Working Paper: CEPR ID: DP3203
Authors: Roman Inderst; Holger M. Müller
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 is optimal 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 low or high. We then endogenize the capital supply and study the relation between venture capital contracts and entry costs, public policy, investment profitability, and market transparency. Finally, we show that entry by inexperienced investors creates a negative externality for the value creation in ventures financed by (regular) venture capitalists.
Keywords: Market Structure; Optimal Contracting; Venture Capital
JEL Codes: C78; D41; G24; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| market structure (D49) | nature of financial claims (G32) |
| degree of competition (L13) | structure of contracts (L14) |
| degree of competition (L13) | net value created (D46) |
| degree of competition (L13) | screening behavior (C92) |
| inexperienced entrants (L26) | value creation in ventures (O36) |