of the drafting law firm. Background research

(including field interviews, reviews of legal formbooks, and extensive pre-testing) suggests that

these dimensions capture virtually the entire range of formal and substantive variation in venture

capital financing agreements during the observation period.6


7It is perhaps worth noting that this methodology defines "idiosyncracy" in fundamentallyretrospective terms: A contractual provision is considered idiosyncratic if it fails to achieveeither widespread usage or normative endorsement during the 1975-1990 observation period,taken as a whole. Consequently, a contractual form might conceivably be both standardized andnormatively endorsed by a limited number of firms (or during a limited period of time) withoutever achieving enough acceptance to avoid the "idiosyncratic" label. Thus, the idiosyncracymeasure employed here reflects institutionalization or lack thereof, rather than "irrationality" or"quirkiness." From this perspective, overlooked innovations and careless mistakes look prettymuch the same, and high idiosyncracy scores do not necessarily imply failures of draftership.

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Using these data, one can examine three distinct, but interrelated aspects of the

structuration process. First, one can measure the standardization and routinization of VCFCs

over time. Second, one can investigate the possibility that these contracts may subdivide into

several distinct "financing archetypes," rather than reflecting a single monolithic standard. And

third, one can explore exogenous factors influencing choices among various contractual forms.

The remainder of this essay presents a few results from each of these analyses. Although the

findings are largely exploratory, they are also quite suggestive.

Standardization: The VCFC data set provides two summary measures of contractual

standardization/idiosyncracy: (1) an "uncodability" score, indicating the number of terms

departing from the "preferred alternatives" identified in interviews, formbooks and pre-testing;

and (2) a "rarity" score, indicating the number of terms shared with fewer than 5% of the other

sampled agreements. From these indices, a combined "idiosyncracy" score was computed by:

(1) logging the "uncodability" and "rarity" counts, (2) standardizing the logged scores, and (3)

adding the standardized uncodability and rarity values together. This combined score provides a

rough index of the degree to which a given contract contains "non-standard," "counter-

normative" or "deviant" terms -- unusual provisions absent both from prescriptive models and

from other observed financing agreements. In the current data set, these idiosyncracy scores are

roughly normally-distributed, over a range from -3.621 to 3.703, with a mean of 0.02 and a

standard deviation of 1.534.7


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In theory, if venture capital financings are becoming more routinized and

institutionalized over time, one would expect to see idiosyncracy scores declining over the

course of the observation period. As Figure 1 illustrates, this is indeed the case: The average

level of contractual idiosyncracy drops sharply from 1975 to 1980, and it continues to decline

slightly from 1980 until about 1987. Significantly, in addition to showing this secular trend of

standardization, the data also suggest that the eventually-dominant financing norms may have

originated in Silicon Valley, and then gradually diffused outward (see also Suchman 1995). The

upper and lower lines in Figure 1 indicate average idiosyncracy levels for two subsets of the

VCFC sample: (a) those agreements involving either a lead investor or a drafting law firm from

Silicon Valley, and (b) those involving neither a lead investor nor a drafting law firm from

Silicon Valley. The results closely follow the classic pattern associated with socio-technical

diffusion processes (Rogers 1983): At all points, the Silicon Valley contracts are more

standardized than the non-Silicon Valley agreements, and over time, the Silicon Valley

agreements become standardized relatively rapidly, while the non-Silicon Valley agreements

retain substantial levels of idiosyncracy even into the late 1980s.

In summary, this first set of analyses suggests that venture capital financings become

increasingly routinized from 1975 to 1990, and that this routinization originates within Silicon

Valley and then gradually diffuses outward. Not only do these findings provide concrete

empirical evidence of contractual standardization, but also they demonstrate the importance of a

"vanguard" local community in this developmental process.

Of course, these results also leave several crucial questions unanswered. Taken alone,

the observation that contracts have become increasingly standardized says little about the nature

of the developing regime: A decline in idiosyncracy is equally compatible with (a) the

ascendance of a single dominant design or (b) the emergence of a fixed "menu" of multiple

acceptable alternatives. It is to this topic -- the nature of Silicon Valley's emergent contractual

archetype(s) -- that the we turn next.


8For clarity's sake, the following discussion will refer to the input of an MDS analysis as a"similarity" (or "dissimilarity") matrix. As output, MDS yields a set of estimated "coordinates,"

15

Financing Archetypes: The second branch of the empirical investigation explores the

substantive content of a "core subset" of the VCFC database. Specifically, it focusses in on the

78 transactions (out of the original 108) that involved at least one "local" party -- either (a) an

attorney from Silicon Valley (including the two leading Silicon Valley-oriented San Francisco

law firms), (b) a lead investor from the greater Bay Area, or (c) a company from the state of

California. This restricted scope highlights the internal dynamics of the local business

community, preserving fine-grained variations that might otherwise be overshadowed by more

radically disparate contracts from other regions. The goal of the analysis is to create an

empirical "map" of Silicon Valley financing contracts -- first tracing the dimensions that

differentiate agreements one from another, and then examining the distribution of agreements

across these dimensions -- in search of clusters and non-uniformities that might indicate the

presence of discrete contractual models or archetypes.

Although one could, perhaps, investigate the development of particular contractual terms

by analyzing the VCFC data on an item-by-item basis, such an approach hardly represents a

feasible methodology for investigating the development of overall contractual structure, as

manifested in the combined patterning of all 400-plus variables in the data set. Rather, the task

of mapping financing structures demands a multivariate technique that can summarize the

contents of entire agreements along a limited number of analytically tractable dimensions. A

number of such "data reduction" techniques are currently available; however, for the present

analysis, Multi-Dimensional Scaling (Kruskal and Wish 1978) seems particularly promising. In

essence, this technique starts with a matrix of "similarity coefficients," measuring the degree of

resemblance between various data objects (VCFCs in the present context); from this similarity

matrix, MDS produces an N-dimensional "map" of the data objects, such that the Euclidean

distance between any two objects on the map corresponds to the dissimilarity of those same

objects in the original input matrix.8 Thus, for example, an MDS analysis of the flight distances


from which one can calculated predicted "proximities" (or "distances") among the data objects(or "stimuli") of interest. In this terminology, the goal of the MDS algorithm is to estimatecoordinates in such a way as to maximize the fit between observed similarities and predictedproximities.

