New venture start‐ups and technological innovation

Purpose - The purpose of this paper is to compare investment in innovation (e.g. R&D) between new venture start‐ups before commercialization and operating businesses after commercialization. Design/methodology/approach - Real options methods were used to model a new venture start‐up as a perpetual call option on an operating business that grows with R&D. The operating business uses R&D to improve actual earnings while the start‐up uses R&D to improve prospective earnings. When the start‐up entrepreneur commercializes his/her new product, device, or service with conventional investment (e.g. plant, property, and equipment to begin production), prospective earnings convert into actual earnings. Findings - The ability of the start‐up entrepreneur to avoid commercialization costs upon failed R&D makes R&D more valuable to the start‐up entrepreneur than to the manager of the already operating business (for whom commercialization costs are sunk) and despite R&D costs that the start‐up incurs without the revenues that only commercialization generates. The value of R&D to the start‐up can be so great that the entrepreneur invests in R&D before the manager of an otherwise similar operating business in similar business conditions. Originality/value - Without favoring eithera priori, the authors show that under broad circumstances, a new venture start‐up undertakes R&D before an already operating business. The authors also discuss the empirical implications of the results.