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Conditional Allocation of Control Rights in Venture Capital Firms

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  • Schmidt, Klaus
  • Gebhardt, Georg

Abstract

When a young entrepreneurial firm matures, it is often necessary to replace the founding entrepreneur by a professional manager. This replacement decision can be affected by the private benefits of control enjoyed by the entrepreneur which gives rise to a conflict of interest between the entrepreneur and the venture capitalist. We show that a combination of convertible securities and contingent control rights can be used to resolve this conflict efficiently. This contractual arrangement is frequently observed in venture capital finance.

Suggested Citation

  • Schmidt, Klaus & Gebhardt, Georg, 2006. "Conditional Allocation of Control Rights in Venture Capital Firms," CEPR Discussion Papers 5758, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:5758
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    References listed on IDEAS

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    1. Rafael Repullo & Javier Suarez, 2004. "Venture Capital Finance: A Security Design Approach," Review of Finance, European Finance Association, vol. 8(1), pages 75-108.
    2. Mayer, Colin & Yafeh, Yishay & Schoors, Koen, 2002. "Sources of Funds and Investment Activities of Venture Capital Funds: Evidence from Germany, Israel, Japan and the UK," CEPR Discussion Papers 3340, C.E.P.R. Discussion Papers.
    3. Klaus M. Schmidt, 2003. "Convertible Securities and Venture Capital Finance," Journal of Finance, American Finance Association, vol. 58(3), pages 1139-1166, June.
    4. Steven N. Kaplan & Per Strömberg, 2003. "Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 70(2), pages 281-315.
    5. Bascha, Andreas & Walz, Uwe, 2001. "Convertible securities and optimal exit decisions in venture capital finance," Journal of Corporate Finance, Elsevier, vol. 7(3), pages 285-306, September.
    6. Hellmann, Thomas, 2006. "IPOs, acquisitions, and the use of convertible securities in venture capital," Journal of Financial Economics, Elsevier, vol. 81(3), pages 649-679, September.
    7. Hannan, Michael T & Burton, M Diane & Baron, James N, 1996. "Inertia and Change in the Early Years: Employment Relations in Young, High Technology Firms," Industrial and Corporate Change, Oxford University Press and the Associazione ICC, vol. 5(2), pages 503-536.
    8. Thomas Hellmann, 1998. "The Allocation of Control Rights in Venture Capital Contracts," RAND Journal of Economics, The RAND Corporation, vol. 29(1), pages 57-76, Spring.
    9. Berglof, Erik, 1994. "A Control Theory of Venture Capital Finance," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 10(2), pages 247-267, October.
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    Cited by:

    1. Rin, Marco Da & Hellmann, Thomas & Puri, Manju, 2013. "A Survey of Venture Capital Research," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 573-648, Elsevier.

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    More about this item

    Keywords

    Corporate finance; Venture capital; Control rights; Convertible securities;
    All these keywords.

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • 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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