Follow-on Investment Research Articles

Interdependencies between Technology and Capacity Investments in the Solar Technology Sector

The impact of venture capital (VC) investment on innovation and technology commercialization as well as the influence of market capacity on venture capital firm decision-making has been extensively covered by the existing literature. However, the interdependency between investment that drives technology and investment that drives market capacity has received relatively little attention. Whereas literature suggests that VC investment in technology companies strengthens technology and/or manufacturing efficiency, asset finance investment drives capacity growth and volume in certain technology sectors. We examine interdependencies in investment in technology and capacity by analyzing the relationship between VC investment in solar technology firms and asset finance investment in solar power infrastructure capacity in the US. We find that investment in solar technology drives investment in solar capacity; however, we find no evidence that market growth caused by solar capacity investment induced follow-on investment by solar technology venture capitalists in the US.

Space science innovation: How mission sequencing interacts with technology policy

Innovation is fundamental to a space agency's mission. Yet, the industry's current dominant approach to new technology development – concerted investment in step-changes in capabilities to support a particular application – contradicts the conventional wisdom of innovation theory. In order to understand why, this paper uses a unique empirical case study, in which exogenous historical circumstances created unexpected additional opportunities for technology investment, to explore the merits of this approach. The value of follow-on periods of R&D is assessed in terms of simple marginal returns, implications for workforce dynamics and the interaction of mission sequencing and technology strategy. The analysis reveals an important contingency between mission paradigm and the value of follow-on investment. Specifically, while marginal performance improvements can be achieved at lower costs, their value depends on the availability of an appropriate mission opportunity. In the current paradigm, the risk of obsolescence is high compared to the potential benefit. However, if a new small mission, frequent flights, paradigm were to take hold, there may be great value in refocusing R&D strategy on later round improvements.

Which Limited Partners Limit VC Opportunism?

We examine the response of different types of Limited Partners (LPs) to alleged opportunistic behavior on the part of Venture Capitalists (VCs). We use a sample of litigated VCs (identified by Atanasov, et al, 2012, Journal of Finance) to proxy for VC opportunistic behavior. Based on their presumed sensitivity to VC malfeasance and headline risk, we predict that university endowments and economic development authorities will be most likely to respond negatively to potential bad press. To test our hypothesis, we employ differences-in-differences (DiD) analysis and compare the participation of different types of LPs in VC funds before and after litigation relative to the LPs of otherwise similar, matched VCs that are not subject to litigation. We find that endowments reduce by more than 50% their participation in follow-on investment funds offered by litigated VCs relative to other types of LPs. Our results suggest that the threat of university endowment withdrawal of funding can deter VC opportunism.

Short-termism, long-termism, and regulatory focus in venture capitalists' investment decisions

Short-termism and long-termism are characterized in the literature as suboptimal intertemporal trade-offs defined, respectively, as prioritizing the short term over the long term (to the detriment of the long term) and prioritizing the long term over the short term (to the detriment of the short term). Advancing this perspective, we argue that short-termism and long-termism could be approached as opportunistic strategies utilized by agents to earn private benefits at the principal's expense. Venture Capitalists (VCs) may use either of these strategies to take advantage of limited partners and entrepreneurs. How can principals detect opportunistic tendencies on the part of VCs as agents? We argue that the principals can do so by examining the effect of the two suboptimal intertemporal trade-offs on VCs’ investment proclivities. Thus, we contend that short-termism amplifies VCs’ eagerness to invest whereas long-termism magnifies VC's eagerness to provide follow-on investment. Counterintuitively, short-termism may also augment long-termism but only under promotion and not prevention framing. Hierarchical linear modeling analysis of the data from a survey of 50 US-based VCs provided support for all the proposed hypotheses.

Venture capital on a shoestring: Bioventures’ pioneering life sciences fund in South Africa

