Early-stage Venture Capital Research Articles

Interactive Effects of Gender, Quality Signals, and Industry in Early-Stage Venture Capital Funding

Interactive Effects of Gender, Quality Signals, and Industry in Early-Stage Venture Capital Funding

Treatment Effects in Strategic Management: With an Application to Choosing Early Stage Venture Capital

This paper uses the Rubin Causal Model to formalize the treatment effects of a firm choice on its performance. Building from Porter, a firm choice can shape profitability through both strategy and operational effectiveness, but they are distinct in how they do so. The strategic treatment effect is the benefit that is predictable from a firm's characteristics (i.e., resources) and their joint configuration. The strategic determinant function is a mapping of resources to treatment effects, and the role of resource interactions in it determines the importance of coherence for a strategy. Under unconfoundedness, the strategic treatment effect, strategic determinant function, and coherence can be estimated in high-dimensional observational data using machine learning. I present an application estimating the gains from choosing venture capital as early stage financing versus other forms of capital. The results highlight the advantage of considering strategic benefits in this choice. For equity outcomes, there is no average treatment effect of early stage VC, but there is significant heterogeneity: some entrepreneurs can benefit substantially from raising early stage VC, while others be negatively affected. This heterogeneity is predictable from founder, industry and location characteristics. The estimated role of coherence in this choice is moderate. The formalizations in this paper also show that several additional assumptions are required when assessing strategic benefits compared to the usual causal inference. R code to replicate these functions will be included.

Long-term perspective on venture capital investments in early stage life-science projects related to health care

Scholars and policymakers agree that early-stage venture capital is the most important element of innovation pipeline in the health care industry. However, securing the financing at the very beginning of innovation pathway in health care is challenging and relies on an in-depth understanding of investment strategies implemented by venture capitalists. In turn, this requires us to take a broader look at global trends in early-stage venture capital funding of health care oriented life-science projects. Referred to the above, this article aims to provide the outlook for early-stage venture capital investment in Europe and provide its benchmarking performance analysis. Using data on early-stage venture investments in health care-related life-science projects, we present its long-term dynamics and analyse current trends. Additionally, we check whether investment decisions are motivated by the short-term return opportunities or they are made as a part of long-term strategy. We find that Europe, with uneven and volatile financings, is still lagging behind the investment levels of the U.S. Our findings also support the cautionary behaviour of investors and their awareness towards the highly volatile nature of short-term returns.

Volatility and Venture Capital

The performance of venture capital (VC) investments load positively on shocks to aggregate return volatility. I document this novel source of risk at the asset-class, fund, and portfolio-company levels. The positive relation between VC performance and volatility is driven by the option-like structure of VC investments, especially by VCs’ contractual option to invest in subsequent (follow-on) rounds. At the asset-class level, shocks to aggregate volatility explain a substantial fraction of VC returns. At the fund level, consistent with the follow-on investment channel, this exposure is concentrated in years two through four of fund life and in early-stage VC funds, which have more embedded follow-on investment options. For VC-backed portfolio companies, volatility shocks correlate with faster and more frequent follow-on investment. The level of volatility at the time of initial investment has no relation with future performance, consistent with competitive markets. Overall, my results imply that the option-like features of VC investments are first-order determinants of risk in VC.

When and Why Do Venture-Capital-Backed Companies Obtain Venture Lending?

I model the decision of an informed early-stage venture capital (VC) investor that considers involving an uninformed VC or venture lending (VL) investor to finance the late stage. Early-stage VC investors that own high-quality value companies tend to signal their quality and they frequently turn to VL investors. Early-stage VC investors prefer VC if the proportion of high-quality companies in the population is high, if their companies have a high upside potential, if they can benefit from the value that late-stage VC investors add, or if uncertainty is high. I find empirical evidence consistent with these predictions.

The decline of venture capital investment in early-stage life sciences poses a challenge to continued innovation.

A key element required for translating new knowledge into effective therapies is early-stage venture capital that finances the work needed to identify a lead molecule or medical device prototype and to develop it to the proof-of-concept stage. This early investment is distinguished by great uncertainty over whether the molecule or prototype is safe and effective, the stability of the regulatory standards to which clinical trials are designed, and the likelihood that large follow-on investments for commercial development can be secured. Regulatory and reimbursement policies have a profound impact on the amount of capital and the types of life science projects that investors pursue. In this article I analyze several recent trends in early-stage venture capital funding, describe how these trends are influenced by regulatory and reimbursement policies, and discuss the role of policy makers in bringing new treatments to market. Policy makers can foster renewed private investment into critically needed early-stage products by increasing Small Business Innovation Research (SBIR) funding and public support for clinical trials in targeted areas of interest; creating regulatory pathways to enable early testing of experimental compounds in limited populations; and offering economic incentives for investors and developers in designated therapeutic areas.

