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Convertible Preferred Stock in Venture Capital Financing

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  • Filippo Ippolito

Abstract

We provide an explanation for the widespread use of senior convertible preferred stock in venture capital financing. We develop a model of cash constrained entrepreneurs who need an investor to finance their project. Investors can either be uninformed, such as small individual bondholders, or informed, such as venture capitalists and banks. There is an entrepreneurial moral hazard problem, which can be partially overcome through monitoring only by informed investors. However, monitoring is only e.ective if investors can commit ex ante to liquidate the project after observing a poor signal. We show that a capital structure that minimizes commitment and information costs requires entrepreneurs to contribute to the financing of the project with common stock and venture capitalists to hold senior convertible preferred stock.

Suggested Citation

  • Filippo Ippolito, 2005. "Convertible Preferred Stock in Venture Capital Financing," OFRC Working Papers Series 2005fe12, Oxford Financial Research Centre.
  • Handle: RePEc:sbs:wpsefe:2005fe12
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    File URL: http://www.finance.ox.ac.uk/file_links/finecon_papers/2005fe12.pdf
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    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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