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Financing the Entrepreneurial Venture

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  • Jean-Etienne de Bettignies

    ()
    (Queen's School of Business, Queen's University, Kingston, Ontario K7L 3N6, Canada)

Abstract

We model financial contracting in entrepreneurial ventures. In our incomplete contracts framework, the entrepreneur can design contracts contingent on three possible control right allocations: entrepreneur control, investor control, and joint control, with each allocation inducing different effort levels by both the entrepreneur and the investor. We find that a variety of contracts resembling financial instruments commonly used in practice, such as common stock, straight and convertible preferred equity, and secured and unsecured debt, can emerge as optimal, depending on two key factors: entrepreneur/investor effort complementarity and investors' opportunity cost of capital. The results of our model are consistent with, and yield new explanations for, empirical regularities such as (a) the prevalence of equity-type contracts in high-growth ventures and of debt-type contracts in lifestyle ventures; (b) geographical and temporal differences in equity-type instruments used in high-growth ventures; and (c) the impact of firm and loan characteristics on the choice between secured and unsecured debt.

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File URL: http://dx.doi.org/10.1287/mnsc.1070.0759
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Bibliographic Info

Article provided by INFORMS in its journal Management Science.

Volume (Year): 54 (2008)
Issue (Month): 1 (January)
Pages: 151-166

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Handle: RePEc:inm:ormnsc:v:54:y:2008:i:1:p:151-166

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Keywords: entrepreneurial finance; incomplete contracts; debt versus equity;

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Cited by:
  1. Cabolis, Christos & Dai, Mian & Serfes, Konstantinos, 2014. "Competition and Specialization: Evidence from Venture Capital," School of Economics Working Paper Series 2014-5, LeBow College of Business, Drexel University.
  2. Yan Alperovych & Georges Hübner, 2013. "Incremental impact of venture capital financing," Small Business Economics, Springer, vol. 41(3), pages 651-666, October.
  3. J.E. de Bettignies & Gilles Chemla, 2003. "Corporate Venture Capital: The Upside of Failure and Competition for Talent," THEMA Working Papers 2003-45, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  4. Marco Da Rin & Thomas F. Hellmann & Manju Puri, 2011. "A survey of venture capital research," NBER Working Papers 17523, National Bureau of Economic Research, Inc.
  5. Douglas Cumming, 2010. "Public policy and the creation of active venture capital markets," Venture Capital, Taylor & Francis Journals, vol. 13(1), pages 75-94, April.
  6. Heger, Diana & Hussinger, Katrin, 2013. "External capital access and new product launch in start-up firms with uncertain intellectual property rights," ZEW Discussion Papers 13-095, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  7. de Bettignies, Jean-Etienne & Brander, James A., 2007. "Financing entrepreneurship: Bank finance versus venture capital," Journal of Business Venturing, Elsevier, vol. 22(6), pages 808-832, November.
  8. Timo Fischer & Gaétan de Rassenfosse, 2011. "Debt Financing of High-growth Startups," DRUID Working Papers 11-04, DRUID, Copenhagen Business School, Department of Industrial Economics and Strategy/Aalborg University, Department of Business Studies.
  9. Cumming, Douglas J., 2005. "Agency costs, institutions, learning, and taxation in venture capital contracting," Journal of Business Venturing, Elsevier, vol. 20(5), pages 573-622, September.
  10. Dang, Viet Anh, 2010. "Optimal financial contracts with hidden effort, unobservable profits and endogenous costs of effort," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(1), pages 75-89, February.
  11. Ambec, S., 2004. "On the governance of start-ups," Working Papers 200406, Grenoble Applied Economics Laboratory (GAEL).
  12. Nofsinger, John R. & Wang, Weicheng, 2011. "Determinants of start-up firm external financing worldwide," Journal of Banking & Finance, Elsevier, vol. 35(9), pages 2282-2294, September.

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