Government as a Venture Capitalist

DRAFT SUBMISSION TO INDUSTRY STUDIES ASSOCIATION ANNUAL CONFERENCE MAY 28-31, 2013.

Government as a Venture Capitalist: Evidence from Estonia Meelis Kitsing [email protected]

May 17, 2013

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Abstract12 This research explores the effectiveness and performance of government venture capital on the basis of Estonian Development Fund (EDF) and its 16 portfolio companies. By using data from the Estonian Business Registry and semi-structured interviews with five EDF portfolio companies, the analysis shows that two investments have been clear failures while one investment have been relatively successful. However, 13 investments belong to grey area where it is impossible to assess the value of government investments as the potential exit remains uncertain. Overall, the EDF portfolio companies are insignificant players in the Estonian economy as they have not created considerable revenues and employment. 14 of these companies are unprofitable. These findings are complemented by network analysis, which show that the EDF plays a central role in the online network of its portfolio companies as well as in the digital venture capital ecosystem of Estonia. Keywords: venture capital, start-up companies, early stage financing, government venture capital, venture capital ecosystem, public policy, Central and Eastern Europe, Estonia.

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Author’s address: Meelis Kitsing, Director, Economic Analysis Division, Ministry of Economic Affairs and Communications, Harju 11, Tallinn 15072, Estonia, Phone +372 625 6455, email [email protected]. 2

Acknowledgment: Laura Visnapuu provided research assistance for this paper by gathering data on portfolio companies and tracking down the literature on the Estonian venture capital.

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1. Introduction Increasingly governments around the world have got engaged in venture capital by either directly investing or through funds of funds in start-up companies. On the one hand scholars have pointed out necessity and benefits of government involvement in such risky asset class. Private investors often do not have invectives to invest sufficient capital in early stage innovative companies as they are not able to capture the positive externalities of innovation. Thus, government financing may serve as a springboard for the emergence of new high growth companies as well as encourage a broader development of innovation economy. However, government involvement in venture capital carries also high risks. Government officials may lack proper incentives, knowledge and experience in making investment decisions directly in start-up companies and funds investing in start-up companies. The probability of failure of government venture capital schemes may be increased by rentseeking. Government officials may think that they are picking winners but losers have greater incentives to pick governments as investors. This study explores the effectiveness of government venture capital on the basis of Estonian Development Fund (EDF) and analyzes the performance of its portfolio companies. The purpose of the study is to assess the impact of EDF on its portfolio companies as well as the role the broader venture capital ecosystem in Estonia. The research aims to find out whether the EDF provides funding to companies which do not have alternative sources of funds available and whether these investments carry potential positive externalities. Both microlevel financial data of the EDF portfolio companies as well as broader impact of this government venture capital scheme is tackled in this research. The EDF was founded by the Estonian Parliament in 2006 with the purpose investing public funds in and offering management support for early stage research and development intensive

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companies. Differently from other government agencies, the EDF does not operate under the executive branch, i.e. it is not an agency under some ministry, but reports directly to the legislative branch – the Riigikogu. Nevertheless, in its ever day business the Ministry of Economic Affairs and Communications has some supervisory duties concerning the EDF. Both Ministers of Finance and Economic Affairs and Communications are members of the Supervisory Board of the fund. Other members include parliamentarians and independent experts. This study focuses solely on venture capital investments of the fund, not on its foresight activities, which at least until 2013 was another major undertaking in the EDF’s agenda. The EDF mandate is to take minority stakes ranging between 10-49 per cent in companies on the equal terms with its private sector co-investors. The time horizon for investments is 3-5 years. Since 2008 the EDF has directly co-invested with private investors in 19 start-ups either directly as the EDF or more recently through its Smartcap fund. This analysis focuses on 16 of these investments as three investments have been made in the end of 2012 or in the beginning of 2013.

Two thirds of these 16 companies are technology start-ups. These

investments include companies such as web-based mechanical engineering community GrabCad operating in Boston, MA and Tallinn, Estonia, and web-based facial recognition software developer RealEyes operating in Boston, London, Budapest and Minsk as well as other new innovative companies. The research is based on the descriptive statistics found in the Estonian Business Registry about the performance of portfolio companies of the Estonian Development Fund. However, the quality and availability of financial data is limited. Hence, semi-structured interviews with portfolio companies were carried out as well as network analysis to gain a deeper understanding of the EDF’s role among its portfolio companies as well as in the broader venture capital ecosystem. 3

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The research starts by sketching out some key themes in the literature concerning government venture capital. This is followed by the discussion of research methods. Then descriptive statistics to characterize the EDF portfolio is summarized. After that the EDF’s role is scrutinized by mapping out its online networks among portfolio companies as well as private venture capital funds. The last part gives a brief overview of five portfolio companies by using the Estonian Business Registry data, secondary sources and semi-structured interviews with managers of the EDF portfolio companies.

2. A Brief Literature Review Obviously, it is impossible to do justice to a vast body of literature on venture capital and government engagement in venture capital industry in this short paper. Hence, only sketch of key findings is offered about government venture capital schemes in the first part of this literature review. The second part discusses briefly previous studies on the Estonian Development Fund. 2.1 Market failures The literature on venture capital has emphasized the importance of relevant information possessed by venture capitalists and how experts with specialized know-how can add value to the specific companies (Fulghieri and Sevilir 2008; Chemmanur et al 2008; Brander et al 2010a). Nevertheless, some scholars have pointed out that private sector may undersupply venture capital because of asymmetric information. Hence, it is possible to speak of market failure resulting from the information asymmetry where government funding could potentially reduce the negative impact (Brander et al 2010a). Conceptually, it is difficult to see how more centralized approach – which is usually the path government’s take - can significantly reduce problems associated with information asymmetry. This relates back to fundamental debates on information and knowledge and whether governments can centrally collect and effectively 4

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exploit decentralized and tacit knowledge, which makes the market system work (see Hayek, 1945, for instance). Other scholars have emphasized market failure stemming from insufficient incentives of private investor to supply funds to innovation and research and development-intensive companies. This is caused by the inability of these companies to capture positive externalities of their investment. If there is a reason to believe that innovation is underprovided, then government intervention can reduce negative effects of this market failure. Several scholars have tried to estimate the extent of these externalities (Kortum and Lerner, 2000; Hsu, 2006). Conceptually, this approach offers a stronger justification for government intervention. However, it would justify government venture capital investment in innovation-driven early stage firms, which do not attract sufficient capital from private sector. Nevertheless, it requires a considerable expertise from government officials to define the target companies and follow these rules in practice without engaging in the conceptual stretching of innovation and positive externalities. 2.2 Performance of government venture capital schemes On the effects of government intervention in venture capital the jury is still out. For instance, Cumming and MacIntosh (2006) have shown that government venture capital tends to “crowd out” private investments. This fits well with the reasoning offered by Wallsten (2000) that government officials may not tackle market failures but select companies, which are likely to be successful rather than businesses that actually cannot raise private sector funds and need government support. Lerner (2002) has found some evidence of success in the United States but also offered critique of government venture capital schemes (2009). Brander et al (2010a) found in their econometric study of companies in the world receiving venture capital financing in 2000-2008 that the modest support of government finance tends to improve the

