companies in high-growth industriesâalong the lines of America's Nasdaq. ... dustries like biotechnologies, computer hardware and software, information ...
Venture Capital in Europe and the Financing of Innovative Companies Laura Bottazzi∗ Universit`a Bocconi, IGIER, and CEPR and Marco Da Rin Universit`a di Torino and IGIER July 2001 Abstract Venture capital is considered to be the most appropriate form of financing for innovative firms in high-tech sectors. Venture capital has greatly developed over the last three decades in the United States, but much less so in Europe, where policy makers are striving to help channel more funds into this form of financial intermediation. We provide the first assessment of venture capital in Europe. We document its development in the 1990s, also providing a conceptual framework for this analysis. Comparing the evolution and structure of European and American venture capital, we find the wedge between these two industries to be large and growing. We then look at the involvement of venture capital with some of Europe’s most innovative and successful companies: Those listed on Europe’s ’new’ stock markets. Venture capital is effective in helping these firms overcome credit constraints, and thus to be born in the first place. Using a unique, hand collected data set from the listing prospectuses and annual reports of these companies, we then find European venture capital to have a limited effect on their ability to raise funds, grow, and create jobs. We conclude that public support of the European venture capital industry should look at both its growth and at its maturation.
Forthcoming, Economic Policy, v.34, 229-69, April 2002.
∗
We thank Erik Bergl¨ of, Jean-Bernard Chatelain, Jan van Ours, Henri Pag`es, Guido Tabellini, and participants to the Economic Policy 33rd Panel Meeting for valuable comments. Detailed suggestions by Richard Baldwin (the editor) helped us improve the quality of the paper. Veronica Guerrieri, Giuseppe Maraffino, Gaia Narciso, and Battista Severgnini provided excellent research assistance. We also thank all the companies which provided us with data and prospectuses. Financial support from Fondation Banque de France and from Universit` a Bocconi (Ricerca di Base) is gratefully acknowledged. All errors remain our own.
1
Introduction
The ability to encourage and sustain technological innovation is one of the main sources of economic growth. In the last decade, the increasingly rapid pace of innovation induced by entrepreneurial firms has substantially contributed to the strong competitiveness and protracted growth of the US economy. Several studies have documented the ability of US venture capitalists to select promising companies, provide adequate financing, and spur innovative firms to behave aggressively and emerge as market leaders (see Hellmann (2000) for an overview). A wide consensus among economists, business leaders, and policy-makers exists that a vibrant venture capital industry is a cornerstone of America’s leadership in the commercialization of technological innovation, and that the lack of venture capital hinders European firms from competing on an equal footing (European Commission (1994)). Several official documents of European governments and institutions suggest bolstering venture capital and revamping the regulation of stock markets as remedies to Europe’s economic slugginesh and dismal unemployment. For instance, the European Commission’s 1998 Risk Capital: A Key to Job Creation in the European Union Communication states as its main message that ‘[d]eveloping risk capital in the European Union, leading towards the development of pan-European risk capital markets is essential for major job creation in the EU’ (European Commission (1998) p.1). As the title of the Communication indicates, the creation of a pan-European equity market for innovative companies was identified by the Communication as a crucial step not only for providing risk capital to companies, but also for the creation of a substantial number of new jobs. More recently, the ’Final Report of the Committee of Wise Men on the Regulation of European Securities Markets,’ ’urges governments and the European institutions to pay particular attention to ensuring that there is an appropriate environment for the development of the supply of risk capital for growing small and medium sized companies, given the crucial importance of this sector for job creation’ (Committee of Wise Men (2001) p.10). The Committee goes on to argue that ’[t]oday there is still an inadequate supply of risk capital in the EU with venture capital only one fifth of US per capita levels. However, if the European Union’s financial markets can integrate (...) European venture capital financing will be encouraged from the bottom up’ (p.78). Other official documents and reports identify the immaturity of Europe’s venture capital industry and the hostility of its stock exchanges towards young firms as powerful obstacles to the growth of European entrepreneurial firms (see for instance Bank of England (2000)). In
