Show Summary Details

Page of

PRINTED FROM OXFORD HANDBOOKS ONLINE ( © Oxford University Press, 2018. All Rights Reserved. Under the terms of the licence agreement, an individual user may print out a PDF of a single chapter of a title in Oxford Handbooks Online for personal use (for details see Privacy Policy and Legal Notice).

date: 08 July 2020

Abstract and Keywords

This article focuses on determining the appropriate discount rate to be used by an entrepreneur who is deciding whether or not to proceed with a prospective venture. First, it analyzes the investment decision from the perspective of a venture capitalist (VC). It shows that the discount rates commonly used by VCs are consistent with the discount rates implied by financial economic theory. It then draws on the same financial economic theory to infer the required rate of return (i.e., opportunity cost of capital) for an entrepreneur who is undertaking a venture that will require commitment of substantially all of the entrepreneur's wealth and effort. Among other things, it concludes that the required return on the entrepreneur's investment is higher than the required return of a VC who represents well-diversified investors and is considering a similar financial claim. The analysis is extended to consider the required return for an entrepreneur who is able to divide total wealth between the venture and a well-diversified portfolio of market assets. It is shown that the required rate of return to the entrepreneur depends on the allocation of wealth between the venture and the market portfolio. Thus, to an extent, by selecting the asset allocation between the two, the entrepreneur can control the required rate of return on the venture. The article includes a discussion of methods of implementation, along with an illustration of one approach. It concludes by focusing on the design of value-maximizing financial contracts between entrepreneurs and outside investors.

Keywords: discount rates, venture capitalists, venture capital, rate of return, asset allocation

Access to the complete content on Oxford Handbooks Online requires a subscription or purchase. Public users are able to search the site and view the abstracts and keywords for each book and chapter without a subscription.

Please subscribe or login to access full text content.

If you have purchased a print title that contains an access token, please see the token for information about how to register your code.

For questions on access or troubleshooting, please check our FAQs, and if you can''t find the answer there, please contact us.