Reading: Introduction

The remainder of the module discusses different types of contractual arrangements to allocate the cash flow streams and the risks of the venture between the parties of the deal.

The primary focus will be on financing situations that involve new ventures. The considerations, however, also directly apply to more established companies. In fact, a number of established firms try to incorporate deal structures as we discuss them in this module to stifle innovation inside the firm (e.g., with an internal venture fund).

We proceed as follows:

• We start with some thoughts about staged capital contributions (SCC), a standard form of financing of new ventures. We look at a simple example that shows staged capital contribution at work and we discuss the costs and benefits of this form of financing. 
• The analysis of SCC allows us to set the stage for a broader discussion about the key elements of deal structuring. We look at the three key elements behind most financial deals, namely:

1. 1. The division of financial returns
   2. The dynamic allocation of control
   3. The provision of incentives to achieve a liquidity event.

• With these considerations in mind, we then look at the actual terms of financial deals and their implications. We thereby follow the logic of the three elements mentioned above:
  1. We first discuss how investors use preferred securities to achieve a more favorable division of returns.
  2. Second, we take a brief look at how to value the various types of preferred securities and the resulting deal arrangements.
  3. To conclude the analysis of return division, we then look at how investors can manage their investments by protecting their valuations and securing rights to participate in future rounds of financing.
  4. Then we turn to the allocation of control in the form of voting rights, board representation, and general employment and participation terms for the employees.
  5. Last but not least, we see how investors make sure that they can exit the investment after the predefined investment period. This will be a crucial message for entrepreneurs who team up with professional money such as venture capitalists (VCs). With redeemability and, listing rights, and other contractual clauses, these investors typically make sure that they can force the company into a liquidity event after a certain period of time.