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turn, entrepreneurial firms are viewed as major contributors to economic growth and to the creation of new jobs (see German Federal Ministry of Economic and Technology (1999a,b)), and venture capital as an important tool for job creation, technological innovation, export growth, and regional development (European Investment Bank (2001)). There is a growing perception that Europe’s growth problems may be caused not as much by rigidities in labour markets, as by weakensses in capital markets, and in particular in the access to risk capital. These documents raise important policy issues. In particular, it is crucial to understand how policy can actually contribute to the growth of a dynamic venture capital industry in Europe. European official documents, but also industry reports like the White Paper of the European Venture Capital Association (EVCA (1998)), tend to focus on the supply of funds and on the creation of favorable structural conditions for entrepreneurship. However, it is far from evident which policy measures would be most appropriate to nurture venture capital in Europe. Here the lack of rigorous investigation is felt most. In this paper we provide a contribution in this direction by developing the first systematic analysis (to the best of our knowledge) of venture capital in Europe. To get around the dearth of firm-level data on European venture capital, we exploit the unique opportunity offered by the opening in 1997 of Euro.nm, the alliance of Europe’s ’new’ stock markets for innovative companies in high-growth industries–along the lines of America’s Nasdaq. Euro.nm brought under its wings the ’new’ markets of Amsterdam, Brussels, Frankfurt, Paris, and (since June 1999) Milan. Euro.nm ceased to exist as an alliance in December 2000, but its five members have continued to operate independently. Over its life span, Euro.nm has allowed nearly 600 companies to list and raise over 40 billion euros of equity capital. We collect a unique data set from issuing prospectuses and annual reports of more than 500 Euro.nm listed companies. These data provide an excellent opportunity to study the effects of venture capital on Europe’s innovative companies, given the wealth of information which they are required to disclose in order to go public. We focus on three key issues. First, we develop a conceptual framework for appraising the role of venture capital in the financing of innovative companies. Second, we document the development of venture capital in Europe, compare it to that of US venture capital, and assess the extent and determinants of venture financing to companies listed on Euro.nm. Third, we study the effect of venture capital on the ability of these companies to raise funds, grow, and create jobs. The evidence we provide is useful in assessing the extent to which European venture capital helps create and nurture innovative companies. We challenge several common beliefs on the role of venture capital in Europe, and question its ability to make a difference for economic
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growth and job creation. In particular, we argue that venture-backed companies do not grow and create jobs faster than non venture-backed companies. Whether this is due to a lack of ’stars’ among European firms or to the immaturity of European venture capital is not possible to tell apart, but several pieces of evidence make the latter possibility more than likely. We also have good news. We find that venture capital does help European innovative companies by providing them with financing crucial for their creation and development. This also means that an increasing number of (venture-backed) companies benefits from the possibility to go public on Euro.nm, with a positive effect on the growth of Europe’s ’new’ stock markets. Since venture capitalists benefit, in turn, of the possibility to exit their investments through a listing on a stock market, this may have triggered a self-reinforcing virtuous circle. These findings provide support for the European Commission’s stated policy of promoting European venture capital. The major action of Commission in this respect has been transformation of the European Investment Fund (EIF) into a major investor in venture capital funds. Our findings suggest that the ’quality’ of European venture capital should be as urgent a concern for the EIF as its sheer ’quantity,’ so as to advance both the size and the maturation of the industry. The rest of the paper is organised as follows: Section 2 provides a primer on venture capital based on the extant economics literature and on the available empirical evidence. Section 3 develops a statistical portrait of the European venture capital industry, comparing it to its American counterpart and assessing its involvement in financing Euro.nm listed companies. Section 4 evaluates the role of European venture capital in the companies it finances. Section 5 concludes. A Data Appendix contains a detailed description of our data collection, and a Web Appendix provides additional tables and material.
