The Bright and Dark Side of Staging: Investment Performance and the Varying Motivations of Private Equity Firms

Abstract

The stepwise allocation of capital from a private equity fund to a portfolio company is known as staging. Theoretical studies assert the importance of staging as a mechanism to manage an investment and to influence its success, but empirical papers are divided as to whether staging has a positive or negative effect on investment performance. We create a unique dataset by merging the Venture Economics and CEPRES* databases. This unique database allows us to measure the influence of staging in financing rounds and exact tranches on investment returns. We are also able to specify an accurate measure of cash-flow based IRR, in contrast to previous studies that were hampered by insufficient data. We analyze 712 matched Private Equity and Venture Capital investments, spanning 1,549 financing rounds and 2,329 precisely dated cash injections during the period from 1979 to 2003. Our results show that during the initial investment phase, the investor uses staging foremost as monitoring instrument to mitigate agency problems and to provide resources that positively influence investment performance. Staging has little impact on return during the maturity phase. However, during the pre-exit phase we find evidence that investment managers face a termination dilemma and do not rigorously use staging as an option to terminate unsuccessful investments at the appropriate time. Rather, they use staging as a turnaround attempt, and partially for window dressing purposes. This kind of motivation behind staging is equivalent to throwing good money after bad. The influence of staging on investment returns depends critically on the motivations behind its use.