Abstract
For venture capital firms, facing undiversifiable risks, multi-staged financing is an optimal contract which offers significant risk reduction at a cost of only slightly lower potential return. The optimality does not depend on the presence of moral hazard and agency problems. Our theoretical model of multi-stage financing, largely based on Asian option pricing theory, allows us to compute the risk reduction ratio due to multi-staging. The return on a staged financing plan is equivalent to an exchange of a straight equity stake for that acquired through stochastic averaging over time. We compare standard deviation ratios for staged vs. up-front financings as well as across asset classes. We find that risk mitigation due to multi-staging is significant in and of itself and enough to markedly improve venture capital’s risk-reward ratios relative to alternatives.
JEL Codes
G24, M13, G13
Keywords
Venture Capital, Options
Recommended Citation
Dubil, Robert
(2004)
"The Optimality of Multi-stage Venture Capital Financing: An Option-Theoretic Approach,"
Journal of Entrepreneurial Finance and Business Ventures:
Vol. 9:
Iss.
3, pp. 1-14.
DOI: https://doi.org/10.57229/2373-1761.1061
Available at:
https://digitalcommons.pepperdine.edu/jef/vol9/iss3/2
