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Venture Capital Contracts and Market Structure

  • Holger M Muller
  • Roman Inderst


We examine the relation between optimal venture capital contracts and the supply and demand for venture capital. Both the composition and type of financial claims held by the venture capitalist and entrepreneur depend on the market structure. Beside, different market structures involve different optimal forms of transferring utility: sometimes it is optimal to transfer utility via equity stakes, sometimes it is optimal to use debt. Transferring utility via equity stakes affects incentives. Consequently, the net value created, the success probability, the market value, and the performance of venture-capital backed investments depend on the supply and demand for capital. Similarly, venture capitalists face different incentives to screen projects if the capital supply is low or high. We then endogenize the capital supply and study the relation between venture capital contracts and entry costs, public policy, investment profitability and market transparency. Finally, we show that entry by inexperienced investors creates a negative externality for the value creation in ventures financed by (regular) venture capitalists.

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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp411.

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Date of creation: Mar 2002
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Handle: RePEc:fmg:fmgdps:dp411
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  1. Klaus M. Schmidt, 2003. "Convertible Securities and Venture Capital Finance," Journal of Finance, American Finance Association, vol. 58(3), pages 1139-1166, 06.
  2. Hellmann, Thomas, 2002. "A theory of strategic venture investing," Journal of Financial Economics, Elsevier, vol. 64(2), pages 285-314, May.
  3. Patrick Legros & Andrew Newman, 2008. "Competing for ownership," ULB Institutional Repository 2013/7020, ULB -- Universite Libre de Bruxelles.
  4. Kaplan, Steven N. & Strömberg, Per, 2003. "Characteristics, Contracts and Actions: Evidence from Venture Capitalist Analyses," SIFR Research Report Series 14, Institute for Financial Research.
  5. Catherine Casamatta, 2003. "Financing and Advising: Optimal Financial Contracts with Venture Capitalists," Journal of Finance, American Finance Association, vol. 58(5), pages 2059-2086, October.
  6. Claudio Michelacci & Javier Suarez, 2000. "Business Creation and the Stock Market," Econometric Society World Congress 2000 Contributed Papers 0673, Econometric Society.
  7. George W. Fenn & J. Nellie Liang & Stephen D. Prowse, 1995. "The economics of the private equity market," Staff Studies 168, Board of Governors of the Federal Reserve System (U.S.).
  8. Giacinta CESTONE, 2001. "Venture Capital Meets Contract Theory: Risky Claims or Formal Control?," UFAE and IAE Working Papers 480.01, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  9. Lerner, Josh, 1995. " Venture Capitalists and the Oversight of Private Firms," Journal of Finance, American Finance Association, vol. 50(1), pages 301-18, March.
  10. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
  11. Holmström, Bengt & Tirole, Jean, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," IDEI Working Papers 40, Institut d'Économie Industrielle (IDEI), Toulouse.
  12. Inderst, Roman, 2001. "Screening in a Matching Market," Review of Economic Studies, Wiley Blackwell, vol. 68(4), pages 849-68, October.
  13. Steven N. Kaplan & Per Stromberg, 2003. "Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts," Review of Economic Studies, Wiley Blackwell, vol. 70(2), pages 281-315, 04.
  14. Rafael Repullo & Javier Suarez, 2004. "Venture Capital Finance: A Security Design Approach," Review of Finance, Springer, vol. 8(1), pages 75-108.
  15. Hellmann, Thomas F. & Puri, Manju, 2000. "Venture Capital and the Professionalization of Start-up Firms: Empirical Evidence," Research Papers 1661, Stanford University, Graduate School of Business.
  16. Gompers, Paul & Lerner, Josh, 2000. "Money chasing deals? The impact of fund inflows on private equity valuation," Journal of Financial Economics, Elsevier, vol. 55(2), pages 281-325, February.
  17. Aghion, Philippe & Bolton, Patrick, 1992. "An Incomplete Contracts Approach to Financial Contracting," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 473-94, July.
  18. Broecker, Thorsten, 1990. "Credit-Worthiness Tests and Interbank Competition," Econometrica, Econometric Society, vol. 58(2), pages 429-52, March.
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