Growth Firms and Relationship Finance: A Capital Structure Perspective

We model a firm in which early investors are less informed than insiders, but better informed than new investors about the firm's prospects. This allows early investors to dictate terms in new financing rounds. They monetize on this power by steering the firm towards issuing equity. Anticipating adverse selection and underinvestment in future financing rounds, firms optimally engage in relationship financing through debt-like contracts and building up equity capacity. Long-term credit lines are an alternative only for small and less uncertain investments. Our results highlight the different financing pecking orders in firms dependent on relationship lending and venture capital financing.

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