Equity Financing and Covenants in Venture Capital

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Dezember 2007



Karoline Jung-Senssfelder presents the first augmented contracting analysis, focusing on the interaction of both, financial instruments and covenants, in the creation of incentives to the contracting parties. With a focus on the German market, she integrates the findings of her model-based theoretical and survey-based empirical analyses to derive value-adding implications for an incentive-compatible contract design in the German venture capital market.


Venture capital and contracting

Review of academic literature

Contract design approach to cash flow incentive mechanisms

Empirical evidence on contractual architecture


Dr. Karoline Jung-Senssfelder promovierte am Stiftungslehrstuhl Unternehmensfinanzierung und Kapitalmärkte der European Business School, Oestrich-Winkel.


3 Review of Academic Literature (p. 29-30)

3.1 Introduction

This chapter presents a critical overview of theoretical and empirical literature on cash flow incentive mechanisms in venture capital contracting and identifies significant research gaps.

Existing academic literature on venture capital contracting proposes the allocation of cash flow rights (Grossman and Hart (1986), Schmidt (2003), Kaplan and Stromberg (2003), Gompers (1997)) and the specification of control hghts (Chan et al. (1990), Hellmann (1998), Kaplan and Stromberg (2003), Lerner (1995)) as solution mechanisms to agency problems arising from the contractual relation between the venture capital company and its portfolio companies. This review, however, focuses on literature related to cash flow incentive properties of augmented contracts as defined by financing instruments and cash flow-related covenants. Control rights are neglected for the following reasons. The venture capitalist is given control rights independent of the financial structure through the use of covenants. This implies that the optimal allocation of control rights can be achieved separately from that of cash flow rights. , In addition, direct control rights are difficult to model sltuationspecifically In theoretical analyses and difficult to measure on a deal-by-deal basis in empirical analyses.

The review is thus more focused than comparable existing literature reviews: Tykvova (2000) critically reviews theoretical literature analyzing the agency conflict resolution potential of typical financial instruments and covenants in venture capital contracts. She groups existing works as to their focus along the venture capital investment process, that is, on the selection, investment, and exit phases. Neff (2003) also presents the main findings from existing theoretical models but concentrates on (double) moral hazard models. Denis (2003) only briefly
summarizes the findings from theoretical and empirical literature on the allocation of cash flow and control rights. The empirical findings discussed refer primarily to the US market. Schertler (2000) presents a survey of the recent theoretical and empirical venture capital contracting literature on cash flow and control right allocations as solution mechanisms to agency problems. She compares theoretical findings with findings from empirical literature on mainly US contracting practices. While the review in this thesis is most closely related to Schertler (2000), it provides a more detailed discussion in two respects: It considers only literature on the allocation of cash flow rights and it discusses empirical studies with US, Canadian, European, and especially German samples. As a result of this wider geographical scope, it determines striking differences in contract design across the globe.

Finally, research gaps are identified from the summary of theoretical and empirical findings. They concentrate on the so-far-neglected notion of augmented contracting, that is, on the complementary interaction between financial Instruments and cash flow-related covenants In the allocation of cash flow rights. A research question is then formulated for the theoretical analysis in Chapter 4 and hypotheses and expectations are framed for the empirical analysis in Chapter 5. Expectations are formulated on data analyzed by means of cluster analysis. Since cluster analysis is a structure-discovering and not a structure-testing method, hypotheses cannot be formulated and tested. Expectations are therefore Introduced to serve a similar purpose.


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EAN: 9783835091887
Untertitel: An Augmented Contracting Approach to Optimal German Contract Design. 2006. Auflage. eBook. Sprache: Englisch. Dateigröße in MByte: 17.
Verlag: Deutscher Universitätsverlag
Erscheinungsdatum: Dezember 2007
Seitenanzahl: xxiv283
Format: pdf eBook
Kopierschutz: Adobe DRM
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