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Convertible Preferred Stock in Venture Capital Financing

Filippo Ippolito ()

OFRC Working Papers Series from Oxford Financial Research Centre

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.

JEL-codes: G21 G24 G32 G33 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-cfn, nep-ent and nep-fin
Date: 2005
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