Raising the returns to venture finance
Most new ventures fail and do not make a positivereturn, which makes it difficult for would-be entrepreneurs to obtainfinancing. This paper proposes a method whereby investors can increase returnson their portfolios, thus increasing the availability of venture capital toentrepreneurs. The central idea is that the venture investor can take advantage ofpotentially valuable asymmetric information about the firms in which they haveinvested to make third-party investments correlated to their initialinvestments. The process outlined assumes new businesses that could disrupt competitorsin established markets and so reduce the value of established firms. Shortlybefore the innovator firm disrupts the markets of the established firms, theventure financier purchases put options (or similar derivatives) on the stockof these rival firms. When the innovative, disrupting firm announces its newproduct or process, or sufficient market penetration has occurred, the reducedfuture profits of the established firms are apparent and the rival's stock willfall. The investor can exercise the options or cash in the derivatives at aprofit. Also considered are the ethical questions of the proposed method, regulatoryand institutional issues, transaction costs, impact of stock-price volatility,and issues of timing. Also shown is that relying on active capital markets canprovide a mechanism for improving financing of new ventures. (TNM)