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performance of companies, while large government support leads to a weaker performance. Brander et al (2010b) found on the basis of Canadian venture capital firms that portfolio companies of private venture capital firms generate more successful exits and better valuations than government backed companies. The fund performance may depend also role of government venture capital plays in the network of local venture capital firms as well as whether government venture co-invests with private VC-s or invests alone. The former implies that the government’s stake would be smaller which may benefit performance of portfolio companies if the findings of Brander et al are taken as given (2010a). If government participates in syndicated investments with private investors, then its ties to private venture capital firms tend to be stronger. Hochberg et al (2007) demonstrate that venture capitalists with strong network ties achieve a better investment performance than venture capitalists with weaker networks. Often, the venture capitalists opt for syndication for investing together with other venture capitalists in the same companies rather than investing alone. These findings are highly relevant for government venture capital funds that directly invest with private sector co-investors such as the Estonian Development Fund. 2.3 Political economy of government venture capital Certainly, the argument for or against government venture capital is not only about performance of its portfolio companies but concerns a broader set of implications. A classic argument against government venture capital stems from rent-seeking behavior, where interest groups, politicians and government officials take advantage of government programs (Buchanan and Tollison, 1984). The political economy of government venture capital may mean that governments may want to pick winners but losers pick governments, highly paid quasi-public jobs are created with minimal accountability and transparency, investment

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decisions are driven by political favoritism, wealthy fund managers minimize risks and allocate more wealth, for instance. Hence, unintended consequences of government venture capital schemes may impose higher costs than actual or perceived benefits. One the basis of Canadian experience, Brander et al (2010b) found their econometric study that private venture capital portfolio companies tend to be more competitive, operate more often in high-tech industries and are more likely to innovative than companies financed by government venture capital. Hochberg et al (2010) found that strong networks among incumbent venture capital firms tend to create a barrier of entry for outside venture capitalists. Even if they do not discuss specifically government venture capital, then encouragement of local venture capital through government measures and building strong networks may lead to “venture capital nationalism,” which may make it more difficult for outsiders to enter this market. To conclude, the literature leads to a number of hypothesis and generates findings which do not provide unified case either for or against the government venture capital. Even if the market failures are taken as given, then the design and implementation of government schemes are crucial for having any impact. In other words, government programs with best intentions may fail if they are not well-designed and implemented. 2.4 Studies on the Estonian Development Fund This section gives a brief overview of studies on the Estonian Development Fund (EDF). Zernike Group, a market research firm, carried out a qualitative study on the Estonian venture capital market in 2004, which was sponsored by the Estonian Ministry of Economic Affairs and Communications. They found that start-ups had difficulties in creating feasible business plans and were ill-informed of alternative financing methods. In addition, there was insufficient supply of venture capital in the market (Zernike Group, 2004). The study offered different ways for government to engage in the supply of venture capital. Thus it can be seen

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as an inspirational research for the creation of the EDF in 2006. In a qualitative study based on secondary sources and semi-structured interviews Pindmaa (2006)3 analyzed economic, financial, political and social costs and benefits of EDF creation and concluded that costs exceed the potential benefits. In 2009, the EDF commissioned the first official review of its activities where authors argue that the fund has been successful in facilitating the creation of sustainable venture capital market (Nightingale and Reid, 2010). The authors argue that there is a lack of a unified Baltic venture capital market, a funding gap for small-scale seed investment (€10,000 to €100,000) and a lack of management expertise that would allow overcoming barriers in the Estonian venture capital market. Nightingale and Reid (2010) suggest the policymakers to allocate more resources to the EDF for providing small scale seed capital, for investing internationally and also attract international co-investors to increase the deal flow as well as develop a fundof-funds approach in the long run. More recently, Jostov and Sonts (2012)4 carried out 10 semi-structured interviews with the EDF, its portfolio companies, co-investors, independent investors and experts.

They

employed the frameworks of Meyer (2007) and Lerner (2009) to determine the changes that have taken place in the Estonian venture capital market after the launch of EDF. The results indicate that the impact of the EDF in kick-starting the market has been limited. They argue that design and implementation issues of the current initiative could be alleviated by turning to a fund-of-funds approach (Jostov and Sonts, 2012). In sum, all of these studies on the EDF have been qualitative, relying on interviews and aggregated opinions of interested parties and experts. Quantitative studies have not been 3

The author was supervisor of Madli Pindmaa’s thesis at the Stockholm School of Economics in Riga in 2006. The author was supervisor of Karoline Jostov’s and Sten Sonts’s thesis at the Stockholm School of Economics in Riga in 2012. 4

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carried out as the fund has not been around for a long enough to create sufficiently quantifiable data. One study has been critical of the government approach in general, while two studies suggest fund-of-fund approach instead of the current model where government agency invests directly with private sector co-investors. 3. Research methods The purpose of this research is to assess the performance of EDF portfolio, whether portfolio companies had alternative sources of financing, the impact of EDF on portfolio companies as well as the role of the EDF on the Estonian venture capital ecosystem. This implies that the research has to rely on multi-method approach by combining descriptive statistics, network analysis and semi-structured interviews. Although the author had access to confidential information on the portfolio companies of EDF, the research is based only on data available in the public domain. Otherwise, the results could not be made publicly available. Since the population size is small, the data cannot be aggregated to the extent where individual companies would not be identifiable. These constraints certainly impose limitations to the research project and introduce several biases. Nevertheless, background knowledge of privileged information is also helpful in interpretation and use of publicly available data and gives a more concrete direction. 3.1 Descriptive statistics The first step was to gather data about 16 EDF portfolio companies from the Estonian Business Registry. The indicators are sales revenue, annual profit, export revenue, number of employees and labor costs. The indicators are relevant from both financial and public policy perspective. Public policy makers may be satisfied with low profits or losses if the portfolio company have generated employment and jobs with higher value-added, which is reflected in the level of salaries. Export revenue matters because Estonia is a small and open economy 9

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with population 1.3 million people and Gross Domestic Product of 17 billion euros. The domestic market is too small for many companies, especially if they operate in a specific market niche. The export revenue demonstrates the ability to enter international markets and gives a signal about the competiveness of the firm. In order to provide some dynamics four years from 2008 until 2011 were taken into account. Certainly, it must be kept in mind that many investments had not been made by 2008 and six companies of 16 were created later than 2008 and hence, the dynamic comparison of results provides only partial picture. The data for 2012 is not available for all portfolio companies as companies have to submit their annual reports to the business registry for 2012 by end of June 2013. It should be kept also in mind that the Estonian Business Registry data does not always give an accurate overview of actual performance of the portfolio companies. Some EDF portfolio companies have not consolidated their business activities into an Estonia-based corporation, while their primary operations take place outside of Estonia. For these purposes they use companies registered in different countries and financial data in the Estonian business registry does not reflect these activities outside of Estonia. This issue is explored in a greater detail in specific case studies about portfolio companies such as RealEyes and Massi Miliano, where semi-structured interviews were used to assess the accuracy of business registry data and actual performance of companies. Nevertheless, the data available from the business registry was aggregated in order to provide an overview of the whole portfolio. Even though, this method does not allow conducting any causal analysis about the role of Estonian Development Fund and its impact on these companies, it does give an understanding of the nature of their investment portfolio.

