Venture Capital Market Research Articles

On the structure of the informal venture capital market in Sweden: developing investment roles

This paper has two objectives: first, to estimate the size of informal venture capital market in Sweden, and second, to explore the heterogeneity of informal investing behaviour. Based on quantitative data on 278 informal venture capital investors and 422 investments, this paper provides an estimation of the size of the informal venture capital market in Sweden and an analysis of its structure by making a categorization of informal investors' investment roles. Four investment roles are identified based on the level of contribution of financial and human resources in the investment situation. The results show that the investment role that an individual assumes in the informal venture capital investment situation is dependent on the availability of the financial and human capital resources, as well as factors related to the willingness to supply them. The actual resource requirements of the firm have been shown to be of less importance in explaining the investment behaviour.

Building Relationships Early: Banks in Venture Capital

This paper examines bank behavior in venture capital. It considers the relation between a bank's venture capital investments and its subsequent lending, which can be thought of as intertemporal cross-selling. Theory suggests that unlike independent venture capital firms, banks may be strategic investors who seek complementarities between venture capital and lending activities. We find evidence that banks use venture capital investments to build lending relationships. Having a prior relationship with a company in the venture capital market increases a bank's chance of subsequently granting a loan to that company. Companies can benefit from these relationships through more favorable loan pricing.

The Public Venture Capital Challenge: The Australian Case

The appropriate role of the public sector in fomenting venture capital activity remains highly controversial. While dynamic new venture markets in such nations as Israel and India have been catalyzed by public interventions, there are also many examples world-wide of failed public sector efforts to promote venture capital activity. This paper describes one effort to avoid the pitfalls of the past, and design a thoughtful set of policies to encourage venture capital activity. In particular, this paper describes the experience of the Australian government between 2004 and 2006 in studying its venture capital market and how to promote it. After reviewing the more general case for a public role in promoting venture activity and the possible pitfalls that may result, we turn to understanding the market as it existed in Australia in 2004. We then outline the key policies that were discussed and adopted.

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

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.

The Syndication Network and Deal Flow of Venture Capital Firms

This paper analyzes the positions that Venture Capital firms hold in a syndication network and determines the effect that network positions have on generating deal flow quantity and quality. Using data on syndicated investments in the German venture capital market and data on the deal flow of the firms, we show that those firms that hold network positions characterized by network openness have a higher deal flow quantity and quality.

Venture capital or private equity? The Asian experience

Venture capital in Asia has exhibited remarkable growth over the last two decades. Researchers and practitioners have, however, expressed doubts as to whether what is being reported as venture capital in Asia can really be classified as such. Authors of scholarly studies often avoid this debate and, consequently, fail to caution readers about the applicability of their research findings. Through an exploration of the history, development, and composition of venture capital in Asia, this article not only confirms significant differences between Asian and traditional venture capital, but also finds that venture capital in Asia differs little from what is commonly called private equity. As such, a need exists within the venture capital literature to recognize this peculiarity of the Asian venture capital market. Moreover, venture capitalists considering expansion into Asia must comprehend the nature of the Asian market in order to avoid disillusionment and frustrations which may result from inadequate understanding.

Venture capital in China: a culture shock for Western investors

PurposeThis study seeks to examine the peculiarities of the venture capital market in China and seeks to compare it with Western markets.Design/methodology/approachThe paper provides insights based on both the practitioner and academic literature in the field.FindingsIt is noted that different cultural norms, corporate governance structures, a lack of appropriate exit strategies, and governmental intervention are important factors that set the markets apart and should be taken into consideration when making venture capital investments in China.Practical implicationsThe paper should be of interest to practitioners considering investing in China and to academics doing research in this area.Originality/valueThe paper is to the best of the authors' knowledge the first to provide a detailed and comprehensive review of the Chinese venture capital market.

Building Relationships Early: Banks in Venture Capital

This paper examines bank behavior in venture capital. It considers the relationship between a bank's venture capital investments and its subsequent lending, which can be thought of as intertemporal cross-selling. Theory suggests that unlike independent venture capital firms, banks may be strategic investors who seek complementarities between venture capital and lending activities. We find evidence that banks use venture capital investments to build lending relationships. Having a prior relationship with a company in the venture capital market increases a bank's chance of subsequently making a loan to that company. Companies can benefit from these relationships through more favorable loan pricing.

Does Gender Matter? Women Business Angels and the Supply of Entrepreneurial Finance

There is a substantial literature on the relationship between gender and access to finance. However, most studies have been concerned with access to debt finance. More recently, the focus of this research has broadened to examine women and venture capital. This article extends the focus further by examining the role of women in the business angel market, which is more important than the formal venture capital market in terms of both the number of ventures supported and total capital flows. Based on a detailed analysis of business angels in the U.K., the study concludes that women investors who are active in the market differ from their male counterparts in only limited respects. Future research into women business angels, and the possible existence of gender differences, needs to be based on more fully elaborated standpoint epistemologies that focus on the experience of the woman angel investor per se, and center on the examination of the role of homophily, social capital, networking, and competition in investment behavior.

