The Public Sector's Role in the Promotion of Venture Capital Markets

Abstract

Over the last decades, governments around the world have increasingly dedicated public financing to the promotion of self-sustainable venture capital markets. In most industrialised nations, the state plays some role in the development of the venture capital industry - particularly the high-tech, early stage sector - and tries stimulating, supporting and influencing this market either directly or indirectly, usually by providing a range of incentives. This paper gives an overview over the growing number of research publications on the public sector's role in the promotion of venture capital markets. Typically these analyses are country-specific and tend to fall short on principles. As policy makers have been using several alternative mechanisms within different and highly idiosyncratic national institutional environments, and the interventions took place at very specific time periods, this paper proposes a general framework for publicly supported venture capital programs. Depending on whether support is targeting developing or existing venture capital markets, a stage wise approach starting with the preparation of a private equity industry, moving on to creating and stabilizing venture capital markets and finally using these markets to achieve policy objectives is proposed. At an advanced stage of the venture capital market's development policy makers are faced with two fundamental issues: when operating under the same conditions as private sector investors the government can only pursue policy objectives as long as other limited partners accept them. A major component of the government's value added, particularly during market downturns, is the signalling and certification inherent in its commitment to a venture capital fund. For private sector limited partners, however, only the public investor's financial track record is of relevance, and to create this track record, the government's approach has to closely comply with the private sector modus operandi. Consequently, with increasing maturity and growing investment return potential of the venture capital market government budgets need to be complemented with and finally replaced by funding from private sector investors.