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In addition to five indicators available in the business registry data, publicly available secondary sources are used to indicate whether the EDF has managed to exit from portfolio companies and whether exit has happened with profit or loss. There is no credible public source on the valuation of the portfolio companies. Even if the confidential sources would be used, the value of the data is highly questionable. The portfolio companies are start-ups where traditional methods of valuation are not useful. These companies do not face just risks, which can be quantified and measured. Their future will be shaped by uncertainty, which is not measurable and quantifiable. Investment decisions are based on belief in the management team and in the business model – both of which can radically change in short time periods. The actual value of the investment is revealed when the EDF exits from the portfolio companies. 3.2 Network analysis Following the insights from the literature review concerning the importance of networks in venture capital, the second step was to carry out network analysis by using issuecrawler.net. The strength of network ties may be crucial determinant of the potential success of investment in the case of syndicated capital allocation decisions (see pages 5-6 above). In addition, the role of venture capital is not just to provide financing but assist businesses in every step in becoming high-growth and mature companies. Venture capitalist may provide important network, which young entrepreneurs could not otherwise access. Even though, offline networks may be more crucial for venture capital activity than online networks, the analysis of the role of EDF website in online networks can offer important insights. By inserting the websites of EDF and its portfolio companies, issuecrawler.net produced an illustrative map of digital relations, which allows accessing the importance of EDF to this network. In addition, network of EDF and all other venture capital firms in Estonia was created, which allows assessing the importance of EDF in the Estonian venture capital scene. 11

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3.3 Semi-structured interviews The third step was to carry out semi-structured interviews with the owners and managers of EDF portfolio companies. All portfolio companies were sent emails in August 2012 with the request for interviews. Five companies responded and 5 interviews were carried out with United Cats and Dogs (UCD), RealEyes, Sportlyzer, Now!Innovations and Massi Miliano (fits.me). In all cases CEOs of the companies were interviewed. Usually they are also founders and owners of the companies. Only exception was UCD were former CEO and founder was interviewed. In addition, one interview was carried out with current owner and former co-investor of the EDF in the UCD. This was especially important because UCD investment is a controversial issue, where the EDF and co-investors lost all of their initial investment. The full list of interviews is available in the appendix 6. The sample was relatively diverse as it consisted the largest investment of 960 000 euros made by the EDF in the Massi Miliano (fits.me) and third largest investment of 750 000 euros in the NOW! Innovations. One of the smallest investment of 95 800 euros made in the Sportlyzer. Two investments were made in 2009, two in 2011 and one investment in 2010. Three investments are made in technology companies and two in social network companies. The main purpose of the semi-structured interviews was to gain a better understanding of company’s performance, discuss whether substitutes for the EDF investment were available, to assess the importance of the EDF investment and broader support for company as well as general cooperation with the EDF. General questions were prepared for interviews (appendix 7), but actual questions varied depending on the nature of company. 5 interviews were made in person. Interview with Massi Miliano was made over the phone as CEO did not find time for a meeting in person. All interviews were recorded and all interviewees agreed to talk on the record. Interviews were not coded because small sample size makes it irrelevant as the

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coding does not provide anonymity. This may result in significant biases as managers may give more constrained responses because they do not want to jeopardize ongoing business relationship. The interview results are presented in the form short case-studies, which give overview of main findings on the basis of each company.

4. The Characteristics of EDF Portfolio The Estonian venture capital ecosystem is characterized by few, small but proud funds. In addition, to state-backed Estonian Development Fund (EDF) only one or two well-structured private venture capital funds exist. The following figure gives an overview of venture capital and private equity market by highlighting the distribution of investments on the basis of geography and investment phase of 18 investors and their 120 portfolio companies. Figure 1. The characteristics of the Estonian private equity and venture capital market.

Seed 11%

Buyout 18%

18 investors including 10 seed and start-up investors 5 private equity investors 2 mezzanine investors 1 institutional investor

120 Portfolio Companies Expansion 31% Early growth 9%

Start-up 31%

Portfolio companies 69 in Estonia 20 in other Baltic states 8 in the US 6 in Scandinavia 4 in Asia 4 in Poland 3 in the UK 6 in other

Source: Jostov and Sonts 2012 and EstVCA 2012.

One of the most active investor has been Ambient Sound Investment (ASI), which invests funds of Estonian co-founders of Skype and does not raise money from outside investors. The

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bottom-line is that existing funds and investors do a relatively small number of deals and are not well diversified and scalable (Jostov and Sonts, 2012). According to the EDF, they have reviewed over 280 different business projects and potential investments between September 2007 and August 2011 (Arengufond, 2012). By May 2012, EDF had made 16 investments in seed and start-up phase totaling 6 372 940 euros. Table 1. The EDF investment portfolio (as of May 2012) COMPANY

INVESTMENT SIZE (€)5

INVESTMENT YEAR

INVESTMENT PHASE

NOW! Innovations OÜ Modesat Communications OÜ Cellin Technologies OÜ BioTaP OÜ United Dogs and Cats OÜ Massi Miliano OÜ GOLIATH Wind OÜ Ilmarine Engineering OÜ Cleveron OÜ SelfDiagnostics OÜ Realeyes OÜ GrabCAD OÜ Inner Circle OÜ Sportlyzer OÜ My!WIND OÜ Wise Guys OÜ

750 0006 750 000

2011 2010

Start-up Start-up

351 500 837 200 239 700 960 0007 251 700 639 100 857 140 210 000 120 0008 127 800 88 000 95 800 17 000 78 000

2010 2009 2009 2009 2009 2008 2008 2011 2011 2010 2010 2010 2011 2012

Start-up Start-up Start-up Start-up Seed Start-up Start-up Seed Seed Seed Seed Seed Seed Seed

Source: Created by author with data from Arengufond (2012). The EDF defines “seed phase” where company already has a prototype for a service or a product but it needs further development. Start-up phase is primarily about product

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The investment size is based on publicly available data, which may not be up to date because there is a significant time lag between the investments and the time, when this information becomes publicly available. 6 Semi-structured interview with Üllar Jaakso, CEO of NOW! Innovation, shows that this amount has been increased to 950 000 euros by August 2012. 7 New equity injections were made by the EDF Smartcap fund in 2013. The amount has not been disclosed. Total amount invested by the EDF and private sector investors was about 6 million euros. 8 Semi-structured interview with Mihkel Jäätma, CEO of RealEyes shows that the amount has been increased to 320 000 euros by June 2012.

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development, expansion of the company and entering into the international markets. The following table provides overview of their investments. The size of investments indicates a total size that combines all the investments made in different times. The investment year is based on the time when the EDF signed agreement with company. Most of the investments have been made in technology sector (including ICT and biotechnology) totaling 4.9 million euros invested in 9 different companies. 639 100 euros has been invested in one engineering company, while three social network companies have attracted 423 500 and two energy companies 268 700 euros. The 78 000 euro investment in the Startup WiseGuys is untypical as the company serves as an accelerator offering mentoring and strategic advice for start-ups. The smallest investment has been 17 000 euros and the largest is 960 000 euros. The most active year was 2010 when 5 investments were made. In 2011, 4 investments were made. 2012 has been remarkably slow as only one investment was made (one additional investment was made in 2012 into cyber defense company Defendec but as it was made after gathering this data, then it is not included in the analysis). 4.1 Sales and export revenue Total sales revenue of all 16 portfolio companies aggregated for four years of 2008-2011 was 16 264 850 euros. Technology sector companies were 53% of that, while one engineering company in the field of metal and machinery was 46 % of total turnover as the graph 1 below demonstrates. Combined turnover of energy companies were less than 0.1% (1257 euros) and social network companies had a turnover of 0.9% (151 982 euros). The average sales revenue per year of the whole portfolio was 4 million euros.

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Graph 1. Total sales revenue of EDF portfolio companies in euros 2008-2011.

