duration analysis of venture capital staging: a real options perspective

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Journal of Business Venturing 23 (2008) 497–512

Duration analysis of venture capital staging:A real options perspective

Yong Li ⁎,1

School of Management, State University of New York at Buffalo, 326 Jacobs Management Center, Amherst, NY 14260 USA

Received 1 December 2006; received in revised form 1 July 2007; accepted 1 October 2007

Abstract

This study takes a real options perspective towards venture capital staging and views the staging decision as a choice betweenholding the current option to invest and investing now to obtain the option to invest subsequently. It proposes that this stagingdecision depends on the factors that influence the value of these two options, such as competition and various sources ofuncertainty. The empirical results suggest that market uncertainty encourages venture capital firms to delay investing at each roundof 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.© 2007 Elsevier Inc. All rights reserved.

Keywords: Venture capital; Staging; Real options; Uncertainty; Agency

1. Executive summary

This study examines the staging decision in venture capital from a real options perspective. Once the initialinvestment in a portfolio company is undertaken, the venture capital firm has an option to invest in each subsequentround. The staging decision can thus be viewed as whether to hold the current option to invest and wait or to investnow and obtain the option to invest subsequently. The current study proposes that this staging decision depends on thefactors that influence the value of these two options, including various sources of uncertainty and competition.

Venture capital investments face exogenous market uncertainty that changes whether or not investment is takingplace. Since venture capital investments are at least partially irreversible, there is a value of waiting for new informationbefore the venture capital firm commits to the current round of financing. Market uncertainty will thus increase thevalue of holding the current option to invest and encourage the venture capital firm to delay.

Delay is not always preferred to investing. First, delaying investing in the current round could increase the cost ofinvesting subsequently, or worse, delay could cause this option to invest in the subsequent round expire. In particular,the right of first refusal does not prevent competitors from developing other portfolio companies with similar growth

⁎ Corresponding author. Tel.: +1 716 645 2522; fax: +1 716 645 5078.E-mail address: [email protected].

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 theirhelpful comments. All errors remain mine.

0883-9026/$ - see front matter © 2007 Elsevier Inc. All rights reserved.doi:10.1016/j.jbusvent.2007.10.004

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498 Y. Li / Journal of Business Venturing 23 (2008) 497–512

prospects. Thus, competition will increase the opportunity cost of waiting, and prompt the venture capital firm toinvest.

Second, if the venture capital firm can obtain more project-specific information through investing about the ventureproject, it may be more beneficial to invest now and obtain the option to invest subsequently than to hold the currentoption to invest. The opportunity to obtain information at each round of financing is particularly attractive when thesources of uncertainty surrounding the venture capital project can be substantially influenced by the endogenousactivity of the venture capital firm. This study examines two forms of endogenous uncertainty that are important forventure capital investments. First of all, each venture project has project-specific uncertainty concerning the costs andbenefits of the project. Project-specific information generally arrives when investment is taking place, and there is littlevalue to waiting. Consequently, the venture capital firm has the motive to invest sooner so as to accumulateinformation. Secondly, the venture capitalist–entrepreneur relationship is characterized by behavioral uncertainty. Inparticular, the venture capital firm has the motive to tighten monitoring and invest more frequently in those portfoliocompanies with potentially higher agency costs.

The empirical results suggest that market uncertainty encourages venture capital firms to delay investing at eachround of financing, whereas competition and agency concerns prompt venture capital firms to invest sooner. Further,portfolio companies at earlier stages receive financing at a much faster pace. This result offers supportive evidence tothe extent that earlier stages of development are indicative of higher project-specific uncertainty.

This study has useful practical implications. Venture capital firms can view the staging decision at each round offinancing as making a choice between investing and delay. Concerning the timing of staging, while portfolio companyperformance, syndicate characteristics, liquidity constraints, and agency concerns are all important factors, venturecapital firms need to further consider the broader decision context and the effects of real options factors such asuncertainty and competitive pressure on the staging decision. Further, it is useful for venture capital firms todifferentiate between exogenous market uncertainty and endogenous project-specific uncertainty or behavioraluncertainty, to the extent that they have different implications for the staging decision.

2. Introduction

Venture capital has had an increasingly important impact on corporate innovation, job creation and economicgrowth (Dushnitsky and Lenox, 2005; Global Insight, 2007; Kortum and Lerner, 2000). A prominent feature of venturecapital investments is staged financing of portfolio companies by venture capital firms (Sahlman, 1990). The currentstudy examines this staging decision and analyzes when portfolio companies will receive each round of financing fromventure capital firms.

The timing of staging is critical for both the entrepreneur and the venture capitalist. For the entrepreneur, timelyfinancing in each subsequent round is just as important as the initial capital infusion. Developing a new product ortechnology with venture capital funds in a timely fashion may make the difference between survival and going out ofbusiness (Dean and Giglierano, 1990). Even if survival is not an immediate concern, the entrepreneur may depend upontimely venture capital funding to fuel growth. On the other hand, each round of financing is surrounded by varioussources of uncertainty, and the venture capitalist has to decide whether to invest sooner or delay.

Extant research has primarily examined the staging of venture capital investments from an agency perspective(Admati and Pfleiderer, 1994; Gompers, 1995; Trester, 1998). Venture capital firms can stage their financing tomitigate information asymmetry and agency problems (e.g. Neher, 1999; Wang and Zhou, 2004). Further, venturecapitalists need to monitor entrepreneurs closely and invest frequently, to learn about the effort of entrepreneurs and toreduce the agency costs of inefficient continuation (Gompers, 1995). While the agency perspective focuses on theventure capitalist's need to manage the relationship with the entrepreneur, it has largely ignored the broader decisioncontext. Beyond the potential self-interest or opportunism on the part of the entrepreneur, the venture capitalist alsofaces market- and project-specific uncertainties as well as competitive pressure that represent important factors toconsider in the staging decision. This study addresses this gap by introducing a real options framework that accountsfor how the venture capitalist responds to uncertainty and competitive pressure.

From a real options perspective, each prior round of financing gives rise to the opportunity to invest subsequently. Oncethe initial investment in a portfolio company is undertaken, the venture capital firm has an option, but not an obligation, toinvest in each subsequent round. In this respect, a critical issue concerning each round of financing is, should the venturecapital firm hold the option to invest in the current round? Or, should the venture capital firm invest now and obtain an

499Y. Li / Journal of Business Venturing 23 (2008) 497–512

option to invest in the subsequent (and future) round(s)? The current study proposes that this staging decision depends onthe factors that influence the value of holding the current option to invest vs. investing now to obtain the option to investsubsequently.

