Early-stage venture capital funds, scale economies and public support

Abstract

This paper looks at the contemporary financing situation facing New Technology Based Firms in the UK. The specific role of venture capital as a source of third party equity to these frequently capital rationed start-ups is explored. Evidence is presented which indicates that, despite a significant increase in finance to venture funds, the share allocated to seed capital and to investment in the earliest stages of a new enterprise remain stubbornly small. A 'Catch 22' situation conundrum exists whereby it is the smallest specialist funds which are prepared to invest small tranches of equity at the earliest and most speculative stages of the investment cycle. Yet, using a spreadsheet model and industry sourced input and output parameters, it can also be demonstrated that small venture funds bear a major cost penalty which imperils their viability. The model is used to illustrate scale effects on an early-stage VC fund and the consequences of guarantee and leverage based, support mechanisms on the returns to the fund's managing and limited partners.