Mentoring and strategy

0

Energy

1 257

Social network

151 982

Engineering machinery

7 534 916

Technology

8 576 696

Source: data from the Estonian Business Registry, graph compiled by the author.

In the 2008-2011, total export revenue of all portfolio companies was 9,5 million euros. The social network companies had export revenue of 66% of their total sales.

Graph 2. Total export revenue of EDF portfolio companies in euros 2008-2011.

Mentoring and strategy

0

Energy

0

Social networks

102 174

Eksport (€)

Engineering machinery

4 629 327

Tehnology

4 998 315 0

2 000 000

4 000 000

6 000 000

Source: data from the Estonian Business Registry, graph compiled by the author.

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9 technology companies had export revenue of 58% of total revenue, while one engineering firm Ilmarine had export revenue of 55 % of its total revenue but almost the same amount in absolute terms as 9 technology companies. At the same time, energy companies and mentoring and strategy accelerator did not have any export revenue. 4.2 Exit, profit, labor Only companies that were profitable in 2011 were Cleveron and Cellin Technologies both belonging to the technology sector. The same companies were also profitable in 2010 while other companies did not earn any profits in 2010 and 2011. On the basis of annual reports, the EDF portfolio companies employed 122 people in 2011 (excluding Ilmarine Engineering, which did not provide data for 2011). In 2010 the portfolio companies employed 90 people (excluding Ilmarine, which employed 45 people in 2010). In 2010, labor costs totaled 1.7 million euros (excluding Ilmarine, which spent half million on labor costs). Labor costs totaled for all portfolio companies to 2.6 million euros in 2011 (excluding Ilmarine, which did not provide data). This would imply that average annual cost per employee in the EDF portfolio company is 21 312 euros in 2011. This means monthly cost of 1776 euros per employee, which would translate into average monthly salary of 1325 euros (1776 minus social and unemployment taxes but inclusive of personal income tax). The average salary in Estonia was 839 euros in 2011. Certainly, the business registry data is not revealing much about the true state of the portfolio. Especially, as it comes with many caps and several companies have not consolidated their business activities in Estonia. However, it can be concluded that the current role of the portfolio is relatively insignificant for the development of Estonian economy. None of the portfolio companies are significant employers, their revenues are small and most of them are unprofitable. Nevertheless, the key to the investor such as the EDF is their growth potential.

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This can be monetized only if others see the potential as well and EDF can exit from the companies with profit. The ability to raise funds from additional investors in the next financing rounds may signal the potential in the form of valuation as well. However, what truly matters is exit when valuation on the paper can monetized. So far the EDF has exited from the United Cats and Dogs and the Ilmarine Engineering with a loss of all initial investment (Tänavsuu 2010; Poom 2012). The total loss of 878 800 is about 14 % of their portfolio as of May 2012. The EDF has exited from the Modesat Communications in September 2012, which was acquired by NASDAQ listed Xilinx, (Anderson, 2012). In this company, the EDF investment totaled 750 000 euros as of May 2012. The terms of the deal have not been publicly disclosed. It should be mentioned that one of its portfolio companies Cleveron operated the SmartPost network, which was the first investment of the EDF in 2008. The SmartPost operation in Estonia was sold to Finnish state-owned postal company Itella for profit of 1.5 million euros in 2010 (Stadnik, 2012). Technically, the EDF exited from one business unit of Cleveron by selling SmartPost OÜ. However, it does not count as exit from the entire business as the Cleveron is a new name of SmartPost OÜ, which aims to enter to other markets with the same technology and the EDF is still a shareholder in Cleveron. Hence, it can be concluded that the exit from remaining 13 businesses remains uncertain According to semi-structured interview results optimistic projection would be that exit should take place in 4-5 years after initial investment and more realistic projection is 7 years. If this assumption is correct, then it is too early to expect exits by 2012 as the EDF started investing in 2008.

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5. The Network Analysis of Estonian Venture Capital Ecosystem and EDF Portfolio The purpose of network analysis was map the digital networks of the EDF, which offers one way to demonstrate its role among portfolio companies as well as in the broader venture capital landscape. The first attempt was done with portfolio companies, where investment was made by the EDF before 2012. It excluded Ilmarine Engineering , Biotap, Inner Circle and Modesat because they did not have active websites at this time. Modesat was taken over Xilinx in 2012. In the case of Cellin Technologies, their own website was not available but their page at Cell Therapy Cluster was used.9 The list of 12 urls entered into the issuecrawler.net harvester is given in appendix 1 and appendixes 3 and 4 demonstrate results. The network is relatively small and does not include most of the portfolio companies. Most importantly, the network is dominated by the United Cats and Dogs (UCD), while the EDF offers alternative, less dominant focal point. The outcome can be characterized as the middleway between centralized and de-centralized network with two core centers. The second attempt included all urls for older and current portfolio companies, inactive and active urls. The full list of 18 urls is available in the appendix 2. The following figure shows the digital network of EDF portfolio companies where the EDF (arengufond.ee) plays a central role among its portfolio companies. 14 portfolio companies link to the EDF directly but do not link to each other. Hence, it can be characterized as centralized network. United Cats and Dogs plays still important role in the network forming an alternative cluster, but it is not larger than the EDF cluster which happened in the first attempt.

Small cluster of

companies is formed around accelerator startupwiseguys.com, which provides a third focal

9

Available at http://www.celltherapycluster.eu/liikmed/43-cellin-technologies.html

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point in addition the EDF and UCD. Several non-EDF funded Estonian start-up companies such as Transferwise, Pipedrive, Zeroturnaround and Fortumo are linked directly to the WiseGuys - and not to the EDF. The centrality of the UCD is probably caused by the fact that it is a social network company providing a platform for cat and dog owners to connect with each other. Figure 2. The EDF portfolio network with inlinks and outlinks (May 7, 2013)

Source: data entered by the author, map produced by issuecrawler.net

The figure 2 shows a map a broader venture capital online ecosystem in Estonia through network analysis. 15 urls of full members of Estonian Venture Capital Association (EstVCA) were entered to the harvester of issuecrawler.net (Appendix 5 gives full list). 8 members of EstVCA are included in the output map below given in the figure 2. The EDF (arengufond.ee) 20

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is certainly in the central position of the network. However, EstVCA itself as well as private sector investors asi.ee and wnb.ee play focal role in the network as many nodes connect to them. As the network nodes are more evenly distributed (many firms connect to each other as well as to the EDF), then this network can be characterized as less centralized than the EDF portfolio network. The network includes also 14 portfolio companies of the EDF. It is surprising that it does not include 7 members of EstVCA. However, it does include most active co-investors of the EDF such as asi.ee and wnb.ee. Figure 3. The Estonian venture capital network with inlinks and outlinks (May 7, 2013).

Source: data entered by the author, map produced by issucrawler.net

In sum, the network analysis revealed that the EDF is an important focal point among its portfolio companies as well as in a broader venture capital ecosystem in Estonia. Among the 21

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portfolio companies it was surprising that the relative centrality of the EDF was not greater in the network as one of its defunct investments played a vital role in the network as well. The analysis of EstVCA members revealed that the EDF plays a central role in the broader venture capital networks. However, its centrality is not dominant as many companies in the network are linked directly to each other. Hence, this network is less centralized than portfolio network which signals maturity and tight contacts among the network members. Following Hochberg et al (2007) the strong network links of the EDF could suggest that the potential performance of EDF portfolio could be better than the performance of venture capital firm with weaker ties. At the same time, it should be kept in mind that most co-investors of the EDF are relatively inexperienced investors as is the EDF itself.