9The analyses reported below measured contractual similarity using Gower's "GeneralCoefficient of Similarity," a covariation index designed for situations in which data objects arescored on a mixture of dichotomous, polytomous and continuous descriptor variables (Gower1971). Separate similarity matrices were computed for five general categories of contractualprovisions -- covering, respectively: routine operations, allocation of downside losses, allocationof upside rewards, safeguards against bad faith, and mandatory stock conversion. These five"views" of contractual similarity were then analyzed using the INDSCAL MDS algorithm, whichuses information about differences in viewpoint to establish a substantively meaningfulorientation for the axes of the resulting scatter plot.

10The MDS algorithm can map objects in any number of dimensions. However, since high-dimension configurations are difficult to visualize, researchers must balance descriptiveprecision against interpretive clarity in each particular application. In the present analysis,statistical tests suggest that the most appropriate MDS solutions are those having either twodimensions or four. For ease of presentation, the discussion here focusses exclusively on thetwo-dimensional version.

16

between American cities would reproduce the geographic configuration of the United States

(Kruskal and Wish 1978:7-8). Applied to a matrix of coefficients indicating similarity among

VCFCs, MDS ought to produce a scatter-plot of these contracts, in which similar agreements fall

near one another, while dissimilar agreements fall farther apart.9

Figure 2 presents the two-dimensional map of VCFCs that results from such an

analysis.10 Several intriguing features become immediately apparent. First, the observed

contracts clearly do not fall randomly throughout the coordinate plane. Rather, the distribution

is quite "lumpy," with three to five obvious clusters surrounding the origin, and a long trail of

isolates extending from the far left to the lower right. Second, the denser portions of the plot

seem to split into two bands, one lying well above the horizontal axis, and the other lying well

below. Finally, at this level of generality at least, all contracts are definitely not unique: In

several places, the observed financing agreements lie so close together that their marker symbols

are almost perfectly superimposed. Financing agreements in Silicon Valley do, indeed, appear to

follow structured patterns.


17

Identifying the substantive meaning of these patterns, however, requires further analysis.

Perhaps the most common strategy for addressing this interpretive problem involves correlating

selected variables with the MDS coordinates, in order to identify which items covary most

closely with each dimension. Table 1 presents standardized regression coefficients obtained in

this manner. Although hardly unequivocal, these coefficients do reveal several broad patterns.

At the most general level, both dimensions of the scatter plot appear to reflect aspects of

contractual elaboration, with each exhibiting strong negative associations with several indicators

of missing or omitted contractual terms. This pattern emerges particularly clearly in the case of

Dimension 1: The horizontal axis of the configuration displays coefficients of -.70 and beyond

for variables that indicate the absence of dividend clauses, merger provisions and anti-dilution

protections. Somewhat less dramatically, Dimension 2 shows at least a modest negative

association (approximately -.20) with items indicating the absence of liquidation provisions and

registration rights limitations. Further, as this "elaboration" interpretation would predict, both

dimensions correlate positively with the length of the stock purchase agreement and with the

number of covenants and representations and warranties that it contains. In short, contracts

located toward the right and the top of Figure 2 tend to be both longer and more specific than

those located toward the left and the bottom.

While both dimensions of the map measure contractual elaboration, each axis seems to

capture a somewhat distinct aspect of this phenomenon. With regard to Dimension 1, Table 1

suggests that location along this horizontal axis reflects the extent to which a financing

agreement explicitly delineates the various rights and obligations of the contracting parties.

Thus, financings that score highly on this dimension tend to involve preferred as opposed to

common stock; they tend to include specific dividend, merger, mandatory conversion and anti-

dilution provisions; they tend to establish formal mechanisms for stock redemption; and they

tend to be heavily laden with protective covenants -- particularly covenants forestalling decisions

which might weaken investors' preferential rights. The poles of this dimension contrast

improvisational flexibility (toward the left) with pre-planned legalism (toward the right).


11Interestingly, the pattern of loadings in Table 1 suggests that the inter-organizationallinkages addressed by Dimension 2 are quite context-specific. While generally encouragingongoing interaction between venture capitalists and entrepreneurs, high-scoring agreements alsoseem to acknowledge that certain developments can fundamentally alter the nature of the newcompany, making continuation of the investor-founder relationship problematic. Theseagreements tend to require companies to disclose prior obligations (such as commitments to payfinders' fees); they tend to provide investors with "vetoes" over changes in the organizationalcoalition (such as future stock issues or mergers); and they tend to facilitate the departure ofinvestors when the corporation takes actions that might alter its fundamental character (such as amergers, public offerings and even simple maturation).

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Dimension 2, on the other hand, has less to do with the rights-based legalism of the

financing agreement than with the anticipated duration and intensity of the resulting relationship

between the start-up and its investors. Fairly consistently, the vertical axis in Figure 2 correlates

positively with contractual provisions designed to foster a close, long-term partnership between

venture capitalist and entrepreneur -- and negatively with provisions designed to facilitate an

early disengagement of these parties. Thus, for example, contracts with high scores on this

dimension are much more likely to contain "rights of first refusal" (which allow investors to

preserve their involvement through multiple rounds of financing) and much less likely to provide

for company-initiated stock redemptions (which allow successful companies to "buy out" their

initial financial backers).11 At its poles, then, Dimension 2 contrasts short-term, arms-length

financial relationships (toward the bottom of Figure 2) with long-term, hands-on partnerships

(toward the top).

