Study Of Convertible Securities In Venture Capital

Venture Capital is a new type of financial intermediation,it raise funds from investors and specialize in intermediate stages of the development of innovative ventures.Intermediate stages are new ideas,new discovery are being incubation of new technologies-mainly corresponds to the stages of seeds,start-up and expansion,which requires a lot of financial support.Venture capital not only provides financial support,but also actively participates in the operation and management of ventures.Its main objective is to exit by way of sale or IPO,thus maximize the investment return.VC-backed ventures promote technological innovation to achieve industria-lization,capitalization,and promote employment and economic growth rate,venture capital also achieves high returns.That creates a multi-win results.Venture capital can be described as an engine of economic development.Initially venture capital generated in the U.S.,and get a great success.Now It is popular in the world.China pay more attention to venture capital,hoping to achieve innovation-driven economic development strategy through the development of venture capital.We did get very good score,but the key problem is that the investment stage gradual shift to the later stage of the ventures,namely maturity,which led to a multi-lose situation.Admittedly,an investment of intermediate stage faces a high degree of uncertainty and asymmetrie information.The investment tool should be able to effectively reduce the adverse selection and double moral hazard,but also to ensure the effective exit of venture capital.The optimal tool is corrvertible securities.To effectively reduce the adverse selection,venture capital has several round selection and due diligence.Entrepreneur can distinguish hinself apart by sending a signal to venture capital.If entrepreneur want to offer convertible securities to venture capital,they need to agree on the conversion ratio.An entrepreneur choose his conversion ratio.Venture capital can judge the quality or state of entrepreneurial venture depending on the signal of corrversion ratio.If the venture has a relatively superior technology and good management,good prospects for business development is expected,it will select a lower conversion ratio,in order to ensure that the control rights is not diluted;conversely,the venture will ehoose a higher conversion ratio,in order to attract venture capital convert its investment into common shares as soon as possible,then both of them share the risk.And in this signaling game,there will be a separating equilibrium 5 both types of venture will not imitate each other in order to mislead venture capital.Signaling game reduces the information asymmetry,thereby greatly reducing the adverse selection problems in the contract.The second problem in the contract is moral hazard.Because both the entrepreneur and the venture capitalist provide value-adding effort.Venture capital not only provide funds,but also provide value-adding services,then he may hide action.In other words,there is a double moral hazard in the contract.The article proves that convertible securities can solve the double moral hazard and ensure the effective exit of venture capital,but the simple combination of debt and equity is not enough.It shows that the important feature of eonvertible securities is not that it looks like debt on the downside(which is what the existing literature has focused on),but that there is automatic conversion in case of an IPO and not in an acquisition.A key property of convertible securities is that it allocates different cash flow rights,depending on whether exit occurs by acquisition or IPO.In case of an acquisition,the venture capitalist own a preferred instrument,but in case of an IPO they simply own common stock.Once they establish the optimality of convertible securities,they are faced with the challenge of implementing efficient exit decisions.The model allows for a general two dimensional distribution of acquisition prices and expected IPO values.The problem is that convertible securities biases exit preferences.For lower IPO values,the entrepreneur wants to remain independent,even when an acquisition is more efficient.And for higher IPO values,the venture capitalist might still want to do the acquisition,even if an IPO would be more efficient.I explain the ensuing renegotiation game.Giving the entrepreneur control works well for lower funding levels.But for a larger fimding requirement,the venture capitalist has to make too many coneessions at the renegotiation stage.Giving full control to the venture capitalist is not optimal either,because the entrepreneur has a binding wealth constraint,which hampers renegotiation and can lead to inefficient exit decisions.For a larger fimding requirement,the optimal contract therefore requires a contingent control structure.Control shifts from the venture capitalist to the entrepreneur whenever the venture has sufficiently good prospects for going public.We can say that the convertible securities is the optimal choice of venture capital.U.S.venture capital rarely used the instruments except convertible securities,Germany,Canada and Israel and other countries are also commonly used in convertible securities.Unfortunately,in China the innovative ventures have no rights to issue convertible securities.Currently China's venture capital investment vehicles are primarily equity investments,but the effect is not ideal.Valuation adjustment mechanism can better solve the incentive problem,but this tool has an obvious flaw,that the investor does not provide value-added services.The essential characteristics of venture capital is to provide value-added services,so the valuation adjustment mechanism is not suitable for venture capital.Venture capital has no the optimal tools,the investment shift to the later stage,which is perhaps the second best option.To promote the healthy development of Chinaese venture capital,we propose the following suggestions:first,the law should permit the innovative enterprises to issue convertible securities as soon as possible,so that promoting venture capital to invest in the intermediate stage,then early realization the innovation-driven economic development strategy.Second,limited partnership has more advantages than other forms of organization,especially it can urge effectively general partner of venture capital firm.Limited partnership is the most appropriate form for venture capital firm.Due to historical reasons,the Inc.form has a higher percentage in China.Limited partnership should become the development direction of the venture capital firm;Third,whole process of the innovative ventures development and exiting of venture capitd require a multi-levels of capital market.Currently,there are many problems to be solved in three board,and regional property rights trading center needs to improve.Addition,intermediary services and entrepreneurial culture of innovation environment can not be ignored.