Staged Investments in Entrepreneurial Financing

Abstract

Venture capitalists deliver investments to entrepreneurs in stages. This paper shows staged financing is efficient. Staging lets investors abandon ventures with low early returns, and thus sorts good projects from bad. The primary implication from staging is that it is efficient to invest more in later rounds. The model yields a number of empirical implications on how the ratio of early to late round financing varies with uncertainty, the outside options of both parties, the value of the venture, the costs of investment, and project difficulty. The main results generalize in a model that includes the entrepreneur’s unknown ability.