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The Complementarity Effect: Effort and Sharing in the Entrepreneur and Venture Capital Contract

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  • Marcos Vergara
  • Claudio Bonilla
  • Jean P. Sepúlveda

    (School of Business and Economics, Universidad del Desarrollo)

Abstract

This paper focuses on the relationship between the venture capitalist and the entrepreneur. In particular, it analyses how both players’ unobservable effort levels affect the equity share that the entrepreneur is willing to cede to the venture capitalist. We solve the entrepreneur’s maximization problem in the presence of double-sided moral hazard. In this scenario, we show that the venture capitalist’s share is binding and, therefore, there is no efficiency wage. We simulate the model and show that the entrepreneur’s effort does not monotonically decrease in the share allocated to the venture capital, while the venture capitalist’s effort does not monotonically increase in his share. We show that as efforts tend to be more complementary, the project cash flows are distributed nearly equally, at approximately 50% for each partner. This theoretical finding is actually observed in real contracts between entrepreneurs and venture capitalists.
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Suggested Citation

  • Marcos Vergara & Claudio Bonilla & Jean P. Sepúlveda, 2016. "The Complementarity Effect: Effort and Sharing in the Entrepreneur and Venture Capital Contract," Serie Working Papers 31, Universidad del Desarrollo, School of Business and Economics.
  • Handle: RePEc:dsr:wpaper:31
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    References listed on IDEAS

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    Cited by:

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    2. Ferreira, Ricardo M. & Pereira, Paulo J., 2021. "A dynamic model for venture capitalists’ entry–exit investment decisions," European Journal of Operational Research, Elsevier, vol. 290(2), pages 779-789.
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    Keywords

    Double-sided moral hazard; Venture Capital; Equity Share;
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