Venture Capital and Sequential Investments

Dirk Bergemann, Ulrich Hege and Liang Peng
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Ulrich Hege: Dept of Finance and Economics, HEC School of Management

No 1682R, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: We present a dynamic model of venture capital financing, described as a sequential in­vestment problem with uncertain outcome. Each venture has a critical, but unknown threshold beyond which it cannot progress. If the threshold is reached before the completion of the project, then the project fails, otherwise it succeeds. The investors decide sequentially about the speed of the investment and the optimal path of staged investments. We derive the dynamically optimal funding policy in response to the arrival of information during the development of the venture. We develop three types of predictions from our theoretical model and test these predictions in a large sample of venture capital investments in the U.S. for the period of 1987-2002. First, the investment flow starts low if the failure risk is high and accelerates as the projects mature. Second, the investment flow reacts positively to information that arrives while the project is developed. We find that the investment decisions are more sensitive to the information received during the development than to the information held prior to the project launch. Third, investors distribute their investments over more funding rounds if the failure risk is larger.

Keywords: Venture capital; Sequential investment; Stage financing; Intertemporal returns (search for similar items in EconPapers)
JEL-codes: D83 D92 G11 G24 (search for similar items in EconPapers)
Pages: 61 pages
Date: 2008-10, Revised 2009-03
New Economics Papers: this item is included in nep-ent and nep-ppm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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Related works:
Working Paper: Venture Capital and Sequential Investments (2012)
Working Paper: Venture Capital and Sequential Investments (2011)
Working Paper: Venture Capital and Sequential Investments (2011)
Working Paper: Venture Capital and Sequential Investments (2011)
Working Paper: Venture Capital and Sequential Investments (2010)
Working Paper: Venture Capital and Sequential Investments (2009)
Working Paper: Venture Capital and Sequential Investments (2009)
Working Paper: Venture Capital and Sequential Investments (2009)
Working Paper: Venture Capital and Sequential Investments (2008)
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