On the one hand, venture capital investments face market uncertainty that resolves primarily with the passage of time(Dixit and Pindyck, 1994). Since venture capital investments are at least partially irreversible, and market uncertaintychangeswhether or not investment is taking place, there is a value ofwaiting for new information before the venture capitalfirm commits to the current round of financing. Thus, market uncertainty increases the value of holding the current optionto invest and encourages the venture capital firm to delay investing.

On the other hand, there are situations where delay is not as beneficial as investing sooner. First, delay in the currentround of financing could increase the cost of investing in the subsequent round (i.e., the cost of purchasing the option toinvest subsequently), or even worse, delay could cause this option to expire. In particular, the venture capitalist may havethe right of first refusal, which provides the preferential right to invest in the subsequent round, but such a right does notprevent competitors fromdeveloping other portfolio companieswith similar growth prospects. Therefore, competitionwillincrease the opportunity cost of delay, and prompt the venture capital firm to invest sooner.

Second, if, through investing, the venture capital firm can obtain information about the costs and potential benefits ofthe venture project, the value of the option to invest subsequently gained from investing now may be higher than thevalue of holding the current option to invest (Pindyck, 1993; Roberts and Weitzman, 1981). Consequently, the venturecapital firm will be prompted to invest for the growth prospects associated with the subsequent rounds of financing. Theopportunity to obtain information at each round of financing is particularly attractive when the sources of uncertaintysurrounding the venture capital project can be substantially influenced by the endogenous activity of the venture capitalfirm. This research study focuses on two forms of such endogenous uncertainty in venture capital. First of all, eachventure project has project-specific uncertainty concerning the costs of completing the project and its potential benefits.Project-specific information about costs and benefits generally arrives when investment is taking place. Thus, there islittle value to waiting and the venture capital firm has the motive to invest sooner to accumulate information. In addition,the venture capitalist–entrepreneur relationship is characterized by behavioral uncertainty, i.e., uncertainty of a‘strategic’ kind attributable to self-interest and opportunism (Williamson, 1985). In this respect, extant research hasviewed information asymmetry and associated agency problems as central concerns in venture capital investments (e.g.Gompers, 1995).

To examine this real options view of the staging decision, the current study analyzes the funding duration of standardventure capital investments in the U.S. during 1975–2005. The empirical analysis presents evidence consistent with thisreal options view: Market uncertainty encourages the venture capital firm to delay, while competition, project-specificuncertainty and agency concerns prompt the venture capital firm to invest sooner. The empirical results indicate that it isimportant to consider the broader decision context beyond agency concerns in examining venture capital staging. The realoptions approach also enables us to examine how the staging decision is influenced by various sources of uncertainty thatare prevalent in venture capital investments.

The remainder of this study proceeds as follows. First, this paper elaborates on the real options view concerningventure capital staging. Then, the data and methods are presented, and the empirical results are reported. This paperconcludes by discussing the implications of the current study for theory and practice and by noting several avenues forfuture research.

3. Theory and hypotheses

Organizations and individuals make capital investments in order to create and take advantage of profitableopportunities. These investment opportunities are real options — rights but not obligations to take some action in thefuture. Therefore, capital investments are essentially about real options (Dixit and Pindyck, 1995). Real options createeconomic value by generating future decision rights, or more specifically, by offering management the flexibility to actupon new information such that the upside economic potential of an investment project is retained while the downsidelosses are contained (Trigeorgis, 1996).

In staged venture capital investments, upon prior round of financing in a portfolio company, the venture capital firm hasan option to invest in the current round of financing. Upon investing, the firm gains another option to invest in a subsequentround. The staging goes on until a successful exit (in the form of initial public offering or acquisition) or abandonment.Thus, once a prior round has been undertaken, the venture capital firmmust choose between: (a) holding the current option


to invest and (b) investing now to obtain the option to invest subsequently. From a real options perspective, this stagingdecision depends on the factors that influence the economic value of these two options. In the following, we discuss twofactors that are particularly important for the staging decision: uncertainty and competition.

3.1. Market uncertainty and venture capital staging

One factor central to the real options theory is uncertainty (Dixit and Pindyck, 1994). Venture capital investments arefraught with uncertainty. Less than one third of venture capital investments will ultimately be successfully exited (Fennet al., 1997; Ruhnka andYoung, 1991). According toCochrane (2005), venture capital investments have amean arithmeticreturn of 59% but its standard deviation is 107%. Therefore, venture capital investments have a small chance of a hugepayoff.

Uncertainty in venture capital investments can be attributed to unexpected market developments, among otherthings. Such market uncertainty is out of the control of entrepreneurs or venture capitalists, and can thus be viewed as‘exogenous’ to organizational activity (McGrath, 1997; Pindyck, 1993). Although market uncertainty does not in itselfcause market failure (Amit et al., 1998), it does affect venture capitalists' investment strategies.

The real options theory of investment suggests that in a world of uncertainty, when investments are at least partiallyirreversible, the option to invest can be more economically valuable than immediate investment because this option offersmanagement the flexibility to defer the investment decision until additional information is revealed (Dixit and Pindyck,1994; McDonald and Siegel, 1986; Trigeorgis, 1996). Venture capital investments are typically irreversible in nature.Many portfolio companies primarily have business concepts, product prototypes, or initial marketing and manufacturing,but have not accumulated substantial tangible assets or financial wealth. Further, unlike public firms or firms withestablished track records, portfolio companies do not have a liquid secondary market to trade their equity shares (Wrightand Robbie, 1998). In view of the irreversibility of venture capital investments, higher uncertainty in the venture capitalmarket will increase the value of holding the current option to invest. Because market uncertainty unfolds primarilyindependent of organizational activities, the venture capital firm is better off towait for new information before committingto the current round of financing. If market conditions turn favorable in the future, the firm can invest immediately andultimately capitalize on any growth opportunities embedded in the portfolio company. If the situation is clearly unfavorableand the project is deeply ‘out of the money’, the firm can defer the decision or abandon the portfolio company and confineits losses to sunk costs.

This strategy of holding the current option to invest under uncertaintymay not be as valuable as the strategy of investingnow and obtaining the option to invest subsequently, if the rights and responsibilities associated with the subsequent roundof financing are pre-determined, and if the cost of financing stays fixed.With pre-determined rights and fixed costs, marketuncertainty would primarily enhance the upside potential of the venture project. However, the rights and responsibilitiesoutlined in venture capital contracts are typically contingent in nature. For example, it is not unusual for the venturecapitalist and the entrepreneur to reallocate cash flow and control rights between rounds of financing (Kaplan andStromberg, 2003). Further, the cost of financing varies from round to round and is highly uncertain for a venture project thattypically takes years to complete. Therefore, since the venture capital firm has already gained a foothold in the portfoliocompany through the initial equity investment, and the investment is at least partially irreversible, market uncertaintywould primarily increase the value of the current option to invest, and the venture capital firm will find it optimal to delay.This logic leads to the following hypothesis:

H1. The higher the level of market uncertainty, the later a portfolio company will receive a staged financing, other thingsbeing equal.

