Venture Capital Finance: A Security Design Approach

Rafael Repullo and Javier Suarez

No 2097, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper provides a theory of venture capital financing based on the complementarity between the financing and advising roles of venture capitalists. We examine the interaction between the staging of investment that characterizes young firms with a high growth potential and the double-sided moral hazard problem that arises from the managerial contributions of entrepreneurs and venture capitalists. The optimal contract combines an incentive-related insurance motive that makes the initial financiers bear the start-up's downside risk and a financing motive that protects their claims against dilution. These motives can explain the widespread use of convertible preferred stock in venture capital financing.

Keywords: convertible preferred stock; Incomplete Contracts; stage financing; start-ups; Venture Capital; warrants (search for similar items in EconPapers)
JEL-codes: D92 G24 G32 (search for similar items in EconPapers)
Date: 1999-03
References: Add references at CitEc
Citations: View citations in EconPapers (24)

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http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2097 (application/pdf)

Related works:
Journal Article: Venture Capital Finance: A Security Design Approach (2004)
Journal Article: Venture Capital Finance: A Security Design Approach (2004)
Working Paper: Venture Capital Finance: A Security Design Approach (1998)
Working Paper: Venture Capital Finance: a Security Design Approach (1998)
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