Venture Capital and Sequential Investments

57 Pages Posted: 4 Nov 2008 Last revised: 20 Feb 2015

See all articles by Dirk Bergemann

Dirk Bergemann

Yale University - Cowles Foundation - Department of Economics; Yale University - Cowles Foundation

Ulrich Hege

Toulouse School of Economics; European Corporate Governance Institute (ECGI)

Liang Peng

Smeal College of Business, The Pennsylvania State University

Multiple version iconThere are 3 versions of this paper

Date Written: April 11, 2011

Abstract

We present a dynamic model of venture capital financing, described as a sequential investment problem with uncertain outcome. Each venture has to pass a sequence of milestones, and there is a chance of terminal failure in each milestone. The investors decide sequentially about the speed of the investment and, due to contract frictions and agency costs, will optimally structure investments in a discrete sequence 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

JEL Classification: D83, D92, G11, G24

Suggested Citation

Bergemann, Dirk and Hege, Ulrich and Peng, Liang, Venture Capital and Sequential Investments (April 11, 2011). EFA 2009 Bergen Meetings Paper; Cowles Foundation Discussion Paper No. 1682R. Available at SSRN: https://ssrn.com/abstract=1295339 or http://dx.doi.org/10.2139/ssrn.1295339

Dirk Bergemann (Contact Author)

Yale University - Cowles Foundation - Department of Economics ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States
203-432-3592 (Phone)
203-432-2128 (Fax)

HOME PAGE: http://www.econ.yale.edu/~dirk/

Yale University - Cowles Foundation

Box 208281
New Haven, CT 06520-8281
United States

Ulrich Hege

Toulouse School of Economics ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France
+33 5 61 12 86 01 (Phone)

HOME PAGE: http://https://www.tse-fr.eu/people/ulrich-hege

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http:/www.ecgi.org

Liang Peng

Smeal College of Business, The Pennsylvania State University ( email )

University Park
State College, PA 16802
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
274
rank
47,571
Abstract Views
1,374
PlumX Metrics