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Venture capital, staged financing and optimal funding policies under uncertainty

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  • Lukas, Elmar
  • Mölls, Sascha
  • Welling, Andreas

Abstract

Our paper presents a dynamic model of entrepreneurial venture financing under uncertainty based on option exercise games between an entrepreneur and a venture capitalist (VC). In particular, we analyze the impact of multi-staged financing and both economic and technological uncertainty on optimal contracting in the context of VC-financing. Our novel approach combines compound option pricing with sequential non-cooperative contracting, allowing us to determine whether renegotiation will improve the probability of coming to an agreement and proceed with the venture. It is shown that both sources of uncertainty positively impact the VC-investor's optimal equity share. Specifically, higher uncertainty leads to a larger stake in the venture, and renegotiation may result in a dramatic shift of control rights in the venture, preventing the venture from failure. Moreover, given ventures with low volatility, situations might occur where the VC-investor loses his first-mover advantage. Based on a comparative-static analysis, new testable hypotheses for further empirical studies are derived from the model.

Suggested Citation

  • Lukas, Elmar & Mölls, Sascha & Welling, Andreas, 2016. "Venture capital, staged financing and optimal funding policies under uncertainty," European Journal of Operational Research, Elsevier, vol. 250(1), pages 305-313.
    • Handle: RePEc:eee:ejores:v:250:y:2016:i:1:p:305-313
    DOI: 10.1016/j.ejor.2015.10.051
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    2. Thomas W. Archibald & Edgar Possani, 2021. "Investment and operational decisions for start-up companies: a game theory and Markov decision process approach," Annals of Operations Research, Springer, vol. 299(1), pages 317-330, April.
    3. Vergara, Marcos & Bonilla, Claudio A. & Sepulveda, Jean P., 2016. "The complementarity effect: Effort and sharing in the entrepreneur and venture capital contract," European Journal of Operational Research, Elsevier, vol. 254(3), pages 1017-1025.
    4. Jiajia Chang & Zhijun Hu & Hui Yang, 2020. "Venture Capital Contracting with Ambiguity Sharing and Effort Complementarity Effect," Mathematics, MDPI, vol. 8(1), pages 1-16, January.
    5. Donia Trabelsi & Baran Siyahhan, 2021. "Startup cash flows and venture capital investments: A real options approach," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 42(3), pages 737-750, April.
    6. Feng Liu & Yingshuang Tan & Sudipto Sarkar & Xueqing Zhang & Xingjun Huang, 2023. "When to invest in electric vehicles under dual credit policy: A real options approach," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 44(4), pages 2186-2198, June.
    7. Dimitrios Zormpas, 2017. "How vertical relationships and external funding affect investment efficiency and timing?," 2017 Papers pzo81, Job Market Papers.
    8. Carayannis, Elias G. & Grigoroudis, Evangelos & Wurth, Bernd, 2022. "OR for entrepreneurial ecosystems: A problem-oriented review and agenda," European Journal of Operational Research, Elsevier, vol. 300(3), pages 791-808.
    9. Ferreira, Ricardo M. & Pereira, Paulo J., 2021. "A dynamic model for venture capitalists’ entry–exit investment decisions," European Journal of Operational Research, Elsevier, vol. 290(2), pages 779-789.
    10. Lili Liu & Heng Jiang & Yonglin Zhang, 2023. "The impact of venture capital on Chinese SMEs’ sustainable development: a focus on early-stage and professional characteristics," Palgrave Communications, Palgrave Macmillan, vol. 10(1), pages 1-11, December.
    11. Shamir, Noam & Zvilichovsky, David, 2022. "Dynamic reputation, project selection and market efficiency: The importance of small projects," International Journal of Production Economics, Elsevier, vol. 248(C).
    12. Jeon, Haejun & Nishihara, Michi, 2018. "Optimal patent policy in the presence of vertical separation," European Journal of Operational Research, Elsevier, vol. 270(2), pages 682-697.
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    14. Dimitrios Zormpas, 2021. "Jointly Held Investment Options and Vertical Relationships," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 58(4), pages 513-530, June.

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