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Aspects of financial contracting in venture capital

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... The focus in this paper is how staged financing can alleviate commitment problems when contracts are not enforceable. Alternatively, staging can arise as a result of uncertainty or asymmetric information, as has been also explored in a number of papers; for example Gompers (1995), Sahlman (1988 and1990), Admati and Pfleiderer (1994), Bolton and Scharfstein (1990), and Roberts and Weitzman (1981). ...
... The feasibility constraints (1) and (6) are satisfied by construction. Let us prove that the incentive compatibility constraint (9) with respect to I 1 holds, that is ...
... For a given T the problem of maximizing the entrepreneur's utility (10) is equivalent to minimizing the payment to the investor.9 The value of every next investment depends only on values of previous investments. ...
... Gompers (1999) recommends coping with conflicts of interest through aligning incentives. Sahlman (1988) When discussing solutions to principle-agent problems, one has to be aware that they can be considered from two different angles, namely the CVC and the start-up perspective. ...
... Although Smith (2005) views preferred equity as inferior to a mixture of common stock and debt 52 , many scholars broadly discuss (convertible) preferred equity as it is part of many VC contracts (e.g. Bascha & Walz, 2002;Correia & Meneses, 2017;Cumming, 2005b;Gebhardt & Schmidt, 2006;Gompers, 1999;Kaplan & Strömberg, 2003;Sahlman, 1988;Schizer & Gilson, 2003). Convertible preferred stock can be seen as combination of equity and an ex-ante call option, more precisely a fixed claim at face value, accumulated dividends and a call option on common stock (Bascha & Walz, 2002). ...
... Convertible preferred stock can be seen as combination of equity and an ex-ante call option, more precisely a fixed claim at face value, accumulated dividends and a call option on common stock (Bascha & Walz, 2002). It gives investors a primary claim on the start-up's earnings and liquidation, thereby shifting risk from the CVC to other shareholders, especially the entrepreneur (Sahlman, 1988). The convertible part allows to exchange the preferred stock toin most casescommon stock at pre-specified events, e.g. ...
Thesis
Corporate Venture Capital (CVC) is an established vehicle for collaboration among a corporation and start-ups. Through equity investments paired with access to resources, capabilities and expert networks, corporations aim at supporting start-up development. Although the efficacy of CVCs is broadly discussed in literature, CVCs are often treated as uniform vehicles. Little is known about the impact of a CVC’s strategic direction and organizational design on the performance of start-ups. Moreover, Corporate Accelerator (CA) is a rather new form of corporate start-up engagement. Due to its newness limited research is available and literature urges – among others – to compare CA with more established form of corporate start-up support, especially CVC. Following these identified research gaps the dissertation consists of two empirical sections. In the first section, the effect of a CVCs organization and strategic direction on start-up performance is evaluated. Using a hand-collected unique data-set of 210 start-ups under the management of 21 German CVCs, the study finds that organization of a CVC impacts the financial and strategic performance in multiple ways. Distinct hypotheses on portfolio size, concentration and fit, previous experience and CVC leadership are developed and tested empirically. The results show that CVC strategy and organization matter for start-up performance, however, disparate effects are observable for financial and strategic performance. Large portfolios enhance the performance of start-ups under CVC management, whereas both portfolio concentration and industry fit have a negative relationship with start-up performance. Moreover, more established CVCs support financial, yet impede strategic start-up performance. Lastly, it is detected that Previous industry experience of CVC personnel leads to financial start-up performance, whereas previous founder experience of CVC personnel strengthens strategic start-up performance. The second section aims at empirically reflecting the differences between CVC and CA, the start-ups under management and performance implications. The work is based on a novel multi-level and hand-collected dataset on financial and strategic performance covering 21 German CVCs with 210 start-ups and 15 German CAs with 132 start-ups. The results show that CVC and CA differ. CVCs tend to support older and further developed start-ups that operate more frequently in strategic proximity to the corporate parent, whereas CAs collaborate with younger and less mature start-ups across varying industries. In addition, CVCs stimulate start-up performance more than CAs do, even when matching CVC- and CA-managed start-ups based on their size and stage of development All in all, the work adds to literature in multiple ways as understanding of CVCs is deepened through a grounding in economic theories, uncovering of white spots determination of performance implications of a CVC’s strategic direction and organizational design and differentiation from a similar corporate venturing form, Corporate Accelerator. The work empirically supports that a differentiation of financial and strategic performance is required in corporate venturing research and sheds light on how CVCs should be organized to foster start-up performance. Moreover, it offers an enhanced understanding of CVC through an empirical comparison with the new phenomenon of CAs. Lastly, empirical evidence on CVC and CA is given based on a German dataset, in contrast to the majority of studies, being based on US data.
... Com relação a pesquisa e desenvolvimento, Kolbe, Morris e Teisberg (1991) discutem elementos de opções embutidos em projetos de P&D. Os elementos de opções envolvidos no desenvolvimento de empresas start-up são discutidos em Sahlman (1988), Willner (1993) e neste artigo. Aquisições estratégicas de outras empresas também envolvem, com freqüência, diversas opções de crescimento, alienação e outras ligadas à fl exibilidade, como discutem Smith e Triantis (1990). ...
