Distributing Start-Up Equity: A Theoretical Foundation for an Emerging Practice

We use agency theory to model equity division in venture capital financing with three complementary value-creation factors-the entrepreneur's effort, the venture capitalist's advising/monitoring service, and the investment amount. While considering that investors often base their funding d...

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Bibliographic Details
Published in:Journal of small business management 2019-07, Vol.57 (3), p.1066-1085
Main Authors: Narayanan, Meyyappan, Lévesque, Moren
Format: Article
Language:English
Subjects:
Entrepreneurs
Equity
Ownership
Startups
Venture capital
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Summary:We use agency theory to model equity division in venture capital financing with three complementary value-creation factors-the entrepreneur's effort, the venture capitalist's advising/monitoring service, and the investment amount. While considering that investors often base their funding decisions on gut feeling, even as they employ rational decision-making processes, we derive closed-form expressions for optimal ownership sharing. Our findings provide theoretical explanation to support the recent call for practitioners to allocate ownership equity based on the relative potential contributions of the entrepreneur and the venture capitalist to generate value for the new investment prospect.
ISSN:0047-2778
1540-627X
DOI:10.1111/jsbm.12420