Sunday, February 18, 2007

An improved VC Mechanism

Design such a contract, game, whatever you call it.

Provide free rent for those signers or players (start-ups) for a particular period, say, 2 years. At the end of that period, for each of them, if he/she makes some progress (say, make a certain amount of profits) then they should agree to allocate a certain share to you just as what they will do in a typical VC game. But if he/she fails then they need to pay back something, say, the rent plus corresponding interests or some (monetary) penalties.

The idea here is to screen potential entrepreneurs by introducing penalty. If they think they have a high probability to succeed then it's good for them to play the game. Otherwise, they should pass the opportunity since their well-being would be worse two years later (and actually they may borrow some money at the prevailing interest rate to pay the rent to try their lucks).

In the classical Ventral Capital playground, those big-money holders select candidates with their eyes, ears, and expertise. There are lots of information asymmetry problems and the success rate is doomed to be low. Here people planning to start up make self-selection.

We can show it's an improved version of VC again by checking this fact: Those who have a high probability to succeed will knock the office door of either the classical VC or the improved VC. Those with low ones will still try their lucks in VC game but wont bother to play in the improved one.

Lots of pros here, say: The lowest return rate for the VC is prevailing interest rate (in each case). Ans maybe more importantly, people playing the game actually signal that they have a high probability to win and this may cause a real effect since business parters may well trust them more hence it's easier for them to succeed.

One con I can think of: Those guys are not sure whether they will succeed may be screened out (but who can bet these guys will win if they don't themselves?).

Here we can replace the word "rent" with "loan".

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