IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this article

IPOs, acquisitions, and the use of convertible securities in venture capital

Listed author(s):
  • Hellmann, Thomas

This paper provides a new explanation for the use of convertible securities in venture capital, which is based on the trade-off between acquisition or IPOs. A key property of convertible preferred equity is that it allocates different cash flow rights, depending on whether exit occurs by acquisition or IPO. The paper builds a model with double moral hazard, where both the entrepreneur and the venture capitalist provide value-adding effort. The optimal contract gives the venture capitalist more cash flow rights in acquisitions than IPOs. This explains the use of convertible preferred equity, including automatic conversion at IPO. Contingent control rights are shown to be instrumental for achieving effcient exit decisions. The model also explains when to use simple versus participating convertible preferred equity.

(This abstract was borrowed from another version of this item.)

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.sciencedirect.com/science/article/pii/S0304-405X(06)00018-3
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 81 (2006)
Issue (Month): 3 (September)
Pages: 649-679

as
in new window

Handle: RePEc:eee:jfinec:v:81:y:2006:i:3:p:649-679
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as
in new window


  1. Black, Bernard S. & Gilson, Ronald J., 1998. "Venture capital and the structure of capital markets: banks versus stock markets," Journal of Financial Economics, Elsevier, vol. 47(3), pages 243-277, March.
  2. Moore, John & Repullo, Rafael, 1988. "Subgame Perfect Implementation," Econometrica, Econometric Society, vol. 56(5), pages 1191-1220, September.
  3. Philippe Aghion & Patrick Bolton & Jean Tirole, 2004. "Exit Options in Corporate Finance: Liquidity versus Incentives," Review of Finance, European Finance Association, vol. 8(3), pages 327-353.
  4. Repullo, R. & Suarez, J., 1998. "Venture Capital Finance: a Security Design Approach," Papers 9804, Centro de Estudios Monetarios Y Financieros-.
  5. Steven N. Kaplan & Per Stromberg, 2002. "Characteristics, Contracts, and Actions: Evidence from Venture Capitalist Analyses," NBER Working Papers 8764, National Bureau of Economic Research, Inc.
  6. Oliver Hart & John Moore, 1998. "Default and Renegotiation: A Dynamic Model of Debt," The Quarterly Journal of Economics, Oxford University Press, vol. 113(1), pages 1-41.
  7. Casamatta, Catherine, 2002. "Financing and Advising: Optimal Financial Contracts with Venture Capitalists," CEPR Discussion Papers 3475, C.E.P.R. Discussion Papers.
  8. Schmidt, Klaus M., 1999. "Convertible Securities and Venture Capital Finance," CEPR Discussion Papers 2317, C.E.P.R. Discussion Papers.
  9. Steven N. Kaplan & Per Strömberg, 2003. "Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts," Review of Economic Studies, Oxford University Press, vol. 70(2), pages 281-315.
  10. Darwin V. Neher, 1999. "Staged Financing: An Agency Perspective," Review of Economic Studies, Oxford University Press, vol. 66(2), pages 255-274.
  11. Ulrich Hege & Dirk Bergemann, 1998. "Venture capital financing, moral hazard, and learning," Post-Print hal-00481696, HAL.
  12. Giacinta Cestone & Lucy White, 2003. "Anticompetitive Financial Contracting: The Design of Financial Claims," Journal of Finance, American Finance Association, vol. 58(5), pages 2109-2142, October.
  13. Mark Grinblatt & Chuan Yang Hwang, "undated". "Signalling and the Pricing of Unseasoned New Issues," Rodney L. White Center for Financial Research Working Papers 01-89, Wharton School Rodney L. White Center for Financial Research.
  14. Stein, Jeremy C., 1992. "Convertible bonds as backdoor equity financing," Journal of Financial Economics, Elsevier, vol. 32(1), pages 3-21, August.
  15. Leslie M. Marx, 1998. "Efficient venture capital financing combining debt and equity," Review of Economic Design, Springer;Society for Economic Design, vol. 3(4), pages 371-387.
  16. 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.
  17. David H. Hsu, 2004. "What Do Entrepreneurs Pay for Venture Capital Affiliation?," Journal of Finance, American Finance Association, vol. 59(4), pages 1805-1844, 08.
  18. Steven N. Kaplan & Per Stromberg, 2001. "Venture Capitalists As Principals: Contracting, Screening, and Monitoring," NBER Working Papers 8202, National Bureau of Economic Research, Inc.
  19. Bascha, Andreas & Walz, Uwe, 2001. "Convertible securities and optimal exit decisions in venture capital finance," Journal of Corporate Finance, Elsevier, vol. 7(3), pages 285-306, September.
  20. Dessi, Roberta, 2004. "Start-up Finance, Monitoring and Collusion," IDEI Working Papers 264, Institut d'Économie Industrielle (IDEI), Toulouse.
  21. Hellmann, Thomas & Puri, Manju, 2000. "The Interaction between Product Market and Financing Strategy: The Role of Venture Capital," Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 959-984.
  22. Green, Richard C., 1984. "Investment incentives, debt, and warrants," Journal of Financial Economics, Elsevier, vol. 13(1), pages 115-136, March.
  23. Philippe Aghion & Patrick Bolton, 1992. "An Incomplete Contracts Approach to Financial Contracting," Review of Economic Studies, Oxford University Press, vol. 59(3), pages 473-494.
  24. Luigi Zingales, 1995. "Insider Ownership and the Decision to Go Public," Review of Economic Studies, Oxford University Press, vol. 62(3), pages 425-448.
  25. Sahlman, William A., 1990. "The structure and governance of venture-capital organizations," Journal of Financial Economics, Elsevier, vol. 27(2), pages 473-521, October.
  26. Hellmann, Thomas, 2002. "A theory of strategic venture investing," Journal of Financial Economics, Elsevier, vol. 64(2), pages 285-314, May.
  27. Habib, Michel A & Ljungqvist, Alexander P, 2001. "Underpricing and Entrepreneurial Wealth Losses in IPOs: Theory and Evidence," Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 433-458.
  28. Inderst, Roman & Muller, Holger M., 2004. "The effect of capital market characteristics on the value of start-up firms," Journal of Financial Economics, Elsevier, vol. 72(2), pages 319-356, May.
  29. Masako Ueda, 2004. "Banks versus Venture Capital: Project Evaluation, Screening, and Expropriation," Journal of Finance, American Finance Association, vol. 59(2), pages 601-621, 04.
  30. Scott Shane, 2001. "Technological Opportunities and New Firm Creation," Management Science, INFORMS, vol. 47(2), pages 205-220, February.
  31. Cestone, Giacinta, 2002. "Venture Capital Meets Contract Theory: Risky Claims or Formal Control?," CEPR Discussion Papers 3462, C.E.P.R. Discussion Papers.
  32. Berglof, Erik, 1994. "A Control Theory of Venture Capital Finance," Journal of Law, Economics and Organization, Oxford University Press, vol. 10(2), pages 247-267, October.
  33. Andrei A. Kirilenko, 2001. "Valuation and Control in Venture Finance," Journal of Finance, American Finance Association, vol. 56(2), pages 565-587, 04.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:eee:jfinec:v:81:y:2006:i:3:p:649-679. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.