Do Specialist Fund Managers Possess Superior Project (Stock) Picking Ability?

This paper finds that industry specialization within a fund is associated with superior project picking ability in the venture capital market. We find that ex-ante judgments of superior project quality are associated with positive abnormal performance for specialist funds, while they are associated with negative abnormal performance for the average fund. During cold IPO markets, abnormal performance associated with project-picking ability is greater than abnormal performance associated with specialization (portfolio risk) independent of project picking ability. During hot IPO markets, however, project picking ability is not rewarded, while specialization is associated with positive abnormal performance independent of project picking ability. Our findings indicate that the ability to shift investments into sectors that are 'hot' is associated with superior performance independent of project picking ability. Consistent with this conclusion, ex-ante judgments of low quality are associated with positive abnormal performance for the average fund during hot IPO markets but not during cold IPO markets.

Taxation of uncertain business profits, private risk markets and optimal allocation of risk

In this paper we explore what happens if the government bears some of the risk through a profit tax when the risk sharing in the venture capital market is incomplete due to non-observability of effort and moral hazard. If the external equity investors can enforce exclusive contracts with the entrepreneurs, the risk relief through a profit tax will lead to too much insurance and too low effort as compared with a second best optimal solution. Bond and Devereux [Bond, S.R. and Devereux, M.P. (1995). On the design of a neutral business tax under uncertainty. Journal of Public economics, 58, 57–71.] show that a proportional profit tax would be neutral in the absence of moral hazard. In the presence of moral hazard we demonstrate that the tax may affect the risk shifting through the market, in which case the premise for the neutrality result will no longer hold.

Executive forum: Public support for the business angel market in Europe – a critical review

Various levels of government have implemented instruments to promote business angel investment, often mirroring those used to support the institutional venture capital market. The paper reviews the existing practices at a point in time when intervention in the field of business angels is becoming increasingly popular in Europe. Governments are looking for innovative ways to enhance business angel investments and the evolution of the policy in the field is rather trial and error based. We see a shift from classical support to network creation and improvement of the fiscal environment, towards guarantee schemes for angel investments and co-investment schemes. This latest, most recent, approach is analysed by a detailed case study of the Belgian Business Angels Plus (BA+) scheme, which matches the financing provided by a business angel investor and the entrepreneur. In its initial two and a half years of operation the BA+ scheme has received close to 70 applications, of which just over 20 have been rejected. The characteristics of the deals financed by BA+ applicants are similar to those found in the average investment in Belgium. Following up the companies applying for the BA+ loan shows that the programme has so far avoided incurring significant losses. However, it is not possible to determine if lack of finance was one of the reasons for the bankruptcy of the companies that did not secure the additional loan.

Empirical evidence on a supply-driven Venture Capital market in the USA

This research focused on the US venture capital (VC) industry over the period of 1980 to 2006. We found that supply and demand shifts occurred in the US VC during that period. Moreover, the US VC industry has gone under fundamental transformation in the early 1990s when pension funds started to invest in the sector. As a result, the US VC industry has transformed into a supply-driven market. We estimate that the VC industry is still inflated and predict degraded future returns if the current trend of institutional investors to further increase their allocation for venture capital investments continues.

A theoretical analysis of optimal financing strategies for different types of capital-constrained entrepreneurs

In this paper, we compare two alternative financing strategies that capital-constrained entrepreneurs can adopt: they can either wait until they raised enough money to complete their project (the more conservative strategy) or use limited resources to achieve some intermediate milestone before contacting large outside investors such as venture capitalists (the more adventurous strategy). We examine how the choice of financing strategy is affected by entrepreneurial types (life-style, serial and pure profit-maximizing entrepreneur). We show that specific entrepreneurial characteristics may ultimately affect the shape of firms as they may pursue different strategies to achieve similar goals. The paper generates a number of empirical predictions on security design, the interplay between angel and venture capital finance, and the professionalization of the venture capital market.

Business angels in a changing economy: The case of Sweden

The Swedish business angel market of 2004 is presented and compared to that of 1992 in order to determine the significance of the time factor. The presentation is carried out against the background of the macroeconomic changes that have taken place and how they have affected the informal venture capital market. The empirical findings reveal how the amounts invested have changed, which companies the business angels have invested in and the ways in which the business angels' deal flow has changed since 1992. The results show that business angels in Sweden have become more professional in their way of identifying new investment opportunities and that the informal venture capital market is becoming more mature with less information asymmetry. Furthermore, the results demonstrate that Internet hype and changes in the Swedish taxation system have probably influenced the business angel market, making investors invest at earlier stages and in high-tech companies.