While the foregoing paragraphs highlight important features of the configuration of

financing agreements, an exclusive focus on dimension loadings also obscures certain parts of

the story. Since the sampled contracts do not fall uniformly across the plane of Figure 2, a full

interpretation requires discussion of clusters as well as of continua, of regions as well as of axes.

In the language of multi-dimensional scaling, a "neighborhood" interpretation is required to

complement the "dimensional" interpretation presented above. To provide such a neighborhood

interpretation, one must first identify a limited number of fairly distinct clusters within the data.

These clusters can then be described both in terms of their location in the plane and also in terms

of their association with specific contractual attributes.


12Figure 3 displays the results of a "group average" hierarchical cluster analysis (Everitt1980), which agglomerates contracts into a limited number of non-overlapping clusters, based ontheir spatial proximity within the MDS configuration. To enhance the robustness of thisanalysis, the 16 agreements (20%) having the fewest other contracts in their immediate vicinityhave been "trimmed" and placed into a "pseudo-cluster" of isolates. Statistical tests indicate thatthe remaining 62 VCFCs compose five empirically distinguishable clusters, as described in thetext.

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As illustrated in Figure 3, statistical cluster analysis12 reveals five distinct groupings in

the MDS map -- along with a sixth "pseudo-cluster" of isolates, lying at the fringes of the other

clusters. In general terms, Cluster 1 occupies the lower left-hand quadrant of the figure, while

Cluster 2 occupies the lower right. Clusters 3 and 4 lie in the upper right-hand quadrant, with

Cluster 4 holding a position above Cluster 3 and slightly to its left. Cluster 5 stands alone in the

upper left-hand quadrant. Finally, a trail of isolates (Cluster 0) extends from the far left of the

horizontal axis down to the outskirts of Clusters 1 and 2, in the lower right.

Table 2 explores the substantive content of these clusters, in a manner analogous to Table

1: Specifically, it presents the "cluster loadings" that arise when selected variables are

standardized and regressed against cluster membership. These loadings indicate what sorts of

contractual provisions are most likely to appear in each cluster. The overall pattern suggests that

each group of VCFCs corresponds to a distinct, internally consistent, archetypal image of the

venture capital relationship, as follows:

Cluster 0: Idiosyncratic Contracts -- This pseudo-cluster of isolates contains a mixtureof relatively non-standard contractual terms. On the whole, these agreements areunited primarily by their minimalism. Cluster membership correlates highly withfailure to specify a wide range of contractual features, including: dividendregimes (both nature and rate), merger treatments, mandatory conversionprovisions, anti-dilution protections, and protective covenants. In addition tothese omissions, agreements in this cluster display idiosyncracy in several otherregards, as well -- such as a disproportionate tendency to involve common-stock-only financings and a significantly elevated likelihood of including restrictions onthe private transfer of stock-ownership.

Cluster 1: Weak Contracts -- This cluster represents weakly-specified, short-termagreements, with only limited protections for investors. These contracts containfewer representations and warranties and fewer covenants than the average, andthey rarely protect investors from stock dilution or from corporate mergers. As ageneral matter, contracts in this group resemble short-term loans more than long-term partnerships: Investors benefit from relatively stringent mandatorycumulative dividends, but they sacrifice items such as anti-dilution protections


20

and rights of first refusal, which would allow then to maintain their ownershipstake through future financing rounds. In keeping with this "take the money andrun" character, Cluster 1 also displays a much higher frequency of discretionarystock redemption provisions, which allow successful companies to "buy out"investors -- usually at a premium over the initial investment price, but at adiscount from the stock's market value.

Cluster 2: Pre-Programmed Contracts -- This cluster contains contracts that are in mostregards relatively conventional, but that exhibit a marked preference forestablishing a priori timetables, milestones and benchmarks for relations betweenthe start-up and its investors. Thus, these agreements are substantially morelikely than others to: (a) condition their merger provisions on the achievement ofcertain benchmarks, (b) structure their anti-dilution clauses so that harsh "ratchet"protections revert to more equitable regimes after a specified number of financingrounds, and (c) permit companies to redeem investors' stock upon the occurrenceof particular triggering events. Coupled with an aversion to rights of first refusal,such timetables, milestones and benchmarks conjure an image of the venturecapital relationship as an indentured servitude -- a limited period of reducedautonomy, during which the start-up faces various carefully-delineatedopportunities to earn its freedom from initially-burdensome obligations.

Cluster 3: Legalistic Contracts -- This cluster contains a bevy of highly-elaboratedagreements that establish detailed legal rights for both the start-up and itsinvestors, covering a wide range of eventualities. Thus, for example, financingsin this group feature specific escape hatches for the start-up if performance isgood and specific protections for the investors if performance is poor: Thesecontracts guard the upside interests of the start-up through mandatory conversionprovisions, discretionary stock redemption clauses and complexly contingentmerger treatments; at the same time, these agreements address the downsideconcerns of investors through cumulative dividend provisions, abundantcovenants, thorough representations and warranties, and nearly-universal anti-dilution protection. Between these performance extremes, Cluster 3 seems toembrace a relatively long-term view of the venture capital relationship, withvirtually all agreements granting rights of first refusal to investors who wish tojoin in future financing rounds. In short, these agreements resemble classic long-term contingent claims contracts.

Cluster 4: Close Contracts -- This cluster represents a collection of hands-on financingsdesigned to foster lasting partnerships between start-ups and investors. Thus,contracts in this group tend to have few easy exits, eschewing discretionary stockredemption and placing stringent conditions on investors' powers to register theirholdings for public sale. At the same time, these financings also enact extensivebarriers against the intrusion of unwelcome interlopers into the venture capitalrelationship. In particular, this cluster features harsh anti-dilution protections,nearly-universal rights of first refusal, and numerous protective covenants(including investor vetoes over future stock sales, mergers and rights changes). Finally, in keeping with the partnership model, these agreements tend to be"enterprise-specific," treating mergers as dissolutions of the corporation, ratherthan obliging shareholders to continue on in a radically altered venture. Theoverall image here is of a "jealous marriage" -- a long-term, close and exclusiverelationship, structured so as to forestall potential infidelities.


