Skip to Main Content
HBS Home
  • About
  • Academic Programs
  • Alumni
  • Faculty & Research
  • Baker Library
  • Giving
  • Harvard Business Review
  • Initiatives
  • News
  • Recruit
  • Map / Directions
Working Knowledge
Business Research for Business Leaders
  • Browse All Articles
  • Popular Articles
  • Cold Call Podcast
  • Managing the Future of Work Podcast
  • About Us
  • Book
  • Leadership
  • Marketing
  • Finance
  • Management
  • Entrepreneurship
  • All Topics...
  • Topics
    • COVID-19
    • Entrepreneurship
    • Finance
    • Gender
    • Globalization
    • Leadership
    • Management
    • Negotiation
    • Social Enterprise
    • Strategy
  • Sections
    • Book
    • Podcasts
    • HBS Case
    • In Practice
    • Lessons from the Classroom
    • Op-Ed
    • Research & Ideas
    • Research Event
    • Sharpening Your Skills
    • What Do You Think?
    • Working Paper Summaries
  • Browse All
    Financing Risk and Bubbles of Innovation
    20 Oct 2010Working Paper Summaries

    Financing Risk and Bubbles of Innovation

    by Ramana Nanda and Matthew Rhodes-Kropf
    While start-up firms are key to any technological revolution, they also run a high risk of failure. To that end, investors often provide limited capital in several careful stages, gaining confidence in a firm before doling out another round of funding. However, these investors still face the possibility that other investors won't provide follow-on funding, even when the firm's prospects remain sound. That's a big risk for individual investors who can't afford to fund a new firm all by themselves, and whose investment will flounder if others don't invest, too. Research by HBS professors Ramana Nanda and Matthew Rhodes-Kropf explores why future investors may not fund the project at its next stage even if the fundamentals of the project have not changed. Key concepts include:
    • The paper introduces the concept of financing risk--the risk that a project cannot garner the additional funding it needs to proceed, even if its fundamentals remain sound.
    • When investors become worried, future investors will not support the project. Withdrawing support today leads to a self-fulfilling jump to a poor financing environment.
    • Investors face a trade-off: either providing more capital to novel ideas to protect against financing risk, or providing less funding to maximize knowledge before providing more capital.
    • The most innovative firms face the most acute trade-off situations, and thus, funding to these firms is the most unstable.
    • The additional capital that enters the market during "hot" times goes not only to weaker projects, but also to more innovative projects that are a good investment only when financing risk is low. Thus, the most innovative projects may need a hot funding environment to get funding at all.
    LinkedIn
    Email

    Author Abstract

    Investors in risky start-ups who stage their investments face financing risk-that is, the risk that later-stage investors will not fund the startup, even if the fundamentals of the firm are still sound. We show that financing risk is part of a rational equilibrium where investors can flip from investing to not investing in certain sectors of the economy. We further demonstrate that financing risk has the greatest impact on firms with the most real option value. Hence, the mix of projects funded and type of investors who are active varies with the level of financing risk in the economy. We also highlight that some extremely novel technologies may in fact need "hot" financial markets to get through the initial period of diffusion. Our work underscores that financial markets may play a much larger and under-studied role in creating and magnifying bubbles of innovation in the real economy.

    Paper Information

    • Full Working Paper Text
    • Working Paper Publication Date: August 2010
    • HBS Working Paper Number: 11-013
    • Faculty Unit(s): Entrepreneurial Management; Finance
      Trending
        • 23 Jun 2022
        • Research & Ideas

        All Those Zoom Meetings May Boost Connection and Curb Loneliness

        • 06 Aug 2021
        • Book

        Steve Jobs and the Rise of the Celebrity CEO

        • 28 Jun 2022
        • Book

        The Moral Enterprise: How Two Companies Profit with Purpose

        • 22 Jun 2022
        • Book

        Four Elements for Finding the Right Career Path

        • 18 Apr 2022
        • HBS Case

        Dick’s Sporting Goods Followed Its Conscience on Guns—and It Paid Off

    Ramana Nanda
    Ramana Nanda
    Visiting Scholar
    Contact
    Send an email
    → More Articles
    Find Related Articles
    • Going Public
    • Finance
    • Financial Services

    Sign up for our weekly newsletter

    Interested in improving your business? Learn about fresh research and ideas from Harvard Business School faculty.
    ǁ
    Campus Map
    Harvard Business School Working Knowledge
    Baker Library | Bloomberg Center
    Soldiers Field
    Boston, MA 02163
    Email: Editor-in-Chief
    →Map & Directions
    →More Contact Information
    • Make a Gift
    • Site Map
    • Jobs
    • Harvard University
    • Trademarks
    • Policies
    • Accessibility
    • Digital Accessibility
    Copyright © President & Fellows of Harvard College