Early-stage venture capital in South Africa: Challenges and prospects

The aim of this paper is to assess which factors impact the development of early-stage venture capital in South Africa. Factors identified for other markets and countries are explored and their relative importance in South Africa determined from the perspective of market participants. These include venture capital and private equity fund managers, government institutions, intermediaries and university research coordinators. The study used both an online survey, to capture a broad representation of opinion, and interviews, for in-depth responses. There was broad consensus among respondents with regards to the key factors requiring attention, which include the lack of funds targeted at early-stage investments, the lack of specialised fund managers, and the low entrepreneurial skillsets in the country. Through a detailed analysis of the responses, certain measures are proposed that can enhance the development of early-stage venture capital in South Africa such as engaging more with angel investors and improving the cooperation between the different market players in the sector.

Fund size and the syndication of venture capital investments

This article argues that the structure of a country's venture capital (VC) sector is a critical factor in the effectiveness of the sector. In particular, it is argued that the balance between small funds and large funds is important: that a preponderance of small VC funds leads to excessive syndication which compromises firm and fund performance, reduces the ability to raise additional capital and leads to a reliance on foreign investors. This implies that public policies that seek to stimulate early-stage VC can lead to a VC sector that is bottlenecked in the sense that the successful portfolio firms may be unable to obtain late-stage investment capital and may be forced to rely on foreign investors. This work tests this premise empirically using data for the Canadian setting and finds results consistent with these expectations.

A Panel Analysis of the Impact of Venture Capital on Innovation Performance in Europe

Prior studies have documented that Venture Capital (VC) boosts innovation in certain countries. But the literature has generally been restricted to firm and industry level. Little research effort has been devoted to investigate the long-run impact of VC on national innovation performance. This study explores European VC’s impact on innovation with a panel of 30 European countries over the period 1980-2009. We measure innovation performance with two indicators—the growth in the number of patent application and of the Total Factor Productivity (TFP). We find that in Western Europe, there is a positive long-run multiplier effect of VC on TFP growth. Both early and later stage VC investment tends to have no impact on the growth of patent applications. Early stage VC investment, however, has a negative impact on short-term TFP growth. In Eastern Europe, VC investment seems likely to boost innovation growth in the short-term but to damage innovation performance in the long-run. We discuss our findings with multiple theories and provide policy implications.

Can Herding Improve Investment Decisions?

Existing models show that herding in decisions can cause signi cant information loss, inferior information aggregation and impaired decision making. However, we show that in a multi-stage decision setting with endogenous information production, herding on the initial decision can actually result in superior aggregate information and improved decisions. This is because the possibility of herding by a follower incentivizes the leader to increase its ex-ante information production to an extent that it can dominate the information loss from herding. Examples include decisions to enter new markets, fund R&D, and provide early-stage venture capital.

From Funding Gaps to Thin Markets: UK Government Support for Early-Stage Venture Capital

Hybrid venture capital funds have a small positive impact on firm performance. This paper explores the implications of this finding for public policy in the United Kingdom.

Public Policy Support for the Informal Venture Capital Market in Europe

The ability of small firms to access finance is hindered by persistent market failure, which creates funding gaps for new businesses, particularly in technology sectors, seeking small amounts of finance. This has prompted various forms of public sector intervention to increase the supply of both debt and risk finance. For the past decade (longer in the UK) both the EU and its member states have increasingly focused on the informal venture capital market as a means of increasing the supply of early stage venture capital. This article describes the changing nature of the forms of intervention and provides a critical review of their effectiveness. The lack of data on angel investing means that there is very little evidence on the impact of these forms of intervention. The article advocates that governments should invest in appropriate methodologies which can accurately measure investment trends in the early stage venture capital market, and specifically angel investment activity, so that the need for public sector intervention can be demonstrated and the impact of such interventions can be measured.

