Profile of firms 354. Venture capitalists bridge the financing gap caused by information asymmetry for new and innovative firms. Financing ...
Profile of firms 354. Venture capitalists bridge the financing gap caused by information asymmetry for new and innovative firms. Financing constraints tend to be more acute for young firms to the extent that they have limited internal funds and a track record to signal their ability to investors. The problem may be exacerbated by the lack of collateral for start-ups and the extremely risky nature of new innovative ventures. Indeed, the problem of insufficient collateral, which affects a large proportion of SMEs across all sectors, is exacerbated for companies whose business model is largely based on intangibles, as it is the case for sectors driven by knowledge-based capital investments, such as R&D and design (OECD, 2013e). 355. Venture capital targets a small pool of high-growth-potential companies with the capacity for high returns in a relatively short time frame. In fact, the venture capital industry is extremely selective and concentrated in sectors with high growth potential from scaling up innovative or disruptive business plans.
Only a few firms have the potential to attract interest of venture capitalists, and only a minority is able to secure funding. According to the US National Venture Capital Association (NVCA, 2014), for every 100 business plans that are submitted to a venture capital firm for funding, about 10 are closely examined, and only one ends up being funded. 356. Typically, firms financed by venture capital feature a high commitment by the entrepreneur to invest his/her own money alongside the external financier, a solid market potential and prospects for high growth and high returns within a relatively short timeframe (35-40% IRR), high R&D spending, a strong and experienced management team, and the willingness of the entrepreneur to give up a significant share of ownership (Industry Canada, 2004). 357. These criteria account for the concentration of VC investments in a few industries, such as the digital economy (i.e. ICT, internet, electronics) and healthcare sectors (i.e. life science, biotech and 80 medical device technology). In 2012, these industries raised, respectively, USD 8.8 billion and USD 3.2 billion venture capital fund worldwide (Idinvest, 2014). In 2013, ICT companies received the greatest share of VC investments in some of the key global markets, such as the US, Canada and Israel, both in terms of number of deals and value share. In these three markets, the subsectors which attracted most investments were software and consumer information services.
In particular, software accounted for 70% of all VC funding to ICT. The preference of venture capitalists for consumer services and ICT can be partly explained by the direct and immediate connection with consumers, which allows for rapid feedback on whether the investment is likely to pay off, as well as for a fast route to value creation. On the other hand, healthcare sectors are particularly popular in mature markets, such as the US and Europe, where an ageing and wealthy population represents a source of value (Ernst&Young, 2014). Enabling factors 358. An enabling environment for innovative entrepreneurship is key for the development of the venture capital industry, which itself can positively affect the entrepreneurial environment (Dossani and Kenney, 2002). In many countries, a major impediment to the development of venture capital is the lack of “investor ready” companies appropriate for VC. A culture of risk-taking and self-confidence, social recognition for an entrepreneurial career, and regulations that ease market entry and exit are among the enabling factors for a critical mass of entrepreneurs to emerge. However, access to knowledge and skills is critical for innovative entrepreneurs, which especially benefit from knowledge networks and linkages, at the local and the global level. More broadly, innovative entrepreneurs require – and are pillars of – an open and dynamic innovation system, in which a diverse network of knowledge producers, users and institutions exchange knowledge and cooperate (OECD, 2010c; OECD 2010d). 359. Highly innovative enterprises are often spin-offs from research institutions and are closely linked to academia, allowing for the commercialisation of innovative outputs. High growth potential may also be identified in spin-offs from established companies, which harness both technological and market knowledge accrued in the parent company to launch the business. 360. The technological and sectoral dimension of the innovative opportunities also matters for the venture capital development. In fact, venture capital can flourish when there is a constant flow of opportunities that have great upside potential. Historically, ICT has been the business field that has offered the longest series of opportunities, which explains the high concentration of VC investments in this area (Dossani and Kenney, 2002). 361. The existence of exit options is another critical factor for venture capitalists. The portfolio companies of a VC fund are typically cash-constrained growth ventures that do not pay dividends in the investment period. Rather, returns are gathered as capital gains when divesting the venture. In this regard, illiquid capital markets, in which venture capitalists find it difficult to sell their shares or engineer an M&A, represent an impediment to VC expansion (Landström and Mason, 2012).
It also follows that taxation of capital gains is especially relevant for venture capitalists, as well as start-up entrepreneurs who may expect a return in terms of share participation, although the empirical literature on the effects of taxation on VC investments is not conclusive42. 362. There may exist regulatory barriers to investment in seed and early stage ventures. These include regulation that makes it difficult for venture capitalists to operate as limited liability entities, and regulation that limits the investment in these stages of certain types of institutions, such as banks, pension funds and insurance companies (OECD, 2013e). 42 See Poterba (1989), Gompers and Lerner (2001), Da Rin et al. (2005), Achleitner et al. (2011), among others. 81 Trends 363. Across OECD and non-OECD countries, venture capital represents a small fraction of GDP, most often less than 0.05%. The countries in which the industry is relatively more developed are Israel (0.31%), the US (0.17%) and Canada (0.08%)43
364. The US VC market is the largest worldwide, accounting for 68% of global VC activity in 2013 (Figure 15). Between 1995 and 2010, venture capital investments in the US were on average three times the size of investments in Europe. However, the number of venture capital deals in Europe is higher than in the US; in other words, European venture capitalists disperse funds more broadly through smaller deals (OECD, 2013e)
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