Study On Capital Structure Of Venture Capital Contracts Based On Financial Contract Theory

Venture capital consists of financing high-tech start-up ventures through equity orequity-like instruments by limited partnerships of professional investors who raise fundsfrom wealthy and/or institutional investors. The venture financing contracts betweenventure capitalists (VC) and is entrepreneurs the basis of VC's investment. They arealso the arrangement voucher of responsibilities, rights benefit as well as the planswhich guides the two parties for future action. Comparing with the empirical analysis,the theoretical studies of these financing contracts is relatively lag and weak.Consequently, the present theoretical outcomes have not yet accurately grasped theinherent properties of venture capital and failed to expound on the relationship betweenthese properties and the structure characteristics of the corresponding venture capitalcontracts. This paper mainly studies the cash flow right allocation of venture capitalcontracts, namely, the capital structure.First, this paper reviews the empirical and theoretical literatures of venture capitaland sums up the disciplines and governance mechanisms of their financing contracts,which points out that the capital structure and the control right is the important concernfor theoretical researching. And then, the paper tentatively explains the terms andstructure of limited partnership agreement and venture financing contract based on therelevant contract theory.Secondly, the paper re-examine the capital structure models of the unilateral moralhazard. The treatment of a financing problem to which not assigning debt contract as asolution in advance, but endogenously derives that the optimal capital structure solutionusing first-order condition (FOC) approach from the original assumptions andoptimization, is a fundamental work. Previous economists believe that the standardanalysis tool of contract theory - the FOC approach can not derive the optimal capitalstructure. In this paper, we find the optimal solution to the financing problem usingFOC approach, and expand the analysis to the situation when of the investor is riskaverse. Our study not only completes the economic explanation of the financingproblem of small enterprises, but also lays the foundation for further study of capital structure of ventures backed by venture capital.Previous attempts to study the capital structure of ventures backed by venture capitalare at the setting of double moral hazard, but these studies do not get the conclusion thatventure's capital structure is convertible preferred stock hold by VC. Based on theempirical study, this paper proposes three important assumptions: (â…°) the efforts of VCand entrepreneur can also increase stochastically the profit of venture; (â…±) efforts arecomplement; (â…²) in view of principle of maximum likelihood, entrepreneur play keyrole in the development of venture. So this paper constructs a double moral hazardmodel and derives endogenously the capital structure of venture backed by venturecapital. We find that the optimal capital structure is a convertible preferred stocks givingto VC, and giving common stocks to entrepreneur only when profit exceeding aparticular level.In the background of incomplete contract, this paper considers two contractingsettings of which one is entrepreneur provide contract to VC and another is the reverse,and designs the convertible debt to induce the efforts of two parties. Debt is a financialinstrument which can gives a specific threaten and provide sufficient motivation to theentrepreneurs. The opportunity of which VC can convert debt to equity, gives the VCincentive to provide effort adding value to the venture. The outcome reveals VC how tomanage the call option which is the conversion right, and how to manage the liquidationright.A report is as the application research part of this paper, which is a research ofstrategic venture capital management and operation of high-tech projects of a publiccompany. The report played an important role in practice, but also has some academicsignificance, as a group of cases of China's state-owned enterprises engaged ininvestment and management of high-tech industry investment.