Comment on Bergemann and Hege

Abstract

Dirk Bergemann and Ulrich Hege examine in this paper the reasons why venture capitalists provide funds to entrepreneurs in successive financing rounds, or stages. This is an interesting analysis of one of the most important mechanisms that venture capitalists employ to control entrepreneurs, an issue that surely deserves greater theoretical and empirical attention. The authors’ approach to these issues is a creative and novel one. At the same time, some assumptions and predictions of the model seem quite at odds with the empirical evidence about venture capital investments. In this discussion, I will first briefly summarize the key features and predictions of the paper. I will then highlight several of my concerns with the model. The discussion concludes with some more general thoughts about the rationales for the staging of venture capital investments in young firms. The paper depicts the interactions between a single entrepreneur and a venture investor. The entrepreneur, who has no financial resources, must turn to a venture capitalist for funding. It is assumed that the entrepreneur initially has the bargaining power in the negotiation: the large number of potential venture investors are not diAerentiated. Dynamic interactions between several venture capitalists in diAerent financing rounds, of the type analyzed by Admati and Pfleiderer (1994), are not considered in this model. The project, whose quality is initially uncertain, can turn out to be one of two types: good or bad. The good projects are not revealed immediately. Rather, in each period, there is some probability that the project will be revealed to be good and generate a fixed return (at which point the venture investor’s involvement ends). The probability of a successful outcome is increasing with