6. Short Case-Studies of the EDF Portfolio Companies This section discusses the results of semi-structured interviews with owner-managers of 5 EDF portfolio companies. The interviews are complemented by secondary data. The purpose is to assess the performance of these companies, gain an understanding of their growth potential as well as analyze the role of the EDF in the development of these companies. The overview will start with two social network companies United Cats and Dogs and Sportlyzer. It will be followed by three technology companies RealEyes, NOW!Innovations and Massi Miliano. 6.1 United Cats and Dogs The company was founded in 2006 by Ragnar Sass with the aim to provide online social network for cat and dog owners. The EDF invested first installment of total 239 700 euros in 2009. Co-investor was Kakssada Kakskümmend Volti OÜ, which is owned by well-known Estonian investor and entrepreneur Raivo Hein, who invested about 65 000 euros as well as Skype founders’ fund Ambient Sound Investments who invested about 320 000 euros 22

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(Tänavsuu 2010). By Spring 2010, UCD got into financial difficulties as its expenditures exceeded its revenues. UCD was not able to raise new funds. The management team was fired. Raivo Hein and Erko Kundla took over all assets and liabilities and company continued operations with 3 people instead of peak employment of 12- 15 people10. The EDF and coinvestors lost all of their initial investment. According to founder and former CEO Ragnar Sass, UCD did not have any other options to raise funds than the EDF. He was critical of the EDF as the decision-making took too long and contracts were too lengthy and overly detailed. Negotiations took 4 months. He pointed out that the EDF approach was narrow-minded and they did not take a longer term perspective. They did not have experience and network that other venture capital firms could provide (he compared the experience with the EDF with his new venture Pipedrive that raised USD 700 000 in Silicon Valley). According to Sass the value of UCD was zero in August 2012, when the interview took place. He argued that the main reason for the failure of UCD was wrong business model. Table 2. Financial Indicators of United Cats and Dogs in euros 2008-2011. Indicator 2008 2009 2010 Revenue 39 729 73 407 38 847 Export revenue 17 933 57 632 24 217 Net profit -237 086 -296 272 -189 157 Labor costs 137 185 251 534 114 047 Employee no. 10 12 4 Source: created by author with data from the Estonian Business Registry.

2011 5190 2391 -20 332 4710 3

However, Sass saw the failure as an opportunity to learn and by the time of the interview he was active as co-founder in a new venture Pipedrive had already attracted seed investment of

10

Business Registry data shows that UCD emplyed 12 people in 2009 while Sass says they employed 14 and Hein talks of 15 employees at its peak.

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USD 700 000 in July 201211 and opened an offices in Tallinn and San Francisco. In sum, Sass was quite critical of the EDF as the fund acted more like government bureaucracy rather than private venture capital firm. He did not understand why the EDF still listed the UCD as active investment in its portfolio in August 2012 which was another sign of bureaucratic inertia as the fund was reluctant to write off investment. According to current owner of the UCD Raivo Hein, who lost his initial investment, the value of the company was zero in 2012. However, if he would take into account his losses it would be below zero. Hein said that his decision to invest in the UCD was clearly mistake and he must have suffered “a temporary loss of mind”, when he made this decision. He says that the EDF invited Hein to join as a co-investor and he did not pay sufficient attention to the details. He invested his own money, while the EDF and other co-investor ASI are investing other people’s money, which may also impact their incentives. Hein was a member of the supervisory board and according to Hein, the board did not execute sufficient control over the company. The CEO was an excellent sales man and was able convince board members that everything is going fine even if numbers showed otherwise. He sees the main reason for the failure the misallocation of resources. “The UCD spent almost 4000 euros on servers per month,” says Hein. CEO paid himself and other employees high salaries, which is out of line with start-ups. Too many people were hired who were given dubious and fancy job titles. Table 2 shows that labor costs almost doubled from 2008 to 2009 while number of employees increased from 10 to 12 (Table 2). The average annual labor cost per employee was 20 961 euros in 2009. This means that average monthly salary of UCD employee in 2009 was approximately 1300 euros (20 961 divided by 12 minus social and unemployment taxes). The average salary in Estonia was about 800 euros in 2012 but the UCD average salary is on the same level with other EDF portfolio companies. Hein suspects 11

http://blog.pipedrive.com/category/startuplife/

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that Sass and some other people where actually using the UCD resources to build their next start-up Pipedrive. Hein has been also approached by the EDF to invest in other business but he says that the proposals have not been sufficiently attractive to him. He is quite constrained in his assessment of the EDF saying that he is not familiar with the details. In sum, UCD was a clear failure for the EDF and does not show the organization as a professional venture capital firm but rather than government bureaucracy, which is also reluctant to admit its mistakes. However, societal value of the investment may be bigger as there seem to be positive externalities. Certainly, management team had an opportunity to learn from the mistakes and now they have created a new venture with 15 employees. Whether this new venture will succeed or not remains to be seen. 6.2 Sportlyzer Sportlyzer was founded by Tõnis Saag in 2009 and offers training programming and analyzing software for sport clubs. In 2010, the EDF made 95 800 euros as a seed investment. Additional investments were made by several Estonian angel investors. In August 2012, company had 5 full-time employees and 4 part-time employees. The revenues were nonexistent. According to Saag, some angel investors such as Jüri Kaljundi, founder of CVOnline, are actively advising the company while others have taken more passive role. Saag says that the EDF has been instrumental in developing the company from the early days and alternative sources of financing have not been available to Sportlyzer. Only realistic alternative could have been bootstrapping, which was not very likely as Saag already had to live off his wife’s maternity leave money then. In addition to financing, which has given the EDF 20 % stake in the company, the EDF provides advice and legal assistance in drafting contracts and so on. Saag stresses that this 25

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really important for him as the company is relatively small and cannot afford such services. He values company at 1.4 million euros and says that competitors have tried to buy them for half million euros. These offers have been declined. In any case, these offers are above 300 000 euros that has been initially invested in the company. Saag thinks that exit will take 7 years from Sportlyzer and safe bet would be 2017-2018. He emphasizes that the EDF has learned and improved significantly in the last years. The fund is not the same as it was in 2009 when he started talking with them about his investment idea. In sum, at this stage it is impossible to evaluate the value of EDF investment and performance of the company as it is in the early stage of development. However, the overall assessment of the EDF is positive as it has provided crucial financing and advice. 6.3 RealEyes RealEyes was founded by Mihkel Jäätma in 2006 while he was a graduate student at the Oxford University, UK. The company offers web based facial expression measurement for video ads and lists Sony, Ebay, the Economist, Nokia, Unilever, Ikea and other large wellknown companies as its clients. The main office of company is in London, UK. It also has sales office in Boston, USA, and its research and development team is in Budapest, Hungary and programmers in Minsk, Byelorussia. As of August 2012, the company employed 23 people – of whom 6 were scientists, 6 were programmers, 4-member management team, 2 sales managers and the rest was support staff. The biggest market is the US with the market share of 40 %, the main competitors are based in Boston, USA, Switzerland and the Netherlands. According to Jäätma, the company tried to recruit research and development team of 30 people in Estonia. However, it turned out be unsuccessful because of lack of qualified staff and they opted for Budapest and Minsk instead. The company cooperates with universities in 26

