The role of venture capital in the bridging of funding gaps: a real options reasoning

825 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. Re e ences Ake lo , G. A. (1970) “The ma ke o “lemons”: Quali y unce ain y and he ma ke mechanism”, The Qua e ly Jou nal o Economics, Vol. 74, No. 3, pp 488-500. 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