BackgroundSince 2000, R&D financing for global health has increased significantly, with innovative proposals for further increases. However, although venture capital (VC) funding has fostered life sciences businesses across the developed world, its application in the developing world and particularly in Africa is relatively new. Is VC feasible in the African context, to foster the development and application of local health innovation?As the most industrially advanced African nation, South Africa serves as a test case for life sciences venture funding. This paper analyzes Bioventures, the first VC company focused on life sciences investment in sub-Saharan Africa. The case study method was used to analyze the formation, operation, and investment support of Bioventures, and to suggest lessons for future health venture funds in Africa that aim to develop health-oriented innovations.DiscussionThe modest financial success of Bioventures in challenging circumstances has demonstrated a proof of concept that life sciences VC can work in the region. Beyond providing funds, support given to investees included board participation, contacts, and strategic services. Bioventures had to be proactive in finding and supporting good health R&D.Due to the fund’s small size, overhead and management expenses were tightly constrained. Bioventures was at times unable to make follow-on investments, being forced instead to give up equity to raise additional capital, and to sell health investments earlier than might have been optimal. With the benefit of hindsight, the CFO of Bioventures felt that partnering with a larger fund might benefit similar future funds. Being better linked to market intelligence and other entrepreneurial investors was also seen as an unmet need.SummaryBioVentures has learned lessons about how the traditional VC model might evolve to tackle health challenges facing Africa, including how to raise funds and educate investors; how to select, value, and support investments; and how to understand the balance between financial and social returns. The experience of the fund suggests that future health funds targeting ailments of the poor might require investors that accept health benefits as part of their overall “return.” Learning from Bioventures may help develop health innovation funding for sub-Saharan African that has combined health, financial, and economic development impacts.

A comparison of new firm financing by gender: evidence from the Kauffman Firm Survey data

This study uses data from the new Kauffman Firm Survey to explore gender differences in the use of start-up capital and subsequent financial injections by new firms. We find that, consistent with previous studies, women start their businesses with significantly lower levels of financial capital than men. A new finding from this research is that women go on to raise significantly lower amounts of incremental debt and equity in years two and three. These results hold even controlling for a variety of firm and owner characteristics, including the level of initial start-up capital and firm sales. Our findings also reveal that women rely heavily on personal rather than external sources of debt and equity for both start-up capital as well as follow-on investments. Our findings have implications for further research into gender differences in financing sources and strategies and business outcomes.

One Hat Too Many?: Investment Desegregation in Private Equity

The nature of private equity investing has changed significantly as two dynamics have evolved in recent years: portfolio companies have begun to experience serious financial distress, and general partners have started to diversify and desegregate their investment strategies. Both developments have led private equity shops - once exclusively interested in acquiring equity positions through leveraged buyouts - to invest in other tranches of the investment spectrum, most particularly public debt. By investing now in both private equity and public debt of the same issuer, general partners are generating a host of new conflicts of interest between themselves and their limited partners, between multiple general partners in the same consortia, and between private investors and public shareholders.In this essay, we identify and explore these various new tensions that have begun to arise in the private equity industry. We then propose and examine an array of possible ways to eliminate or alleviate those conflicts, exploring the regulatory, fiduciary, and pragmatic strengths and weaknesses of each approach. General partners can seek investor unanimity or consent for follow-on investments, but certain tax and practical barriers complicate that approach. Alternatively, they can opt for a range of architectural prophylaxes to protect against conflicts. These add costs on everyone, however, and, experience in related fields shows, they do not work. Investors, for their part, can attempt to diversify their own investment holdings to counterbalance risk, but this still leaves some vulnerable to opportunistic fund managers, and may increase costs for all investors as well. We propose a less costly and more efficient solution: advisers and investors should work together to create a vibrant secondary market for private equity interests to create a salutary exit option, which would in turn discipline the investment behavior of fund managers in this turbulent new investing environment.

How does initial public financing influence private incentives for follow-on investment in early-stage technologies?

One common rationale supporting public financing programs for small firms is that initial public investment creates incentives for follow-on private investment. However, there does not appear to be a unified statement in the literature describing how initial public investment creates incentives for follow-on private investment. Focusing on external private investors, we use a two-stage net present value model to identify four effects from initial public investment on the private decision for follow-on investment. Our empirical analysis uses a sample of non-venture backed firms entering the SBIR program to examine how reduced risk, the number of SBIR awards, and size of initial public investment influence the likelihood of follow-on venture capital investment. We find the probability of follow-on venture capital investment is more likely when firms reach Phase II of the program, is less likely as firms win multiple Phase I and Phase II awards, and is more likely as the size of initial public investment in Phase I increases.

Technological Change as Reflected in Hotel Property Prices

This paper investigates the effects of age on the sale prices of hotel real estate. Value erosion of commercial property due to the passage of time may be offset by renovation, although substantial follow-on investment usually occurs several years following construction. Obsolescence produces value losses during the post-construction period prior to new investment that result from technological change (Colwell & Ramsland, Journal of Real Estate Finance and Economics, 8(1), 47–63, 2003). A hedonic model is specified to allow age to measure the effects of obsolescence in hotel prices. Although the long-run obsolescence rate for hotel properties of 1.93%/year aligns closely with the rate estimated elsewhere for retail properties, the path of obsolescence through time shows some marked departures. Contrary to the theory and the empirical results from the retail real estate market, hotel prices do not reveal much more obsolescence in the years immediately following construction than later. Also, the age and sale price relation turns positive nearing the third decade of the lives of hotels indicating a vintage effect. Thus, a V-shaped obsolescence function emerges that either may be explained by a fixed-cost renovation expenditure function or a vintage effect produced by the demand for surviving assets. A series of tests of hotel brand-specific obsolescence rates reveals considerable variation in these rates among seasoned properties, perhaps an indication of a convex renovation expenditure function and sequential follow-on investment.

