Real Options Applied Research, Venture Capital

Investment assessment of venture project, asymmetric information between the venture capitalists and entrepreneurs and the designing of investment contracts clauses are all important contents in venture capital investment. The real option approach, which can properly deal with the uncertainties, is widely used in venture project evaluation. Besides, it has exploited a new direction for the application of real option in the study of venture capital because of the contingent implementation of investment contracts clauses.Firstly, this thesis introduces the basic concepts of venture capital investment in simple, then we go detail into the real options approach, such as its definition,classification, its frequently used pricing measures and the comparison of the real options approach with the traditional approaches such as the NPV Method.Secondly, in order to well illustrate venture capitalists'benefit brought by the characteristic of stage financing, this thesis applies the binominal-tree method to analyze a new drug development and compares the differences between conclusions made by traditional NPV Methods and the real options approach. It indicates that the real options approach not only appropriately deals with the uncertainties in venture projects and makes more venture projects gain the chance to develop. The case clearly shows investors'decision path.Thirdly, after introducing the real option model for convertible clauses which is initiated by Cossin et al (2002) and pointing out its deficiencies, we make further study on its improvement. We introduce the principal-agent problem into the real option model for convertible clauses. By designing the conversion cost of convertible stock which Venture Capitalists (VCs) use as the main investment tool, VCs can maximum their profit and solve the incentive problem. Accordingly, we put the conversion cost into the real option model to calculate the option value. As we can't get analytic solution, we numerically solve the incentive problem for the convertible cost, entrepreneurs'effort and option value.Finally, we use the comparative static analysis to find out the relationship between the option value and the parameters such as investment amount, the origin value of venture project and so on. The results show that the effort that entrepreneurs put into the venture project can affect not only the converting cost, but also the option value. To some extent, the thesis sheds light on the designing of investment contracts between VCs and entrepreneurs with the real options approach.