Venture Capital Supply Research Articles

The complementarity effect in the venture capital contract: a generalised formulation and new insights

The moral hazard problem plagues the start-ups and even mature enterprises when they incorporate venture capital to pursue business upgrade or expansion. Especially in the value chain where the venture capitalist can synergise with the entrepreneur to contribute to the firm value. This paper proposes a game theoretic approach to solve the entrepreneur's optimisation problem in a venture capital financing scheme and generalises the formulation without a specific revenue function. Furthermore, this study generates managerial insights for venture capital market and relevant sustainable supply chain management. The key results also show that the complementarity effect can incentivise both the entrepreneur and the venture capitalist to exert more effort, thus achieving larger enterprise value when it is relatively significant, and the inefficiency caused by the allocation of equity share could be mitigated.

Foreign Venture Capital in Europe: Consequences for Ventures’ Exit Routes and Entrepreneurial Migration

An increasingly global venture capital (VC) business raises the question whether foreign VCs’ investments pull economic activity away from domestic economies. Using a large sample of VC-backed European ventures, we analyze whether involvement of foreign VCs influences firms’ and entrepreneurs’ migration patterns. We provide evidence that foreign investors, in particular from the U.S., on average, back much better European ventures and increase the likelihood of foreign exits and emigration of entrepreneurs. These effects are robust to endogenous selection. Our findings suggest that VC firms are a funnel through which high-impact economic actors are absorbed by countries with foreign VC presence. Governmental efforts to increase domestic supply of VC should have a positive impact on domestic economies.

Determinants of Venture Capital Supply in Sub-Saharan Africa

The purpose of this paper is to determine the variables that influence venture capital supply in Sub-Sahara Africa. The study developed econometric models and examined a 10-year period (2006 to 2015) pertaining to eight (8) Sub-Sahara African countries namely: Botswana, Ivory Coast, Ghana, Kenya, Mauritius, Nigeria, South Africa and Uganda. The empirical model includes six determinants (initial public offering, market capitalisation, unemployment rate, foreign direct investment inflow, inflation rate and trade openness). Secondary data was utilised for the study. The primary sources of data were the World Bank Development indicators and Preqin data base. All the statistical analyses in the study were performed using E-views version 8. Panel data models of pooled, fixed and random effects were employed. The results suggest that there is a significant positive relationship between initial public offering, market capitalisation and venture capital supply. Second, there is no significant relationship between unemployment rate, foreign direct investment inflows, trade openness and venture capital supply. Based on the empirical findings, this study recommends that Sub-Sahara African governments should attempt to develop their economies by improving infrastructure and corporate governance. There is also a need for African countries to develop the equity market.

Determinants of Venture Capital Supply in Sub-Saharan Africa

The purpose of this paper is to determine the variables that influence venture capital supply in Sub-Sahara Africa. The study developed econometric models and examined a 10-year period (2006 to 2015) pertaining to eight (8) Sub-Sahara African countries namely: Botswana, Ivory Coast, Ghana, Kenya, Mauritius, Nigeria, South Africa and Uganda. The empirical model includes six determinants (initial public offering, market capitalisation, unemployment rate, foreign direct investment inflow, inflation rate and trade openness). Secondary data was utilised for the study. The primary sources of data were the World Bank Development indicators and Preqin data base. All the statistical analyses in the study were performed using E-views version 8. Panel data models of pooled, fixed and random effects were employed. The results suggest that there is a significant positive relationship between initial public offering, market capitalisation and venture capital supply. Second, there is no significant relationship between unemployment rate, foreign direct investment inflows, trade openness and venture capital supply. Based on the empirical findings, this study recommends that Sub-Sahara African governments should attempt to develop their economies by improving infrastructure and corporate governance. There is also a need for African countries to develop the equity market.

The Link between Venture Capital Supply Factors and Economic Development in South Africa

The purpose of this paper is to provide a new theoretical model for the factors that influence the supply of venture capital investment in South Africa. Based on extant literature, the study puts forward a tentative framework to explain the link between venture capital supply factors and economic development. To this point, the paper has established that there is a link between venture capital supply and economic development and the link is mediated by formal job creation in the MSME sector. The framework depicted in Figure 4 shows three key determinants of venture capital supply including the MSME density, the extent to which industrialisation has taken place and the share of natural resource contribution to GDP. While the utility of the framework is limited without empirical evidence, the study draws attention to the need of the South African economy to find mechanisms of increasing formal job creation in the small and medium enterprise sector while simultaneously focusing on increasing the rate of industrialising the economy. DOI: 10.5901/mjss.2014.v5n9p18

What lures cross-border venture capital inflows?

