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Venture Capital Finance: a Security Design Approach

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  • Repullo, R.
  • Suarez, J.

Abstract

This paper provides a theory of venture capital financing based on the complementarity between the financing and advising roles of venture capitalists. We examine the interaction between the staging of investment, that characterizes young firms with a high growth potential, and the double-sided moral hazard problem arising from the managerial contributions of entrepreneurs and venture capitalists. The optimal contractual arrangements have features that resemble the securities actually employed in venture capital financing. In particular, we identify an incentive-related insurance motive for making the initial financier bear the start-up's downside risk, as well as a financing motive for protecting him against dilution. This can explain the widespread use of convertible preferred stock.

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Bibliographic Info

Paper provided by Centro de Estudios Monetarios Y Financieros- in its series Papers with number 9804.

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Length: 46 pages
Date of creation: 1998
Date of revision:
Handle: RePEc:fth:cemfdt:9804

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Postal: Centro de Estudios Monetarios Y Financieros. Casado del Alisal, 5-28014 Madrid, Spain.
Phone: 914290551
Fax: 914291056
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Web page: http://www.cemfi.es/
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Keywords: CAPITAL ; INVESTMENTS ; BUSINESS FINANCING;

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