Valuation and Control in Venture Finance

Abstract:     
A model is presented representing the expectations of a venture capitalist and an entrepreneur who are working on the development of a new enterprise. The model assumes that the venture capitalist requires more control because of his or her financial investment. The entrepreneur is compensated for lack of control by receiving special consideration through better financing terms, the ability to extract higher rents from asymmetric information, and the added benefit of improved sharing of risks involved in the new business venture. The model is used to investigate how an optimal allocation of control rights can be implemented through direct mechanisms. The conclusion is that an optimal level of control rights can be implemented via a competitive market for control or bilateral bargaining procedures.(JSD)

Keywords: Adverse selection, Startups, Venture capitalists, Bargaining, Control rights, Firm financing, Risk management

Accepted Paper Series