We investigate if economic factors drive gross and net cross-border venture capital inflows differently. Using a dataset of venture capital investments in European and North American countries from 2000 to 2008, we find that higher expected economic growth goes hand in hand with higher gross as well as net inflows, while higher market capitalization and a more favorable environment for venture capital intermediation entail higher gross inflows, but lower net inflows. The latter two findings may suggest that cross-border venture capital inflows partly compensate for potential limits in domestic venture capital supply. However, the findings may also reflect that venture capitalists’ locational decisions depend on the viability of capital markets.

The Regional Supply of Venture Capital: Can Syndication Overcome Bottlenecks?

In our study, we investigated whether the supply of venture capital (VC) is driven by spatial proximity between a VC company and the portfolio firm. Our analysis was based on information about VC investments in Germany between 2004 and 2009. We found that possible problems caused by the geographic distance to a portfolio firm seem to be overcome by the syndication of investments with one of the VC firms located close to the investment. The results suggest, however, that a short geographic distance between an investor and the investment has an increasing effect on the probability of syndication as well as on the number of firms that join the syndicate. Hence, local VC suppliers may assume the role of an anchor, connecting the regional economy to more distant parts of the industry.

Management Insights

Management Insights

Networking as a Barrier to Entry and the Competitive Supply of Venture Capital

ABSTRACTWe examine whether strong networks among incumbent venture capitalists (VCs) in local markets help restrict entry by outside VCs, thus improving incumbents' bargaining power over entrepreneurs. More densely networked markets experience less entry, with a one‐standard deviation increase in network ties among incumbents reducing entry by approximately one‐third. Entrants with established ties to target‐market incumbents appear able to overcome this barrier to entry; in turn, incumbents react strategically to an increased threat of entry by freezing out any incumbents who facilitate entry into their market. Incumbents appear to benefit from reduced entry by paying lower prices for their deals.

What Lures Cross-Border Venture Capital Inflows?

We investigate if economic factors drive gross and net cross-border venture capital inflows differently. Using a dataset of venture capital investments in European and North American countries from 2000 to 2008, we find that higher expected economic growth goes hand in hand with higher gross as well as net inflows, while higher market capitalization and a more favorable environment for venture capital intermediation entail higher gross inflows, but lower net inflows. The latter two findings may suggest that crossborder venture capital inflows partly compensate for potential limits in domestic venture capital supply. However, the findings may also reflect that venture capitalists’ locational decisions depend on the viability of capital markets.

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.

Noncompete Covenants: Incentives to Innovate or Impediments to Growth

We find that the enforcement of noncompete clauses significantly impedes entrepreneurship and employment growth. Based on a panel of metropolitan areas in the United States from 1993 to 2002, our results indicate that, relative to states that enforce noncompete covenants, an increase in the local supply of venture capital in states that restrict the scope of these agreements has significantly stronger positive effects on (i) the number of patents, (ii) the number of firm starts, and (iii) employment. We address potential endogeneity in the supply of venture capital by using endowment returns as an instrumental variable. Our results point to a strong interaction between financial intermediation and the legal regime in promoting entrepreneurship and economic growth. This paper was accepted by Gérard P. Cachon, entrepreneurship and innovation.

Non-Compete Covenants: Incentives to Innovate or Impediments to Growth

We find that the enforcement of non-compete clauses significantly impedes entrepreneurship and regional growth. Based on a panel of metropolitan areas in the United States from 1993 to 2002, our results indicate that, relative to regions in states that enforce non-compete covenants, an increase in the local supply of venture capital in states that restrict them has significantly stronger positive effects on (i) the number of patents, (ii) the number of firm starts, and (iii) employment. We address potential endogeneity issues in the supply of venture capital by using endowment returns as an instrumental variable. Our results point to a strong interaction between financial intermediation and the legal regime in promoting entrepreneurship and growth.

Community development venture capital: concept and status quo in Germany

As most other countries, Germany also faces dramatic regional differences in terms of socio-economic development. Important drivers of such development are entrepreneurial activity and the creation of new companies. We argue that venture capital (VC) and especially community development venture capital (CDVC) can be a powerful instrument to stimulate entrepreneurship and to support the growth of ambitious companies. Hence, the present paper deals with the general questions of whether there are regional gaps in the supply of VC in Germany, whether these regional gaps do geographically correspond to the most deprived areas in Germany and which kind of VC companies are currently in place in order to close potential regional gaps. We find that the primary potential target area for CDVC activities in the country is the state of Brandenburg. Our assessment of the German VC market reveals that real CDVC engagement in the country is yet to come.

Networking as a Barrier to Entry and the Competitive Supply of Venture Capital

We examine whether strong networks among incumbent venture capital firms help restrict entry into local VC markets in the U.S., thus improving VCs' bargaining power over entrepreneurs. We show that VC markets with more extensive networking among the incumbent players experience less entry. The effect is sizeable economically and appears robust to plausible endogeneity concerns. Entry is accommodated if the entrant has established relationships with a target-market incumbent in its own home market. In turn, incumbents react strategically to an increased threat of entry, in the sense that they freeze out any incumbent that builds a relationship with a potential entrant. Finally, companies seeking venture capital raise money on worse terms in more densely networked markets while increased entry is associated with higher valuations.