... 10. Ver em Sahlman (1988) uma boa discussão qualitativa dos esquemas de financiamento por venture capital. Mauer e Triantis (1992) apresentam outro tratamento das interações dinâmicas entre as decisões de financiamento e investimento corporativos, em que se referem à flexibilidade financeira como a capacidade de ajustar o nível de endividamento da empresa ao longo do tempo (recapitalização). ...
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This paper has two main goals. First, it provides a comprehensive overview of the existing real options literature and applications, and presents practical principles for quantifying the value of various real options. Second, it takes a fi rst step towards extending the real options literature to recognize interactions with fi nancial fl exibility. The comprehensive literature review traces the evolution of the real options revolution, organized around thematic developments covering the early criticisms, conceptual approaches, foundations and building blocks, risk-neutral valuation and risk adjustment, analytic contributions in valuing different options separately, option interactions, numerical techniques, competition and strategic options, various applications, and future research directions.
... This framework, which helps outline the existing literature as well as the future research potential, also provides the structure for this monograph. It comprehensively defines these entrepreneurial finance Knockaert et al. (2010); Leleux and Surlemont (2003); Lerner (1994a); Lerner (1995); Lockett and Wright (2001); Lumme et al. (1998); MacMillan et al. (1985); MacMillan et al. (1987); Manigart et al. (2006); Mason and Harrison (1996); Morrissette (2007); Muzyka et al. (1996); Nahata (2008); Nahata et al. (2015); Norton and Tenenbaum (1992); Ooghe et al. (1991); Parhankangas and Hellström (2007); Reiner (1989); Romain and van Pottelsberghe de la Potterie (2004); Ruhnka and Young (1991); Sahlman (1988); Sahlman (1990); Shane and Cable (2002); Shepherd and Zacharakis (2002); Sorenson and Stuart (2001); Stevenson et al. (1987); Swartz (1991); Uhlaner et al. (2007) et al. (1996); Swartz (1991); Tyebjee and Bruno (1984); Walske et al. (2007);Wright et al. (2002) Interaction Bonnet and Wirtz, 2012;Bruton et al. (2015); ; Harrison and Mason (2000); Schwienbacher (2009); Van Osnabrugge (2000) Hornuf and Schwienbacher (2015b); Hornuf and Schwienbacher (2015a); Brown et al. (2015) Bonnet and Wirtz, 2012;Bruton et al., 2015;Dutta and Folta (2016); ; Mason and Harrison (2002); Vanacker et al. (2013) players in their theoretical settings and outlines the current empirical literature examining them. Researchers interested in these fields require a solid understanding of the way they interact. ...
... This initial research identified the characteristics of venture capital investments, namely that they are highly risky, have investment durations of five years or more, that there is no secondary market after the initial investment has been made, and that subsequent investment rounds are required for a successful exit. Certain papers that followed in the 1980s (such as Cooper, 1985;Gorman and Sahlman, 1989;MacMillan et al., 1985;Sahlman, 1988;Stevenson et al., 1987;and Tyebjee and Bruno, 1984) focused on the investment process, and the behavior and activities of venture capitalists. Bygrave (1987) and Bygrave (1988), on the other hand, began to study VC syndication and networks. ...
Article
Venture capital, angel financing, and crowdfunding have evolved and matured in the entrepreneurial finance market. These market developments have also been accompanied by a growing body of research. In this monograph, we provide an overview of a vast body of literature in the field of entrepreneurial equity finance, presenting the current state of research and succinctly identifying its subcategories. We also provide insight into major research trends and research gaps and examine the growing research field of cognition in entrepreneurial equity finance. Our review is structured using a theoretical framework that aims to link venture capital, angels, and crowdfunding whilst considering the significant differences exhibited between each investment stage.
... Venture capitalists' financing decisions are fraught with difficulties because entrepreneurs possess information about their opportunities and themselves that potential financiers find difficult or impossible to obtain (Amit, Glosten & Muller, 1990;Barry, 1994;Chan, Siegel & Thacker, 1990;Gompers, 1995). Because these significant information asymmetries exist between entrepreneurs and venture capitalists, it could allow entrepreneurs to engage in opportunistic behaviour after an investment is made (Sahlman, 1988). ...
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This research empirically examined the relationship between organizational culture and the effectiveness of project management. The study made use of two conceptually developed constructs. The one, a framework of organizational culture, consists of twelve dimensions that emerged from a study of the project management literature as important organizational conditions for effective project management. The second construct, project management effectiveness, comprises eleven dimensions constituting the persistent leading and outcome indicators of project management success, similarly based on literature. The research found a statistically significant relationship between the two constructs in a sample of matrix organizations. Each of the twelve dimensions of organizational culture also correlated significantly with project management effectiveness. A total of 29 organizations, operating within the boundaries of South Africa, took part. Although generalizability is not possible, given the sample size, the study nevertheless takes a substantial step forward in this important context of project management. Pointers are offered for future research, and for organizations that find that project management fails to perform in accordance with their expectations.
