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Going Public and the Option Value of Convertible Securities in Venture Capital

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  • Hellmann, Thomas F.

    (Stanford U)

Abstract

This paper considers potential disagreements between an entrepreneur and a venture capitalist about the desirability of taking a company public. Convertible securities are shown to be optimal for a novel reason. In particular, it is shown that automatic conversion at the time of the IPO takes away the option value of the convertible security. This provides an optimal incentive for the venture capitalist not to push the company too hard (or too early) into going public. The paper also derives the optimality of demand registration rights.

Suggested Citation

  • Hellmann, Thomas F., 2000. "Going Public and the Option Value of Convertible Securities in Venture Capital," Research Papers 1703, Stanford University, Graduate School of Business.
  • Handle: RePEc:ecl:stabus:1703
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    File URL: http://gsbapps.stanford.edu/researchpapers/library/RP1703.pdf
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    References listed on IDEAS

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    1. 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.
    2. 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.
    3. 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, February.
    4. Rafael Repullo & Javier Suarez, 2004. "Venture Capital Finance: A Security Design Approach," Review of Finance, European Finance Association, vol. 8(1), pages 75-108.
    5. Hellmann, Thomas, 2006. "IPOs, acquisitions, and the use of convertible securities in venture capital," Journal of Financial Economics, Elsevier, vol. 81(3), pages 649-679, September.
    6. 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.
    7. Sahlman, William A., 1990. "The structure and governance of venture-capital organizations," Journal of Financial Economics, Elsevier, vol. 27(2), pages 473-521, October.
    8. Gompers, Paul A., 1996. "Grandstanding in the venture capital industry," Journal of Financial Economics, Elsevier, vol. 42(1), pages 133-156, September.
    9. Lerner, Joshua, 1994. "Venture capitalists and the decision to go public," Journal of Financial Economics, Elsevier, vol. 35(3), pages 293-316, June.
    10. 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.
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    Cited by:

    1. Schwienbacher, Armin, 2007. "A theoretical analysis of optimal financing strategies for different types of capital-constrained entrepreneurs," Journal of Business Venturing, Elsevier, vol. 22(6), pages 753-781, November.
    2. John Armour, 2002. "Law, Innovation and Finance: A Review," Working Papers wp243, Centre for Business Research, University of Cambridge.

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