CHAPTER TWO

LITERATURE REVIEW 2.1 AN OVERVIEW

Technology-based firms are important contributors to the world economy. For the last two decades, technology firms have been a major source of innovation, business development and growth, and new jobs. Securing funding for new technology-based firms is particularly problematic, however. Many such firms are built upon intellectual capital rather than on physical assets, so it is difficult to determine the value and prospects of the firm. The problem of asymmetric or incomplete information is especially acute (Brierley, 2001), often resulting in a shortage of capital or capital that can only be obtained under unfavorable terms and conditions.

Prior research suggests that the owners of new technology-based firms use a combination of personal equity and debt that is often secured by the personal assets of the entrepreneur. In this sense, new technology-based firms are not that different from new firms in general. As technology-based firms grow, however, it becomes increasingly important for them to attract external sources of capital. External debt in the name of the business is often a problem, since many of these firms have few tangible assets that can be used as collateral (Colombo & Grilli, 2007). There is also a higher risk of failure for firms based on new technologies, which serves as an added deterrent to bank lending (Guidici & Paleari, 2000). Some technology-based firms may be able to attract external equity the form of angel investors and venture capital (Audretsch & Lehmann, 2004). This can also be a challenge as well, however, since it is difficult for investors to evaluate the demand for new technologies and products.

To date, there have been few research studies specifically targeting the financing strategies of new technology firms. A review of literature done by Brierley in 2001 (Brierley, 2001) cited a small number of studies conducted prior to that time. Those studies that had been done, however, suggested that new technology-based firms face particular difficulties. These difficulties are associated with a lack of tangible assets that can be used as collateral, products that have little or

no track record, and entry into untested markets. Brierley (2001) noted that angel investors and venture capitalists who might serve as funding sources to this sector have a difficult time identifying and evaluating the potential of high tech companies. He observed, however, that firms that were capable of securing SBIR (Small Business Innovation Research) awards or other external sources of funding were more likely to survive. Brierleys findings were supported by an earlier study of firms that had received SBIR funding conducted by Lerner (1999). Lerner made use of a data set of firms that received SBIR funding between 1983 and 1997 compiled by the U.S. General Accounting Office. He found that SBIR awardees enjoyed substantially greater employment and sales growth than firms that did not receive awards. He also observed that SBIR awardees were more likely to receive venture capital funding. Lerner concluded that receipt of an SBIR award may convey information to potential investors thereby at least partially reducing the informational asymmetries associated with new technology-based firms. Audretsch (2002) also addressed the importance of SBIR funding, noting that a significant number of new technology-based firms would not have been started without its support. Our objective in this research is to explore the financing strategies of technology-based enterprises.

2.2 DEFINITION OF TBF In the Bank of England report (1996) on The Financing of Technology-Based Small Firms, we find James Allens definition of what makes a technology-based firm instructive to our analysis. He defines a technology-based firm as a business whose products or services depend to a significant extent on the application of scientific or technological skills or knowledge (whether it be novel application of advanced technology to provide a totally new product or service, or an application of existing technology in an innovative manner). Often the technology component in the product or service provides a competitive edge above the incumbent. Arthur D. Little Group definition of Technology Based Firm (NTBF) as an independently owned business established for not more than 25 years and based on the exploitation of an invention or technological innovation which implies substantial technological risks, makes the

Oil and Gas, Financial Services, Health, Education and every other area of business and society that employs Information Communication Technology (ICT) worth consideration and attention. With the benefit of hindsight, industries and companies established within 25 years that use technological innovation or exploitation of an invention qualify as a New Technology-Based Firm. According to Martin Luggen (2004), the term TBF refers to an organization with focus on creation, development and exploitation of technological innovation. Technological innovations comprise new products and processes and significant changes of products and processes. An innovation has been implemented if it has been introduced to the market (product innovation) or used within a production process (process innovation). Innovations therefore involve a series of scientific, technological, organizational, financial and commercial activities (OECD 1992a, p. 28). All industries generate or exploit new technology and knowledge to some extent, but some are more technology or knowledge intensive than others (OECD STI Scoreboard, 2001).

2.3 TBFs AND THE BUSINESS ENVIRONMENT New firms require finance to start up, to do research, to produce new products and to bring the new products to market. While there are banks that support established firms, there is a need for venture capital firms that understand the market and the risk of bringing a new product to the market (Gault, 2010). The presence of institution such as Venture capital (VC) serves as a strong mechanism for innovation, by providing early stage equity and strategic support in form of vested interest in the success of the technology-based firm (Oyelaran-Oyeyinka, Sampath, 2007; Ariyo, 2000).The development of high growth technology-based firms (TBFs) in Silicon Valley, Israel, Bangalore and UK is attributed to Venture Capital. They helped create new industry and sectors, which in turn provides job creating opportunities for these nations. Research works in universities have been commercialized through the backing of Venture Capital fund. Novel ideas (like Facebook) from people with little or no business pedigree have known commercial success all with the support enjoyed from VCs.

ICT is known as a major contributor to social-economic, industrial development and economic competitiveness (Aderemi, 2008). Also, it is a major offshoot of TBFs, Aderemi (2008) referred Information Communication Technology (ICT) to include all electronic technologies and equipment used in facilitating information processing and communication. The ICT industry spans broadcast, electronics and print media, computers, telecommunications and e-commerce activities.

2.4 ACCESS TO FUNDING BY TBFs

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