... The relationship between the two is usually characterized by a difference in the level of information about the prospects of the firm leading to information asymmetry, and the requirement of risk capital for the firm to develop which is provided by the VC. In this regard, VC staging has been explored as a means to combating aspects of entrepreneurial finance such as information asymmetry, risk, moral hazard, potential hold-up, and agency concerns (Sahlman 1988(Sahlman , 1990Hellmann 1998;Neher 1999;Cornelli and Yosha 2003;Wang and Zhou 2004;Yerramilli 2008). Staging of investments has been viewed as a controlling function to deal with agency problems, as a monitoring function to facilitate good governance and against inefficient continuation, as a risk-averse option to exit, abandon the venture or wait for more information before making an investment. ...
Article
This paper examines the staging of investments when private equity (PE) invests in the infrastructure sector. This sector is characterized by large upfront investment requirements and non-recourse deal structures. Over the last two decades, it has witnessed increasing PE investment activity. PE firms have the option to finance infrastructure project by infusing capital at once, or by staging infusions through multiple investments. In case the PE firm decides to disburse the capital in multiple investments, it creates the staging function, a mechanism successfully used in the past to combat risk and uncertainty. This study hypothesizes that the decision to stage investment is a response to the factors that influence infrastructure deals including institutional and financial environments, project structure, and reputation of the PE firm. This paper examines 358 worldwide infrastructure deals from 1990 to 2009 with PE investments of US$9.74 billion to analyze the choice for, the motives behind, the duration between, and the determinants of staging. We find that developing/transition economies and markets characterized by high inflation and interest rates increases PE propensity to stage. Further deals with larger investment sizes and younger investee companies pose increased risks, and PE firms seem to use their prior infrastructure experience and bargaining power to stage financing. Our results also confirm that long-term relationships between the PE firm and the investee company are advantageous to both parties. We believe that the positive results acquired through the PE staging strategy will help perpetuate it as one of the best tools available for PE investing in the infrastructure sector.
... Given the alleviation of agency problems and the learning dynamics associated with staging, it might be argued that the use of staging by BA investors leads to better start-up performances. However, it has also been suggested that staging could induce entrepreneurs to "window dress" in order to secure the next round of financing, eventually to the detriment of long-run value creation (Sahlman 1988). From an empirical point of view, the literature examining the consequences of staging on entrepreneurial firms' performance is limited and focuses exclusively on VC. ...
Article
In this paper, we investigate what drives the performance of high-tech start-ups receiving angel financing, while taking a closer look at the capabilities (i.e., experience) and investment behavior of business angels (BAs). We exploit a new data set (extracted from Crunchbase), which consists of 1,933 high-tech start-ups that received at least one financing round from a BA. The results indicate that the experience of BAs in early stage investments is positively associated with additional receipt of follow-on rounds of financing and sequential capital injections from venture capitalists (VCs). Later-stage experience is positively associated with the start-up's success (i.e., probability to be listed or acquired), but reduces the need for new VCs to invest in the start-up. Furthermore, we find consistent evidence that start-ups that combine BA and VC financing experience higher levels of funding amounts, additional VC financing, and an improved likelihood of success. Finally, we find that the co-localization of BA investors and start-ups in the same area facilitates the attraction of VC financing.
... Given the alleviation of agency problems and the learning dynamics associated with staging, it might be argued that the use of staging by BA investors leads to better start-up performances. However, it has also been suggested that staging could induce entrepreneurs to "window dress" in order to secure the next round of financing, eventually to the detriment of long-run value creation (Sahlman 1988). From an empirical point of view, the literature examining the consequences of staging on entrepreneurial firms' performance is limited and focuses exclusively on VC. ...
Article
In this paper we investigate what drives the performance of high-tech start-ups receiving angel financing, while taking a closer look at the capabilities (i.e. experience) and investment behaviour of business angels (BAs). We exploit a new dataset (extracted from Crunchbase) which consists of 1,933 high-tech start-ups that received at least one financing round from a BA. The results indicate that the experience of BAs in early stage investments is positively associated with additional receipt of follow-on rounds of financing and sequential capital injections from venture capitalists (VCs). Later stage experience is positively associated with the start-up's success (i.e. probability to be listed or acquired), but reduces the need for new VCs to invest in the start-up. Furthermore, we find consistent evidence that start-ups that combine BA and VC financing experience higher levels of funding amounts, additional VC financing and an improved likelihood of success. Finally, we find that the co-localization of BA investors and start-ups in the same area facilitates the attraction of VC financing. JEL classification: G24, D22.
