Adverse Selection and Capital Structure: Evidence from Venture Capital

35 Pages Posted: 14 Mar 2001 Last revised: 10 Sep 2008

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Recent non-U.S. venture capitalist datasets around the world have consistently reported the use of a variety of instruments by venture capital funds around the world, including common equity, preferred equity, convertible preferred equity, debt, convertible debt, and combinations (in the U.S., venture capitalists typically use convertible preferred equity, and there is a tax bias in favour of that instrument in the U.S.). The types of entrepreneurial firms that receive venture finance may be defined by a variety of characteristics, such as stage of development, type of industry, and capital requirements. Given this broad context observed in practice, previous research has not considered the extent to which different securities, among the complete class of forms of finance, attract different types of entrepreneurial firms. In this paper we investigate the empirical tractability of the adverse selection risks associated with capital structure from 4114 Canadian venture capital investments. We characterize of the nature of uncertainty (in terms of the risk of financing a lemon or a nut) facing investors for different types of entrepreneurial firms. We show that venture capitalist syndication significantly mitigates problems of adverse selection.

Keywords: Financial contracting, capital structure, adverse selection, entrepreneurship, venture capital

JEL Classification: G24, G28, G32, G38

Suggested Citation

Cumming, Douglas J., Adverse Selection and Capital Structure: Evidence from Venture Capital. Entrepreneurship Theory and Practice, Vol. 30, pp. 155-184, 2006, Available at SSRN: or

Douglas J. Cumming (Contact Author)

Florida Atlantic University ( email )

777 Glades Rd
Boca Raton, FL 33431
United States


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