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The Role of Convertible Securities in Venture Capital Financing

Journal of Financial Studies

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Field Value
 
Title The Role of Convertible Securities in Venture Capital Financing
 
Creator Shih-Chung Chang
Ho-Mou Wu
 
Description In this paper we study the role of convertible securities in the financing of start-up enterprises when the entrepreneurs are better informed than the venture capitalists (VCs). We demonstrate that for a well-designed contract the conversion ratio of the securities can be used as a signaling device to overcome the problem of information asymmetry. If the variability of the return is sufficiently large, the entrepreneurs will find it desirable to rely on convertible securities with the conversion ratio revealing part of his information, that is, a â€separating equilibrium†will arise. Such an equilibrium has the advantage of avoiding the incentive constraints that appear in the other â€pooling equilibriumâ€, in which the privately held information is not revealed. We show that the time-lag of decisions between investment and conversion will also benefit the VCs, with the extra return as the â€time valueâ€. In addition, we study the impact of introducing â€technical shares†with which the entrepreneurs are awarded equity shares without investment outlays. We compare the different financing devices with convertible securities and explain why convertible securities have become the most commonly used financial instrument for start-up enterprises.
Key words: Venture capitalists, Entrepreneur, Convertible securities, Signaling
 
Publisher Journal of Financial Studies
財務金èžå­¸åˆŠ
 
Date 2011-03-10
 
Type —
 
Format application/pdf
 
Identifier http://www.jfs.org.tw/index.php/jfs/article/view/2011051
 
Source Journal of Financial Studies; Vol 17, No 4 (2009); 93
財務金èžå­¸åˆŠ; Vol 17, No 4 (2009); 93
 
Language —