Notes Venture Capital

Renovo case discussion:

The optimal contract calls for leaving control with the entrepreneur as long as the VC breaks even, and allocating cash flow rights to the VC, subject to leaving the minimum stake to the entrepreneur in the case of an IPO. (Kaplan)

Renovo Founders: Ferguson & O’Kane

a) Security design, including valuation and ownership

Founders often get majority. Keep incentives.

Stage financing can reduce cost of equity (initially greater risk premiums are required), but it also increases the share of external company and market risk they have to bear.

The greater the perceived external risk is the more can stage financing help the Entrepreneurs

Convertible preferred equity, relative to straight common equity, reduced the ownership dilution. (cumning)

Convertible preferred shares also enable a greater amount of funds to be raised relative to straight debt as the venture capitalist has some equity participation. (cumning)

BUT convertible preferred equity might be popular in US due to tax advantages that may look different in Europe.

Much depends on the Agency problem. Do we expect this firm to have this type of problem?

Yes: VC not as knowledgeable. The info asymmetry between informed entrepreneurs and uninformed investors are typically large.

No: VC trusted Mark. Both have incentives to make the deal work, the VC has incentive to monitor. But their downside is not as great as the entrepreneur’s.

One of the most robust findings in the empirical tests was that seed stage firms are more likely to be financed with either straight preferred equity than convertible preferred equity, which is consistent with the conjecture that straight preferred equity mitigates agency problems among investor syndicates.

b) cash flow rights (fraction of equity) Panel A indicates that the VC typically controls roughly 50% of the cash flow rights; founders, 30%; and others, 20%. This suggests that substantial equity ownership on the part of founders is...