3. Discussion

The preceding example has shown that staged financing can (and often does) make projects more valuable: Instead of committing the full capital upfront, we make comparatively small investments into initial "experiments" to validate the key assumptions or value drivers behind a business case. Only if these experiments are successful do we proceed with the investment. Else, we abandon the project. This allows us to fail much faster and cheaper if failure is unavoidable.

  

Firms as Real Options

In finance language, the right to postpone an investment and make it conditional on information that we will learn in the meantime is called an option. Such options are especially crucial in the context of startups, as these companies often face comparatively larger uncertainty and have more flexibility with respect to their investment policy. The trick is to be able to identify these options and value them correctly. The module "Startup valuation" extensively deals with the optionality of startups.

 

Lean Startups and Agility

The option view on a firm or project is very common in startup financing. More recently, it has also received tremendous attention in general management.

Popular management principles such as Lean Startup and, more generally, Agility, essentially build on the option view:

  • Instead of implementing investment projects according to an elaborated centralized business plan that is based on many assumptions, the recommendation is to start product development by conducting a "Minimum Viable Experiment (MVE)" that tests the central premise of a business idea.
  • With the learnings from such experiments, developers can then start to build the actual product. Product development will again start with a minimum viable version, i.e., the simplest possible product version that adds customer value (Minimum Viable Product, MVP).
  • Through continuous experimenting and learning, developers will iteratively reach a complete product.

 

The simple example from the preceding section allows us to better understand under what conditions such experimentation is particularly valuable. This is the topic of the next section.