... La nature des contrats qui lient la société de gestion aux fonds est une bonne illustration de contrats conçus pour limiter au maximum les divergences d'intérêt entre les deux parties 5 et les incitations financières y jouent un rôle important (Bellando, 2008 ;Gompers et Lerner, 1996 ;Harris, 2008 ;Klausner et Litvak, 2001 ;Mahieux, 2010). (Glachant et al., 2009 ;Harris, 2008 ;Jones et Rhodes-Kropf, 2003 ;Klausner et Litvak, 2001 ;Litvak, 2009 ;Mahieux, 2010 ;Phalippou, 2007Phalippou, , 2009 Des mécanismes d'incitations très similaires sont également mis en place par les fonds dans les sociétés dans lesquelles ils investissent pour contrôler leurs relations avec les managers qui sont leurs agents (Kaplan et Strömberg, 2003 ;Mahieux, 2010 ;Phalippou, 2007 ;Sahlman 1988 ...
... According to Sahlman (1988), to resolve this problem, there should be a contract between two parties. In a VC model, there exists two contracts between three parties. ...
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In a venture capital (VC) deal, a partnership contract is designed to avoid different conflicts arising due to information asymmetry and agency problem and to make appropriate provision for compensation. This study investigated different theoretical approaches that have been deployed to understand this phenomenon. This article extracted the important aspects of the compensation structure and covenants required to set in the contract between venture capitalists and their limited partner (LP) in order to meet the agreed-upon proportion of return distribution and proposed a VC compensation model. Various studies were analyzed to get evidence on various aspects of a VC deal, such as the reasons why professional VCs exist, and factors that determine the design of a contract. Private ownership, information asymmetry, and illiquidity associated with a VC investment are key explanatory factors, which make VC - LP partnership agreement different from other financial contracts. The findings of this study could be alienated into two constituents. First, the compensation that a VC receives from its LP is performance based, which varies according to the size of the fund, experience of VC, past performance of VC, and signalling function. Second, some important covenants are generally mentioned in such a contract during raising funds for investments, though these are heterogeneous in each deal and their contribution in compensation allocation varies with each deal. In this study, we have proposed a compensation model for venture capitalists as a general partner by their limited partner, which is based on a principal-agent model. Also, this study focuses on contractual covenants, which are responsible for imparting flexible incentive provision and provide control over VC activity. The arrangement of VC compensation and covenants depend upon the management support and effort of VCs. This study can contribute to resolving the conflicts - between venture capitalists and their investors - that arise due to the agency problem and bring to light the compensation arrangement and provision of covenants used in the contract between VCs and their LPs.
... 6 There is large empirical evidence that venture capitalists are able to obtain specific information on their portfolio investments: see e.g. Sahlman (1988), Fenn, Liang and Prowse (1995, Gompers (1995), or Kaplan and Strömberg (2004). 7 Our analysis is immune to the introduction of costly signals: We discuss this issue in section 7.. that a VC with experience α has observed a signal s, and N P V (s α ) the corresponding net present value, conditional on the signal s. ...
Article
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We study the fund-raising strategy of an entrepreneur when investors have private information about his project’s profitability. The entrepreneur cares about monetary profits and about the probability to obtain financing. If he contacts both venture capitalists (VCs) simultaneously, he obtains high monetary profits. If he commits to a period of exclusive negotiation with one VC, he increases the probability to obtain financing but deal terms deteriorate. The optimal negotiation strategy results from this tradeoff. We also solve for the equilibrium financial contracts and obtain implications for VCs’ portfolios and entrepreneurs’ deals.
... Une durée de vie des fonds adaptée Kaplan et Strömberg, 2000 ; Mahieux, 1993 ; Phalippou, 2007 ; Sahlman, 1988). ...
Article
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Delegated Portfolio Management in the Private Equity Industry : Agency Relationship and Covenants of Funds Since the mid 1980’s, the development of the French private equity sector has heavily relied on delegated portfolio management. Private equity funds are structured so that their legal and financial framework is well fitted to the needs of investors regarding the specific features of private securities investments, notably illiquidity. This paper analyzes the particular agency relationship binding funds managers and investors in the private equity sector. The major moral hazard risks faced by the investors are extensively treated in the different covenants of the funds in order to prevent their appearance. Despite this, all risks cannot be avoided as has been highlighted during the recent financial crisis. Classification JEL : D82, G24, G34.
... Once an investment is made, the investment is illiquid, and its success is highly dependent on a small group of managers/entrepreneurs. Significant information asymmetries allow managers to engage in opportunistic behaviour after an investment is made (Sahlman, 1988), making it all the more important that the initial decision to invest becomes a good one. ...
... See, for example,Sahlman (1990),Gompers (1995).21 See, for example,Sahlman (1991).22 See, for example,Cole and Sokol (1997).23 ...
Article
I show that in the environment of imperfect information and costly learning, com-petitive investors overinvest in innovation, compared to a social optimum of maximized proÞts. I also show that in competitive markets, it is generally impossible to design a mechanism that implements a socially optimal level of investment in innovation as a Nash equilibrium of a noncooperative game. I argue that contractual provisions that restrain the entry of new investors, while ensuring the exit of existing investors can mitigate the problem of overinvestment in innovation. The argument is supported by the presence in venture capital contracts such restraining provisions as pre-emptive rights, approval rights, rights of Þrst refusal, antidilution protection, demand rights, and exit rights.