2 2.1
Venture capital and the creation of innovative companies History, definitions and jargon
In 1946 Georges Doriot, a professor at Harvard University, created American Research and Development (ARD) together with Karl Compton, president of the Massachusetts Institute of Technology, Merrill Griswold, chairman of Massachusetts Investors Trusts, and Ralph Flanders, president of the Federal Reserve Bank of Boston. ARD was created to raise funds from wealthy individuals and college endowments and invest them in entrepreneurial startups in technology-based manufacturing: Modern venture capital was born. Half a century
3
later venture capital has become the form of financial intermediation most closely associated with dynamic entrepreneurial start-ups, especially–though not exclusively–in high-tech industries like biotechnologies, computer hardware and software, information technology (IT), e-commerce, medical equipment, and telecommunications.1 Many of today’s most dynamic and successful corporations received venture capital at the initial stages of their lives: Amazon, Apple, Cisco, e-Bay, Genentech, Genetic Systems, Intel, Microsoft, Netscape, and Sun Microsystem, to name just a few. As a result, venture capital has developed into an important, established form of financial intermediation (see Gompers and Lerner (2001)). The maturation was not smooth, though (see Gompers (1994)). Until the 1980s, venture capital firms were in large part publicly funded Small Business Investment Companies (SBICs). While SBICs trained many venture capitalists and helped the industry reach a critical mass by channeling large sums to start-ups, their ability to perform was limited by bureaucratic constraints, lack of professional expertise, and a faulty design of capital structure and incentives (Lerner (1994a)). Their investment record was in fact mixed, and spurred a fall in investor confidence and in committed funds around the late 1980s. Also, many venture firms, including ARD, were organized as closed-end funds, but this attracted retail investors with short-term horizons, whose needs clashed with the long-term returns of venture capital. Only in the late 1980s were SBICs and closed-end funds superseded by the limited partnership as the dominant organizational form of American venture capital firms. Another major contribution to the adoption of a more efficient organizational form was the clarification, in 1979, of the Employment Retirement Income Stabilization Act, which allowed pension funds to invest in venture capital. This resulted in a staggering increase of funds invested, and in a faster professionalization of the industry. Until the early 1990s, venture capital remained essentially an American phenomenon. Its success in supporting dynamic companies which create jobs and wealth brought many governments to look for ways to nurture a national venture capital industry. At the same time, the high returns enjoyed by US venture capital firms induced venture capitalists to become active also in other countries. Venture capital is by now a sizeable industry also in Europe and Asia. While no standard definition of venture capital exists, there is wide consensus that it corresponds to the professional financing of young, unlisted dynamic ventures through equity or equity-like instruments like convertible securities. Unlike wealthy individuals who occa1
Dynamic firms in traditional services, like Federal Express, Staples, or Starbucks, also received a sizeable share of venture finance.
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sionally invest in start-ups (’business angels’), venture capitalists are professional investors, organised in small limited partnerships, who raise funds from wealthy individuals and institutional investors and invest on their behalf. They specialise in financing young firms which typically have not yet produced any sales, but which have high growth and earnings potential–many investees are ’start-ups’ which come into life through venture financing. Box 1 provides an explanation of some common terms of the venture capital jargon.
2.2 2.2.1
Financing an innovative company: The alternatives How to start a start-up
Why do innovative companies in high-tech industries get financed primarily by venture capitalists? To set the stage for our empirical investigation, it is useful to consider what we know about this question, and therefore what one would expect to find from companies backed by a venture capitalist. Consider the hypothetical case of a brilliant academic engineer who has just discovered in his lab a technology to produce a new type of circuit for mobile phones. He believes his product would make an important breakthrough by opening a market for three-dimensional messaging. He thinks he could get rich and famous by creating a start-up which could hopefully go public. However, the industrial implementation of his product requires an investment in the order of three million euros. This sum far exceeds his personal wealth and that of his family and friends. He asks his bank for a loan, but is told that the bank does not lend to start-ups–unless enough collateral is pledged to cover the full value of the loan. The same disappointing answer comes from several other banks he then contacts. 2.2.2
Why banks won’t do
Why do banks typically refrain from investing in start-ups? The reason is that they are not a suitable financier for this type of projects. Banks specialize in raising deposits from the public, lending these sums to businesses, and earning an interest margin in the process. The high liquidity of deposits requires that loans be made only to businesses likely to repay within a relatively short period and with high probability. Banks also rely heavily on a firm’s tangible assets for collateral, but the assets of entrepreneurial start-ups are in large part intangible, like marketing knowledge or technology. In other words, the very nature of banks makes them suitable to lend to firms in established industries, with reasonably predictable cash flows.