Delay is not always preferred to investing. In particular, the cost of investing subsequently could increase with delay,and the option to invest subsequently could expire. It is critical for the venture capital firm to retain the option to invest insubsequent rounds, since the venture capital firm usually does not obtain sufficient immediate cash inflows to recoverinvestment expenditures, but rather profit from subsequent investment opportunities that may lead to successful exits.

The venture capital firm may not have the ‘luxury’ to delay when competition is high. Venture capital as a whole is avery competitive market with low barriers to entry (Cochrane, 2005). The venture capital firm (or the syndicate) is usuallynot alone in funding entrepreneurial companies to capitalize on some attractive growth opportunities. Competitors arelikely to also perceive similar opportunities and seek to take out their own options (McGrath and Nerkar, 2004), throughinvestments in other portfolio companies. The venture capitalist may have the right of first refusal, but such a right does not


prevent competitors from developing other portfolio companies with similar growth opportunities. For this reason,competition will likely depreciate the value of the venture capital firm's option to invest subsequently in its portfoliocompany, and increase the opportunity cost of delay. In addition, delay may increase the cost of nurturing the portfoliocompany for a successful exit, if the venture capital firm and the portfolio company must compete with an increasingnumber of rival venture firms and portfolio companies. Thus, we expect that the venture capital firm will speed up itsfunding in a more competitive environment.

H2. The higher the level of competition among venture capital firms, the sooner a portfolio company will receive astaged financing, other things being equal.

3.2. Project-specific uncertainty and venture capital staging

The venture capital firm will also have the motive to invest sooner when there is significant endogenous uncertainty. Ifthe venture capital firm can learn about the costs and potential benefits of the venture project through investing (Pindyck,1993; Roberts andWeitzman, 1981), the option to invest subsequently obtained from investing now can be more valuablethan holding the current option to invest. Information updating at each round of financing is particularly attractivewhen theinvestment is fraught with endogenous uncertainty.

Extant real options research has suggested that investments generally are subject to two types of uncertainty: exogenousuncertainty that are largely irreducible through organizational efforts, and endogenous uncertainty that can be substantiallyinfluenced by endogenous organizational activity (Folta, 1998;McGrath et al., 2004; Roberts andWeitzman, 1981).Whileboth types of uncertainty increase the economic value of real options, they affect investment decisions differently(Pindyck, 1993). Under exogenousmarket uncertainty, delay is more beneficial than investing because delay preserves theflexibility to invest when the market develops more favorably, but to back off when market conditions turn adverse.Endogenous uncertainty, on the other hand, implies opportunities for information updating and learning, and as such, mayencourage the firm to invest (Pindyck, 1993; Roberts and Weitzman, 1981). In fact, existing research suggests thatendogenous uncertainty in equity alliances or joint ventures implies opportunities for learning about the benefits ofcollaboration (Chi and McGuire, 1996).

In terms of the timing of staged financing in venture capital, two forms of endogenous uncertainty are especiallyimportant. First, each venture project has project-specific uncertainty concerning the costs of completing the project and itspotential benefits. Such uncertainty may be of a non-strategic kind. Second, each venture project is also characterized bybehavioral uncertainty of a ‘strategic kind’ (Williamson, 1985). In particular, information asymmetry between the venturecapitalist and the entrepreneur, coupled with self-interest or opportunism, gives rise to agency problems (Jensen andMeckling, 1976). The following two sections examine these two forms of endogenous uncertainty and analyze two generalscenarios where investing sooner might be more beneficial than delay.

A venture capital project typically takes years to complete before a successful exit. The venture capitalist facessignificant uncertainty about the costs of completion and the potential benefits of the project. It is not clear howmuch timeand effort will ultimately be required to complete the project. Such project-specific uncertainty about the costs differs frommarket uncertainty in that project-specific uncertainty can largely be resolved as the investment proceeds. If project-specific information arrives primarily when investment is taking place, there is little value to waiting (Pindyck, 1993).Similarly, it is unlikely that the venture capitalist could have an accurate assessment of the economic value of the ventureproject at the outset. Since the venture capital firm has the option to abandon inmid-stream, it has additional motive to payrunning costs to accumulate information about the potential benefits of the project (Roberts and Weitzman, 1981).Consequently, we expect that the venture capital firm will accelerate its funding when information about the costs andbenefits of the venture project can be obtained through investing. Hence:

H3. The higher the level of project-specific uncertainty, the sooner a portfolio company will receive a staged financing,other things being equal.

3.3. Agency concerns and venture capital staging

In terms of the other form of endogenous uncertainty— behavioral uncertainty, research has long focused on informationasymmetry in venture capital investments. Two types of information asymmetry exist in the venture capital market (Amit


et al., 1998). If the entrepreneur's effort cannot be observed by the venture capitalist, then it is a “hidden action” and gives riseto agency problem. In particular, since the private benefits frommanaging the portfolio companymay not always be perfectlycorrelated with shareholder value, the entrepreneur has the incentive to continue running the company that she knows hasnegative expected returns but high non-pecuniary benefits (Gompers, 1995). If the entrepreneur knowsmore about the qualityof her company than the venture capitalist, then it is hidden or private information and gives rise to potential adverse selection.While the venture capitalist and the entrepreneur are more or less equally informed about exogenous market uncertainty, theventure capitalist usually is less informed about the effort of the entrepreneur and the quality of the portfolio company, sincethe entrepreneur usually gains more in-depth knowledge of her company through running daily operations.

There are several ‘remedial’measures to attenuate the hidden information and agency problems. The financial contractingliterature has focused on the optimal design of contracts between the venture capitalist and the entrepreneur, such assyndication and allocation of control and cash flow rights (Gompers, 1995; Hellmann, 1998; Kaplan and Stromberg, 2003;Sahlman, 1990). In view of numerous contingencies that may not be anticipated ex ante, however, contracts are typicallyincomplete. Thus, monitoring remains critical for venture capital investments (Sorenson and Stuart, 2001).

If monitoring and information gathering are important, venture capital firms should invest in companies in whichasymmetric information is likely to be a problem (Gompers, 1995). Amit et al. (1998) find from Canadian data thatventure capitalists concentrate investments in high-tech industries where informational asymmetries are likely to besignificant and monitoring is valuable. Given that learning about each party's behavioral tendencies is endogenous toorganizational efforts (e.g., Chi and McGuire, 1996), the venture capitalist can mitigate information asymmetryconcerns by learning through investing about the effort of the entrepreneur and the quality of the portfolio company. Atthe same time, the venture capitalist can use tighter monitoring to examine the progress of the portfolio company, and toavoid inefficient continuation of the venture project. Thus, we expect that the venture capital firm has the motive totighten monitoring and invest more frequently in case of information asymmetry and agency problems.