... " It is perhaps due to these risks that venture capitalists tend to stage their capital investments. Sahlman (1988, 1990) shows that by staging capital to an entrepreneurial project, a venture capitalist is able to create an abandonment option that leads to an increase in the value of the investment. Admati and Pfleiderer (1994) find that the abandonment option may be valuable because entrepreneurs always prefer to continue bad projects as long as others finance them. ...
Article
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In this paper we look at the effects of bargaining power on the types of entrepreneurial projects chosen by venture capitalists and show that a wealth-constrained venture capitalist prefers to provide equity financing to a two-stage rather than to a similar single-stage project. as well as a Professor of Finance at the Martin J. Whitman School of Management, Syracuse University. He is the Editor-in-Chief of The Journal of Entrepreneurial Finance and Business Ventures, and has authored or co-authored nine books and monographs, over 90 articles and chapters in leading academic and professional publications and books, and given over 150 lectures outside the university setting for business and professional groups on each of the world's continents. His current research interests include, among other areas, developmental finance, micro lending, valuation, privatization, emerging and developing financial markets and entrepreneurship and other related topics. 30 While the venture capitalist does not have bargaining power over the entrepreneur of a single-stage project and is thus unable to extract any surplus, the venture capitalist does have this advantage in a two-stage project and, provided the project is good, can demand a portion of the surplus as a pre-condition for providing follow-on capital. This suggests that venture capitalists should stage their capital investments in order to improve their bargaining power, allowing them to earn greater profits from successful entrepreneurial projects.
... As Sahlman (1988Sahlman ( , 1990 and Gompers (1995) point out, preferred stock combined with staged financing and investor monitoring is a prominent feature of start-up financing. Staging is generally thought to be a way to control agency costs arising from providing managers with too much capital. ...
Article
This paper investigates capital-structure changes around Initial Public Offerings (IPOs). We find that the magnitude and persistence of leverage reductions among IPO firms is sensitive to sample selection and whether preferred shares are treated as debt when computing pre-IPO leverage. Overall we find that prior to going public, firms rely more heavily on debt financing than they do as publicly traded firms. Consistent with investor concern with overinvestment, firms that rely on preferred stock prior to their IPO are more likely to engage in staged equity financing after they go public. Finally, using a broader sample of IPO firms than previous studies, we find little evidence of transitory declines in leverage in hot-issues markets.
... For, as the authors of a recent review of research an entrepreneur and the VC investor is to divide between the interested parties the responsibility for the future risks of the deal, and the ownership of the future cash flows it generates, in a way that is expected to maximize the value of the enter- prise. 14 He goes on to note that the present value of the overall enterprise-and specifically how that value is expected to be split between the suppliers and the users of financial capital- is determined by these negotiations. ...
Article
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In a recent article in this journal, the authors documented the growing tendency of emerging growth companies to raise substantial equity while remaining privately held through private IPOs, or PIPOs. PIPO financing has created scores of “unicorn” firms—private enterprises with imputed market values of $1.0 billion or more—while allowing them to avoid the challenges of being publicly traded. But as has also been noted, the PIPO process, with its multiple financing rounds and increasingly complex terms, has almost certainly result in some inflated market valuations. Along with inflated values, the contracting process and many of the provisions that result from it often have economic consequences that are poorly understood by at least some of the participants, including the potential for significant wealth transfer between stakeholders as well as overall destruction of enterprise value. And the term sheets containing such provisions appear to become even more “opaque” and more “toxic” with each round of financing. More specifically, the liquidation preferences and ratchets often provided new investors in the later rounds of PIPOs can greatly affect the allocation of the risks and the ownership shares and, in so doing, transfer significant wealth from the entrepreneurs and other older owners. Using a numerical analysis of a representative term sheet, the authors discuss the process of financial contracting for early-stage companies, providing examples of how negotiations can go wrong and showing exactly when and where the agreed-upon conditions start to turn toxic for some of the stakeholders. The article closes with the authors’ assessment of the disincentives for entrepreneurs and early-stage investors created by this often confusing and dilutive venture capital contracting and funding process.
... Staged financing has been also explored in a number of papers. For example Gompers (1995), Sahlman (1988Sahlman ( , 1990, Admati and Pfleiderer (1994), Bolton and Scharfstein (1990), and Roberts and Weitzman (1981). Staging there arises as a result of uncertainty or asymmetric information, rather than the commitment problem outlined above. ...
