Duration analysis of venture capital staging: A real options perspective

https://doi.org/10.1016/j.jbusvent.2007.10.004Get rights and content

Abstract

This study takes a real options perspective towards venture capital staging and views the staging decision as a choice between holding the current option to invest and investing now to obtain the option to invest subsequently. It proposes that this staging decision depends on the factors that influence the value of these two options, such as competition and various sources of uncertainty. The empirical results suggest that market uncertainty encourages venture capital firms to delay investing at each round of financing, whereas competition, project-specific uncertainty and agency concerns prompt venture capital firms to invest sooner. This study has useful implications for theory and practice.

Section snippets

Executive summary

This study examines the staging decision in venture capital from a real options perspective. Once the initial investment in a portfolio company is undertaken, the venture capital firm has an option to invest in each subsequent round. The staging decision can thus be viewed as whether to hold the current option to invest and wait or to invest now and obtain the option to invest subsequently. The current study proposes that this staging decision depends on the factors that influence the value of

Theory and hypotheses

Organizations and individuals make capital investments in order to create and take advantage of profitable opportunities. These investment opportunities are real options — rights but not obligations to take some action in the future. Therefore, capital investments are essentially about real options (Dixit and Pindyck, 1995). Real options create economic value by generating future decision rights, or more specifically, by offering management the flexibility to act upon new information such that

Data and sample

We test the real options view on the timing of staging using venture capital data collected from Venture Economics' VentureXpert database. We focus on standard venture capital investments in the U.S. We must drop investments for which portfolio companies' names are undisclosed, because such investments cannot be uniquely identified and the duration between financing rounds cannot be determined. The resulting sample includes 46,976 portfolio company-round pairs for 1975–2005, involving 3737

Analysis and results

Table 1 presents the mean and standard deviation of the measures. None of the correlations are sources of concern for multi-collinearity.

Table 2 reports the estimation results. Model 1 is the baseline model that includes all the control variables. Models 2–5 examine the effects of the variables of our interest. Model 6 is the full model specification with all the explanatory variables, and Models 7–8 are for robustness checks. The Wald chi square tests in Table 2 indicate that all the models

Discussion and conclusions

This study investigates the staging decision in venture capital. Venture capital firms have the choice between investing and delay at each round of financing. From a real options perspective, venture capital firms must decide whether to hold the current option to invest or to invest now and obtain an option to invest subsequently. This timing decision depends on the factors that influence the economic value of these two options, such as market uncertainty, competition, and project-specific

References (61)

  • RuhnkaJ.C. et al.

    Some hypotheses about risk in venture capital investing

    Journal of Business Venturing

    (1991)
  • SahlmanW.A.

    The structure and governance of venture–capital organizations

    Journal of Financial Economics

    (1990)
  • TitmanS.

    The effect of capital structure on a firms liquidation decision

    Journal of Financial Economics

    (1984)
  • TresterJ.J.

    Venture capital contracting under asymmetric information

    Journal of Banking & Finance

    (1998)
  • WangS.S. et al.

    Staged financing in venture capital: moral hazard and risks

    Journal of Corporate Finance

    (2004)
  • AdmatiA.R. et al.

    Robust financial contracting and the role of venture capitalists

    Journal of Finance

    (1994)
  • BradleyM. et al.

    On the existence of an optimal capital structure — theory and evidence

    Journal of Finance

    (1984)
  • BranderJ.A. et al.

    Venture–capital syndication: improved venture selection vs. the value-added hypothesis

    Journal of Economics & Management Strategy

    (2002)
  • CameronA.C. et al.

    Microeconometrics: Methods and applications

    (2005)
  • CarruthA. et al.

    What do we know about investment under uncertainty?

    Journal of Economic Survey

    (2000)
  • ChiT. et al.

    Collaborative ventures and value of learning: integrating the transaction cost and strategic option perspectives on the choice of market entry modes

    Journal of International Business Studies

    (1996)
  • CornelliF. et al.

    Stage financing and the role of convertible securities

    Review of Economic Studies

    (2003)
  • CossinD. et al.

    Understanding the economic value of legal covenants in investment contracts: a real options approach to venture equity contracts

  • DixitA.K. et al.

    Investment under uncertainty

    (1994)
  • DixitA.K. et al.

    The options approach to capital investment

  • FaveroC.A. et al.

    A duration model of irreversible oil investment — theory and empirical-evidence

    Journal of Applied Econometrics

    (1994)
  • FennG.W. et al.

    The private equity market: an overview

    Financial Markets and Instruments

    (1997)
  • FoltaT.B.

    Governance and uncertainty: the trade-off between administrative control and commitment

    Strategic Management Journal

    (1998)
  • FoltaT.B. et al.

    Entry in the presence of dueling options

    Strategic Management Journal

    (2004)
  • Global Insight

    Venture impact: the economic importance of venture capital backed companies to the U.S. Economy

  • Cited by (91)

    • Two-stage investment, loan guarantees and share buybacks

      2023, Journal of Economic Dynamics and Control
    • Venture capital staging under economic policy uncertainty

      2022, International Review of Economics and Finance
      Citation Excerpt :

      Particularly, by studying the influence of VCs’ government background on the EPU effect in China, this paper sheds light on severe policy uncertainty in developing economies and the importance of political connections in managing such uncertainty. Venture capital investment decision under uncertainty can be viewed as a trade-off between two choices: delay to invest, or invest now and obtain the option to investment subsequently (Li, 2008). We expect that in times of high economic policy uncertainty, VCs would adjust their timing of investment based on the cost-benefit tradeoff.

    • Financing a corporate venture capital program

      2022, Journal of Banking and Finance
    View all citing articles on Scopus
    1

    I acknowledge funding from the Academy for Entrepreneurial Leadership at the University of Illinois at Urbana-Champaign. I thank Tailan Chi, Tim Folta, Glenn Hoetker, Huseyin Leblebici, Joseph Mahoney, Steven Michael, Dean Shepherd, Tony Tong, and the anonymous reviewers for their helpful comments. All errors remain mine.

    View full text