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Budapest and London such as the Imperial College as well as with the Tartu University in Estonia. Company does not have office and any clients in Estonia. Annual reports submitted by RealEyes to the Estonian Business Registry do not include consolidated accounts. Hence, they do not offer realistic picture of company’s business activities as it takes place outside of Estonia. Nevertheless, Jäätma says that the company plans to start consolidated reporting of its financial accounts in the Estonian Business Registry in 2013. For the first couple of years, the RealEyes was bootstrapping with 7 people and was able to attract sufficient number of clients that generated enough revenue to cover its expenses. In 2009, company was officially registered in Estonia and shares of UK based corporation were sold to the Estonian entity in order to receive research and development grant of 770 000 euros from the Enterprise Estonia, a government’s agency that distributes EU structural funds for encouraging entrepreneurship and innovation. The EDF invested 120 000 euros as a seed investment in 2011, which was matched by Bellus (now Caplia Invest) owned by Rolf Relander and Rikard Relander, who are also co-investor in several other EDF portfolio companies. By June 2012, the EDF has invested additional 200 000 euros which has been matched by Kaplia Invest, which means total equity injection of 640 000 euros. As of August 2012, the EDF share was 12.5 % while founders owned 60 % of the equity. According to Jäätma, RealEyes needed investment for product development and the investments have allowed company to grow faster. Alternative options would have been to raise money from the UK and the USA. These options would have taken longer than raising the capital from the EDF. “If the EDF would not have injected capital, then the company would have found other options,” says Jäätma. According to Jäätma, they have talked with 100 investors in order to find suitable options for fund-raising.

RealEyes had the first

contacts with the EDF in the summer of 2010 and made some presentations, but started serious negotiations in December 2010 and it was completed by the beginning of 2011. “In 27

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the beginning, the requirements of the EDF were too complex and bureaucratic, but it was possible to simplify them,” said Jäätma. He argues that it is too early to tell when the exit will take place but probably it will take 3-5 years for the EDF to exit. The valuation of the company can be 10-12 million euros but it is too early to say and it is highly subjective depending on what perspective the potential buyer might have. The company is trying to raise additional four million euros of equity capital in Europe and in the US. However,

the US

option would mean moving headquarters to the United States, which is not attractive for the owners Overall, impression of the EDF relationship with the RealEyes comes across as positive and the decision-making process of the EDF is characterized by Jäätma as quite effective. The EDF acts mainly as a financial investor and provides a necessary format for decision-making which comes with the involvement of the institutional investor. As the potential exit remains uncertain and publicly available financial data of the company is inaccurate, then it is impossible to assess this investment. 6.4 NOW! Innovations This mobile parking solutions provider was founded in 2003 and has since been through several changes in the ownership. In 2006 software company Helmes acquired 50 % stake in NOW! Innovations. Üllar Jaaksoo joined the company in 2010 with his previous team from Tele2, a telecommunications company, and became CEO in 2011. Jaaksoo’s immediate task was to restructure the company as the company experienced financial difficulties as a result of losing an important client in Belgium. In 2011, the EDF invested 750 000 euros and its coinvestors Bellus (now Caplia Invest) additional 750 000 euros. Later stage, Artiston Invest invested close to 1 million euros. The EDF and Bellus have invested additional funds and total investment by the EDF and private sector co-investors exceeds three million euros where

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the EDF share is about third of that. The EDF and Bellus are not likely to make new investments in the company, while Artiston may make new invesments. The company has also received a grant totaling half million euros from the Enterprise Estonia, a government agency that distributes EU structural funds for businesses. Currently, company operates mobile parking solutions on the basis of software as a service principle in commercial or pilot stage in nine different countries and has processed over ten million parking transaction by half million users. The company has two offices in New York, USA and Tallinn, Estonia. R&D expenditure is about 15-20 % of company’s revenues and 2 full time people focus on R&D and additional 4 people contribute. As the following table shows the company earns most of its revenue outside of Estonia. At the same time, it is not completely consolidated financial data as the NOW! Innovations acquired a company in the US in 2011 and did not consolidate the revenues in its revenue figures, but consolidated the value of acquisition in the profit figure. The employee indicator shows only permanent employees while significant number of employees are contracted out. Table 3. Financial Indicators of NOW! Innovations in euros 2008-2011. Indicator 2008 2009 2010 Revenue 258 308 225 875 137 177 Export revenue 241 408 219 804 126 159 Net profit -14 523 516 -207 988 Labor costs 126 267 139 220 20 776 Employee no. 5 4 4 Source: created by author with data from the Estonian Business Registry.

2011 59 670 56 069 (942 737) 114 281 5

Jaaksoo has previously worked at the EDF foresight division, not in their venture capital division. Jaaksoo argued that the EDF has fulfilled important gap in the market as in 2006 only one serious private venture capital firm existed in the Estonian market. According to him, the NOW! Innovations did not have any real alternatives to the EDF investment and mobile parking solutions would seem too utopian for investors outside of Estonia. Jaaksoo 29

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argued that the NOW! Innovations needs to raise additional equity capital of 1-2 million euros but there are not sufficient funds available. Additional capital would be necessary to secure sustainability of his team, which should be 2-3 times larger. The new equity injection would enable the NOW!Innovations to be competitive in the mobile parking business, which has market size of 50 billion euros in the US and EU. According to Jaaksoo, the EDF has primarily provided oversight over finances. The EDF has accepted management strategies and not intervened in the core business. However, he pointed out it is impossible to have a good quality investment team in such small fund such as the EDF. “The minimum requirement would 50-100 million euros under management for hiring a highly professional investment team,” said Jaaksoo. His assessment is that the EDF’s legal competence is very strong, but negotiations take too long, fund is not effective in making quick decisions, decision-making process is too formal and not very clear always. “The mandate of EDF representative is not always clear. You need to take 2-3 steps to figure it out but only 1-2 steps with private investors,” said Jaaksoo. The EDF required very detailed final accounts dating several years back as a part of due diligence, which was difficult for the company as the previous management had not kept them and it required additional time and substantial work. According to Jaaksoo, the company value is approximately four million euros. Nevertheless, it is impossible to evaluate the true value of the company as the exit remains uncertain. The most likely exit strategy is acquisition by large IT company rather than IPO. The exit should take place within 5 years from the initial investment as this is the investment horizon of the EDF and Bellus. Jaaksoo pointed out that EDF’s goal is to maximize profits but it should consider more broader public goals. “In the end, any return on investment would be marginal from the point of view of Estonian economy. What really matters is creating success stories and fulfill gap in the venture capital market,” said Jaaksoo. He argued that the EDF should not 30

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focus too much technology-centric companies because they are acquired early by other companies. The EDF should invest more in sales-oriented companies, where new companies create brands, which allows have positive impact on the broader image of Estonia. 6.5 Massi Miliano (fits.me) Fits.me provides virtual fitting room solutions on software as a service basis for online clothing retailers. This allows online retailers to increase conversions and reduce garment returns. The company lists Adidas, Hugo Boss, Thomas Pink, Mexx and many other wellknown clothing brands as its customers. Fits.me was launched by Heikki Haldre and Paul Pällin and company’s technology was developed by researchers from the University of Tartu in Estonia, Tallinn University of Technology in Estonia, University of Bologna in Italy and Human Solutions Gmbh in Germany. In 2009, the EDF invested 960 000 euros in this venture which was matched by private investors. The company has also received research and development grants worth of half million euros from the Enterprise Estonia, government agency. Table 4. Financial Indicators of Massi Miliano in euros 2008-2011. Indicator 2008 2009 2010 Revenue 21 660 7382 250 Export revenue 0 0 0 Net profit -5611 -196 096 -432102 Labor costs 0 34 422 28 499 Employee no. 0 9 13 Source: created by author with data from the Estonian Business Registry.