H4a. The higher the level of information asymmetry and agency concerns, the sooner a portfolio company will receive astaged financing, other things being equal.

While extant research has posited that agency costs prompt the staging of capital (Gompers, 1995), it remains to be seenwhether this agency effect on the staging decision will persist over timewhen venture capital has becomemore established asan alternative asset market. Venture capital investments require close monitoring and complex contracting concerningallocation of cash flow and control rights (Kaplan and Stromberg, 2003). In the early development of venture capital whenmonitoring procedureswere not as routinized and contractual termswere not as developed as now, venture capital investmentsmight be subject to higher agency costs. With its rapid development over the last decade, venture capital has become asignificant source of funds for entrepreneurs and a significant source of employment and innovation (Global Insight, 2007).As venture capital becomesmore institutionalized, the level of information asymmetry and agency concerns on averagemightbe lower and its effect on the timing of staging less for more recent investments. Thus, we hypothesize that:

H4b. The level of information asymmetry and agency concerns will have a less pronounced effect on the timing of stagedfinancing for more recent venture capital investments.

4. Methods

4.1. 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 whichportfolio companies' names are undisclosed, because such investments cannot be uniquely identified and the durationbetween financing rounds cannot be determined. The resulting sample includes 46,976 portfolio company-round pairs for1975–2005, involving 3737 venture capital firms and 15,786 portfolio companies.

4.2. Model specification and estimation procedures

The empirical analysis focuses on the funding duration, i.e., the time elapsed between two adjacent rounds of financingfor a portfolio company. The shorter the duration, the sooner a portfolio company receives its next round of financing. Let


T denote the duration or the spell length. We can describe the behavior of a spell through its survival function, S(t)=p(T≥ t), which yields the probability that the spell T lasts at least to time t.

To estimate the effects of the real options and agency factors on the funding duration, we consider an accelerated-failure-time (AFT) model:

ln T ¼ Xbþ e ð1Þ

where the dependent variable is the natural logarithm of the duration, X is a vector of explanatory variables, and β is avector of parameters to be estimated. The error term ɛ is assumed to follow an extreme value Weibull densitydistribution. For this Weibull model, S(t) =exp(−at p), and the hazard function h(t)=apt p−1, where a is a function ofthe explanatory variables and a parameter that shifts the hazard up or down, and p is the shape parameter thatdetermines the shape of the distribution of the duration (Cameron and Trivedi, 2005).

The Weibull model is selected for the following reasons. First of all, the model fits the current paper's focus on thetiming of staging and is intuitively appealing since the coefficients in the Weibull regression model can be interpretedas the influence of explanatory variables on the log of duration. This model is also commonly used in other durationstudies (e.g. Favero et al., 1994; Gompers, 1995; Mitchell, 1989). Second, we can use the Weibull model to accountfor right-censoring in the data by modifying the log-likelihood function as a weighted average of the sample density ofcompleted spells and the survival function of uncompleted spells (Kiefer, 1988). Without adjustment for right-censoring, the model would produce biased parameter estimates. The data are right-censored when we do not observethe subsequent round of financing and thus the completion of a spell. We may not observe the subsequent roundbecause the portfolio company is in the middle of an ongoing financing round, or because it went public, wasacquired, or went bankrupt. For those ongoing investments, the censoring date is assumed to be either the time whenthe youngest syndicate fund that participated in the last round of financing was liquidated or five years after the fund'sfinal close. For the other cases, the censoring date is the date of initial public offering, acquisition or bankruptcy.Finally, the empirical results remain unaltered if a semi-parametric Coxmodel or an alternative parametric model suchas exponential and log-normal is used.

We estimate the Weibull model using the maximum likelihood method. Since the sample includes ‘multiple-failure’ data (i.e., a single portfolio company may receive multiple rounds of financing), we apply the robustprocedure and cluster the observations by portfolio companies to obtain the variance–covariance matrix forcoefficient estimates.

4.3. Measures

4.3.1. Dependent variableThe dependent variable is the time elapsed (Duration) between two adjacent rounds of financing for a portfolio

company. The time elapsed is computed in days, but converted to years by dividing the time over 365.25. Explanatoryvariables are described as follows.

4.3.2. Market uncertaintyVenture capital firms would find it optimal to hold the current option to invest under significant uncertainty in the

venture capital market. Little public accounting and financial information is available for generating such anuncertainty measure for the venture capital market per se. However, extant research indicates that public marketshifts influence venture capital investment behavior and returns (Cochrane, 2005; Gompers et al., 2005). Thus, weuse market price volatility in each industry as a proxy of venture capital market uncertainty (Uncertainty). Suchmarket price-based measures have a distinct advantage in that they arguably capture all the relevant sources of marketuncertainty (Carruth et al., 2000). We estimate the market returns following Fama and French (1993), and use theconditional variance estimated from a GARCH(1,1) process as our measure of market uncertainty (e.g. Folta andO'Brien, 2004; Price, 1995). The GARCH process incorporates two characteristics of market prices: market priceseries are serially correlated and the volatility may not be constant over time. Likelihood ratio tests indicate that theGARCH (1, 1) model outperforms alternative GARCH models. Since the average funding duration for stagedinvestments is a little more than one year in our sample, we lag the uncertainty measure by one year.


Generating this industry-level uncertainty measure requires industry classification for portfolio companies. Wematch the Venture Economics Industry Classification (VEIC) codes to the SIC codes by examining all portfoliocompanies in each VEIC class that had gone public and been assigned a three-digit SIC code. Specifically, a VEIC classis matched to a three-digit SIC code to which the majority of companies going public in that VEIC class have beenassigned (Gompers and Lerner, 2000). The other industry-level measures are also generated with this match.

4.3.3. CompetitionCompetitiveness is reflected in the number of venture capital firms competing in the industry of the portfolio

company. The number of venture capital firms tends to increase mechanically over time. To control for such a timetrend, we measure Competition as the log of the number of venture capital firms competing in an industry in a givenyear over the total number of venture capital firms participating in the venture capital market in that year.

4.3.4. Project-specific uncertaintyIt is difficult to measure project-specific uncertainty for a large sample study like ours. We use the stage of

development at the time of financing as an indicator of the level of project-specific uncertainty. On the basis of theVenture Economics classification, we group portfolio companies into Seed/Startup, Early, and Expansion/Late stages.First, portfolio companies at the Seed/Startup-stage engage in continued research and product development and havenot yet fully established commercial operations. As a result, it is highly uncertain how much cost is required tocomplete a venture project and whether and when a successful exit will materialize. Then, portfolio companies at theEarly stage start to undergo product development and initial marketing, manufacturing and sales activities. The costrequirement and profit prospect will become clearer but the level of project-specific uncertainty is likely to remain high.Finally, as companies grow to the Expansion/Late stages, they will have developed products and an establishedconsumer base, experience increasingly growing revenue, and even exhibit consistent growth. By now, venture capitalfirms will have fairly good knowledge of the costs and profit potential of their projects, and thus the project-specificuncertainty will be much lower. Thus, the level of project-specific uncertainty in general decreases as the projectprogresses.

