|Research Paper 63|
Understanding the Economic Value of Legal Covenants in Investment Contracts:
A Real-Options Approach to Venture Equity Contracts
COSSIN - HEC-University of Lausanne, FAME and IMD
SALIASI - HEC-University of Lausanne and FAME
Click here to download a .pdf of this paper
early-stage high-technology growth-oriented companies is a challenge to current valuation methodologies.
This inability to come up with robust point estimates of value should not and does not lead to a breakdown
of market liquidity: instead, efforts are redirected towards the design of investment contracts which
materially skew the distribution of payoffs in favor of the venture investors. In effect, limitations
in valuation abilities are addressed by designing the investment contracts as baskets of real options
instead of linear payoff functions. This paper investigates four common features (covenants) of venture
capital investment contracts from a real option perspective, using both analytical solutions and numerical
analysis to draw inferences for a better understanding of contract features. The impact of the concept
for pricing issues, valuation negotiation and for contract design are considered. It is shown for example
how “contingent pre-contracting” for follow-up rounds is theoretically a better proposition than the
simple “rights of first refusal” commonly found in many contracts. We also provide for results (such
as timing of investments, length of rounds, choices of liquidation levels, conversion levels) that take
into account full interaction of the different features considered. We document some complex facts,
such as the concavity of the VC contract value depending on the amount invested at the different stages,
the actual share impact of the most common antidilution feature, some endogenous motivation for early
VC exits from otherwise performing companies, and stress overall the importance of a full analysis for
efficient contract negociation and understanding.
Lunch and Learn @ SFI
SFI Evening Seminar with Prof. Darrell Duffie, Geneva
Topic: Stresses and Strains on China's Financial System
SFI Evening Seminar with Prof. Paul Embrechts
Topic: Risk Management: Then, Now, and Tomorrow
Asset Management Study Switzerland by zeb und SFI. Asset Management in Switzerland faces huge challenges.
Swiss Finance Institute has attributed its Outstanding Paper Award to “The Impact of Treasury Supply on Financial Sector Lending and Stability”, a research paper by Arvind Krishnamurthy of Stanford University and Annette Vissing-Jorgensen of the University of California Berkeley that studies how government debt crowds out financial sector short-term debt.
Swiss Finance Institute publishes the first comprehensive Swiss study on structured products. The most recent SFI White Paper sheds light on the performance, costs, and investments of structured products.
English version, German version, French version, Italian version
More press releases...
SFI in the news
L'Agefi: Le décloisonnement des compétences
Article referring to the 10th Annual Meeting of SFI (13.11.2015)
L'Agefi: SFI Prof. Philipp Krüger remporte le Moskowitz (10.11.2015)
L'Agefi: Le sens des buyouts secondaires
Article on SFI Prof. Francois Degeorge's Practitioner Roundup on Secondary Buyouts (Sep 2015)
Finanz und Wirtschaft: Bewusster anlegen mit Evolutionary Finance
Article by SFI Professor Thorsten Hens (25.07.2015)
Finanz und Wirtschaft: Barriere-Zertifikate langfristig oder punktuell
Article referring to the SFI White Paper—Structured Products: Performance, Costs, and Investments (18.07.2015)
SRF: Radio program on the impact of the Greek crisis on the banks
Including interview with SFI Senior Chair Harald Hau (16.07.2015)
More press coverage...