2011 22 869 0 -1 246 886 135 792 21

According to CEO Heikki Haldre, company did not have any realistic alternatives for the EDF investment. It is difficult for an Estonian company to raise money, particularly if it is very research intensive. He said that research and development expenditure is 70 % of all the funds company has raised so far. Haldre argued that the company could not have made necessary investments without this equity injection. Patent applications alone take 4-5 years to handle

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and this means investors have to take a long time horizon. Haldre sees the EDF role as a passive financial investor rather than active hands-on investor. “There is no need for active involvement in the company as they do not have experience and there is no necessity for that,” said Haldre. The company’s actual performance cannot be measured by data from the Estonian Business Registry (Table 4) because according to Halder they have not consolidated results from their operations in other countries. The company’s main office for marketing and sales is in London, UK. They have also offices in Munich, Germany, Paris, France, New York, USA and Auckland, New Zealand. According to Haldre, there is no certain date when the exit must take place but usually exits take 5 years. He was not willing to discuss details when potential exit may take place and what is the valuation of the company. In April 2013, fits.me raised almost 6 million euros from EDF Smartcap fund and new investor Conor Venture Partners, Fostergate Holdings and The Entrepreneurs Fund. In sum, fits.me has attracted 1.5 million euros in equity investments and R&D grants from the Estonian government agencies. The role of EDF is that of passive financial investor. Certainly, there has been positive externalities of these investments has the company cooperates closely with two largest universities in Estonia. However, the performance of the company cannot be assessed on the basis of publicly available data. The new investments from private venture capital funds suggest a positive valuation of the company. However, exit remains uncertain at this point.

7. Conclusion The findings suggest that the 16 EDF portfolio companies are small and insignificant from a broader perspective of the Estonian economy. None of them has created significant revenues, employment and monetized major innovative breakthroughs. Only two companies have been

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profitable. The EDF has exited from three companies. Two of these exits are clear failures as initial investment has been lost. One can be classified as successful – even though the details of the deal are not disclosed publicly. One investment in SmartPost/Cleveron seems also relatively successful as the business operations in Estonia have been sold. However, the EDF remains a shareholder in the Cleveron with aim to use the same technology for international expansion. This approach certainly carries risks. Hence, it can be argued that 13 exits remain uncertain. Nevertheless, it may be too early to expect significant number of exits because the EDF made its first investments in 2008 and exits may take 5-7 years. The analysis of the EDF online networks shows that the EDF plays an important role among its portfolio companies as well as in the broader venture capital ecosystem in Estonia. This is consistent with previous qualitative studies based on semi-structured interviews that have suggested a crucial role of the EDF in getting venture capital networks started in Estonia (Nightingale and Reid; Jostov and Sonts 2012). The portfolio network is relatively centralized with most companies connecting to the EDF but not to each other. The broader venture capital ecosystem network is less centralized where network nodes connect to the EDF as well as to other members of networks. One of the portfolio companies - accelerator Startup WiseGuys has become a focal point in this network in less than a year. Certainly, the analysis of online networks gives only a partial understanding of the EDF role as the offline world may not match online world. Nevertheless, it is a crucial factor – especially as many EDF portfolio companies are social network and ICT companies. The case studies of five portfolio companies reveal that in several cases Estonian Business Registry data is not useful in assessing the performance of the EDF portfolio companies. Three companies have built significant international operations and not consolidated or consolidated partially their financial data in Estonia – even though as they have attracted considerable equity injections and grants from the Estonian government. In the case of 33

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fits.me, it is possible to see potential positive externalities as it cooperates with two universities. The RealEyes investment does not seem to carry any positive externalities of innovation for the Estonian society – other than hope that their Estonian born managers may return and start new innovative ventures at some point. Overall, one investment of the five cases can be considered a clear failure and all other investments cannot be classified as successful or failing at this stage as the exits have not taken place. Overall, CEOs of portfolio companies have relatively positive assessment of the EDF with the exception of one former CEO. However, the EDF comes across as a passive financial investor rather than hands on venture capital fund and is seen as too bureaucratic and inflexible in comparison with the private sector funds. However, lengthy formalities and inflexibility may also stem from the fact that the EDF is an institutional investor while its co-investors are less institutionalized. Three companies out of five case-studies have significant operations in the US, UK and other countries which may signal their competiveness in the international markets. This is the first step in evaluating the performance of the EDF. The future research will include data about financial year of 2012 as well as try to track down publicly available data about portfolio companies from other countries. Semi-structured interviews will be carried out with all portfolio companies as well as co-investors as well as with the EDF current and former management team and investors and experts who have not co-invested or otherwise cooperated with the EDF. Network analysis can be used to explore the performance of IT and social network companies in the EDF portfolio. Furthermore, a comparison could be made with other government venture capital schemes (for instance, in Latvia and Lithuania). Nevertheless, the limitations of publicly available data and uncertainty over potential exits reveal several major obstacles for evaluating government venture capital schemes. This is a fundamental issue that cannot be solved by more publicly available data and more interviews with actors whose interests are at stake. Only time may allow overcoming these barriers 34

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because only exits matter in the end and exists take time. Meanwhile, information about different financing rounds, valuations provided by vested interests and interviews with other portfolio companies, co-investors and non-EDF affiliated investors can be used to explore more but these results will not solve a fundamental uncertainty concerning exits. Obviously, this is not just a methodological issue but creates substantial issues for policymakers as they would have to make long-term commitment of public funds with limited accountability, transparency and ability to track the performance of government fund and justify the investments in the broader public discourse. Even if government venture capital schemes are able to establish incentive structure that would make decision-making processes incentive compatible and establish the best possible investment model, the performance of government venture capital is challenging to measure. First, partially these measurement difficulties are conceptual. The point of venture capital is to invest in high risk companies, which are surrounded by uncertainty. This implies that many traditional performance measures of companies are not useful in this asset class. The true value of investment is usually revealed in the long run – especially now when exits from companies take may take up to 7 years. Politicians and government officials may want certainty and short-term result, which may lead to the adoption of superficial performance indicators. Second, measurement difficulties are empirical. This study explored measurement issues on the basis of Estonian Development Fund, which during the last five years has co-invested together with private investors in 19 companies. The Estonian case may not be relevant for all countries but it is certainly relevant for small countries or countries, where investments are made in a small number of companies. As the number of companies is small, then significant portion of information cannot be aggregated and published without revealing sensitive business information. In addition, public information sources such as the Estonian Business Registry do not always reveal relevant information as the portfolio companies of the Estonian 35

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Development Fund operate in different countries and have not consolidated their annual reports. Qualitative methods such as questionnaires and interviews are also limited as small number of interviews makes coding not useful and company managers are reluctant to discuss openly important issues.

