DP5758 Conditional Allocation of Control Rights in Venture Capital Firms

Author(s): Georg Gebhardt, Klaus M. Schmidt
Publication Date: July 2006
Keyword(s): control rights, convertible securities, corporate finance, venture capital
JEL(s): D23, G24, G32
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5758

When a young entrepreneurial firm matures, it is often necessary to replace the founding entrepreneur by a professional manager. This replacement decision can be affected by the private benefits of control enjoyed by the entrepreneur which gives rise to a conflict of interest between the entrepreneur and the venture capitalist. We show that a combination of convertible securities and contingent control rights can be used to resolve this conflict efficiently. This contractual arrangement is frequently observed in venture capital finance.