Since project-specific uncertainty is primarily resolved through investing, we propose that venture capital firmshave the motive to accelerate the funding under significant project-specific uncertainty. It follows that venture capitalfirms will invest sooner when portfolio companies are at their Seed/Startup or Early stage of development. In fact,Roberts and Weitzman (1981) show analytically that in a staged project that takes time to complete, when uncertaintyabout the costs and benefits of the project can be reduced through investing, and when the project can be stopped inmid-stream, it is worthwhile to invest in the early stages of the project even though ex ante the net present value of theentire project is negative.

4.3.5. Agency concernsThree factors are particularly indicative of information asymmetry and agency concerns in venture capital

investments (Gompers, 1995). First, as assets become more tangible, venture capitalists can recover more of theirinvestments in abandonment, and expected losses due to inefficient continuation are reduced. The value of intangibleassets is harder to assess than that of tangible assets, and intangible assets would be associated with higher agencycosts. Second, in industries where company value is largely dependent upon future growth opportunities, entrepreneurshave more discretion to invest in personally beneficial strategies at shareholders' expense, and venture investments aremore susceptible to agency problems. Lastly, investments in industry-specific assets tend to have lower liquidationvalue (Williamson, 1988) and are also subject to greater discretion by entrepreneurs. Following Gompers (1995),therefore, we expect that tangible assets would be associated with an increase in the funding duration, whereasinvestments with significant growth potential and asset specificity are subject to more discretion by the entrepreneur,requires closer monitoring, and thus would be associated with a decrease in the funding duration.

We measure tangibility as the industry median tangible-to-total assets ratio (Tangible), where tangible is the totalassets from Compustat less current assets, investments and advances, intangible assets, and other assets, if any (Rajanand Zingales, 1995). We use the industry median market-to-book ratio (Growth) computed from the CRSP andCompustat databases as an indicator of growth opportunities (Myers, 1977). Finally, since R&D intensity is associatedwith the specificity of assets in an industry (Bradley et al., 1984; Titman, 1984), we measure asset specificity as theindustry median R&D-to-sales ratio (R&D) (Pisano, 1989).


4.3.6. Recent investmentsAlthough venture capital has been used for over 60 years, it is only recently that it has become an important

alternative asset market. In 1990 venture capitalists in the U.S. invested less than $4.0 billion in less than 1500companies. By 1996, the disbursements have more than tripled ($12.9 billion) and the number of venture capital-backed companies more than doubled (Venture Economics/National Venture Capital Association, 2006). Thus, weregard those investments since 1996 (included) as more recent venture capital investments.

Other factors may also affect the timing of staging. We discuss three groups of such factors: liquidity constraintsfor venture capital funds, syndicate characteristics such as experience and size, and portfolio company characteristicssuch as performance, age, industry, and the size of financing.

4.3.7. CommitmentsIf venture capitalists are liquidity constrained, larger capital commitments to venture capital funds would allow

venture capitalists to invest more often in positive NPV projects. If venture capitalists are susceptible to free cash flowagency costs (Jensen, 1986), they might waste the extra cash by investing in bad projects. Thus, we include a measureto indicate capital commitments to the venture capital industry (in log of the amount of money raised) in the year beforethe investment (Gompers, 1995).

4.3.8. Syndicate size and experienceVenture capital firms typically syndicate their investments. Thus, we need to control for the potential influence of

syndicate characteristics on the staging decision. Syndication may lead to improved project selection and learning(Lerner, 1994a), and thus improved continuation decisions. At the same time, syndication may lead to better value-creating services for portfolio companies (Brander et al., 2002). For these reasons, syndication may increase thesyndicate partners' incentive to invest and decrease the funding duration. Syndicate size is measured as the totalnumber of venture capital firms participating in a portfolio company's financing round.

Syndicate experience may affect the staging decision through its influence on monitoring, screening, andadvising. First of all, venture capitalists with more industry-specific experience will have more effective and efficientmonitoring and contracting. Knowledge regarding portfolio companies' industry enhances venture capital firms'ability to recognize signs of trouble at an early stage (Sorenson and Stuart, 2001). Experienced venture capitalistswill also have established the routines for renegotiating and re-contracting with entrepreneurs at each subsequentround of financing. Thus, experience can relax the cost constraint on frequent monitoring. In addition, experiencemay increase venture capitalists' capabilities to select high-quality projects to undertake. As a result, selectedcompanies may hit their milestones on time or early and need follow-on funding to grow even faster. Finally, moreexperienced venture capitalists can provide more industry-specific expertise in terms of market access, strategic andoperational advice (Brander et al., 2002; Gorman and Sahlman, 1989), as well as greater industry-specific socialcapital (Stuart et al., 1999). If so, experienced venture capitalists may grow portfolio companies faster. In summary,we expect that venture capitalists would perform monitoring, screening, and advising more successfully andexpeditiously when they have more extensive investment experience in the portfolio company's industry (Sorensonand Stuart, 2001).

We construct the measure of industry-specific experience as the total number of investments made by a venturecapital firm in the industry of the portfolio company prior to the investment in year t. Because the measure mayincrease over time, we adjust for the changing maturity of the industry by subtracting from the measure the averageexperience of all other venture firms active in the industry in year t prior to year t. We normalize the syndicateexperience measure (Syndicate experience) by the size of the syndicate.

4.3.9. Portfolio company performanceThe timing of staging may also be driven by the portfolio company's need for capital. Although we cannot directly

measure a company's capital needs, we consider several relevant control variables, including the age of the portfoliocompany, the size of financing and the industry in which the company competes.

The portfolio company with better performance may have more urgent need for capital to fuel continuing growth.More importantly, the better-performing portfolio company is muchmore likely to meet the ‘milestones'. After all, theventure capitalist will not likely provide follow-on funds even if the company has an urgent need for capital, unless itmeets the ‘milestones’ and is worth refinancing.