Thesis
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This thesis makes three important theoretical contributions to the existing literature. First, the thesis explores the hold-up problem between two parties (an entrepreneur and an investor) when one of the parties (the entrepreneur) is unable to commit not to repudiate the initial contract. As in Neher (1999), we allow the parties to stage investments over time to help mitigate the hold-up problem. However, unlike Neher, we derive the optimal investment path for a variable rate of return. We show that when the rate of return is not constant the optimal investment path is significantly different. For example, our model predicts that neither positive wealth of the entrepreneur nor the lack of discounting ensures that all profitable projects proceed. The model is extended in several ways: first, both agents are allowed to repudiate the initial contract; and, second, new costs of staged financing are introduced. Second, the thesis explores the hold-up problem when trading parties can choose to make specific investments simultaneously or sequentially. An advantage of staging investments is contracting on any subsequent investment becomes possible after the project is underway and better defined. It is shown that there can be efficiency improvements with the sequential regime, as compared with simultaneous investment, if the parties are sufficiently patient. Further, as previously emphasized in the literature, sequencing of investments can allow some projects to proceed that would not be feasible with a simultaneous regime. This however, is not always the case. A cost of sequencing investment is that it can disadvantage some parties, reducing their incentive to invest. In fact, the mere possibility of sequential investment can be detrimental to overall welfare. In the extreme it can prevent mutually beneficial trade from occurring. This is a new result: it allows the choice about the timing of investment to be interpreted as a new (potential) form of hold-up. Additionally, in a continuous set-up when the two investments are independent, three effects are identified when comparing the two regimes: sequential investment increases the costs of delay; sequential investment reduces the incentive for the first player to invest; and the sequential regime increases the second player’s incentive to invest. Third, the thesis also examines a dynamic investment game where industry sunk costs provide an incentive for a firm to be a follower into the market as opposed to a leader. Interesting dynamics can arise: as the potential investment horizon is extended the game can switch from a prisoners’ dilemma to a coordination game and back again. The model also exhibits an investment cascade: once one firm has entered the market all other firms enter immediately after. This result arises without the presence of asymmetric information.
... The menu of contract features that characterize venture capital investing may be explained as solutions to this agency problem. These include the staging of venture capital investments to assure optimal exercise of production options and efficient stopping (Sahlman 1988, Chan, Siegel, and Thakor 1990, Admati and Pfleiderer 1994, Gompers 1995, Bergemann and Hege 1998 control and the choice of equity/debt instrument ( Gompers 1993, Marx 1993, Comelli and Yosha 1997, Trester 1998), entrepreneur compensation (Sahlman 1990), restrictive covenants (Chan, Siegel, andThakor 1990, Gompers andLemer 1996), board representation (Lemer 1995), and the allocation of voting rights (Fenn, Liang, and Prowse 1997). In addition, venture capitalists expend considerable resources monitoring their portfolio firms (German and Sahlman 1989), and they often tend to specialize in particular industries where they develop expertise (Ruhnka and Young 1991, Gupta and Sapienza 1992, Norton and Tenenbaum 1993. ...
... As Indian VC industry is very different from many developed country, the characteristics of VC contract are also quite different. Considering the highly unpredictable and uncertain business environment for a start-up business, venture capitalists prefer to diversify their risk of investment through including more investor in their prospective portfolio (Robinson & Sensoy, 2011;Sahlman, 1988). This phenomenon is known as 'syndication'. ...
Article
Indian economy witnessed high inflow of capital for start-ups in current fiscal year through venture capital (VC) investment. From different Indian VC deals, it is evident that VC investors prefer to invest jointly. In other words, joint investment or co-investment or syndication is a common trend in Indian VC industry. VCs adopt this strategy to minimise their future uncertainties as a part of the control mechanism. In this study, an attempt is made to find out different determinants of this syndication strategy. The samples taken in this study are retrieved from Venture Intelligence database for the period 2005–2014. The data are analysed through linear regression and binomial logistic regression. Two empirical models have been developed. The derived models validate different control variables and deal with specific characteristics to comprehend the rationale of syndication mechanism. The findings of the study indicate that the past experience and the number of industry exposure of a VC in IT and ITES industry are the major predictors for a syndication decision. Subsequently, the precautionary investment attributes like number of investment round, stage funding, etc. draw the interest of potential co-investors in a syndicated deal. Syndication mechanism benefits the VC investors through sharing of risk of investment in a start-up and preparing them for a successful exit. Extant literature supports the results as Indian VC investors prefer to share the risk profile of a start-up business and adopt different risk diversion mechanisms to attract co-investors in the deal. Furthermore, the joint investment by investors drag more funding amount and also create more human capital for efficient management of the investment in VC-backed portfolio.
... The last type of real option, the compounded real option, involves the real options described above, and their combination. Sahlman (1993) identified three types of options from the foregoing that are inherent in venture capital investment, such as the option to reject, the project revaluation option (staging option), and the capital increase option (growth option). ...
Article
Venture capital investments play an important role in the development and growth of start-up companies that are characterized by a high degree of uncertainty and growth potential, and venture capital is also one of the major sources of financing for entrepreneurial businesses. In the case of venture capital investment, staging has a huge potential, so the venture capitalists keep the right to participate in further financing rounds. The real option approach as an evaluation method provides an opportunity to evaluate this kind of investment with the help of flexibility in the case of a high degree of uncertainty. The paper puts the emphasis on the evaluation and the effectiveness of venture capital investments primarily from the aspect of real option theory tested on Hungarian venture capital cases. The paper concludes that the option-based valuation methods are more suitable for evaluating venture capital investments than others, especially the discounted cash flow method.
... Our results are consistent with those in the prior literature. Sahlman [159] indicated that managers are likely to engage in opportunistic behavior after VCs provide funds due to severe information asymmetries. Hisrich and Jankowicz [8] indicated that VCs' funding decisions may be affected by the personal integrity of managers. ...
