Venture Capital Finance: A Security Design Approach

CEMFI Working Paper No. 9804

47 Pages Posted: 24 Jan 1999

See all articles by Rafael Repullo

Rafael Repullo

Centre for Monetary and Financial Studies (CEMFI); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Javier Suarez

Centre for Monetary and Financial Studies (CEMFI); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

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 arising from the managerial contributions of entrepreneurs and venture capitalists. The optimal contractual arrangements have features that resemble the securities actually employed in venture capital financing. In particular, we identify an incentive-related insurance motive for making the initial financier bear the start-up's downside risk, as well as a financing motive for protecting him against dilution. This can explain the widespread use of convertible preferred stock.

JEL Classification: G32

Suggested Citation

Repullo, Rafael and Suarez, Javier, Venture Capital Finance: A Security Design Approach. CEMFI Working Paper No. 9804. Available at SSRN: https://ssrn.com/abstract=145134 or http://dx.doi.org/10.2139/ssrn.145134

Rafael Repullo (Contact Author)

Centre for Monetary and Financial Studies (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91429 0551 (Phone)
+34 91429 1056 (Fax)

HOME PAGE: http://www.cemfi.es/~repullo/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Javier Suarez

Centre for Monetary and Financial Studies (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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