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Box 1: The jargon of venture capital Start-up: a new company which is created by an entrepreneur in a high-tech industry, often with the goal of going public within a few years. Limited partnership: the typical form of organization of a venture capital firm. Its ’general partners’ (venture capitalists) manage the firm and assume full liability, while ’limited partners’ (investors) provide funds and assume no liability beyond the contributed capital. Captive: a venture capital firm which is owned by an industrial company or a financial intermediary. Captives are common in Europe, whereas in the US ’independent’ venture firms, which raise money from institutional investors, are the norm. Convertible securities: equity-like financial instruments which offer venture capitalists strong protection in case of liquidation, while ensuring participation in the upside should the project succeed. Vesting: a legal term which indicates the process by which a person comes into possession of corporate stock. It usually applies to entrepreneurs or employees whose right of possession over their stocks is contractually deferred until a certain date or until certain targets are met. ’Exit’ : the mode of exit from an investment. Venture capitalists typically exit their investee companies through an IPO, a trade sale, or by writing-off (liquidating) a non-performing company. Initial Public Offering (IPO): the offering of corporate stock to the public through which a company ’goes public’. It is the most sought after way of cashing in their investment by venture capitalists and entrepreneurs, since it allows the highest valuation. Trade sale: sale of a start-up to another company, typically a large competitor. It is a common way for venture capitalists to liquidate their investment when a company is not growing enough for an IPO or the stock market is experiencing a downturn. Write-off: the disaster scenario. When a funded company fails, the venture capital writes off the investment from its assets. Most venture investments end up as writeoffs. 6
A start-up, on the contrary, is an utterly risky business: Most start-ups go bust but are extremely profitable if eventually successful. Another reason for banks’ reluctance to finance start-ups is their being heavily regulated intermediaries which face severe limits to holding equity. 2.2.3
Some possible alternatives...
What other options could our engineer consider? The embryonic form of his project rules out direct access to capital markets, which is feasible only for firms with a proven business model, a solid organization, and a clear earning potential. Moreover, the capital needed by a start-up (three million euros in our example) is far below the minimal threshold for an Initial Public Offering (IPO). Government grants are also unsuited for such a project, since they are typically targeted at very small firms, and often require a proven track record which no high-tech start-up may provide (see Gordon (1998) and Lerner (1999)). Four practicable options remain: convincing a ’business angel’ or a financial company to invest in the start-up, finding an established industrial company interested in supporting the project (a ’corporate venture capitalist’), or going for a venture capitalist. A business angel is a wealthy individual who invests directly in a private company (see Benjamin and Sandles (1998) and Prowse (1998)). In some countries associations or groups of business angels provide some legal and organizational support, but these individuals largely invest based on personal relationships. In some cases they also provided expert knowledge of an industry, since many of them are (or have been) executives. A financial company is a holding company which invests in industrial companies. Financial companies rarely invest in start-ups. They prefer more mature firms which are close to going public, to which they often provide ’bridge financing’ to strengthen a company’s equity base in the wake of the IPO. A corporate venture capitalist is an industrial company which invests in start-ups directly or through a dedicated subsidiary–such as Innovacom, the venture capital arm of France Telecom. Established companies invest in new ventures in order to keep up with technological developments and acquire a foothold on possible breakthrough. In other words, they invest for financial but also strategic reasons (see Hellmann (2001)). Corporate venture capitalists bring to new ventures not only money but also knowledge of the market and organizational strength (see Gompers and Lerner (2000)).
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2.2.4
... and their drawbacks
Our engineer ponders over these possibilities. He discards business angels, since they are a good source of funds, but only for smaller start-ups. Moreover, business angels lack the financial power which is needed at later stages–and he would rather not risk being stranded once his business starts rolling. Corporate venture capitalists have their drawbacks, too. Sometimes, especially in Europe, they are bureaucratic and slow, while start-ups need speed and thrust to succeed. Also, a start-up which threatens to ’cannibalise’ a major source of revenue of its corporate venture capitalist may end up being delayed or even stopped. In fact, start-ups backed by a corporate venture capitalist have been found to choose a less aggressive strategy than those financed by independent venture capitalists (Zahra (1996). Our investor believes his project to be highly innovative, and therefore wants to avoid the risk of being put on hold by a corporate venture capitalist. His scant experience in business suggests that a professional venture capitalist, with his extensive business contacts and experience in mentoring start-ups, may be a better solution. These gains of being financed by a venture capital seem to outweigh its costs, which consist of a constant scrutiny of all decisions, of the risk of losing control if performance is unsatisfactory, and of the large amount of equity the venture capitalist takes in exchange for his money and support. Our engineer decides to seek support from a venture capitalist. What should he expect?
