Product Market Competition and the Financing of New Ventures

70 Pages Posted: 9 Mar 2014 Last revised: 24 Oct 2017

See all articles by Jean-Etienne de Bettignies

Jean-Etienne de Bettignies

Queen's University - Smith School of Business

Anne Duchene

IPAG Business School

Date Written: July 22, 2014

Abstract

This paper examines the interaction between venture risk, product market competition and entrepreneurs' choice between bank financing and venture capital (VC) financing. Under bank financing, a debt-type contract emerges as optimal, which allows the entrepreneur to retain full control of the venture and thus yields strong effort incentives, as long as she can service the debt repayment; but leads to liquidation in case of default, making the venture's success quite sensitive to exogenous, even temporary shocks that may hinder debt repayment. Under VC financing an equity-type contract emerges as optimal, which is not sensitive to exogenous shocks, but requires the entrepreneur to share a fraction of the rents with the financier, thus yielding lower effort incentives for the entrepreneur. There exists a threshold level of venture risk such that bank financing is optimal if and only if venture risk is below that threshold. Product market competition increases the value of stronger entrepreneurial incentives, and thus increases the maximum level of risk the entrepreneur is willing to take before switching from bank financing to VC financing. This is a robust result that is shown to hold in various models of competition, including Hotelling, Salop, Dixit-Stiglitz, Cournot-to-Bertrand switch.

Keywords: product market competition, venture risk, bank financing, venture capital

JEL Classification: D23, D43, G32, L13, L22, M13

Suggested Citation

de Bettignies, Jean-Etienne and Duchene, Anne, Product Market Competition and the Financing of New Ventures (July 22, 2014). Available at SSRN: https://ssrn.com/abstract=2403211 or http://dx.doi.org/10.2139/ssrn.2403211

Jean-Etienne De Bettignies (Contact Author)

Queen's University - Smith School of Business ( email )

Smith School of Business - Queen's University
143 Union Street
Kingston, Ontario K7L 3N6
Canada

Anne Duchene

IPAG Business School ( email )

184 BD Saint Germain
Paris, 75006
France

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