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This Handbook charts the development of venture capital research in light of the global financial crisis, starting with an analysis of the current venture capital market and the changing nature of the business angel market. Looking at governance structures, the performance of venture capitalists in terms of investments, economic impact and human capital, and the geographical organization of business angels and venture capital global 'hotspots', this book also analyses the current state of venture capital research and offers a roadmap for the future.
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A fundamental characteristic of many entrepreneurial ventures is the imbalance between the resources currently controlled and those needed to capitalize on the opportunities. Few ventures truly face pure financing problems, but rather more complex “resourcing” issues, i.e., how to gain access to the extensive collection of resources needed to succeed, such as management skills, distribution channels, networks, technology, and the like. In many instances, money will indeed provide access to those resources. But when there are funding constraints, where access to finance is not unlimited or is associated with huge costs, it becomes critical to use the fundraising exercise in a more creative manner, as a holistic approach to resourcing the firm. This chapter will focus on how to develop a proper financing strategy for early-stage, higher risk ventures, which investors to target, and how to develop a compelling investment case.
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Zur theoretischen Fundierung der Arbeit werden zwei potenziell geeignete Theoriegebiete auf ihre Anwendung geprüft: Naheliegende Grundlage für die Analyse der Nutzung von privatem Beteiligungskapital ist zunächst die Finanzierungstheorie. 205 Wegen ihrer thematischen Nähe zur Fragestellung der Arbeit und ihrer fortgeschrittenen inhaltlichen Reife wird ihre Anwendung daher in einem ersten Schritt genauer geprüft. Nach einer kurzen allgemeinen Einführung (Kapitel 3.2.1) wird erarbeitet, welche theoretisch- relevanten Eigenschaften das Forschungsobjekt „privates Beteiligungskapital im Mittelstand“ aufweist (Kapitel 3.2.2 und 3.2.3) und welche Ergebnisse innerhalb der Finanzierungstheorie spezifisch für dieses Forschungsobjekt existieren (Kapitel 3.2.4). Die Prüfung ihrer Zweckmäßigkeit für die Beantwortung der aufgestellten Forschungsfragen ergibt in Abschnitt 3.2.5 allerdings, dass die Finanzierungstheorie trotz ihrer weiten Verbreitung und ihrer starken theoretisch-axiomatischen Verankerung nicht für diese Arbeit ausgewählt wird.
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This article focuses on the structure, governance, and performance of leveraged buyouts in Italy. It defines the term "private equity" as an expansion financing of existing firms. It notes that Italy has previously experienced periods of exhausting regulation over such transactions. The discussion analyzes the governing and financing behavior used by private equity investors in order to manage investment risks and related agency problems. From there it turns to a study of how venture capitalists affect the governance of their portfolio companies within the private equity market of Italy.
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Venture capitalists (VCs) fund ventures with the aim of reaping a capital gain upon exit. Research has identified information asymmetry between inside investors and follow-on investors as a major source of friction. It is thus in the interest of VCs to reduce information asymmetry at exit. Matthias Eckermann analyzes how VCs integrate information efficiency considerations into their exit strategies. He shows that VCs adopt specific strategies to cope with information gaps upon exit in terms of timing, exit vehicles and promotion efforts. On this basis he develops a framework to help VCs to improve profitability through decisive exit strategies. © Deutscher Universitats-Verlag/GWV Fachverlage GmbH, Wiesbaden 2006.
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The European VC industry is still a young industry-the median year of foundation of European venture capital firms is 1998 (Bottazzi et al., 2004)-and presents a lot of specificities. In a first part of this chapter, we present the European VC industry and in particular the European VC practices. Then, the second part of the paper is dedicated to the performance of European VC financing and the convergence of U.S. and European performances and practices is then examined. In particular, we showed that the European VC industry has gained in experience and old grievances that have been made should be reinvestigated. Moreover, the gap of performance with the US has almost disappeared. Now, the industry of European VC professionalized and that the performances in terms of IPO of European VC firms are now comparable to those of their American counterparts.
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The nature of entrepreneurial risk, particularly in corporate ventures, is explored. Dimensions of risk are investigated. Emphasis is placed both on downside risk and risk associated with missed opportunities. A number of risk management strategies are reviewed.
Chapter
Early-Stage Unternehmen sind regelmäßig hoch riskante Investitionen: zu der Prognoseunsicherheit tritt die große Bedeutung der Person des Unternehmensgründers als Risikofaktor. Finanzierungsverträge enthalten deshalb zahlreiche Klauseln mit Optionseigenschaften. Die verwendeten Methoden zur Feststellung des Unternehmenswertes als „Eintrittspreis“ eines neuen Financiers sind dagegen recht einfach. Verfahren, die auf Multiples beruhen, übertragen Bewertungsrelationen von vergleichbaren Unternehmen auf das zu bewertende Unternehmen. Das Kurs-Gewinn-Verhältnis als das bekannteste Verfahren stellt dabei den Unternehmenswert als ein Vielfaches seines Gewinns dar. Bei Wachstumsunternehmen sind die prognostizierten Gewinne häufig noch negativ; deshalb kommen hier verstärkt Multiples zum Einsatz, die sich nicht auf Überschussgrößen beziehen, wie z.B. Asset- oder Umsatzmultiples. Für Biotech- und Internet-Unternehmen haben sich spezielle Multiples außerhalb des Rechnungswesens etabliert. Als Alternative zu den Multiple-basierten Ansätzen bietet sich die sog. Venture-Capital Methode an; es handelt sich dabei um ein vereinfachendes, kapitalkostengestütztes Bewertungsverfahren, das die stufenweise Finanzierung von Early-Stage Unternehmen berücksichtigt.
