stages of the escalator often improves later-stagefinancing. This holds when the quality of the early-stage funding selection provides ‘certification’,reducing the typical asymmetric informationproblems that plague the financing of innovationprojects. For instance, selection in highlycompetitive public grant schemes may make iteasier to access further venture capital funding.Firms that have been backed by famous businessangels may find it easier to access venture capital.And firms that have been backed by qualityventure capital may find it easier to find financingpartners at later stages.Nevertheless, the escalator seldom runssmoothly, with entrepreneurs incurringsuccessive costs to find and negotiate with newand multiple parties, imperfect transformation of information between parties, existing financiersexpressing concerns about dilution and otherconflicting interests between old and newfinancing partners.
2.2The supply of venture capital to aspiringyollies
When innovative projects from young companiesenter the commercialisation and growth phases,venture capital becomes a critical financingsource (eg Lerner, 2009). At this stage, financingrequirements quickly become too large to besupplied by friends or business angels. The highrisk profile of young highly innovative growthcompanies is often a barrier to bank financing atthis stage. A deficient VC market may thus hamperthe development of young highly innovativecompanies into world-leading yollies.Venture capital is guided by the VC cycle (Gompersand Lerner, 2004)
. After the fundraising,screening and negotiating, the investmentprocess starts. At this stage, non-capital value isadded to the firms in VC portfolios through themonitoring, advice and guidance of the fundmanagers. The entire length of the investmentprocess for early-stage ventures is estimated to
2. Venture capital is definedas dedicated pools of capital provided by thirdparty investors that focuson equity, or equity-linkedinvestments in privatelyheld, high-growthcompanies (Lerner, 2009).The limited liabilitypartnership arrangement,LLP, is the dominant fundmodel in the venture-capitalindustry. The fund is ownedby third-party investors,known as the limitedpartners, and managed bythe venture capital fundmanagers.
‘When innovative projects from young companies enter the commercialisation and growth phases, venture capital becomes a critical financing source. A deficient VC market may thushamper the development of young highly innovative companies into world-leaders. ’
be on average about 6-7 years. Exit is the finalstage of the VC cycle. This occurs through an initialpublic offering (IPO), trade sale, secondary sale toanother financial institution or fund, buy back bythe entrepreneur or write off. The first of these, theIPO, is perhaps the most celebrated and prominentin the literature, yet the second method, the tradesale is the most common successful exit methodfor VC funds (Soderblom, 2006).Venture capital financing has some distinctivefeatures. Because venture capital funding isequity funding, it transfers part of the ownershiprisk from the entrepreneur to the investor. Unlikedebt funding, it encourages venture capitalists toprovide managerial support to entrepreneurs. Asfund managers are typically rewarded with apercentage of returns above a certain threshold,fund managers are incentivised to focus on the‘big wins’ from a portfolio of investments. Inaddition, because VC is a very costly and riskytype of financing, high financial returns arerequired from their successful investments inorder to be economically viable. The returns toinvestment are highly skewed. Where attractivenet returns are made by the fund, it is likely toresult from the realisation of a small minority of exceptional investments within the portfolio. Aconsequence of this is that venture as an assetclass shows extremely large variation in returns,and only a small number of exceptional start-upsare likely to attract VC attention.In summary, for venture capital to be a viablebusiness model, it needs to be ‘smart’, ie able toselect potential ‘hits’ and carry them through tothe exit stage by providing both financial and non-financial support.
2.3The demand from aspiring yollies for venturecapital
The number of companies requiring equity financeis a relatively small percentage of the totalcompany population. For example, Shane (2008)notes that since 1970, VC firms have funded
MIND EUROPE’S EARLY-STAGE EQUITY GAP