Abstract
We develop a two-stage investment model to examine a novel financing arrangement emerging from the financial services sector. We assume that an entrepreneur, who must borrow funds from a bank to exercise the option to invest in a project, enters into an agreement with an insurer. The insurer guarantees the debt and promises to finance a possible growth investment in the future. The entrepreneur pays a fixed fee to the insurer upon borrowing and grants an equity stake upon the growth investment. We analyze the relationship between the fixed fee and the insurer’s eventual ownership stake, showing that the venture capital alternative succeeds in making a penniless entrepreneur start a project. The project is more valuable if the growth option is granted to the insurer, since it can mitigate the underinvestment problem.
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