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THE ROLE OF VENTURE CAPITAL IN THE BRIDGING OF FUNDING GAPS – A REAL
OPTIONS REASONING
Balázs Fazekas, Pa ícia Becsky-Nagy
Uni e si y o Deb ecen, Facul y o Economics and Business, Ins i u e o Accoun ing and
Finance, Deb ecen, Hunga y
[email protected]
becsky.nagy.pa [email protected]
Abs ac : Funding gaps occu when o a pa icula g oup o en e p ises he e a e no
enough a ailable unds o inance hei g ow h. Such en e p ises a e ypically young,
inno a i e and echnology-o ien ed s a up companies. These companies do no ha e
signi ican e enues o colla e als; hence hey a e no sui able o bank inancing. On he
o he hand he in o ma ion p oblems dec ease hei chances o a ac in es o s and also
he e is high unce ain y in ol ed in hese companies. The me hod o en u e capi al
inancing was es ablished o ope a e in his inancing gap and o p o ide unds o hese
echnology-o ien ed, young s a up en e p ises. The e is an ex ensi e li e a u e ha
highligh s ha en u e capi alis s a e capable and willing o p o ide inancing o hese
en e p ises as a esul o hei special expe ise and business expe ience and hei
sophis ica ed alue c ea ion me hods. In his a icle he au ho s in oduce a eal op ions
easoning in o de o gi e an in e p e a ion o en u e capi al decision-making me hod and
why en u e capi al is willing o ope a e in unding gaps and how i is able o b idge hem.
Wi h he in ol emen in he ope a ion o he in es ed companies en u e capi alis s c ea e
op ions ha inc ease he alue o he i m. Also in op ion- alua ion he highe he
unce ain y o he asse is, he highe he alue o he op ion is. Tha is he eason, why
o he passi e unding o ms ejec he inancing o s a up en e p ises, while en u e capi al
is willing o p o ide unds o hem. In his a icle we will desc ibe he p oblem o unding
gaps, han we will in oduce eal op ions and hei e ec on in es men decision. In he las
pa o he a icle we will demons a e how eal op ions appea and a e c ea ed in en u e
capi al inancing as a esul o i s special cha ac e is ics and how he eal op ions app oach
can explain he abili y o en u e capi alis o b idging unding gaps.
Keywo ds: en u e capi al; eal op ions
JEL classi ica ion: G24
1. Funding gaps and en u e capi al
We can de ine unding gaps as he hia us o he supply and demand o inancial sou ces
(Nagy, 2004). Funding gaps occu usually in cases o companies in a gi en poin o hei
li e and wi h special ield o ac i i y. The p oblem o unding gap is p e alen in young,
echnology-o ien ed s a up en e p ises. As a esul o he unding gaps, companies wi h
huge g ow h po en ial a e no able o ob ain he necessa y capi al o hei ope a ion;
hence hey canno li e up o hei g ow h po en ial.
Funding gaps e ol e in case o s a up companies as a esul o hei special
cha ac e is ics. In he seed and ea ly s ages o hei li es hese companies a e in he
phase o p oduc de elopmen o hey ha e jus made hei ma ke en y. They a e in he
lack o colla e als o signi ican e enues; hence hey a e unable o ob ain bank inancing.
The capi al s uc u e o hese en e p ises a ec s hei compe i i eness and he dominance
o loans in hei capi al s uc u e would esul in a hea y bu den on hei cash lows
(He czeg, 2009). On he o he hand he 3F unds ( amily, iends and ools) a e no
su icien o inance he u he g ow h o hese en e p ises.
826
Also hese companies ha e high isk and unce ain y. Becsky-Nagy and Fazekas (2015)
discusses he special isks and he sou ces o unce ain y ha plays an impo an ole in
case o young, inno a i e companies. The e is a high business isk in ol ed in s a up
companies. Coch ane (2005) showed, ha in case o en u e capi al in es men s ha aims
inno a i e, young companies, he e u ns a e s ongly posi i ely skewed ha sugges s ha
mos o he companies gene a e low and e en nega i e e u ns bu ew en e p ises a e
able o each ex emely high e u ns. Coch ane (2005) also showed ha he isk o hese
en e p ises is company-speci ic idiosync a ic isk and no sys ema ic isk.
The high unce ain y also de i es om impe ec in o ma ion. As hese companies do no
ha e a ack eco d and hei ac i i y is speci ic i is di icul o e alua e hem, hence
ad e se selec ion desc ibed by Ake lo (1970) occu s. Fu he mo e, as hese en e p ises
need ex e nal inancing he p incipal-agen p oblem desc ibed by Jensen and Meckling
(1976) also occu s and he unce ain y de i es om his ela ionship con ibu es o he
unding gaps as well.
