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Venture Capital Contracts and Market Structure

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  • Inderst, Roman
  • Mueller, Holger

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.

Suggested Citation

  • Inderst, Roman & Mueller, Holger, 2002. "Venture Capital Contracts and Market Structure," CEPR Discussion Papers 3203, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:3203
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    References listed on IDEAS

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    Cited by:

    1. Keuschnigg, Christian, 2003. "Optimal Public Policy for Venture Capital Backed Innovation," CEPR Discussion Papers 3850, C.E.P.R. Discussion Papers.
    2. Inderst, Roman & Mueller, Holger M., 2009. "Early-stage financing and firm growth in new industries," Journal of Financial Economics, Elsevier, vol. 93(2), pages 276-291, August.
    3. Thomas J. Chemmanur & Zhaohui Chen, 2014. "Venture Capitalists Versus Angels: The Dynamics of Private Firm Financing Contracts," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 3(1-2), pages 39-86.
    4. Claudio Michelacci & Javier Suarez, 2004. "Business Creation and the Stock Market," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 71(2), pages 459-481.
    5. Keuschnigg, Christian & Nielsen, Soren Bo, 2004. "Start-ups, venture capitalists, and the capital gains tax," Journal of Public Economics, Elsevier, vol. 88(5), pages 1011-1042, April.
    6. Bowen Tang & Yuanzhang Sun & Nan Zhou & Bo Shen, 2019. "Sustainable Development of Power Retailers and Industrial Parks in China’s Belt and Road Initiative," Sustainability, MDPI, vol. 11(19), pages 1-19, September.

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    More about this item

    Keywords

    Venture capital; Optimal contracting; Market structure;
    All these keywords.

    JEL classification:

    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • D41 - Microeconomics - - Market Structure, Pricing, and Design - - - Perfect Competition
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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