21

Cluster 5: Flexible Contracts -- This final cluster embraces a relatively flexible, open-ended view of venture capital financing. On the one hand, agreements in thisgroup resemble the minimalist agreements of Cluster 0 and the weak agreementsof Cluster 1, in that they often fail to specify certain "key" terms, such as dividendrates and anti-dilution protections. On the other hand, the non-specificity ofCluster 5 appears to be a conscious strategy for building adaptive relationships,rather than an oversight or an effort to avoid lasting entanglements. Here, theomission of certain obligations goes hand in hand with the careful elaboration ofothers. Numerous representations, warranties and covenants protect investorsagainst prior and future claims on the start-up's assets; financial reportingrequirements and other covenants provide investors with relatively closesupervision over corporate operations; rights of first refusal and stock registrationrights allow investors to reevaluate their involvement as the company matures. Inshort, these agreements resemble relational contracts in laying a solid foundationfor a long-term relationship, while leaving the specifics of that relationship opento future development.

In summary, the six clusters portrayed in Figure 3 correspond, respectively, to: (0)

idiosyncratic contracts, (1) weak contracts, (2) pre-programmed contracts, (3) legalistic

contracts, (4) close contracts, and (5) flexible contracts. As a general matter, none of these

cluster-descriptions invalidates the dimensional interpretation offered above: The pre-

programmed and legalistic clusters located at the extreme right of Dimension 1 do, indeed,

contain more extensively elaborated contractual obligations than do the idiosyncratic, weak and

flexible clusters located at the left; similarly, the legalistic, close and flexible clusters located in

the upper half-plane do, indeed, contemplate more lasting relationships than do the weak and

pre-programmed clusters located below. At the same time, however, this neighborhood

interpretation also suggests numerous characteristics of each cluster that are not easily deducible

from its location with respect to the coordinate axes: Both short-term loans and indentured

servitudes reflect obligations of limited duration, but they involve two radically divergent types

of inter-organizational relationships. Similarly, close supervision and legalistic formalism

address common underlying concerns in fundamentally different ways, and past research

suggests that these differences may have profound effects on important maturational phenomena

such as organizational growth and diversification (Scott 1992:261-262). By shedding light on

such distinctions, a neighborhood interpretation adds important insights into the emerging map

of Silicon Valley financings.


13Significantly, contrary to the tenor of much of the trade literature, none of these sixarchetypes seems unequivocally "pro-company" or "pro-investor." Although the burdens andrewards of individual models may fall unequally in specific transactions, each model represents alogically defensible vision of the venture capital relationship -- a coherent, facially-neutral imageupon whose merits well-intentioned community members might honorably disagree. In short,these six contractual archetypes reflect different ways of reconciling competing interests, ratherthan total victories for one side or the other.

22

Overall, the combined weight of the foregoing analyses suggests that Silicon Valley has

produced several alternative financing archetypes, rather than a single unitary standard.

Moreover, each of these archetypes corresponds to a distinct, internally-consistent model of the

venture-capital relationship.13 From a theoretical perspective, one could argue that these results

illustrate both the existence and the nature of the community's emerging cultural typologies.

Determinants of Financing Structure: Finally, having identified distinct financing archetypes,

one might wish to examine the exogenous factors that influence choices among these alternative

contractual structures. Two key factors emerge: historical timing and inter-organizational

pollination.

Historical Timing: Looking at the data -- or, indeed, even looking at the contractual

documents themselves -- one relationship that fairly leaps out is the pervasive importance of

historical time. There are several ways to see this temporal pattern. First, one can examine the

drafting date of the various contracts in the MDS mapping, as illustrated in Figure 4. Shading in

this figure corresponds to date of financing, with darker symbols indicating more recent

agreements. The superimposed arrow represents the predicted coordinates for an average

contract in each year, based on a two-dimensional, curvilinear OLS regressions equation.

Substantively, Figure 4 portrays a general increase in the expected duration of the financing

relationship, coupled with a curvilinear trend in the level of legalism: While Relational Duration

scores rise throughout the observation period, Rights Elaboration rises only until 1986 -- after

which it experiences a notable decline. Figure 4 also reveals a dramatic concentration of the


14This analysis uses SAS's PROC CLUSTER (SAS Institute 1988) to determine the localdensity of all non-idiosyncratic contracts drafted within each five-year window. For a givencontract, this score corresponds to the number of other contracts lying within a 0.5-unit radius inthe MDS configuration, divided by the total N in the five-year subsample.

23

most recent contracts in the upper half-plane -- and, in particular, in Clusters 4 and 5 (Flexible

contracts and Close contracts). Indeed, by the close of the observation period in 1990, the

pluralism that characterized the community at mid-decade has given way to a situation in which

roughly 75% of all venture capital transactions fall into these two clusters.

These findings highlight the complex succession of organizational models that often

characterizes the early years of an emerging community. At this level of detail, the term

"structuration" seems a misnomer: The results appear to paint a picture of flux, not of structure.

Before concluding the discussion of temporal dynamics, however, it may be worth pausing to

reexamine this tumult from a slightly broader perspective -- looking not at the "typical" contract

in each year, but at the shifting overall configuration. To this end, Figure 5 plots the historical

trajectory of four summary statistics, each of which captures a distinct facet of the structuration

process:

Deviance: Since structuration involves the emergence of behavioral norms and cognitiveschema, it presumably suppresses departures from conventional behavior. InFigure 5a, such departures are indicated simply by the percentage of contractsfalling into the pseudo-cluster of outliers, Cluster 0.