Figu e 1: The a ailable equi y- unding o young en e p ises in hei di e en s ages o
g ow h
Sou ce: Sze b (2006)
As we can see on Figu e 1, en u e capi al is he main ex e nal unding sou ce o
en e p ises. Ven u e capi al appea s in he ea ly s ages o he li e o companies when hey
a e gene a ing losses and he ai h and iabili y o he company is doub ul. In he so called
dea h- alley, be o e he ma ke en y he unce ain y o hese en e p ises is high, bu
p o ided ha adequa e capi al and knowledge is a ailable o hese en e p ises hey can
achie e high g ow h a e and each he poin whe e an IPO is easible.
2. Basics o eal op ions easoning
The ole o unce ain y plays a c ucial ole in op ion alua ion. In he adi ional in es men
analyses me hods he highe he unce ain y is he lowe he alue o he in es men is. On
he o he hand in op ions alua ion he highe he ola ili y o he unde lying asse is he
highe he alue o he op ion is. The eason o his ela ionship o ola ili y and op ions is,
827
ha in case o op ions he losses a e limi ed (we do no exe cise he op ion, when i is ou
o he money so we only lose he p ice o he op ion), while in case o a ou able changes
in he p ice o he unde lying asse we can gain p o i (in case o pu op ion, he maximum
o ou p o i is he s ike p ice, while in case o call op ions he p o i is unlimi ed in heo y).
Vola ili y inc eases he alue o op ions because he downside isk and he p obabili y o
loss a e elimina ed while he chance o high p o i inc eases.
The ole o unce ain y appea s simila ly in case o eal op ions. In an unce ain business
en i onmen he managemen o he company has he abili y o eac o he changes o he
en i onmen and he occu ing p oblems and possibili ies. The adi ional DCF (Discoun ed
Cash Flow) based in es men analyses me hods a e no able o inco po a e he alue o
manage ial lexibili y in o he e alua ion, al hough in s a egic in es men s his lexibili y o
he managemen can inc ease he alue. Rózsa (2004) based on he li e a u e desc ibes
he ollowing op ions ha manage s may ha e in he implemen a ion o an in es men :
§ de e men
§ ejec ion
§ expansion
§ s aging
§ swi ch
§ al e a ion
§ lea ning
Real op ions in eg a e he adi ional DCF based e alua ion me hods wi h op ion alua ion
and p o ide a s a egic app oach o in es men analyses whe e he alue o he
managemen lexibili y appea s. Figu e 2 shows how eal op ions change he DCF based
NPV’s (Ne P esen Value) dis ibu ion.
As we can see on Figu e 2, he p esence o op ions changes he dis ibu ion o NPV in wo
ways. Fi s o all, he expec ed alue o he in es men inc eases as a esul o he added
alue o he op ions. On he o he hand he dis ibu ion will be posi i ely skewed. The
eason o he changed skewness is ha op ions can mi iga e losses and enhance he
posi i e ou comes. The design o he op ion allows i s holde o bene i om unce ain y in
he occu ence o a ou able e en s (McG a h, 1997).
Figu e 2: The e ec o eal op ions on he dis ibu ion o in es men ’s NPV
Sou ce: Yeo, K. T. and Qiu, F. (2003)
3. The ole o eal op ions easoning in en u e capi al inancing
Compa ed o o he unding o ms en u e capi al is willing and mo e success ul in
managing isks and unce ain y. The li e a u e explains his ea u e o en u e capi al wi h
he special expe ise and business expe ience o he en u e capi al in es o s ha enables
expec ed
NPV1
expec ed
NPV2
dis ibu ion o
p ojec ’s NPV
dis ibu ion o p ojec ’s NPV in he
p esence o eal op ions
P obabili y
NPV
828
hem o inc ease he alue o he i m in o de o ealize p o i ia exi ing he in es ed
companies (Becskyné Nagy, 2006). As hey p o ide equi y ype inancing, he in es o s
become owne s o he in es ed companies and as owne s hei p io i y is o maximize hei
weal h ia inc easing he i m’s alue (Rózsa and Tálas, 2012). As a esul o hei
expe ise hey can selec he in es ed companies mo e e icien ly and hey can also
p o ide non- inancial alue added se ices a e he in es men in o de o inc ease he
alue o he in es ed companies (Chemmanu e al., 2011).
The eal op ions app oach o en u e capi al in es men s also elies on he special
expe ise o en u e capi al in es o s. Real op ions can be iewed as a decision-making
me hod and alua ion echnique, a logic o s a egic planning (D iouchi and Benne ,
2012). The eason why eal op ions can be applied in en u e capi al in es men s is ha
he in es o s p o ide manage ial assis ance as well; hence hey can in luence he
ope a ion o he in es ed companies (Nagy, 2002; Becsky-Nagy, 2014). This ea u e o
en u e capi al c ea es eal op ions in he in es men s. As Copeland and Keenan (1998)
shows, he unce ain y and he u u e oppo uni ies o in es men s alone does no c ea e
eal op ions. They emphasize he ole o he managemen ’s capabili ies o ecognize he
op ions. I is also c ucial how e ec i ely he managemen can espond o he changes o
he unce ain en i onmen . Mille (2002) also highligh s he compe ence o he
managemen as a de e minan o he alue o he op ions. Rangan (1998) desc ibes ha
he alue o op ions can be ealized only i he e is adequa e knowledge, ools and
esou ces.