2.3 2.3.1
A conceptual framework for venture capital The soft side of venture capital
Systematic accounts of the operations of US venture capital firms are provided by Barry et al. (1990), Sahlman (1990), and more recently by Kaplan and Str¨ omberg (2000). These studies show that venture capital constitutes a special form of financial intermediation, with contractual arrangements substantially different from debt contracts. The nature and complexity of these arrangements suggest that the financial ’hard’ side of the capital contribution is complemented by a non-financial ’soft’ side consisting of mentoring and monitoring. Venture capitalists are often thought of as providing firms with expert advice together with stringent incentives to perform. Venture capitalists’ expertise and network of contacts with potential suppliers and customers allow entrepreneurs to focus on what they are best at–technical development. Their industry knowledge is precious for honing strategies. They concentrate on start-up firms located nearby, and use their knowledge of industries and markets to evaluate and mentor entrepreneurs. Indeed, most venture capitalists have higher degrees, and a tech-
8
nical, not economic or financial, background. Venture capitalists also provide ’reputational capital’ by allowing firms to boast being venture-backed so as to lure top-fly executives or to obtain new contracts. But venture capitalists are also demanding investors, who retain the right to remove the entrepreneur from his post of chief executive officer should she fail to meet any agreed upon milestone. The combination of these ’soft’ sticks and carrots is widely seen to provide venture-backed start-ups with an advantage over others firms, since it should increase the chances of survival, and help start-ups attract further funding as they expand. The narrative literature on venture capital documents extensively these ’soft’ aspects of venture capital. For instance, Gorman and Sahlman (1989) find that the lack of business experience of many entrepreneurs makes mentoring from expert venture capitalists crucial to their chances of success. Survey evidence from four countries collected by Sapienza, Manigart, and Vermeir (1996) shows that venture capitalists see themselves as mentors and advisors. Sapienza (1992) also finds that the involvement of venture capitalists increase with the degree of innovation pursued by a firm. Rosenstein et al. (1993) find that entrepreneurs who are financed by leading venture capitalists regard these as the most useful board members. More formal studies of how venture capital works in the US corroborate this anedoctal findings. For instance, venture capitalists do not provide full financing upfront, but disburse money in installments at different stages of a firm’s development. contingent on the achievement of milestones such as the construction of a prototype, a certain amount of sales, or the hiring of key management figures. Financing at different stages is found to take different roles (see Box 2) and to allow venture capitalists to gather information over time, thus keeping the option of abandoning firms whose hopes of success have dwindled (Gompers (1995)). Venture capitalists are also found to closely oversee investee firms, and to be active board members who step in and take control when times get difficult (Lerner (1995)). Some recent analyses of the influence of venture capital on corporate strategy and performance provide even tighter evidence that non-financial aspects are crucial to define the activity of venture capital. Venture-backed firms are found to be faster in developing their products and in bringing them to the market (Hellmann and Puri (2000))–an important advantage in technology markets, where timing is essential to achieve market leadership. This implies that venture capitalists provide dynamic companies with money but also with support and monitoring of their management. Venture-backed companies are in fact found to pursue more radical and ambitious product or process innovations than other companies (Hellmann and Puri (2000)). Venture capitalists also play an important role in the professionalization of the firms they invest in, for example by helping them hire experienced financial and marketing
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executives and by firing under-performing chief executive officers (Hellmann and Puri (2002)). Very importantly, venture-backed companies produce more, and more valuable, patents than non venture-backed firms (Kortum and Lerner (2000)).2 Venture capitalists also shield companies from the need to rush to markets, thus prematurely disclosing strategic information to competitors. They also allow firms to go public only when market conditions are most favorable (Lerner (1994a)).
Box 2: The stages and roles of venture capital financing Seed finance: Small investment, in the order of a few hundred thousand euros at most, which allows an entrepreneur to verify whether his project is feasible and economically attractive. At this stage the venture capitalist helps explore the viability of a project. Start-up finance: Investment aimed at making a firm operational by attracting the necessary employees and executives, developing a prototype and/or implementing marketing tests. At this stage the venture capitalist may become involved in the organization of the company. His contribution to shaping corporate strategy is felt most heavily at this stage. Expansion finance: Investment aimed at reaching the scale of industrial production, upgrading the production facilities and attracting further employees. At this stage the venture capitalist may help find additional financing and help the company contact clients and suppliers. As the company grows and needs revenue, he may also help recruit marketing and other non-technical executives. Later stage finance: Investment aimed at helping the firm grow fast enough to become a market leader and unleash its earning potential and to make it ready for a trade sale or for listing on a stock exchange. At this stage the venture capitalist may help set the stage for either a trade sale or an Initial Public Offering.
