Staged Venture Capital Contracting with Ratchets and Liquidation Rights
32 Pages Posted: 9 Dec 2009 Last revised: 1 Aug 2011
Date Written: July 30, 2011
This paper uses real options analysis to study later round financing in the presence of two standard venture capital contracting provisions: anti-dilution (ratchet) and liquidation preference. We argue that such provisions can preclude financing of a positive NPV venture in the case of a large follow-on financing relative to firm value. Liquidation preference contracting at multiples greater than one is not feasible in the later round if the financing is small relative to firm value. We highlight an interaction effect between the two provisions: increasing the liquidation multiple can help to avoid dilution and the need for the prior venture capitalist to waive ratchet provisions.
Keywords: options, venture capital, preference rights
JEL Classification: G13, G24, G30
Suggested Citation: Suggested Citation