Density: In addition to eliminating idiosyncratic behaviors, structuration implies anincreasing routinization and typification of more conventional behaviors, as well. In the present context, this suggests that contracts should coalesce intoincreasingly dense clusters. To measure this effect, Figure 5b employs themedian "local density" of all non-idiosyncratic contracts within a five-yearwindow.14

Diversity: According to most accounts, not only does the structuration process reduceidiosyncracy and standardize conventional behavior, but also it restricts thenumber of conventional alternatives "on the menu." In Figure 5c, the diversity ofconventional alternatives is captured by a Herfindahl Index (Weinstock 1982),with a potential range from 0 to 0.8.


15The elaboration of established institutions is not, of course, exactly equivalent to theelaboration of contractual provisions. Contracts could, for example, become simpler becausealternative regulatory structures were becoming more complex (cf. Macaulay 1963 [reportingthat business transactions are often governed by informal community norms]). Nonetheless,contractual elaboration and institutional elaboration are clearly related, since contractualpractices are one of the various regulatory institutions that an emerging community mightelaborate.

24

Elaboration: A final aspect of structuration is the increasing elaboration of establishedinstitutions. Consequently, Figure 5d includes, as an index of contractualelaboration, an average of Rights Elaboration and Relational Elaboration15.

Figure 5 offers strong confirmation for the proposition that Silicon Valley's venture

capital financing practices do, indeed, undergo substantial structuration from 1979 to 1990. The

first stage of this developmental process occurs prior to 1983, with the emergence of distinct

contractual archetypes. Initially, most contracts are fairly simple and poorly elaborated. Many

do not fall into any archetypal cluster, and the clusters that do exist are relatively diffuse,

suggesting a great deal of variance in contractual terms. From 1978 to 1983, however, contracts

become more elaborated, less idiosyncratic, and more tightly clustered into distinct archetypes.

Interestingly, the level of diversity actually increases substantially during this early period,

presumably reflecting the introduction of several previously non-existent contractual models.

Between 1983 and 1987, the focus shifts from generating new alternatives to fleshing out

existing approaches. Both density and diversity stabilize at fairly high levels, while elaboration

rises steadily and deviance falls to virtually zero. Then, from 1987 onward, financing practices

enter a consolidation phase: Elaboration reaches a plateau, and although density remains

constant, diversity begins to decline, as some archetypes fall by the wayside. By the end of the

observation period, the structuration process appears to be nearing completion. Most new

contracts in these final years embrace one of two well-defined and highly-elaborated archetypes,

and deviance/innovation remains rare. Thus, the community ultimately arrives at a fairly narrow

range of highly-typified and widely-diffused models of "accepted" contractual structure. In a

word, venture capital financing becomes institutionalized.


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Before moving on, it is perhaps worthwhile to speculate briefly on possible linkages

between the overall process of structuration and the trends in Rights Elaboration and Relational

Duration described above. With some simplification, one might characterize the institutional

environments of organizations as being comprised of both normative institutions and cognitive

institutions (Scott 1995 [distinguishing between regulative, normative, and cognitive

institutions]). Normative frameworks impose moral rules of behavior and support both formal

and informal sanctions for deviance; cognitive frameworks impose taken-for-granted definitions

of reality and support both prospective and retrospective accounts for action. As the

structuration of a new organizational community progresses, both sorts of cultural structure

increase -- but at different paces and with different implications for contractual elaboration. In

new communities, it seems likely that cognitive understandings will tend to become

institutionalized before normative controls, since one must generally develop descriptive models

for cognizing the world before one can develop evaluative criteria for judging it. This initial rise

in cognitive structure presumably fosters both Rights Elaboration and Relational Duration, since

the emergence of shared expectations allows contracting parties to identify (and contract for)

"plausible" contingencies and to envision long-term relationships. As structuration proceeds, the

attendant rise in interaction, hierarchy and social consciousness begins to generate normative

order, as well. The emergence of behavioral norms tends to accelerate the rise in Relational

Duration, because transacting parties can now rely on defectors being stigmatized and

sanctioned. Under many conditions, however, the growth of normative structure may actually

decrease Rights Elaboration, because generalized norms can often substitute for contractual

terms, and because informal sanctions can often substitute for legal enforcement. Thus, early

cognitive structuration fuels an increase in both Relational Duration and Rights Elaboration; but

as normative structuration catches up, only Relational Duration continues to grow, with Rights

Elaboration giving way to more informal standards and controls. While this explanation is


16If this account is correct, it suggests that the precise empirical patterns of Rights Elaborationand Relational Duration observed in Silicon Valley may be typical of new organizationalcommunities, but not generic to all business settings. It seems likely that levels of normative andcognitive structure would follow quite different trajectories in other contexts, such as when twopre-existing business communities are brought into new contact with one another, or when anestablished business community experiences an exogenous economic shock.

26

obviously speculative, it fits reasonably well both with the structuration statistics depicted in

Figure 5 and with the curvilinear trajectory depicted in Figure 4.16

Inter-organizational Pollination: In addition to showing the effects of historical

dynamics, the choice of contractual structure also shows the influence of sponsorship on the part

of both law firms and venture capital funds. In other words, some law firms and some venture

capital funds act as "paradigm pushers," employing contracts that disproportionately reflect a

limited subset of the available archetypes.

