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A Portfolio Approach to Venture Capital Financing

Pascal François, Georges Hübner: This paper studies the contracting choices between an entrepreneur and venture capital investors in a portfolio context.

Auteur(s) :

Pascal Francois

Associate Professor of Finance, HEC Montréal

Georges Hubner

Affiliate Professor of Finance, EDHEC Business School

We rely on the mean-variance framework and derive the optimal choices for an entrepreneur with and without the presence of different kinds of venture capitalists. In particular, we show that the entrepreneur always has the incentive to share the risk and benefits of the venture whenever possible. On the basis of their objectives and characteristics, we distinguish the situations of the corporate, independent, and bank-sponsored venture capital funds. Our framework enables us to derive the optimal contract design for the entrepreneur, featuring the choice of investor, the entrepreneur’s investment in the venture, and her dilution in the project’s equity as a function of her bargaining power. This result allows us to characterise the choice of the investor depending on her cost of equity and debt capital. In addition to project size and risk, entrepreneur’s risk aversion turns out to be a critical determinant of VC investor choice — a finding which is strongly supported by a panel analysis of VC fund flows for 5 European countries over the 2002—2009 period.

Type : Working paper
Date : le 08/11/2010
Pôle de recherche Finance

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