Startup cash flows and venture capital investments: A real options approach

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Abstract
This paper studies venture capitalists' (VCs') sequential investment decisions in a real options model. We account for VCs' risk aversion, agency costs, and VC activism. We identify two separate investment policies: when startups have positive cash flows, more risk averse and more active VCs expedite their investments while higher agency costs delay staged investments. The opposite is true for negative‐cash‐flow startups. The model predicts a negative relation between risk aversion and stage length in line with the idea that VCs use stage length as a monitoring tool. We also show that higher growth rates and lower volatility encourage earlier investments.

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