Abstract

http://ssrn.com/abstract=952037
 
 

References (28)



 
 

Citations (17)



 


 



Entrepreneurial Finance: Banks versus Venture Capital


Andrew Winton


University of Minnesota - Twin Cities - Carlson School of Management

Vijay Yerramilli


University of Houston, C. T. Bauer College of Business

December 2006


Abstract:     
We analyze how entrepreneurial firms choose between two funding institutions: banks, who monitor less intensively and face liquidity demands from their own investors, and venture capitalists, who can monitor more intensively but face a higher cost of capital due to the liquidity constraints that they impose on their own investors. Because the firm's manager prefers continuing the firm over liquidating it, and aggressive continuation strategies over conservative strategies, the institution must monitor the firm and exercise some control over its decisions. Bank finance takes the form of debt, whereas venture capital finance often resembles convertible debt. Venture capital finance is optimal only when (1) the aggressive continuation strategy is not too profitable, ex-ante; (2) the firm faces high uncertainty in its choice of continuation strategy; and (3) the firm's cash flow distribution is highly risky and positively skewed, with low probability of success, low liquidation value, and high returns if successful. A decrease in venture capitalists' cost of capital encourages firms to switch from safe strategies and bank finance to riskier strategies and venture capital finance, increasing the average risk of firms in the economy.

Number of Pages in PDF File: 50

Keywords: Venture capital, Contracting, Banks, Entrepreneur, Cost of capital

JEL Classification: G20, G24, G21, G30, G32

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Date posted: December 17, 2006  

Suggested Citation

Winton, Andrew and Yerramilli, Vijay, Entrepreneurial Finance: Banks versus Venture Capital (December 2006). Available at SSRN: http://ssrn.com/abstract=952037 or http://dx.doi.org/10.2139/ssrn.952037

Contact Information

Andrew Winton (Contact Author)
University of Minnesota - Twin Cities - Carlson School of Management ( email )
321 19th Avenue South
Department of Finance
Minneapolis, MN 55455
United States
612-624-0589 (Phone)
612-626-1335 (Fax)
Vijay Yerramilli
University of Houston, C. T. Bauer College of Business ( email )
Houston, TX 77204
United States
713-743-2516 (Phone)
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