Perhaps the most straightforward way to see this is simply to compare the output of the

three law firms that are most heavily represented in the VCFC sample. Figure 6 offers such a

comparison. The first panel depicts the output of LawFirm1, one of Silicon Valley's largest law

offices. While LawFirm1 is clearly a "generalist," the firm displays a noticeable preference for

contracts in Quadrant 1 and Quadrant 3 -- and a clear aversion to the Pre-programmed contracts

of Quadrant 4. LawFirm2 shows an even tighter focus. As depicted in Figure 6b, this San

Francisco-based firm is a classic "specialist": All but four of its fourteen financings occupy

either Quadrant 2 or Quadrant 4 -- and in the latter instance, its six Flexible agreements fall so

close together that their plot symbols cannot be individually distinguished. These narrowly

targeted efforts stand in stark contrast to LawFirm3, another San Francisco-based firm, whose

contracts appear in Figure 6c. LawFirm3's financing agreements scatter almost randomly across

the coordinate plane, with only limited clustering and little standardization: Whereas over half of

the LawFirm2 agreements produce contiguous or overlapping plot symbols, none of the

LawFirm3 agreements do. The pattern is one of extreme generalism, with few clear preferences,

whatsoever.


17This proposed relationship between specialization and typification presumably dependsupon the total number of pollinators in the community and the total number of archetypes thatthey propound. Clearly, a community with fifty generalists each supporting the same menu offive models will experience more rapid typification than a community of fifty specialists eachsupporting a single model of its own.

18In the present investigation, OLS regressions address the factors affecting a contract'slocation along the axial dimensions of "rights elaboration" and "relational elaboration," whilelogistic regressions address the factors affecting a contract's odds of falling into each of the sixarchetypal clusters. Specifically, the OLS regressions reported below employ dimensioncoordinates as their dependent variables, while the logistic regressions employ a series of sixdichotomous dummy variables, each coded "1" for a given cluster and "0" for all others. Methodologically inclined readers will note that the "multiple-dichotomy" approach to clustermembership employed in these logistic regressions is similar -- but not identical -- toconventional "multinomial logit" analysis (e.g., Aldrich & Nelson 1984:73-77). Suchman (1994)provides a detailed comparison of relative strengths and weaknesses of the two approaches.

27

Taken as a whole, these results suggest at least two distinct ways in which the

development of community norms may reflect the actions of inter-organizational pollinators.

First, and most obviously, when a specific pollinator adopts and promulgates a specific model,

the fate of the model and the fate of the pollinator become closely intertwined. Thus, for

example, as LawFirm2 has grown, the Flexible contracts that LawFirm2 favors have proliferated

as well. In addition to such direct paradigm-pushing, however, Figures 6a, 6b and 6c also

suggest that community norms may reflect more subtle aspects of pollinator behavior, as well.

In particular, the contrast between LawFirm2 and LawFirm3 illustrates the fact that law firms

may differ dramatically in the degree of generalism or specialism that they embrace and in the

degree of standardization that they impose on their counseling efforts. These strategic choices

may, in turn, determine both the degree of commercial success that these law firms enjoy and the

degree of structuration that the community experiences. In most situations, the greater the

specialism of inter-organizational pollinators, the faster the typification of community

activities.17

Multivariate Models: In addition to the foregoing bivariate examinations, one can also

employ multivariate regression-like techniques to explore the relative importance of various

determinants of contractual structure, when other determinants are statistically "held constant."18


The relatively small number of cases in the present data set limits the feasibility of large-scale multivariate models -- particularly models including interaction effects and other possiblesources of multicollinearity. To address this difficulty, the analyses reported here each employonly a limited selection of regressors, chosen as follows: First, a preliminary multivariate modelestimated parameters for the full complement of independent variables. Then, a backwardstepwise analysis sequentially removed independent variables, until all remaining itemsdisplayed significance levels of p<.15 or better. Finally, a "compromise" model combined (a) allvariables identified by the stepwise selection algorithm, plus (b) any additional items displayinga significance level of p<.25 or better in the initial all-variables regression. Although somewhatungainly, this technique proved surprisingly robust: In all cases, the "full" model, the "minimal"model and the "compromise" model agreed quite closely, and the estimated parameter valuesshowed remarkable stability. Consequently, the present write-up reports "compromise" models,only.

19In these models, YEAR measures the impact of drafting date, and YEAR2 tests for theexistence of non-linear time trends. LAWFIRM2, LAWFIRM3 and OTHER LAW FIRM arebinary variables identifying the drafting law firm for each contract (with LawFirm1 being theomitted, comparison category). SOURCE 2 and OTHER INVESTOR are binary variablesidentifying the lead venture capital fund in each deal; SOURCE 2 identifies the smaller of thetwo funds that provided contracts for the study, with the larger source fund serving as theomitted, comparison category. SILICON VALLEY COMPANY is a binary variable, coded 1 ifthe start-up is headquartered in or near Silicon Valley. SEMICONDUCTOR,MISCELLANEOUS ELECTRONICS, NETWORKING/TELECOM, SOFTWARE andBIOTECH are binary variables identifying the primary industry of the start-up (with computersystems being the omitted category). The remaining variables measure characteristics of thetransaction itself: VC STAKE is the percentage of corporate ownership that the investorsyndicate is purchasing, VALUATION is the implied valuation of the company as a whole,NUMBER OF INVESTORS is the total size of the investor syndicate, and INVESTORDIVERSITY is a measure of the concentration of ownership across the various members of thesyndicate.

28

Table 3 presents OLS models that regress each VCFC's position on the two MDS axes

against various temporal, institutional and economic predictors.19 Several features of these

results merit comment. The first noteworthy aspect is the relatively high predictive power that

these models achieve based on only a handful of variables. With six independent variables,

Model 1 manages to explain over 40% of the variance in Rights Elaboration (R2=.44; p<.0001),

and Model 2 explains a similar percentage of the variance in Relational Elaboration using just

five regressors (R2=.41; p<.0001).

The individual parameter estimates in Table 3 reveal temporal factors to be by far the

strongest predictors of scores on both dependent variables. In a pattern that accords well with

the graphical data presented in Figure 4, above, Table 3 depicts a fairly steady increase in the

expected duration of venture capital relationships, coupled with a curvilinear trend in legalism:


29

Here, as before, Rights Elaboration appears to rise until the mid-1980s and then to decline

slightly thereafter. Beyond these powerful temporal effects, however, Models 1 and 2 show only

a limited number of additional significant relationships. Model 1 reveals a handful of

differences in Rights Elaboration across industries, but no clear overall pattern emerges. Model

2 finds only one significant non-temporal influence on Relational Duration: start-up location.