2
Venture capitalists also play an important role in the process of going public. Their experience helps companies choose the most favorable time for their IPOs (Lerner (1994a)) and experience lower underpricing (Megginson and Weiss (1991)). Venture-backed companies which went public in the US in the 1970s and 1980s are also found to perform better than non venture-backed companies over five years spells (Brav and Gompers (1997)).
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2.3.2
Venture capital as a package of services
Why should the ’hard’ and ’soft’ sides of venture capital coexist under the same roof? In ’standard’ economic conditions straight debt contracts provide the optimal form of financing (Gale and Hellwig (1985)), so that the separation of financing and mentoring would also be optimal. However, technological start-ups are not ’standard’ borrowers. A start-up relies on the talent and skills of its founder, who knows more about its technical aspects than anybody else. This makes it particularly difficult to evaluate her performance, and requires of the financier a technical and not purely financial expertise. Moreover, running a laboratory requires more freedom than operating a factory, so that an entrepreneur can more easily appropriate funds than a manager in an established firm. Finally, entrepreneurs can use privy information, like the status of technical tests, to pursue strategies which conflict with the interest of investors–like rushing to market to gain a reputation of first-comer at the cost of long-term profitability. Moreover, the very nature of entrepreneurship prevents start-ups and financiers to write ’complete’ contracts which specify all conceivable future contingencies (Hart and Moore (1998)). The right to control future strategic decisions is in fact even more important in determining success for start-ups than for mature firms. These characteristics of start-ups provide good economic reasons for the coexistence of the ’hard’ and ’soft’ sides of venture capital. Financial economists have produced several justifications for why the optimal contract between entrepreneur and venture capitalist should be different from debt. Optimal financing should not arrive all upfront but should be ’staged,’ coming once new milestones have been met, in order to reveal information on the venture as it arises (Admati and Pfleiderer (1994) and Bergemann and Hege (1998)). Financing of startups should also take the form of convertible securities in order to induce the entrepreneur to behave efficiently (Cornelli and Yosha (1998), Repullo and Suarez (1999)), and to allow financiers to take control of the venture if the entrepreneurs under-performs (Bergl¨of (1994). A key aspects of these models is that, unlike in standard financial contracting, both the entrepreneur’s effort and the venture capitalist’s mentoring and monitoring are not verifiable by a court, and therefore cannot be contracted upon. A start-up therefore creates a situation where both sides have special skills to contribute for which they experience a problem of moral hazard. This situation is fundamentally different from that of a bank loan, and in the context of start-up finance a standard debt contract simply does not work. A formalization of these results can be found in Casamatta (2000), who focuses on the complementary role of the hard and soft sides of venture capital, and in Hellmann (1998), who shows that the expertise of
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a venture capitalist in replacing an under-performing entrepreneur as CEO of his company is a necessary ingredient for convertible securities to entail an optimal allocation of control rights.
