Venture Capital and Private Equity Contracting

Chapter 12. Security Design and Adverse Selection

12.1. Introduction and Learning Objectives

This chapter considers the screening of venture capital investments. In particular, it investigates the issue of whether the use of different financial instruments (including debt, common equity, preferred equity, and convertible securities) “attract” different types of entrepreneurial firms, in terms of the adverse selection risks associated with financing low-quality firms in relation to the financial security used. A central contribution of this chapter is in the assessment of whether syndication mitigates such adverse selection risks.

As we examined in Chapter 11, firm-specific characteristics affect the choice of financial security (see also, e.g., ...