Multiyear patterns regarding the relative availability of venture capital for the US biotechnology industry

Venture capital (VC) funding of US biotechnology companies was analysed relative to total VC investments placed in US companies from 1995 to 2007. During those years, except for a spike because of the dot-com bubble from 1999 to 2001, VC funding of US biotechnology companies grew at a faster rate percentagewise than total VC funding of US companies, with respect to annual dollars invested, number of deals closed and the mean dollar investment. Start-up and early-stage VC funding of US biotechnology companies also grew at a faster rate percentagewise, with respect to all three parameters, than total start-up and early-stage VC funding of US companies. It was further observed that long-term trends in the availability of VC for biotechnology do not appear to be affected by perturbations in the financial markets and short-term fluctuations in the availability of VC. It was concluded that the biotechnology industry should continue to attract VC over the long run particularly because of the emerging impact of personalised medicine and the coming of age of bioenergy.

Firm Level Implications of Early Stage Venture Capital Investment - An Empirical Investigation

The paper analyses the impact of venture capital finance on growth and innovation activities of young German firms. Among other variables, our panel of firm data includes data on venture capital funding and patent applications. With a statistical matching procedure we draw an adequate control group of non venture funded firms. The analysis gives evidence that innovative firms will be able to close a venture capital deal with higher probability. Once the firms are venture funded, they display higher growth rates but do not differ in their innovative output from otherwise comparable firms. We derive strategic implications.

The Economics of State Subsidies in Early Stage Venture Capital Investments

We analyze the effect of state subsidies on early stage investments. In a two period investment model with incomplete stage financing contracts we describe optimal and second best investment levels. Optimality depends on how we include external effects. The subsidies might be designed to maximize early stage investments, to use state money most efficiently to mobilize private investment capital, or to contribute to greater efficiency without regard to external effects. Refinancing subsidies can be optimal under all three perspectives and are always optimal under the first and last of the mentioned approaches. A comparison of different types of subsidies gives a further insight into the optimal design of subsidies.

Improving Access to Early Stage Venture Capital in Regional Economies: A New Approach to Investment Readiness

It is now recognised that many businesses are unsuccessful in raising equity finance because they are not investment ready. This has prompted enterprise support organisations in various countries to develop investment ready programmes. In the UK, the emphasis of these programmes is on providing information on sources of finance and how to access them, and on presentational skills. These are necessary but not sufficient conditions to get a business investment ready because they do not address business development issues which discourage potential investors. These issues are generally company specific and often require the input of significant expertise in order to make a company investable. This paper reviews LINC Scotland's approach, which is based on investment facilitation. It suggests that this approach does effectively address the business development support component of investment readiness at limited public cost and provides useful lessons for the design of investment ready programmes.

Closing the Regional Equity Gap? A Critique of the Department of Trade and Industry's Regional Venture Capital Funds Initiative