3
Venture capital in Europe: A statistical portrait
3.1
Venture capital in Europe and the US: A comparison
The first step in assessing the contribution of European venture capital to the creation of innovative companies requires a quantitative look at the state and structure of the European venture capital industry and at its evolution over time. Since the US venture capital industry is the most mature and developed, we use it as the term of comparison for European venture capital. We base our analysis on the aggregate statistics published by the European Private Equity and Venture Capital Association (EVCA) for Europe and by the National Venture Capital Association (NVCA). These data come from extensive surveys of venture capital firms in both economies. For Europe, EVCA distributes each year a survey to venture capital firms irrespective of their EVCA membership status in cooperation with PricewaterhouseCoopers. For 2000, the last available year, the number of respondents was 949, corresponding to a 70% response rate. The yearly statistics published by NVCA are based on the commercial database VentureXpert by Venture Economics, a division of Thomson Financial Securities, which contains data on over 5,000 American venture capital firms. Tables 1 through 6 and Figures 1 and 2 report our elaborations on these aggregate data for 1991-2000. There is much that one can learn from these data. Figure 1 shows the amount of funds raised by venture capital firms, and Table 1 provides a break-down of the sources of finance. The explosion in venture capital activity during the 1990s is apparent, but has been uneven. In the US, the amount of funds raised increased by a factor of 80. Figure 1 about here In Europe, only by a factor of twelve. What is intriguing is that the level of funding in Europe increased mostly after the opening of Euro.nm in 1997, which paved the way for the listing of high-tech start-ups. Whether this coincidence conceals a causal link or reflects broader changes cannot be told apart based on simple inspection of these figures, but it suggests a challenging research topic. Figure 1 also shows a widening gap in the amount of
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funds raised in the two economies (which we express in dollars for sake of comparability). The figure also shows that growth has been smoother in the US, whereas Europe has experienced several ups and downs. Venture capitalists finance their activity by raising ’funds’ from institutional investors like pension funds, insurance companies, or endowments. Each ’fund’ is invested in a number of firms with a five to ten years horizon. Once a ’fund’ is ended, its cash proceedings, which come from IPOs and trade sales, are distributed to investors together with any remaining equity holdings. Table 1 uncovers a substantial difference in the structure of venture capital funding across the Atlantic. Institutional investors (mainly pension funds) are by far the largest contributor in the US, accounting for nearly two thirds of all funds, as compared to less then one third in Europe. The stability of the share of institutional investing in the US is also worth pointing out as a sign of maturity of that market. European venture capital is instead dominated by funding from financial institutions (mainly banks), which still remain the largest source of funding. Funds controlled by a financial or corporate entity (’captive’ funds) are in fact more common this side of the Atlantic, where the share of corporate investment has doubled in the second half of the 1990s.3 The table also highlights the lower reliance of American venture firms on ’other’ sources (individual investors and realized capital gains), another sign of the maturity of that market. Government funding is virtually inexistent in the US, where publicly-funded Small Business Investment Companies are not considered venture firms, and it is low in Europe. These profound differences in funding patterns largely reflects the different structure of capital markets in the two economies. Europe is still dominated by banks, which control a large part of the mutual funds industry. Since also the nascent pension fund industry is likely to be controlled by banks, we should expect these differences to persist, and to influence the behaviour of venture capital firms.
3
The drop in the share of corporate funding in the US in 2000 is partly due to the shift from corporate funds to ’in-house’ corporate investing, which does not get recorded in NVCA statistics.
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Table 1. Venture capital: Sources of finance Europe Institutional Investors
Corporations
Financial
Government
Other
(%)
(%)
(%)
(%)
(%)
1991
15
5
48
2
30
1992
13
6
45
9
27
1993
16
5
40
6
33
1994
20
9
41
3
27
1995
29
5
36
3
27
1996
34
3
35
2
26
1997
26
11
42
2
19
1998
24
10
37
5
24
1999
23
10
43
5
19
2000
31
10
32
5
22
United States Institutional Investors
Corporations
Financial
Government
Other
(%)
(%)
(%)
(%)
(%)
1991
76
5
6
-
13
1992
67
4
17
-
12
1993
73
8
12
-
7
1994
69
9
10
-
12
1995
59
5
20
-
16
1996
70
20
3
-
7
1997
56
25
6
-
13
1998
66
12
10
-
12
1999
61
14
16
-
9
2000
61
4
23
-
12
Notes: Institutional investors includes endowments and pension funds, corporations include investments by corporations (including corporate venture capital through dedicated funds), financial institutions includes banks, insurance companies, and funds raised from capital markets, other includes individuals and realized capital gains. European data in millions of euros (ECUs before 1999) and US data in millions of dollars. Source: Authors’ calculations on EVCA and NVCA data.