Table 1Descriptive statistics

No. Variables Mean S.D. Min Max (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)

(1) Commitments(log)

9.67 1.35 4.49 11.97 1.00

(2) Syndicateexperience(log)

3.72 1.18 −0.028 7.25 0.20 1.00

(3) Syndicatesize

3.43 3.02 1.00 34.00 0.02 0.05 1.00

(4) IPO 0.13 0.33 0.00 1.00 −0.16 −0.03 0.06 1.00(5) Company age 5.15 7.96 −20.00 184.00 −0.03 −0.04 −0.11 0.01 1.00(6) Round

amount (log)7.67 1.73 −0.22 14.75 0.41 0.14 0.28 0.04 −0.06 1.00

(7) Uncertainty 2.83 0.71 0.10 5.42 0.57 0.15 0.05 −0.11 −0.06 0.26 1.00(8) Competition

(log)−1.38 0.94 −7.39 −0.26 0.20 0.24 0.15 −0.02 −0.22 0.14 0.30 1.00

(9) Seed/Startup 0.13 0.33 0.00 1.00 −0.14 −0.05 0.02 0.02 −0.15 −0.13 −0.07 0.02 1.00(10) Early 0.24 0.42 0.00 1.00 0.08 −0.01 0.01 −0.04 −0.14 0.02 0.07 0.07 −0.21 1.00(11) R&D 0.11 0.14 0.00 0.96 0.27 0.14 0.08 0.02 −0.08 0.15 0.12 0.25 −0.01 0.06 1.00(12) Tangible 0.21 0.17 0.05 0.86 −0.33 −0.22 −0.04 0.05 0.07 −0.14 −0.34 −0.44 0.03 −0.06 −0.42 1.00(13) Growth 2.69 1.20 0.44 6.39 0.17 0.15 0.11 0.04 −0.11 0.14 0.22 0.43 0.05 0.06 0.43 −0.40 1.00

N=46976; Correlations with absolute values larger than 0.03 are significant at pb0.05.


Data limitations prevent us from computing company-level rates of return. Thus, we use two indirect measures ofcompany-level performance. The first measure is the post-money valuation of the portfolio company (Valuation),which is defined as the product of the price paid per share in the financing round and the shares outstanding post thefinancing round. Since as many as 72% of the investments in our sample do not have disclosed valuation data, we alsoconsider an indirect ex postmeasure of company performance. We view an initial public offering as a final signal of theinvestment's success (see also Brander et al., 2002; Gompers and Lerner, 2000; Sorenson and Stuart, 2001): IPO is adummy equal to one for those companies that are taken public.

4.3.10. Additional controlsOlder companies may have track records available for venture capitalists to evaluate, and could thus be associated

with lower project-specific uncertainty and agency problems. Company age is the time in years between the foundingand the financing of the portfolio company. One might expect that larger financing rounds lead to longer fundingdurations, as larger financing (Round amount) would result in larger losses in case of abandonment, due to theirreversible nature of venture capital investments. Finally, we include industry and year dummies in all our estimationsto account for unobservable industry-specific fixed effects and macroeconomic trends in the venture capital market. Inthe following, we present the analysis and results.

5. Analysis and results

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

Table 2 reports the estimation results. Model 1 is the baseline model that includes all the control variables. Models2–5 examine the effects of the variables of our interest. Model 6 is the full model specification with all the explanatoryvariables, and Models 7–8 are for robustness checks. The Wald chi square tests in Table 2 indicate that all the modelsare statistically significant.

Hypothesis 1 proposes that under market uncertainty, delay is more beneficial than investing because delay keepsthe flexibility to invest under favorable market conditions, but to back off under adverse market conditions. Theempirical implication is that the portfolio company will receive the staged financing much later when there is a higherlevel of market uncertainty. Model 2 shows that the coefficient estimate for Uncertainty is positive and statisticallysignificant at pb0.001, providing strong support for H1. Concerning the substantive effect of uncertainty, holding the

Table 2Weibull model of funding duration

1 2 3 4 5 6 7 8

Commitments −0.652⁎⁎⁎ −0.706⁎⁎⁎ −0.862⁎⁎⁎ −0.878⁎⁎⁎ −0.632⁎⁎⁎ −0.887⁎⁎⁎ −0.633⁎⁎⁎ −0.659⁎⁎⁎(0.0084) (0.0093) (0.014) (0.014) (0.0086) (0.014) (0.015) (0.026)

Syndicateexperience

−0.000773⁎⁎⁎ −0.000752⁎⁎⁎ −0.000854⁎⁎⁎ −0.000889⁎⁎⁎ −0.000705⁎⁎⁎ −0.000807⁎⁎⁎ −0.00126⁎⁎⁎ −0.000202⁎⁎(0.000062) (0.000062) (0.000056) (0.000056) (0.000061) (0.000055) (0.000089) (0.000064)

Syndicate size −0.0153⁎⁎⁎ −0.0148⁎⁎⁎ −0.00753⁎⁎⁎ −0.00775⁎⁎⁎ −0.0110⁎⁎⁎ −0.00391⁎⁎ −0.00616⁎⁎ 0.00367(0.0017) (0.0017) (0.0015) (0.0015) (0.0016) (0.0015) (0.0019) (0.0021)

IPO 0.0299 0.0381+ 0.0808⁎⁎⁎ 0.0743⁎⁎⁎ 0.0580⁎⁎ 0.109⁎⁎⁎ 0.106⁎⁎⁎ –(0.020) (0.020) (0.018) (0.018) (0.020) (0.018) (0.022) –

Company age 0.0111⁎⁎⁎ 0.0112⁎⁎⁎ 0.00806⁎⁎⁎ 0.00734⁎⁎⁎ 0.0103⁎⁎⁎ 0.00686⁎⁎⁎ 0.00892⁎⁎⁎ 0.0117⁎⁎⁎

(0.0012) (0.0012) (0.0010) (0.00098) (0.0012) (0.0010) (0.0013) (0.0022)Round amount 0.00914⁎ 0.00715 0.00470 −0.000541 0.0146⁎⁎⁎ 0.00581 0.00844+ 0.0114

(0.0044) (0.0044) (0.0040) (0.0041) (0.0043) (0.0040) (0.0051) (0.011)Constant 4.801⁎⁎⁎ 8.557⁎⁎⁎ 3.248⁎⁎⁎ 4.291⁎⁎⁎ 8.099⁎⁎⁎ 4.069⁎⁎⁎ 2.361⁎⁎⁎ 5.244⁎⁎⁎

(0.21) (0.22) (0.31) (0.32) (0.14) (0.24) (0.31) (0.84)Uncertainty 0.185⁎⁎⁎ 0.172⁎⁎⁎ 0.292⁎⁎⁎ 0.0744⁎⁎⁎

(0.014) (0.014) (0.018) (0.022)Competition −0.181⁎⁎⁎ −0.0639⁎⁎⁎ −0.0341+ −0.0965⁎⁎⁎

(0.016) (0.016) (0.023) (0.023)Seed/Startup −0.0921⁎⁎⁎ −0.0547⁎⁎⁎ −0.0594⁎⁎ −0.0589⁎