Ven u e capi al in es o s ha e he necessa y expe ise and knowledge o ealize op ions.
Ven u e capi alis s es ablish hei manage ial ne wo ks in o de o ma ch en e p ises wi h
he sui able manage s who ha e he necessa y skills and business expe ience (Ca alho
e al., 2005). The li e a u e emphasizes he ole o he in es ed company’s managemen
and acco ding o many s udies he managemen eam o companies a e mo e impo an in
he in es men decisions han he idea o he ac i i y o he en e p ises i sel (Kaplan e al.,
2009). These ea u es o en u e capi al a e consis en wi h eal op ions easoning as he
knowledge p o ided by he in es o s and wha makes i possible o u ilize he op ions in
he companies.
Ven u e capi alis s use special me hods and ools ha allow hem o c ea e and ake
ad an age o he op ions o in es men s (Becsky-Nagy and Fazekas, 2015). The p ac ice
o mul i-s aged inancing is gene ally used by en u e capi alis s hence he op ion o
s aging occu s in hese in es men s. S aging plays an impo an ole in he isk
managemen o en u e capi al. The i s inancing ound can be iewed as a es pe iod,
whe e he in es o s can ga he mo e in o ma ion abou he in es ed companies wi hou
commi ing he ull amoun o capi al ha is needed o he in es men . S aging can mi iga e
losses in case o un iable companies while keeping ali e he po en ially success ul ones.
Con e ible secu i ies a e also widesp ead in en u e capi al inancing as hey can
dec ease downside isk o in es men s as hey can unc ion as deb -like inancing i he
alue o equi y is lowe han he ace alue o he secu i ies while in case o high equi y
alue he secu i ies can be con e ed hence he in es o s ha e he bene i s o he
inc eased alue o he i m’s equi y (Hellmann, 2006).
Moni o ing and pa icipa ion in he ope a ion o he company is also impo an in he eal
op ions app oach. The in o ma ion p o ided by he ope a ion is c ucial in he managemen
o he companies (Feny es e al., 2014), because he unce ain y connec ed o he
in es ed companies is endogen o he en e p ises and gene a ed by he in es men
p ocess i sel (Rózsa, 2007). Moni o ing is essen ial in o de o be able o ga he his
in o ma ion and eac o he possibili ies o he companies.
I is also impo an on he long un ha each in es men p o ide in o ma ion o he
in es o s so hey become mo e expe ienced. The ole o his in o ma ion has high
impo ance especially in a apidly changing echnical en i onmen (O bán M s. Tamás
Dékán, 2013). In es o s can ha ness his knowledge in hei u u e in es men s and hey
829
can inc ease hei e iciency. Tha is he eason why lea ning op ions, desc ibed by Yeo
and Qiu (2003) occu as well, because he knowledge gained by he in es men p ocess
has alue.
As i is discussed abo e, eal op ions occu and a e c ea ed in en u e capi al in es men s.
I we apply eal op ions easoning o en u e capi al inancing we can see why en u e
capi al is willing o inance companies ha o he unding o ms a e no , and why en u e
capi al can b idge he unding gaps. Fi s o all, he op ions alue inc eases he expec ed
alue o he in es men s; hence in es men s ejec ed by adi ional DCF-based analyses
me hods will be accep ed i we inco po a e he alue o op ions in o he alua ion me hod.
The ole o unce ain y in eal op ions app oach plays an e en mo e impo an ole. In
op ions alua ion ola ili y inc eases he alue o op ions as he downside isk can be
elimina ed while he upside pa o he ola ili y c ea es he chance o high e u ns. In he
companies ha a e in he ocus o en u e capi al inancing he e is a high unce ain y and
ha is he eason why mos unding o ms a e a e se o p o ide hem capi al. On he o he
hand, as en u e capi alis s a e able o c ea e and ecognize op ions and hey can ealize
he bene i s o he high unce ain y while minimizing i s nega i e consequences.
4. In conclusion
The young, inno a i e echnology-o ien ed s a up en e p ises ha b ing no el y o he
ma ke o en canno ob ain capi al in o de o inance hei g ow h, hence unding gaps
occu . As a esul o he high deg ee o asymme ic in o ma ion and unce ain y in hese
companies he mo e isk a e se unding sou ces a e no willing o p o ide capi al o hem,
on he o he hand en u e capi al has a unique app oach owa ds isk ha can be
desc ibed ia eal op ions easoning.
Via he in ol emen in he ope a ion o he en e p ises, special expe ise and isk
managemen echniques en u e capi alis can c ea e and u ilize op ions in he
in es men s. Real op ions easoning gi es an explana ion o en u e capi al’s in es men
ac i i y and why his unding o m is willing and able o bea and manage highe isks mo e
e icien ly han o he unding sou ces. In op ions easoning he highe ola ili y o
in es men s become a a ou able ea u e and ha is he eason why en u e capi al
p o ides p ima ily unding o s a up en e p ises and why en u e capi al can b idge
unding gaps.
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