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Support and Interference: Venture Financing with Multiple Tasks

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  • Ibolya Schindele

    ()
    (University of Amsterdam, Department of Financial Management)

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    Abstract

    The paper focuses on the financing possibilities for capital constrained entrepreneurs when venture financiers perform two tasks, monitoring and advice. We model advice as effort that results in an increase in the probability of success. In turn, we consider monitoring as an activity exerted to control entrepreneurial project choice, which results in an increase in the returns in the less successful state. Thus entrepreneurs favor advice and dislike monitoring. Through the financial claim offered, an entrepreneur can affect the financier’s effort exertion on the two tasks. The primary result is that highly capital constrained entrepreneurs can get financing only with intense monitoring and limited advice. The optimal financial claim resembles to a convertible debt contract. Entrepreneurs endowed with more self-financing can restrain the level of monitoring, thus induce more advice, and can offer an equity contract. The results may shed light on contracting practices observed in the venture capital industry, namely the unusual negative correlation between control and cash-flow rights and the use of a variety of securities.

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    File URL: http://econ.core.hu/doc/dp/dp/mtdp0215.pdf
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    Bibliographic Info

    Paper provided by Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences in its series IEHAS Discussion Papers with number 0215.

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    Length: 38 pages
    Date of creation: Dec 2002
    Date of revision:
    Handle: RePEc:has:discpr:0215

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    1. Klaus Schmidt, 1999. "Convertible Securities and Venture Capital Finance," CESifo Working Paper Series 217, CESifo Group Munich.
    2. Repullo, R. & Suarez, J., 1998. "Venture Capital Finance: a Security Design Approach," Papers 9804, Centro de Estudios Monetarios Y Financieros-.
    3. Sahlman, William A., 1990. "The structure and governance of venture-capital organizations," Journal of Financial Economics, Elsevier, vol. 27(2), pages 473-521, October.
    4. Douglas Cumming, 2008. "Contracts and Exits in Venture Capital Finance," Review of Financial Studies, Society for Financial Studies, vol. 21(5), pages 1947-1982, September.
    5. Bergemann, Dirk & Hege, Ulrich, 1998. "Venture capital financing, moral hazard, and learning," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 703-735, August.
    6. Bengt Holmstrom & Jean Tirole, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," Working papers 95-1, Massachusetts Institute of Technology (MIT), Department of Economics.
    7. Cestone, Giacinta, 2002. "Venture Capital Meets Contract Theory: Risky Claims or Formal Control?," CEPR Discussion Papers 3462, C.E.P.R. Discussion Papers.
    8. Thomas Hellmann, 1998. "The Allocation of Control Rights in Venture Capital Contracts," RAND Journal of Economics, The RAND Corporation, vol. 29(1), pages 57-76, Spring.
    9. Thomas Hellmann & Manju Puri, 2002. "Venture Capital and the Professionalization of Start-Up Firms: Empirical Evidence," Journal of Finance, American Finance Association, vol. 57(1), pages 169-197, 02.
    10. Kaplan, Steven & Strömberg, Per Johan, 2002. "Characteristics, Contracts and Actions: Evidence from Venture Capitalist Analyses," CEPR Discussion Papers 3243, C.E.P.R. Discussion Papers.
    11. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," Journal of Law, Economics and Organization, Oxford University Press, vol. 7(0), pages 24-52, Special I.
    12. Sapienza, Harry J. & Manigart, Sophie & Vermeir, Wim, 1996. "Venture capitalist governance and value added in four countries," Journal of Business Venturing, Elsevier, vol. 11(6), pages 439-469, November.
    13. Casamatta, Catherine, 2002. "Financing and Advising: Optimal Financial Contracts with Venture Capitalists," CEPR Discussion Papers 3475, C.E.P.R. Discussion Papers.
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