(0.016) (0.015) (0.020) (0.025)Early −0.0757⁎⁎⁎ −0.0542⁎⁎⁎ −0.0559⁎⁎⁎ −0.0649⁎⁎⁎

(0.012) (0.012) (0.017) (0.017)R&D −0.439⁎⁎⁎ −0.257⁎⁎⁎ −0.379⁎⁎⁎ 0.0104

(0.066) (0.063) (0.080) (0.068)Tangible 0.924⁎⁎⁎ 0.959⁎⁎⁎ 0.945⁎⁎⁎ 0.858⁎⁎⁎

(0.069) (0.066) (0.078) (0.15)Growth −0.132⁎⁎⁎ −0.144⁎⁎⁎ −0.224⁎⁎⁎ −0.0497⁎⁎⁎

(0.0050) (0.0056) (0.012) (0.0067)Valuation 0.0133

(0.012)Observations 46,976 46,976 46,976 46,976 46,976 46,976 35,933 12,654Log-likelihood −67,365 −67,221 −64,798 −64,898 −66,651 −63,949 −50,771 −14,647Wald chi

square10,998 11,247 10,521 10,446 12,368 13,105 8079 4524

Notes:1: Robust standard errors appear in parentheses.2: ⁎⁎⁎pb0.001, ⁎⁎pb0.01, ⁎pb0.05, +pb0.10.3: All Wald chi square tests are significant at pb0.001.4: The estimated values of the shape parameter for the Weibull models are larger than one at pb0.01 (based on one-sided tests).5: Industry and Year dummies are included in models but not reported.


values of other variables at their median level, when Uncertainty increases from its median to 75th percentile, theaverage funding duration increases by more than 12%, i.e., by almost one and a half months. This economic effect isquite substantial since the average funding duration is a little more than one year.

Hypothesis 2 maintains that competition will depreciate the value of the venture capital firm's option to invest insubsequent rounds and increase the opportunity cost of waiting, thus prompting the venture capital firm to invest ratherthan delay. The empirical implication is that the portfolio company will receive the staged financing much sooner whena larger number of venture capital firms compete in the same industry. Model 3 shows that Competition has astatistically significant negative coefficient, offering support for H2.

The catalyst role of competitive entry might be significant only to the extent that the opportunities in an industry arelimited. In addition, the number of venture capital firms investing in an industry might be driven by venture capitalfunds available for investing. For these two reasons, it is important to control for industry growth and liquidityconstraints. Model 3 shows that upon accounting for the effects of Growth and Commitments, Competition remainsnegative and statistically significant. An increase in Competition from the median to 75th percentile leads to a decreasein the average funding duration by 8%, holding the values of other variables at their median level.

Table 3Test of the equality of coefficients

Variables 1 2

Investments pre-1996 Investments since 1996

R&D⁎⁎⁎ −1.526⁎⁎⁎ −0.314⁎⁎⁎(0.16) (0.069)

Tangible⁎⁎⁎ 0.567⁎⁎⁎ 1.582⁎⁎⁎

(0.070) (0.10)Growth⁎⁎⁎ −0.276⁎⁎⁎ −0.117⁎⁎⁎

(0.018) (0.0052)Other variables IncludedObservations 46,976Log-likelihood −63,947Wald chi square 12,774

Notes:1: ⁎⁎⁎pb0.001, ⁎⁎pb0.01, ⁎pb0.05, +pb0.10.2: Other variables are the same as in Model 6 of Table 2.3: The asterisks on the variable names indicate the level of significance at which the coefficients differ.


The venture capital firm has the motive to accelerate its staging when each round of financing reveals informationabout the cost of completion and potential benefits of a project. Since earlier stages of development tend to beassociated with a higher level of project-specific uncertainty and thus entail greater opportunities for learning byinvesting, Hypothesis 3 suggests that a portfolio company at its Seed/Startup or Early stage will receive the stagedfinancing sooner than an expansion- or late-stage company. Model 4 shows that both Seed/Startup and Early havestatistically significant negative coefficients, an empirical result consistent with H3. The funding duration for a Seed/Startup-stage company is 10% shorter than that for an expansion- or late-stage company; that is, a Seed/Startup-stagecompany receives a staged financing 1.2 months sooner. Similarly, the funding duration for an Early stage company is8% shorter; that is, such a company receives a staged financing almost 1 month sooner.

Finally, Hypothesis 4 examines the agency arguments concerning the timing of staging (Gompers, 1995).Companies subject to higher level of information asymmetry and agency problems should be monitored more often.Agency costs are likely to be high when R&D intensity and thus asset specificity is high, when industry assets are lesstangible, and when industry growth potential is high. In Model 5, the coefficients of R&D, Tangible, and Growth areall statistically significant at pb0.001. R&D and Growth are negatively associated with the funding duration, whereasTangible is positively related to the funding duration. These empirical results offer supportive evidence for H4a, and areconsistent with those in Gompers (1995). An increase in R&D from its median to 75th percentile leads to a 13%decrease in the funding duration, holding the values of other variables at their median level. A similar increase inTangible leads to about 10% increase in the funding duration, whereas a similar increase in Growth leads to almost13% decrease in the funding duration. The empirical results remain unchanged if we use Tobin's Q to measure growthand the R&D-to-assets ratio to measure asset specificity.

If the venture capital industry as a whole has become more established, with routine monitoring procedures andstandard contractual negotiation and enforcement, we would expect the effects of the agency variables to be lesspronounced for more recent investments. We perform a Wald-test on the equality of the coefficient estimates for R&D,Tangible and Growth. Table 3 shows that while the agency variables have the expected effects for both recent and pastinvestments, there is a systematic difference in the magnitude of the effects. Specifically, R&D and Growth havegreater effects for pre-1996 investments, but Tangible has a greater effect for investments since 1996. Consistent withH4b, these results suggest that agency concerns as reflected by these variables have less pronounced effects on thetiming of staging for more recent venture capital investments. To see whether the empirical results are driven by theInternet frenzy during 1999–2001, we drop about one quarter of the investments undertaken during this period and re-estimate the full model. The results in Model 7 of Table 2 remain qualitatively similar to those in previous models.

Let's turn to the control variables. Several empirical findings are worth highlighting. First, the funding duration isreduced by greater capital commitments to the venture capital industry (Commitments). Second, Syndicate experiencehas a consistently negative and statistically significant effect on the funding duration, as does Syndicate size except inModel 8. Third, the coefficient of IPO turns out to be statistically significant but positive. This effect remains positive


when we view both IPO and acquisition as exit successes. We have also estimated Model 8 with 12,654 observationsthat have post-money valuation data. This sub-sample is biased towards syndicated investments (see also Gompers andLerner, 2000): 32% of syndicated investments in our sample have valuation data whereas only 15% of non-syndicatedinvestments do. The sign of Syndicate size turns positive, but the results for explanatory variables of our interest remainunchanged. The coefficient of Valuation in Model 8 is again positive albeit statistically insignificant.

