Financing the Entrepreneurial Venture

This paper is about …nancial contracting choices for the entrepreneur. In an incomplete contracts model, the entrepreneur can design contracts contingent on three possible control right allocations: entrepreneur-control, investor-control, and joint control, with each allocation inducing di¤erent e¤ort levels by both the entrepreneur and the investor. Four types of contract emerge as potentially optimal: debt with liquidation, debt with reorganization, equity-like …nancing, and preferred-type (convertible and straight) …nancing. The model: a) determines optimality along two dimensions: the “convexity”of output as a function of incentives, and the investor’s opportunity cost of capital; b) highlights the importance of ex-ante and ex-post e¢ ciency in contracting; c) generates empirical predictions about the determinants of …nancial contracts. Keywords: Entrepreneurial …nance, incomplete contracts, debt versus equity. JEL Codes: M13, G32. I thank Martin Boyer, Jim Brander, Gilles Chemla, Matt Clements, Doug Cumming, Murray Frank, Keith Head, Bob Helsley, Thomas Hellmann, Gordon Phillips, John Ries, Tom Ross, and Ralph Winter, for helpful comments. Able research assistance was provided by Chris Bidner. All errors are mine. ySauder School of Business, University of British Columbia. Tel: (604) 822-8481. Email: [email protected].