Venture Capital, Entrepreneurship, and Regional Economic Growth

Using a panel of U.S. metropolitan areas from 1993 to 2002, we find that an increase in the local supply of venture capital (VC) positively affects (i) the number of firm starts, (ii) employment, and (iii) aggregate income. Our results remain robust to a wide variety of specifications, including ones that address potential endogeneity in the supply of venture capital. The magnitudes of the effects, moreover, imply that venture capital stimulates the creation of more firms than it directly funds. That result appears consistent with either of two mechanisms: One, would-be entrepreneurs that anticipate a future need for financing more likely start firms when the supply of capital expands. Two, companies funded by venture capital may transfer tacit knowledge to their employees thereby enabling spinoffs, and may encourage both their own employees and others to become entrepreneurs through demonstration effects.

Community Development Venture Capital: Concept and Status Quo in Germany

As most other countries, Germany also faces dramatic regional differences in terms of socioeconomic development. One important driver of such development is the existence of a healthy entrepreneurial activity and the creation of new companies. We argue that venture capital (VC) and especially community development venture capital (CDVC) can be a powerful instrument to stimulate entrepreneurship and to support the growth of ambitious companies. Hence, the present paper deals with the general questions, whether there are regional gaps in the supply of VC in Germany? Whether these regional gaps do geographically correspond to the most deprived areas in Germany, and which kind of VC companies are currently in place in order to close potential regional gaps? Geographically, we find that the north-eastern part of Germany is far more deprived than the rest of the country, but is relatively well supplied with VC. Nevertheless, the primary potential target area for CDVC activities in the country is the federal state of Brandenburg in this area. Our assessment of German players in the VC market reveals that some public VC companies do investments similar to CDVC. However, these companies do not offer real hands-on support for entrepreneurs, and real CDVC engagement in the country is yet to come.

High‐tech Start‐up Access to Public Funds and Venture Capital: Evidence from Italy

Several studies have highlighted that new technology‐based firms (NTBFs) are often financially constrained, with these constraints hindering firms’ growth and even threatening their survival. Even though the provision of venture capital (VC) may allow firms to overcome these constraints, VC supply may be fairly limited, especially in bank‐based countries such as Italy and the cost of accessing VC funds may be too high for most young high‐tech firms. Policy makers may try to relax the financial constraints suffered by NTBFs through the provision of direct subsidies to firms. Technology policy may also aim at signalling the high quality of subsidized firms to external investors, reducing information asymmetries. However, policy makers may not be able to identify those firms that most need public aid. In this paper we investigate the determinants of NTBF access to public funds and venture capital. This analysis enables us to draw some considerations both on the investment selection criteria adopted by venture capitalists and on the existing Italian technology policy’s capacity to address NTBFs’ financial constraints. In order to do so, we consider a sample composed of 550 Italian NTBFs that operate in both manufacturing and services and resort to the estimation of a dynamic bivariate survival model so as to highlight simultaneously the determinants of firms’ access to both these modes of financing. The results of our estimates only partially confirm the relevance of founders’ competencies as important drivers of VC investment decisions, pointing to the multifaceted nature of human capital, and suggest the presence of inefficiencies in venture capital markets that are not alleviated by the existing Italian technology policy measures towards high‐tech start‐ups.

Networking as Entry Deterrence and the Competitive Supply of Venture Capital

Many financial markets are characterized by strong relationships and networks, rather than arm's-length, spot-market transactions. We examine the entry-deterring effects of this organizational choice in the context of relationships established when VCs syndicate portfolio company investments using U.S. data for the period 1980 to 2003. Our results show that networking does present an effective barrier to entry: VC markets with more extensive networking among the incumbent players experience less entry, and the economic effect is sizeable. However, potential entrants can use their prior relationships with the incumbents as well as previous investment experience in the industry or state to overcome this barrier to entry. We also document that companies seeking venture capital are valued less highly in better protected markets, and that increased entry into a market is associated with companies receiving increased valuations.

V2C activity on a local level: qualitative cases – Tampere and Silicon Valley

The increased capital intensity of venture capital supply and the increased knowledge intensity of new venture supply have created a knowledge gap and recreated a capital gap between new venture activity and venture capital industry. This development has given rise to an all‐new breed of players. In this descriptive, qualitative study, V2C activity is explored in a local context through comparison of cases Tampere (Finland) and Silicon Valley (USA). In Silicon Valley, the dominant group of V2C players is business angels, whereas in Tampere, publicly funded incubators play the most visible role in new venture development. Nevertheless, in both areas, five different categories of V2C players are represented, and, in both, bridge the gaps to a significant extent.