Venture Capital Contracts and Market Structure
36 Pages Posted: 5 Nov 2008
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Venture Capital Contracts and Market Structure
Venture Capital Contracts and Market Structure
Venture Capital Contracts and Market Structure
Date Written: January 2002
Abstract
We examine the relation between optimal venture capital contracts and the supply and demand for venture capital. Both the composition and type of financial claims held by the venture capitalist and entrepreneur depend on the market structure. Moreover, different market structures involve different optimal forms of transferring utility: sometimes it isoptimal to transfer utility via equity stakes, sometimes it is optimal to use debt. Transferring utility via equity stakes affects incentives. Consequently, the net value created, the success probability, the market (or IPO) value, and the performance of venture-capital backed investments all depend on the supply and demand for capital. Similarly, venture capitalists face different incentives to screen projects ex ante if the capital supply is lowor high. We then endogenize the capital supply and study the relation between venture capital contracts and entry costs, public policy, investment profitability, and markettransparency. Finally, we show that entry by inexperienced investors creates a negative externality for the value creation in ventures financed by (regular) venture capitalists.
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