Impact of Licensing on Investment and Financing of Technology Development

Technology innovations continue to be one of the greatest drivers of economic growth. Realizing the value of such innovations, however, requires substantial follow-on investments in development and commercialization. The value of these investments is difficult to capture because of uncertain demand and potential competition. This often leads to difficulties in obtaining outside financing for these investments. In this paper, we explore how licensing contracts can both dissuade other firms from developing alternative technologies and alleviate the financing problem. We develop a model in which a firm that invests in the development efforts of an innovation can license its technology to a potential competitor. A variety of licensing possibilities is considered, including fixed fees, royalty schedules, and two-part licenses consisting of an up-front payment and a capped royalty schedule. When the firm has no financial constraint, a royalty schedule that depends on realized demand dominates a fixed fee per license. When investment funds are constrained, a royalty cap license with an up-front payment can serve as a source of financing. We also study the investment problem conditional on the licensing and financing decisions.

Real Options and Real Tradeoffs

The commentaries on our article fail to come to grips with the distinct challenges raised by a process of experimentation that leads to the discovery of new possible initiatives. These challenges differ from those posed by an investment that provides privileged access to a prespecified set of possible follow-on investments. By treating these challenges as simple problems of implementation, the commentaries ignore the strategic tradeoffs implied by efficient abandonment processes and, therefore, fail to clarify where the logic of real options is likely to be more (and less) helpful to strategy thinking.

When Choosing R&D Projects, Go with Long Shots

How can R&D managers pick the best projects? In particular, how should they compare projects with different distributions of possible outcomes and different amounts of risk? Our approach to this question begins by addressing a special class of projects -- those that have equal expected values, but varying levels of uncertainty and risk. We use this intentionally simplified framework to highlight some general insights about why R&D projects may be less valuable to the firm than R&D projects. The intent is not to provide new modeling methods, but rather to shed light on underlying principles that apply, no matter how complicated the analysis. We show that if two projects have the same expected payoffs and the same costs, but different risks, and different ranges of possible outcomes, a conscientious R&D manager should bet on the long shot and choose the riskier project (if he or she must choose only one). We further show that this result often holds even for managers, and that if a manager can choose several projects, there are benefits to having a portfolio of risky projects. This initially surprising answer that riskier is better hinges on the fact that if the R&D phase of either project fails, the large follow-on investment for commercialization need not be made. In other words, if the research fails, then only the initial R&D investment is lost. Thus, even though the so-called project has less chance of failure, the riskier project cannot lose more money than the safer project. On the other hand, more can be gained with the riskier project because of its chance of exceptionally high values in its commercial stages. Hence, the riskier project has a higher expected payoff if the R&D is successful. Related Literature Our results extend ideas presented in two Harvard Business Review articles. Hodder and Riggs argue that correct valuation of a long-term investment, such as R&D, requires explicit consideration of the risks of three distinct project phases: research, product development and sales (2). Our insights also hinge on separate consideration of the research and commercialization phases of a project. We show analytically that a project with more risk has a higher expected value in the commercial phase and that this higher value outweighs the lower chance of success in the research phase. Kester argues that investments that create growth possibilities for a company are analogous to call options on securities (3). (This idea is also mentioned by Brealey and Myers in 4, Chapter 7 and by Mitchell and Hamilton in 13.) As a result, Kester finds that risk is a positive factor in valuing these investments. Our logic and results for R&D projects are consistent with Kester's view. We also rely on option valuation for our basic intuition, and illustrate and expand the insight using decision analysis. R&D is analogous to a call option in the sense that it creates future opportunities (such as development of new product lines or efficiency improvements) without committing the company to the full investment. We go beyond the arguments of the previous articles to show that even risk-averse managers will often prefer R&D projects if they consider the separate phases of the project and account for the option value of future opportunities. We also note that a company can employ this risky strategy for individual projects while reducing the risk of the company's R&D portfolio through diversification. What Is Risk? Many alternative definitions of risk have been proposed, ranging from simple statistics of a probability distribution (e.g., range and variance) to more general measures that include the decision maker's aversion to potential bad outcomes (e.g., utility functions). For example, Rothschild and Stiglitz compare four specific risk measures (5,6). Here, we use an intuitive definition of called downside risk, which is the expected loss if a project is not successful. …