Apparently, non-local companies enter into significantly shorter-term financing relationships

than do start-ups headquartered within Silicon Valley (p<.04). This result comports equally well

with either (a) an explanation highlighting Silicon Valley's cultural emphasis on "company-

building," or (b) an explanation highlighting the elevated transaction costs involved in long-term

contractual relationships between remote parties. Unfortunately, the current investigation

(which only examines agreements involving Bay Area investors) offers little potential for

adjudicating between these two competing accounts.

Significantly, while Table 3 certainly illustrates the importance of community

structuration, it provides little evidence that inter-organizational pollinators play an important

role in this structuration process: None of the variables identifying drafting law firms or lead

investors are significantly associated with the overall level of Relational Duration or Rights

Elaboration. Although disconcerting, this result is not entirely unexpected: The cluster analysis,

above, clearly demonstrates that the map of Silicon Valley financings contains numerous non-

linear patterns that are not well-summarized by mere location along the coordinate axes. Before

dismissing the relevance of law firms and venture capital funds in the structuration process, one

would be wise to examine the determinants of cluster membership, as well as the determinants of

axial location.

This task requires a series of six logistic regressions, each focussing on membership in a

single contract-cluster. Table 4 presents such an analysis. Although this table contains several

intriguing individual parameter estimates, the general patterns that emerge across all six models

are the present investigation's primary concern. One such pattern is the fairly consistent

predictive strength of these models. All six logistic regressions reach conventional levels of


30

significance, with most models obtaining a pseudo-R2 of roughly .25, on the basis of only four to

eight regressors. Two equations -- for the "idiosyncratic" cluster and for the "pre-programmed"

cluster -- do substantially better, achieving pseudo-R2 scores of .482 and .615, respectively.

These results attest to the relevance of temporal, inter-organizational and economic factors, taken

together, in explaining the distribution of contracts among archetypes.

Looking at these three groups of determinants individually, one can delineate a number

of additional regularities. First, and most obvious, is the fact that either Year or Year2 (or both)

achieve significance in all six logistic regressions. This finding reconfirms the previously-noted

importance of temporal dynamics in the structuration process: The popularity of contractual

archetypes clearly changes over time, even with other exogenous factors held constant. A

second general pattern appears in the degree to which economic factors show substantial

coefficients. Industry significantly effects the likelihood of adopting Idiosyncratic, Weak, and

Pre-programmed contractual forms, while Investor Diversity significantly influences the chances

of adopting Pre-programmed and Legalistic forms. In total, four out of the six clusters display

significant economic effects of some kind. Finally -- and perhaps most strikingly -- while Table

3 indicates that potential pollinators have little actual impact on the overall level of contractual

elaboration in Silicon Valley, Table 4 suggests that pollinators play a pervasive role in

determining what form that elaboration takes. In four out of the six logistic regressions,

institutional sponsors exert a substantial influence on the probability of employing particular

contractual archetypes: Investors affect the odds that contracts will adopt the Weak and Pre-

programmed forms, while law firms affect the odds that contracts will follow the Pre-

programmed, Close and Flexible models. Specifically, within the Silicon Valley legal

community, the two San Francisco-based firms (LawFirm2 and LawFirm3) produce a

disproportionate number of Pre-programmed contracts, with LawFirm2 showing an additional

inclination toward Flexible agreements, and with the large Palo Alto-based firm (LawFirm1)

emphasizing the Close approach.


31

Taken together, these multivariate models paint a relatively complex picture of the

determinants of contractual form in Silicon Valley. Although temporal dynamics clearly occupy

a position of paramount importance and economic conditions significantly affect several specific

archetypes, the activities of law firms and venture capital funds exert substantial and pervasive

influences as well. Either lead investor, or drafting law firm, or both, is a significant predictor of

membership in virtually every archetypal cluster -- even after controlling for time, company

characteristics, and deal structure. This suggests that the structuration of financing practices in

Silicon Valley was, indeed, driven in large part by the activities of concrete organizational

entities in the community's legal- and financial-services sectors. The foregoing evidence

demonstrates that one cannot explain the genesis of venture capital financing practices in Silicon

Valley without reference to the institutional mechanics of community development.

Overall, then, the quantitative data on venture capital financing contracts offer fairly

detailed empirical evidence of institutional structuration. From 1975 to 1990, Silicon Valley

developed a limited repertoire of relatively standardized financing archetypes, with the choice of

structure in any given transaction turning largely on factors of historical timing and network-

embeddedness. During this period, the contractual approach that each start-up employed

depended heavily on which models were "in" at the time of the financing -- and on which models

were being "pushed" by the law firm handling the drafting work. Thus, the preceding

quantitative analyses largely confirm institutional theorists' predictions about the trajectory of

institutionalization and standardization in new industries. In doing so, the results also illustrate

the substantial impact of local business culture and of social-influence processes on what might,

at first blush, appear to be isolated, rationally-engineered financial transactions.

Conclusion

This investigation highlights a number of noteworthy aspects of the role of law firms in

the structuration of emerging organizational communities. As Silicon Valley illustrates, the


20In some ways, this portrayal of incremental rule-building resembles the Law and Economicsaccount of a social system moving toward efficient governance principles (cf. Ellickson 1991[describing emergence of "efficient" customs]). On the whole, however, the foregoing analysispaints a picture not of progressive optimization, but rather of social construction and historicalpath-dependence (DiMaggio 1991 [describing social construction of an organizational field];Arthur 1989 [predicting path dependent development of certain economic systems]) -- twoaspects of governance that the law and economics tradition tends to ignore (but see Klausner1995 [analyzing path dependence in the development of standardized contracts]).

