Given these odds, investors are always looking for ways to increase returns from their winner. Bill Hilliard and Charles Baden-Fuller, visiting scholars at Wharton’s Sol C. Snider Entrepreneurial Research Center, believe they have a strategy that can provide investors with an extra edge from investments that prove to be profitable, and perhaps take the edge off some of the losing ones.
In a paper pending publication entitled, “Should a Venture Capital Fund Act More Like a ‘Venture Hedge Fund?’” they propose that venture investors consider a strategy that some investors routinely use in the public markets: Hedge. They admit that there could be legal and ethical issues involved in the process, but having examined numerous legal cases and law review articles, they conclude that these issues are not insurmountable.
Typically, successful venture capital-backed companies act as disruptive forces in their industries. The freshly-conceived products or services they promise to bring to the market threaten the entrenched position of an established competitor, causing any publicly-traded rival’s stock price to decline. In that situation, a put option – which is the right, but not the obligation, to sell stock at a certain price by a certain date – acquired on the competitor’s stock would be a tool to capture profits that are in addition to those obtained from sales of the new product or service, the two authors say.
The owner of a put option is betting that the option will go up in value as the underlying stock goes down in value; he or she can make money either by selling the option or trading the stock at an opportune time.
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