References Anderson, G. 2012. Ambient sound investments exits modesat in acquisition by xilinx. ArcticStartUp, September 18, 2012. Arengufond. 2012. in Estonian Development Fund [database online]. Tallinn, Estonia, 20122012]. Available from http://www.arengufond.ee/VC/portfolio/ (accessed May 25, 2012). Brander, J., Q. Du, and T. Hellmann. 2010a. The effects of government-sponsored venture capital: International evidence. Paper presented at EFIC Conference 2010 , Cambridge, MA, USA. Brander, J., E. Egan, and T. F. Hellmann. 2010b. "Government sponsored versus private venture capital: Canadian evidence". In International differences in entrepreneurship ., eds. J. Lerner, A. Schoar, 275-320. Chicago, IL, US: University of Chicago Press. Buchanan, R., and R. D. Tollison. 1984. The theory of public choice. Ann Arbor: University of Michigan Press. Chemmanur, T., K. Krishnan, and D. Nandy. 2008. How does Venture Capital financing improve efficiency in private firms? A look beneath the surface Center for Economic Studies, U.S. Census Bureau, Working Papers. Cumming, D., and J. MacIntosh. 2006. Crowding out private equity: Canadian evidence. . Journal of Business Venturing 21 : 569-609. Estonian Business Registry. Data. . 2012Available from https://ariregister.rik.ee/ (accessed Retrieved in August 3, 2012). EstVCA. 2012. Statistika.in EstVCA: [database online]. 2012 Available from http://www.estvca.ee/estvcast/statistika (accessed March 30, 2012). Fulghieri, P., and M. Sevilir. 2009. Organization and financing of innovation, and the choice between corporate and independent venture capital. Journal of Financial & Quantitative Analysis 44 (6): 1291-321. Hayek, F. A. 1945. The use of knowledge in society. American Economic Review 35 (4): 51930.

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Hochberg, Y. V., A. Ljungqvist, and Y. Lu. 2010. Networking as a barrier to entry and the competitive supply of venture . The Journal of Finance. 65 (3): 829-59. ———. 2007. Whom you know matters: Venture capital networks and investment performance. The Journal of Finance 62 (1): 251-301. Hsu, D. H. 2006. Hsu, D. H. 2006. venture capitalists and cooperative start-up commercialization strategy. 52, (2) (02): 204-19. Management Science 52 (2): 204-19. Jostov, K., and S. Sonts. 2012. Quo vadis, arengufond. . BSc Thesis., Stockholm School of Economics in Riga, Latvia. Kortum, S., and J. Lerner. 2000. Assessing the contribution of venture capital to innovation. . RAND Journal of Economics 31 (4): 674-92. Lerner, J. 2002. When bureaucrats meet entrepreneurs: The design of effective 'public venture capital'. . The Economic Journal 112 (477): F73-84. ———. Boulevard of broken dreams:Why public efforts to boost entrepreneurship and venture capital have failed--and what to do about it. . Princeton, New Jersey: Princeton University Press. Meyer, T. 2007. The public sector's role in the promotion of venture capital markets. . Japan: Development Bank of Japan; Hitotsubashi University., . Nightingale, P., and A. Reid. 2010. Early-stage invstment by estonian development fund.. Tallinn, Estonia: Arengufond, . Pindmaa, M. 2006. The advantages and disadvantages of creation of a state venture capital fund in estonia. . BSc thesis., Stockholm School of Economics in Riga, Latvia. Poom, R.. 2012. Riigi toel pankrotti: Üliusinate ametnike lemmikettevõtte ilmarise kurb lõpp . Eesti Päevaleht, May 7, 2012. Stadnik, A.. 2012. Arengufond teenib SmartPostist dividende. Äripäev, September 25, 2012. Tänavsuu, T. 2010. Loomade facebook mängiti pankrotti, loomaomanikud shokeeritud. july 1. . Eesti Ekspress, July 1, 2010. Wallsten, S. J. 2000. The effects of government-industry R&D programs on private R&D: The case of the small business innovation research program . Rand Journal of Economics 32 (1): 82-100. Zernike Group. Access of enterprises to venture capital financing in estonia. . Tallinn, Estonia: Enterprise Estonia., .

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Appendix 1 Network analysis of older EDF portfolio on May 3, 2013, with following 12 urls: http://www.arengufond.ee http://www.celltherapycluster.eu/liikmed/43-cellin-technologies.html http://www.goliath.ee http://www.mywind.ee/htdocs/my_home.php http://www.nowinnovations.com http://www.realeyesit.com/homepage.aspx http://www.selfdiagnostics.eu http://www.smartpost.ee http://www.sportlyzer.com http://www.startupwiseguys.com http://www.unitedcats.com http://www.uniteddogs.com Appendix 2 Network analysis of new and old EDF portfolio on May 7, 2013, with following 18 urls: http: //www.smartcap.ee http://www.arengufond.ee http://www.celltherapycluster.eu/liikmed/43-cellin-technologies.html http://www.goliath.ee http://www.mywind.ee/htdocs/my_home.php http://www.nowinnovations.com http://www.realeyesit.com/homepage.aspx http://www.selfdiagnostics.eu http://www.smartpost.ee http://www.sportlyzer.com http://www.startupwiseguys.com http://www.unitedcats.com http://www.uniteddogs.com http://www.defendec.ee 38

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http://www.vitalfields.com http://www.newspin.com http://www.cleveron.eu http://www.biotapristine.com

Appendix 3 The network map of EDF portfolio with inlinks (May 3, 2013)

Source: data entered by the author, map produced by issuecrawler.net

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Appendix 4 The network map of EDF portfolio with outlinks and inlinks (May 3, 2013).

Source: data entered by the author, map produced by issuecrawler.net Appendix 5 Network analysis of EstVCA full members on May 7, 2013, with following 15 urls: http://www.arengufond.ee http://www.asi.ee http://www.baltcap.ee http://www.cresco.ee http://www.danskecapital.ee http://www.essentiacapital.com http://www.estban.ee http://www.estvca.ee http://www.masainvest.com http://www.mtvp.ee 40

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http://www.pioneer.ee http://www.redgatecapital.eu http://www.smartcap.ee http://www.swedbank.ee/private/investor/funds/funds/hai http://www.unitedpartners.ee Appendix 6 List of semi-structured interviews Name Ragnar Sass

Position Former CEO/Owner

Company United Cats and Dogs

Date August 13, 2012

Raivo Hein

Investor/Owner United Cats and Dogs

September 7, 2012

Heikki Haldre Üllar Jaaksoo

CEO/Owner

Tõnis Saag

CEO/Owner

Sportlyzer

August 17, 2012

Mihkel Jäätma

CEO/Owner

RealEyes

August 23, 2012

CEO/Owner

Massi Miliano September (Fits.me) 4, 2012 NowInnovations! September 3, 2012

Place Pipedrive Office, Tallinn, Estonia Raivo Hein office at Järve Selver, Tallinn, Estonia Phone

Method In person

In person

Phone

Now In person Innovations office, Tallinn, Estonia Sportlyzer In person office, Tartu, Estonia MKM In person office, Tallinn, Estonia

Appendix 7 A summary of semi-structured interview questions. 1) What has been the contribution of the EDF to the development of your company? 2) Has the EDF investment enabled you to grow faster? Why? Why not? 3) Has the market position of your company improved? What has been the role of EDF? 4) Did you have any alternative sources of finance available? What would you have done without the EDF? 5) How many investors did you contact? What were the reasons they gave for negative answers? 6) Have you received any other government support? 41

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7) How would you characterize the decision-making processes of the EDF? How long did it take to get a response? 8) To what extent do the EDF representatives take part in the management of company? Do they contribute more than other investors? Has the EDF created contacts and opportunities that otherwise would not be available? 9) What is the value of your company? When will the exit take place? What is the average time for exit? 10) How has innovation and R&D grown in your company? Have you created new products and processes? What kind of cooperation do you have with other companies and universities in R&D? 11) To what export markets have you entered? Would the expansion have taken place without the EDF investment? 12) Has the EDF investment enabled you to create new jobs?

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