Financing Risk and Bubbles of Innovation

Thursday, October 4, 2012, 2:00 AM | Leave Comment

Technological revolution can take place mainly because of start-up firms that come up with innovative and serendipitous ideas. These firms embark upon their business journey with excitement and hopes that they will succeed. But, there exists a high risk of failure also.

  • What Is Financing Risk?

    The long-term survival of these firms will not be determined by their novel ideas but by another crucial element called investments. But, investors prefer to tread cautiously because they have not felt the pulse of the firms. So, they provide the firms only with limited capital in several stages.

    Unless investors gain confidence in the firms, they do not go ahead with the next rounds of funding. These investors will watch if other investors will provide follow-on funding. But, it is not likely to happen even if the prospects of the firms are quite good.

    The initial investors cannot fund these new firms wholly. So, they face a big risk because firms cannot succeed if new investors do not extend the follow-on funding. This is known as Financing Risk.

  • Complexity of behavior as exhibited by initial and new investors

    The initial investors are now in a quandary. They are worried that new investors may not provide the additional funds even if the firms have sound fundamentals. When these investors are worried, other investors may not support the firms.

    The initial investors can not withdraw also because it may create a poor financing environment. Now, there are only two options for the initial investors. They should either provide more funds to these firms or they should limit their funding in the initial stage itself so as to acquire more knowledge about the firms before infusing more funds.

    Firms that have come out with the most innovative ideas may be the worst affected because these firms may not get stable funding for doing their businesses. But, there are certain “hot” times when additional funds will be infused into these firms.

    This phenomenon of investors oscillating between investing and not investing in new firms is apparently predominant in certain industries. Further, financing risks can impact those firms that have the most innovative ideas.

    Depending upon the financing risk of the economy, the types of active investors and the mix of projects funded will vary. Firms that have highly innovative technologies may have to wait for “hot” environments for getting their investments. This means that it is the financial markets that create and enlarge the bubbles of innovation in the economy.

  • What should investors do to help new firms with novel technologies?

    There should be an increase in experimentation in the economy. Especially, investors should be ready to do such experiments in new projects that come up with innovative ideas because novel technologies are in need of “hot” financial markets to successfully get through the initial phase.

    Therefore, investors who expect that there is a possibility of financing risk should come forward to eliminate its impact by funding upfront or by committing to invest more.

Author BIO

Author of this blog James Hopes, is an avid financial blogger. He gives tips on finance management and much more through his website

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