32

structuration process involves a gradual building of (a) conceptual and material connections,

linking initially disparate groups of organizations; (b) descriptive and prescriptive accounts,

identifying which situations are alike and which are distinct; and (c) instrumental and ritual

decision rules, delineating which attributes are beneficial, proper, and appropriate for specific

organizations in specific situations. Moreover, this incremental process of mutual-adaptation

seems to be channeled in significant ways by the interventions of concrete intermediary actors,

such as law firms and venture capital funds. These apparently ancillary organizations provide

new start-ups with pre-processed infusions of relevant know-how -- serving, in effect, as inter-

organizational pollinators. Over time, such interventions exert a perceptible impact on the

emergence of local business practices, fostering (among other things) a distinctive set of highly

standardized contractual models.20

For sociologists of law, this study offers two significant messages, -- one empirical and

the other theoretical. First, at an empirical level, the study brings some concrete evidence to bear

on the vexing question of what, exactly, corporate lawyers do. In particular, the project

documents the development of a specific "legal device" -- the standard-form VCFC -- and it

demonstrates how the construction of this device was intimately intertwined with the emergence

of a specific organizational community -- Silicon Valley. As one interviewee put it, "Silicon

Valley made venture capital, and venture capital made Silicon Valley." By tracing the trajectory

of this reciprocal process, the preceding analysis helps to delineate the contribution of local law

firms to the making of both.

Beyond this empirical contribution, however, the project offers a theoretical contribution

as well, illustrating the conceptual leverage that one can obtain by linking the study of corporate


33

legal practice to the study of organizational environments. In Silicon Valley, at least, lawyers do

not just engineer technical "devices" that allow specific clients to capture excess economic value

in specific transactions; Silicon Valley lawyers also play a key intermediary role in

institutionalizing the characteristic beliefs, rituals and practices of an entire organizational

community. If we think of law firms in organizational terms, however, it also becomes clear that

lawyers may not be the only actors competing to fill this particular niche. Clearly, for example,

venture capitalists engage in a substantial amount of inter-organizational pollinating, as well.

Consequently, research on corporate law cannot be disentangled from research on the various

populations of clients, competitors and collaborators that make up the corporate law firm's

organizational environment.

This perspective opens the door to an intriguing (but as yet unresolved) debate about

whether Silicon Valley's "pollinator" model of legal practice can survive the maturation of the

organizational community that it helped to produce. On the one hand, the larger institutional

structure of the American legal system clearly places law firms in a privileged structural position

from which to engage in pollination activity: First, as independent consultants, law firms enjoy

fairly intimate contacts with a wide pool of organizational clients, and these contacts generate a

broad vicarious experience-base from which lawyers can synthesize relevant know-how.

Second, lawyers occupy a privileged position from which to disseminate relevant know-how, as

well. The American legal system leaves new companies little choice but to seek professional

legal assistance for even the most basic of organizational acts, and as a result, attorneys enjoy

early and frequent contact with new companies, at precisely that point in the organizational

lifecycle when demands for constitutive information are most intense. Finally, not only do

attorneys observe a wide range of clients and enjoy numerous opportunities to impart advice, but

also they do so in the context of relatively low perceived opportunism. Although lawyers' and

clients' interests can and do diverge, professional ethics and prevailing cultural assumptions tend

to minimize (or at least to obscure) these conflicts to a much greater extent than is the case with


34

many other potential intermediaries. Your lawyer is "yours" in a way that your banker, your

OSHA inspector, and even your accountant never will be.

So, in short, the larger institutional structure of the American legal system places

attorneys in a nearly ideal position from which to monitor wide ranges of organizational

behavior, to convey the results of these observations to new companies at times of maximum

permeability, and to have this advice be received with relatively little skepticism or suspicion.

As a result, as long as Silicon Valley continues to attract new, "unsocialized" entrants, law firms

may continue to find themselves well-situated to perceive, promulgate and institutionalize the

community's distinctive beliefs and practices. In this view, the Silicon Valley law firm's

pollinator role is secure for the foreseeable future.

On the other hand, the structuration model clearly suggests that the organizational

environment may place scope conditions on theories about corporate lawyering, in much the

same way that it places scope conditions on theories about the structures and operations of other,

more commonly studied, organizational populations. If so, there is good reason to wonder

whether the influence of Silicon Valley lawyers can outlive the current, formative period of the

community's history. It is easy, in day-to-day research, to take the law for granted, and to lose

sight of the fact that the legal environment is a social construct, resting in large part on specific

acts of collective categorization. The evidence from Silicon Valley highlights such social

construction processes, precisely because the region's cultural and legal categories still remain

only partially constructed. Given this, however, It seems possible that many of Silicon Valley's

distinctive legal practices are not themselves permanent attributes, but are instead reflections of

this unsettled (and presumably transitory) state of affairs.

From this perspective, one might predict that as local business activities become

increasingly institutionalized and well-understood, a number of changes in legal practice will

ensue: New entrepreneurs will have less need for general business counseling; a wider range of

legal work will be routinized and moved in-house; and any pollination that remains will

increasingly be absorbed by specialized consulting firms. If this account of environmental


35

contingency is correct, the distinctive characteristics of Silicon Valley legal practice may

represent a relatively fleeting state of affairs. As the surrounding organizational community

matures, the role of corporate lawyers in Silicon Valley may gradually come to look more like

the role of corporate lawyers in established communities elsewhere.

Even so, however, the blueprints for organizational life in the stable, over-determined

community of the future would still trace their origins to the pollinating work of law firms in the

fluid, under-determined community of the present. And the legal doctrines that tomorrow's

attorneys invoke in court might very well reflect the informal norms that today's attorneys

construct around the bargaining table.

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the contracting universe: law firms and the evolution of

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