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The number of students who wish to learn about entrepreneurship and actively engage in entrepreneurial activities - either by creating their own companies or by spurring innovation within a large organization - has grown greatly in recent years. Motivating engineers and scientists to become entrepreneurial has particular appeal in light of the abundance of technological knowledge that lurks hidden in today's research institutes and technology-based enterprises, waiting for commercialization. However the expanding number of teaching programs fail to address the particular challenges and opportunities for starting up viable businesses based on science and engineering. Nurturing Science-based Ventures: An International Case Perspective presents case studies of more than 30 businesses in scientific fields such as biotechnology, biomedicine, high-tech engineering and information technology. The case studies are arranged in modules tracking the typical life cycle of creating and growing new ventures. The book is a value-adding teaching device that will greatly enhance the learning experience of future high-tech entrepreneurs. The case studies will also foster a general appreciation of technological venturing among current and future business leaders. Module topics include recognizing and evaluating opportunities, creating viable business plans, securing financial resources, managing growth and eventually harvesting the value created. The view of large firms is also taken into account, with studies on corporate entrepreneurship and the integration of internal and external knowledge to successfully seize business opportunities. Each module of the book is completed by a topic primer and a concluding summary of key learning points. Case studies include: Google, Logitech, adidas, Ducati, EndoArt, 4M Technologies, Novartis and Nespresso and many more university spin-offs and new start-up enterprises. Praise for Nurturing Science-based Ventures: An International Case Perspective While timing and luck are important factors for entrepreneurs, they are certainly no substitute for perseverance, hard work, and the ability to spot opportunities before others. Opportunity springs from many sources, not the least of which are breakthroughs in science and engineering. To close this gap is a critical issue, and that is why I am enthusiastic about this book, which I think will help entrepreneurs in their journey. In fact, this book will be a key resource for scientists and engineers looking to take research into development by creating exciting growth ventures. Dietmar Hopp, Co-Founder SAP Major R&D organizations in Europe and around the world increasingly adopt a venture mindset to manage internal and external technologies within a common innovation pipeline. Therefore, this is a timely and practical book. The work provides case studies of both market-based and corporate-venture initiatives, appropriately bridging the two sources of financing into a common theme. 'Nurturing Science-based Ventures' will surely provide an effective teaching guide to the subject of modern science and technology management. Werner Bauer, Chief Technology Officer, Nestle SA While there is no blueprint for success, this book should be compulsory reading for entrepreneurs, ready to embark in the thrilling world of high-tech ventures! With its unique European focus, readers will learn through an impressive set of real world examples. If "the journey is the reward", this book will give readers a host of useful hints on how to "travel" best! Daniel Borel, Founder and President of Logitech International This book will be a practical resource - and an inspiration - to a new breed of global entrepreneurs interested in starting science- and engineering-based businesses. It takes an easy to follow step-by-step approach to starting a company and has a host of stimulating, well-researched international cases that illustrate the key concepts in a clear, succinct fashion. Mary Tripsas, Harvard Business School Moving science out of the labs and into the markets has always been one the tallest challenges; managers often disregard the basic science under the products or services, while scientists dismiss the contribution of the business people. Success requires the best of both worlds and the ability to work together over time. This book offers invaluable insights in the difficult Art of transforming science into successful businesses, building on the experiences of various European technology companies. Must read for anyone involved in or considering technology ventures. Martin Velasco, Business Angel, Chairman & CEO, Speedlingua SA There is a growing consensus in Europe that its future lies in knowledge, technology and innovation. That is why politicians call so much on scientists and engineers to be entrepreneurial and to transform the results of their research work into commercial success. This book is not only showing that Europe has its success stories and very inspiring ones, it gives above all a methodical view on how to go about setting up a successful science or technology-based venture. It is recommended reading for all those who want to contribute to overcoming Europe's (in)famous innovation paradox. Janez Potocnik, Commissioner for Science & Research, European Commission.
Agency Cost of Free Cash Flow, Corporate Finance and Takeovers For an extended elaboration of Jensen's arguments, see also
  • I Thinking
  • Michael Jensen
I am thinking, especially, of Michael Jensen's article, " Agency Cost of Free Cash Flow, Corporate Finance and Takeovers, " American Economic Review (May 1986). For an extended elaboration of Jensen's arguments, see also Vol. 1 No. 1 of this journal.