Shock and Change in the German Venture Capital Market, 1995-2005

Mark Huberty, Johns Hopkins School for Advanced International Studies, The Johns Hopkins University The development of the high-technology startup sector in Germany is critical for the adjustment of the German economy to growing international competition in traditional industrial sectors. The article explores whether changes to the German venture capital financing sector in the period 1995-2005 indicate an improved development path for high-technology startup firms. Based on the volumes and structure of venture capital investments during this period, I conclude that the venture capital sector has undergone substantial change in favor of financing and supporting high-technology startup firms. However, small firm behavior suggests that even with a changed venture capital sector, the overall regulatory structure of the German economy will result in lower rates of firm success than otherwise would be expected from a resurgent venture capital market. The policy implication is that, without additional regulatory reform favoring small, high-technology enterprises, the transformation of German industry will continue to be constrained.

The High Cost of IPOs Depresses Venture Capital in the United States

The fundamental reason for the small numbers of IPOs is the reluctance of public investors to buy IPO stock. The technology bubble burst in 2000 and investors still remember their losses in the IPO industries. But the IPO market would be more active if IPOs were not so expensive. They cost too much to do and, once done, a company has much higher ongoing costs. The higher ongoing costs are a significant bone of contention, particularly with the implementation of Section 404 of the Sarbanes-Oxley Act of 2002. Lowering the cost of IPOs would not only enable small companies to net more money per offering, it would also enable small companies to float smaller offerings. And lowering the cost of IPOs is something that the Securities and Exchange Commission could do by allowing small companies to make their IPOs over the Internet. The SEC's foot-dragging on the use of the Internet for IPOs is depressing venture capital in the United States. The most active venture capital IPO market for small companies is now the AIM market in London. This comment briefly describes the current regulation of IPOs, describes an alternative system of public offering that uses the Internet, and concludes with a discussion of whether there are regulatory problems with a system of Internet IPO.

The legislative road to Silicon Valley

Must policymakers seeking to replicate the success of Silicon Valley's venture capital market first copy other US institutions, such as deep and liquid stock markets? Or can legislative reforms alone make a significant difference? In this paper, we compare the economic and legal determinants of venture capital investment, fundraising, and exits. We introduce a cross-sectional and time series empirical analysis across 15 countries and 14 years of data spanning an entire business cycle. We show that liberal bankruptcy laws stimulate entrepreneurial demand for venture capital; that government programmes more often hinder than help the development of private equity, and that the legal environment matters as much as the strength of stock markets. Our results imply generalizable lessons for legal reform. Copyright 2006, Oxford University Press.

Do Venture Capitalists' Characteristics Affect the Performance of the Firms They Back?

Previous research has already addressed the issue of the impact of venture capital (VC) backing on the growth patterns of investee firms. Based on qualitative, hand-collected data, other studies analyzed the different tasks performed by venture capitalists (VCs) to add value to their portfolio companies. The aim of this paper is to provide evidence of the effect of some VCs’ characteristics on the performance of the portfolio firms over time. The characteristics tested are: age of the VCs, size of the funds under management, number of portfolio companies per investment manager and specialization strategy. We base our analysis on a highly representative, unbiased sample of VC-backed firms in a country that ranks third in the Continental Europe VC market. The sources of data are two databases, one reporting VC activity and the second one including financial accounts of the firms. Additionally, historical and observable VCs’ characteristics have been added. The findings are based on panel data methodology, analyzing several years of financial results, from the year of the first round of financing, for each VC-backed firm. This approach allows us to keep track of the changes over time and to control for the effect of the money invested and the value added by VCs separately. We analyze the whole sample and three subsets based on the portfolio company stage. Our findings show that value added is significant in companies at the expansion stage for some VCs characteristics, such as age, size or number of portfolio companies per investment manager, whereas performance on start-up companies seems related to funding alone.

Venture capital, initial public offerings and political economics: the case of Germany

The availability of venture capital is closely linked to stock markets for young growth companies as an initial public offering is usually the most attractive exit channel. For decades the German economy was bank centred and stakeholder oriented. Inherent to the system, the capital market did not play a central role, and a market for venture capital basically did not exist. Since the 1990s, the German economy has undergone some fundamental changes. The old 'Germany Inc.' is in the process of disintegration. With an increasing capital market orientation, the venture capital and IPO market almost gained ground automatically. The Neuer Markt, although very successful for several years, finally failed. We argue that the reasons go beyond the global downturn of the stock markets and are to be found in the system of political economics. In Germany, the political economic system is far from being a full-fledged capital market, outsider control system.