The empirical analysis suggests that venture capital firms do not necessarily invest sooner in portfolio companiesthat are eventually taken public or sold. We offer two possible explanations. First, these successful companies have mettheir milestones, and may have lower project-specific uncertainty. Second, successful companies may require lessfrequent monitoring, since venture capitalists can infer from the (intermediate) successes that entrepreneurs have dulyexercised their efforts. These explanations remain conjectural since we do not have direct measures of company-levelrate of returns prior to each round of financing.

Finally, Company age is positively related to the funding duration, whereas Round amount does not have anyconsistently significant effect. Overall, the empirical results for our main explanatory variables remain robust toconsideration of liquidity constraints, syndicate characteristics, and portfolio company characteristics.

Since several venture funds usually syndicate to participate in a financing round, investments may be received overthe course of several months and be recorded in the Venture Economics database as several rounds (Lerner, 1994b). Tosee whether this could potentially bias the estimation results, we have recoded those investments that occurred withinone month or six months as belonging to a single financing round and re-estimated Model 6. The empirical resultsremain unaltered in both cases.

6. Discussion and conclusions

This study investigates the staging decision in venture capital. Venture capital firms have the choice betweeninvesting and delay at each round of financing. From a real options perspective, venture capital firms must decidewhether to hold the current option to invest or to invest now and obtain an option to invest subsequently. This timingdecision depends on the factors that influence the economic value of these two options, such as market uncertainty,competition, and project-specific uncertainty. Our empirical analysis indicates that market uncertainty encouragesventure capital firms to delay since market uncertainty increases the value of holding the current option to invest. Onthe other hand, in the presence of competition and endogenous project-specific uncertainty, venture capital firms mayfind it optimal to invest sooner, either to avoid losing the option to invest subsequently or to obtain information aboutthe costs and benefits of venture projects.

The current study has several implications for theory and practice. First, prior research has primarily studied thestaging decision from an agency perspective (e.g., Gompers, 1995). This study extends this line of research by taking areal options approach, which enables us to identify various sources of uncertainty surrounding venture capitalinvestments and to examine how exogenous and endogenous uncertainties influence the timing of staged financing.The empirical results suggest that the venture capitalist needs to look at the broader decision context beyond agencyconcerns when considering the staging decision.

Second, this study contributes to extant real options research on venture capital. Hurry et al. (1992) apply realoptions theory to understand the difference between the venture capital investment strategies of Japanese and US firms.It is held that Japanese firms follow an ‘option’ strategy, by which a venture capital investment can be viewed as an‘external’ investment to create an initial call option, while the subsequent ‘internal’ development such as R&D can beviewed as the exercise of this call option (to capitalize on technology opportunities). The current study focuses on thetiming of staging for broadly defined venture capitalists that may not have ‘internal’ R&D investments. Conceptually,this study views investing in each round of financing as giving up the current option to invest but simultaneouslycreating an option to invest subsequently. By focusing on this staged decision, the current study also complementsexisting research on initial entry decisions, such as Folta and O'Brien (2004) that consider how the options to delay and(invest to) grow under industry uncertainty influences the decision of industrial firms to enter a new industry.

Third, this study has useful business policy implications. Venture capital firms can view the staging decision at eachround of financing as making a choice between investing and delay. While portfolio company performance, syndicatecharacteristics, liquidity constraints, and agency concerns are all important factors to consider concerning the timing ofstaging, venture capital firms need to look at the broader decision context. In particular, real options value drivers suchas uncertainty and competitive pressure also have important influence on the staging decision. Further, it is useful for


venture capital firms to differentiate between exogenous market uncertainty and endogenous project-specificuncertainty or behavioral uncertainty, to the extent that they have different implications for the staging decision.

There are a number of opportunities for future research, which may also help address some limitations of this researchstudy. First, this study focuses on the staging decision concerning investment in a single portfolio company. Venturecapital firms may invest in a portfolio of companies and these portfolio investments may be interdependent. Extant realoptions research suggests that the value of real options embedded in a portfolio of investments may not be additive(Kulatilaka, 1995; Vassolo et al., 2004). Future research may extend this study by examining how such portfoliointerdependence, if any, influences the staging decision. Second, our empirical analysis implies that agency costs haveless pronounced effects on the timing of staging for more recent venture capital investments. Although a moreestablished venture capital market may have lower agency costs on average, organizations vary in the level of agencycosts incurred and their capabilities to reduce agency costs. While our study focuses on industry-level indicators ofagency concerns, future research may look at firm-specific indicators. Third, future research may extend this study bymodeling the staging of venture capital investments from a real options perspective and conduct simulation analyses ofthe relative effects of real options factors. The modeling approach along the line of Pindyck (1993) may offer insightsinto how exogenous and endogenous uncertainties interact to influence the timing of staging, an aspect that is difficult toanalyze with measures of project-specific uncertainty and agency costs generated primarily from secondary data.

This study can be extended in other ways. First, our analysis shows that competitive entry will drive venture capitalfirms to invest sooner. The broader implication of competition for the venture capital market remains an interesting area forfuture research. On the one hand, such a competitive effect may benefit those early stage portfolio companies that wouldotherwise find it difficult to obtain financing. On the other hand, competitive entry may create ‘bandwagon’ effects inwhich venture capitalists rush to increase their commitments without much regard to the business fundamentals ofportfolio companies (Gompers and Lerner, 2000). Prior research indicates that venture capitalists' assessment of thesurvival probability of their portfolio companies may suffer with competitive entry in these companies' industries(Shepherd, 1999). Future research may thus examine the short-term and long-term effects of competitive entry on venturecapitalists' investment strategies and the performance of venture capital investments. Second, survey and first-hand datacan be used to have finer-grained research on venture capital staging. For example, one may use questionnaires to measuredirectly endogenous project-specific uncertainty for companies at different stages of development. In addition, surveymayprovide information about other forms ofmonitoring such as board participation and informal interactions between venturecapitalists and entrepreneurs. Future research may use such information to examine how informal interactions may helpreduce information asymmetry and affect the staging decision.

Finally, there is an increasing interest in a real options approach towards venture capital (e.g. Cornelli and Yosha,2003; Cossin et al., 2002; Hurry et al., 1992; Seppa and Laamanen, 2001). Real options theory can be applied to studyventure capital since venture capital investments, like R&D investments, involve managerial discretion and are long-term investments fraught with uncertainty (Li et al., 2007). Future real options research can shed light on not onlyinvestment and staging decisions, but also contracting and valuation in venture capital.

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duration analysis of venture capital staging: a real options perspective

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