MASON C. M. and HARRISON R. T. (2003) Closing the regional equity gap? A critique of the Department of Trade and Industry's regional venture capital funds initiative, Reg. Studies 37 , 855-868. The UK Labour Government has provided support for the establishment of regional venture capital funds in each of the English regions as part of its drive to create an entrepreneurially led knowledge- based economy. This initiative is a response to persistent gaps in the provision of start-up and early stage venture capital. In this paper we question the likely effectiveness of the initiative on four counts. First, there is a lack of early stage venture capital skills available to manage the funds. Second, the small size of the funds will make it difficult for them to achieve financial viability. Third, the funds are targeting the wrong problem. The maximum investment that they are allowed to make is £250,000; they may subsequently provide up to an additional £250,000 in follow-on financing. However, the main funding gap in the UK is in the £250,000 to £1 million range. Finally, the proposal ignores the role of demand-side constraints in contributing to the equity gap. The paper concludes that a more comprehensive approach is required to address equity capital gaps at the regional level. MASON C. M. et HARRISON R. T. (2003) L'accè s au capital, comment réduire l'écart régional?: une critique de l'initiative du ministère du Commerce et de l'Industrie quant au capital-risque regional, Reg. Studies 37 , 855-868. Au Royaume-Uni, la majorité travailliste a été favorable au lancement des fonds de capital-risque régionaux dans chacune des régions d' Angleterre comme partie intégrante de sa campagne visant la cré ation d'une économie d'entreprise basée sur la connaissance. Cette intiative constitue une réponse à la présence persistante d'écarts dans l'accès au capital risque de démarrage et de développement. Cet article cherche à remettre en question l'efficacité éventuelle de l'initiative de quatre points de vue. Primo, il s'avère un manque de compétences en capital risque dans la phase de développement pour assurer la bonne gestion des fonds. Secundo, l'importance faible des fonds rendra difficile leur viabilité financière. Tertio, les fonds ciblent le mauvais problè me. Dans un premier temps, l'investissement maximal autorisé se chiffre à £250 000; dans un deuxième temps, des fonds supplé mentaires d'un montant de £250 000 sont autorisés sous forme de financement additionnel. Toujours est-il que le principal écart de financement au Royaume-Uni se trouve dans une fourchette comprise entre £ 250 000 et £1m. Finalement, la proposition ne fait aucune attention au rôle des contraintes de la demande dans le creusement de cet écart de financement régional. En guise de conclusion, l'article affirme qu'il faut une façon plus détaillée afin d'aborder la question des écarts de financement sur le plan régional. MASON C. M. und HARRISON R. T. (2003) Schließung der regionalen Kapitallücke?, Reg. Studies 37 , 855-868. Eine Kritik an der regionalen Initiative des Ministeriums für Industrie und Handel zur Einrichtung von Beteiligungskapitalfonds Die Labour Regierung des Vereinigten Königreichs hat in allen englischen Regionen der Einrichtung von Beteiligungskapitalfonds als Teil ihrer Aktion unterstützt, eine unternehmerisch geführte, auf Kenntnissen beruhende Wirtschaft zu schaffen. Diese Initiative stellt eine Erwiderung auf anhaltende Lü cken in der Bereitstellung von Kapital für Anfänger und Jungunternehmer dar. In diesem Aufsatz wird die voraussichtliche Wirksamkeit der der Initiative in vierfacher Hinsicht in Frage gestellt. Erstens fehlt es an Fä higkeiten der Handhabung derartiger Fonds von Jungun- ternehmerkapital. Zweitens wird der geringe Umfang der Mittel es ihnen erschweren, finanzielle Rentabilität zu erreichen. Drittens gehen die Fonds das falsche Problem an. Es ist ihnen nur gestattet, Investierungen von maximal £250,000 vorzunehmen; danach dürfen sie zusätzlich höchstens weitere £250,000 gewähren. Die Mehrzahl der zu überbrückenden Finanzierungslücken im UK liegen jedoch in der Region £ 250,000-£1 mill. Letztlich aber gehen die Vorschläge an der Rolle der Beschränkungen seitens der Nachfrage vorbei, die zu der Kapitallücke beitragen. Der Aufsatz kommt zu dem Schluß, daß ein umfassenderer Ansatz vonnöten ist, wenn man die Probleme der Eigenkapitallü cken auf Regionalebene in den Griff bekommen will.

Influences on the Supply of Informal Venture Capital in the UK: An Exploratory Study of Investor Attitudes

COLIN MASON IS PROFESSOR OF Economic Geography at the University of Southampton, England; Richard Harrison is Director of the Centre for Entrepreneurship and Professor of Management, University of Aberdeen, Scotland. The need to increase the availability of small-scale early stage venture capital has been recognised as a key factor in the development of an entrepreneurial economy. Informal venture capital plays a key role in financing the earliest stages of entrepreneurial growth ventures. This paper is an exploratory attempt to identify the factors that influence the supply of informal venture capital. A questionnaire survey of business angels sought to examine the macro-economic factors that influence the proportion of their personal investment portfolio allocated to investments in unquoted small businesses. The findings indicate that tax is the most significant influence on the willingness of business angels to make such investments whereas the economic environment-the rate of economic growth, interest rates and the rate of inflation-exerts a much mote modest influence.

Multiyear patterns regarding the relative availability of venture capital for the US biotechnology industry

Venture capital (VC) funding of US biotechnology companies was analysed relative to total VC investments placed in US companies from 1995 to 2007. During those years, except for a spike because of the dot-com bubble from 1999 to 2001, VC funding of US biotechnology companies grew at a faster rate percentagewise than total VC funding of US companies, with respect to annual dollars invested, number of deals closed and the mean dollar investment. Start-up and early-stage VC funding of US biotechnology companies also grew at a faster rate percentagewise, with respect to all three parameters, than total start-up and early-stage VC funding of US companies. It was further observed that long-term trends in the availability of VC for biotechnology do not appear to be affected by perturbations in the financial markets and short-term fluctuations in the availability of VC. It was concluded that the biotechnology industry should continue to attract VC over the long run particularly because of the emerging impact of personalised medicine and the coming of age of bioenergy.