Abstract
During the venture capital development, replacing the management work team or keeping up the status quo is a key strategy choice for venture capitalist and venture entrepreneur about the long-term development of enterprise and the control right transferring. In fact, the contract designing focuses on the distribution of cash flow to encourage both efforts in order to avoid double moral hazard, and the strategy behavior has similar effects according to the developing condition of venture enterprise. In this paper, we consider both contract design and strategic behavior, regarding this strategic behavior choice as a motivator and combining strategic behavior with financial instrument options. The main innovation is to redesign and optimize the contract based on dynamic perspective, which will analyze initial contract designed to motivate both sides’ effort if a venture enterprise is in good state, and then renegotiate whether to replace the management work team or keep up the status quo according to the venture enterprise’s development state in the process of venture investment cooperation. The paper also puts forward some conclusions: joint effort of both sides can be motivated through strategic behavior choice and then lead to increasing the overall value of the venture enterprise; after the venture enterprise has gained private benefits in the early stage, the venture capitalist needs to make appropriate assignments and demisability in benefits to remotivate the venture enterprise’s efforts, aiming to further balance venture enterprise’s private benefits and the earnings redistributed by venture capitalist.
Highlights
Funding difficulties of startup firms can be mitigated by venture capitalists’ initial or multiple stage investments, after which the value of venture capital backed firm is shared by venture capitalists and entrepreneurs
One typical case is that even entrepreneurs are not well qualified; entrepreneurs tend to continue to operate the firm for private benefits, rather than to be replaced by professional managers, causing entrepreneurs’ moral hazard that holds up venture capitalists [1,2,3,4,5]. erefore, it presents a key challenge to venture capitalists to motivate entrepreneurs to maximize the value of the firm and the benefits shared by both entrepreneurs and capitalists [6]
We propose a potential solution for capitalists, that is, an optional choice on replacing managers or keeping up the status quo in initial contract design. is design of renegotiation contract provides capitalists an optional choice to remotivate entrepreneurs after the company has developed to a certain stage and entrepreneurs have attained personal benefits. e remotivation leads entrepreneurs to operate the firm targeted with long-term performance and to keep align their interest with capitalists, ensuring the interests of venture capitalists
Summary
Funding difficulties of startup firms can be mitigated by venture capitalists’ initial or multiple stage investments, after which the value of venture capital backed firm is shared by venture capitalists and entrepreneurs. We analyze initial contract designed to motivate both sides’ efforts from entrepreneurs and capitalists and renegotiate whether to replace the management team or keep up the status quo according to the enterprise’s development state in the process of cooperation between capitalists and entrepreneurs. Venture capitalists and entrepreneurs tend to shirk and optimize their own interest and behavior after their own incentives, which leads to less than the first-best level of effort [10] It brings about double moral hazard between venture capitalists and entrepreneurs. Us, stage financing and contingent control right can be used as important measures according to the development situation of venture enterprise to prevent double moral hazard. The aims are to design contract or compare and choose contract to motivate more effort of venture capitalist and venture entrepreneur and to choose strategy behavior to threaten venture capitalist and venture entrepreneur in order to motivate their effort, but it goes blank to study on the contract designing and optimization under the framework with various strategy choices. erefore, the paper will focus on making up the deficiency, which will design contract considering various strategy choices
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