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Stage financing and the role of convertible securities

Subject

Finance

Publishing details

Publication Year

2001

Abstract

Venture capital financing is characterized by extensive use of convertible securities and stage financing. In a model where an entrepreneur obtains funding for a project from a venture capitalist, we illustrate an advantage of convertible debt over a mixture of debt and equity in stage financing situations. Essentially, when the venture capitalist retains the option to abandon the project, the entrepreneur has an incentive to engage in window dressing and bias positively the short-term performance of the project, reducing the probability that it will be liquidated. An appropriately designed convertible debt contract prevents such short-termistic behavior since window dressing also increases the probability that the venture capitalist will convert debt into equity.

Publication Research Centre

Institute of Finance and Accounting

Series Number

FIN 348

Series

IFA Working Paper

Available on ECCH

No


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