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Financial contracting with optimistic entrepreneurs

Suppose you have decided to become a venture capitalist, but you are worried about capital losses and lower rate of return. Therefore, you must review important information related to financial contracting with optimistic entrepreneurs.

1) What are the important points (terms and conditions, clauses) that you should consider adding in the financial contract with optimistic entrepreneurs to mitigate capital losses risk and to achieve higher rate of return? For example, you can sign a contract with optimistic entrepreneurs that grants you cash flow rights, voting rights, control rights, etc., to mitigate capital losses risk.

2) Are there any challenges with the above mentioned points (important points that you described in question one, e.g., cash flow rights, voting rights, control rights, etc.) that you should be aware of? For example, there can be conflict of interest between an agent (optimistic entrepreneur) and principal (Shareholder : you) because entrepreneur can take actions that yield private benefits.

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Financial contracting with optimistic entrepreneurs
Suppose you have decided to become a venture capitalist, but you are worried about capital losses and lower rate of return. Therefore, you must review important information related to financial contracting with optimistic entrepreneurs.

1) What are the important points (terms and conditions, clauses) that you should consider adding in the financial contract with optimistic entrepreneurs to mitigate capital losses risk and to achieve higher rate of return? For example, you can sign a contract with optimistic entrepreneurs that grants you cash flow rights, voting rights, control rights, etc., to mitigate capital losses risk.

Before discussing the important terms and conditions , lets us discuss the most important financial goal of the organization. As this will be the foundation of the terms and conditions. The most important financial goal of the firm is to maximize shareholder wealth as reflected in the market price of the stock. This goal is in conformity with the best long-run interests of stakeholders and society in the long run. (Blackwellpublishing, 2009)
Wealth maximization is achieved by maximization of the cash flows of the organization. Cash flow is a better yardstick than the profits. There are several objections against the profit maximization:
a) Vague: There are multiple meanings of Profit. For example profit after tax, retained earnings. Thus profits cannot be the ultimate goal.
b) Uncertain
As per freemba, "Profit cannot be ascertained well in advance to express the probability of return as future is uncertain. It is not at possible to maximize what cannot be known." Hence the timing of the profit can't be estimated.
c) Ignores time value of money
Profits ignore the time value of money which is not in the case of cash flows. One can exactly find the timing of cash flows. Hence cash flow is a better measure.
d)Narrow outlook
As per freemba, The goal of Maximization of profits is considered to be a narrow outlook. "Evidently when profit maximization becomes the basis of ...

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Response discusses financial contracting with optimistic entrepreneurs

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