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Investment and financing analysis for a venture capital alternative

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  • Dong, Linjia
  • Yang, Zhaojun

Abstract

We develop a two-stage investment model to examine a novel financing arrangement emerging from the financial services sector. We assume that an entrepreneur, who must borrow funds from a bank to exercise the option to invest in a project, enters into an agreement with an insurer. The insurer guarantees the debt and promises to finance a possible growth investment in the future. The entrepreneur pays a fixed fee to the insurer upon borrowing and grants an equity stake upon the growth investment. We analyze the relationship between the fixed fee and the insurer’s eventual ownership stake, showing that the venture capital alternative succeeds in making a penniless entrepreneur start a project. The project is more valuable if the growth option is granted to the insurer, since it can mitigate the underinvestment problem.

Suggested Citation

  • Dong, Linjia & Yang, Zhaojun, 2023. "Investment and financing analysis for a venture capital alternative," Economic Modelling, Elsevier, vol. 126(C).
    • Handle: RePEc:eee:ecmode:v:126:y:2023:i:c:s0264999323002067
    DOI: 10.1016/j.econmod.2023.106394
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    References listed on IDEAS

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    More about this item

    Keywords

    Real options; Loan guarantees; Alternative venture capital; Growth option; Underinvestment;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H81 - Public Economics - - Miscellaneous Issues - - - Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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