Start up law Lesson 1-3 Flashcards
What is a dual company structure?
is a company that issues two (or more) types of shares with different voting rights. This structure allows founders, executives, or early investors to retain control over the company, even if they own a minority of the total shares.
Normally used in unicorns to give founders superior voting power and control despite dilution of ownership.
Why banks are not an option for innovative firms?
Interest rates, timing of ROI, risk, collaterals. Depends in the type of contract. Banks specialize in loans, Startups are not their business, they not really care about the objective of the company, bank just cares about that you can payback. If they don’t know anything about the business how can the bank be sure if they can payback.
Startups rely on venture capital (VC) or angel investment rather than bank loans due to:
High failure rates.
Negative cash flow.
Lack of tangible assets.
Why investors ask for equity instead of offering loans? What makes it more attractive for them?
You get decision making in the company. Assigning directors. Which is important because you get to direct how your money is being managed.
right to take benefits of the company like dividends and the increase in share value
How investors ensure the right use of the money by directors of the company? (How can they avoid moral hazard)
Voting for investing decisions. STAGE FINANCING. PUNISHMENT. CASH DEPRIVATION. Liquidation preference.
What’s Moral Hazard?
Is a situation when one party is promised to behave someway and has the possibility to change that without the other party to stop it. Asymmetric information. Gollum buying a Ferrari.
What’s adverse selection?
Hidden unobservable characteristics. A market process in which buyers or sellers of a product or service are able to use their private knowledge of the risk factors involved in the transaction to maximize their outcomes, at the expense of the other parties to the transaction.
Market for lemons. (Example of sells used cars)
IS THERE SOMETHING IN BETWEEN A LOAN AND EQUITY?
-Bonds are a representation of a loan contract with a piece of paper.
-Convertible Bonds are Loans with right to convert your position of a lender to a position of a shareholder (owner).
optimal debt-equity ratio or capital structure
is determined at the point where the marginal benefit of keeping the manager from taking perks is offset by the marginal cost of causing risky behavior.
What’s the agency problem?
a (potential) conflict of interest between an agent who takes an action (in this case, the manager choosing the level of perks) and a principal who bears the consequences of that action (other share-holders or creditors. the best way to deal with them is to put the agent on an optimal incentive scheme.
Financial Contracting
The theory of what kind of deals are made between financiers and those who need financing.
The design of contracts that govern financial relationships, including debt and equity agreements and of who controls decisions.
What are non-pecuniary benefits?
Perks refer to things like fancy offices, private jets, the easy life, etc.
Diversion in financial contracting
Misuse of funds or assets by a borrower or agent for purposes other than those originally intended or agreed upon in a contract.
It typically occurs when a borrower uses funds for personal benefit, alternative projects, or activities that are not aligned with the agreed financial arrangements.
What is patronage?
involves providing aid or support to another entity, often with an expectation of loyalty, influence, or benefit in return. (Sponsor)
What happens to a firm financed by a Vc, if the firm performs poorly?
the VCs obtain full control.
And what if the firm financed by a VC performs very well?
The VCs retain their cash flow rights, but relinquish most of their control and liquidation rights. The entrepreneur’s cash flow rights also increase with firm performance
What is the Aghion-Bolton model?
is a theoretical framework in the field of financial economics that examines how contracts can be structured to allocate control rights and resolve conflicts between parties, particularly in scenarios involving incomplete contracts.
Why companies without debt are risky?
because managers can’t be controlled on buying perks. When there is debt the manager focuses on paying debt rather than buying a Ferrari.
What’s the theory of control rights?
The theory is often discussed in the context of incomplete contracts, where not all future contingencies can be accounted for. Control rights help address uncertainties by determining who makes decisions under specific circumstances.
Why Modigliani–Miller Theory Doesn’t Work in Practice?
doesn’t hold in the real world due to factors like taxes, bankruptcy costs, agency issues, and market imperfections.
What’s the Modigliani-Miller Theorem?
In a frictionless world, capital structure (debt/equity mix) does not affect firm value. However, in reality, financial frictions exist (taxes, bankruptcy costs, asymmetric information).
What’s the trade off theory
Firms balance tax benefits of debt (interest deductibility) against bankruptcy costs.
What’s the Pecking Order Theory?
Firms prefer internal financing over debt, and
only issue equity as a last resort due to adverse selection.
