The Optimal Staging of Venture Capital Financing when Entrepreneurs Extract Private Benefits from Their Firms

Abstract

Two of the most common features of venture capital are staged capital infusion and active monitoring. These mechanisms are used to mitigate agency conflicts among entrepreneurs and venture capitalists, especially in innovative start-up firms. The aim of this work is to develop a theoretical model of the agency relationship between the venture capitalist (VC) and the entrepreneur (E), which takes into account both the value added by the VC in the post-investment phase and the incentives for the VC to allocate his scarce time between improving current ventures and evaluating new investment opportunities. The model shows the existence for the VC of an optimal level of attention to dedicate to his portfolio's ventures, measured by the length and the number of financial rounds. The VC's optimal choice does not match the E's expectations, whose objective function depends both on the firm's equity stake he retains, and on the value of private benefits extracted from the venture. The results are coherent with the...