14
Taken at face value, the aggregate funding data shown in Figure 1 would suggest that in the second half of the decade Europe has seen an impressive growth in the amount of funds raised, which increased nearly twelve-fold between 1995 and 2000 after remaining stagnant in the first half of the decade. Unfortunately, this is not the case. Figure 2 and Table 2 tell us why. The problem is that aggregate data for funding comprise two very different types of data. They include funds raised for venture capital, but also funds raised by firms which specialize in management buy-outs (MBOs). These are financing operations which enable management to acquire (’buy out’) an existing business from its original owners. MBOs typically involve established companies in mature industries, and are therefore quite distinct to venture capital, which is directed to new ventures.4 Figure 2 about here That the resulting bias is serious is shown by Figure 2, which plots the amount of funds invested each year. Aggregate data on investments separate between funds which go into venture capital proper and into MBOs.5 Once we compare the amount of funds raised with that of funds invested into venture capital proper, we see that the performance of Europe is less thrilling than suggested by Figure 1: The growth of funds invested in venture capital between 1995 and 2000 has been near six-fold, a mere fourth of that experienced in the US. A similar results holds if we look at the whole decade, since its early years saw sluggish growth in both economies. Despite the rise of venture capital activity, the gap between Europe and the US has actually widened, and at an increasing pace. Table 2 reveals that European venture capital invests an increasing share of its funds at ’early stage,’ which are those where its contribution is expected to be most significant, though the monetary amount invested in early stage in Europe is about a fifth of what is invested in the United States. In Europe, the share of early stage financing has more than doubled between 1997 and 2000, and since 1999 it has been greater than in the US. Again, though one is intrigued by the coincidence of the opening of Euro.nm and the increase in this riskier type of investments, a causal can only be conjectured at this stage. In both countries the majority of funds goes to expansion investments. These go to companies which have 4
EVCA started separating the amount of funds raised for these two purposes only in 1999. It should be noticed that the amount of funds raised and invested each year may diverge, since venture capital firms invest the money they raise over a three to five year time span. Therefore they may accumulate resources when good investment opportunities are scarce, and invest more when good projects abound. For instance, US venture capital firms raised 29.1 billion dollars in 1998, but invested only 19.2 of them, whereas in 2000 they invested about 8 billions more than they raised. 5
15
survived the perilous early years and have shown good success prospects. As for funding, the higher variability of investment patterns in Europe can be taken as a sign of immaturity of the industry, which still has to find a stable structure.
Table 2. Venture capital investments, by stage Europe Total
of which in VC
(Early stage %)
(Expansion %)
(Later stage %)
1991
6,381
3,429
10
80
10
1992
6,354
3,828
10
76
14
1993
4,639
2,794
8
78
14
1994
6,635
3,707
10
75
14
1995
7,370
3,952
11
77
12
1996
8,389
4,652
12
71
18
1997
8,992
5,388
15
70
15
1998
15,662
7,636
23
62
15
1999
25,628
12,623
27
64
9
2000
33,177
19,516
32
63
5
(Early stage %)
(Expansion %)
(Later stage %)
United States Total
of which in VC
1991
2,464
2,257
32
47
21
1992
5,059
3,759
25
43
32
1993
4,919
4,560
40
36
24
1994
5,263
3,723
35
32
33
1995
5,471
4,810
40
38
22
1996
11,211
9,676
38
37
25
1997
17,213
14,931
26
47
27
1998
21,981
19,190
30
46
24
1999
59,372
54,111
24
53
23
2000
103,494
100,622
24
56
20
Notes: Data are in millions of current dollars. Early stage includes seed and start-up financing. Source: Authors’ calculations on EVCA and NVCA data.
The gap between Europe and the US is also evident from Table 3, which compares the amount invested in venture capital as a percentage of GDP in the US, in Europe, and in some
16
of its national economies. Two facts stand out. First, Europe invests a smaller share of its GDP into venture capital than the US, a difference which widened in 2000, reflecting the boom in venture capital investment on the western side of the Atlantic. The second striking fact is the large and persistent variability of venture capital intensity across European countries. One also notices that a higher venture capital intensity does not necessarily corresponds to a higher number of stock market listings. Countries like Sweden, Belgium or the Netherlands, with a high venture capital intensity, have very few companies listed on Euro.nm. One likely explanation is that many venture-backed companies from these countries list in the US on Nasdaq, or in their national ’traditional’ stock markets. For instance, 25 Dutch companies are listed on Nasdaq, 9 of which did so since 1997. One intriguing fact is that the opening of Euro.nm seems to have spurred also venture capital intensity at national level, albeit with some delay. Indeed, intensity increased more than sixfold in Germany since 1997, and nearly doubled in France since 1996, the year the Nouveau March´e opened. Not all countries experienced such an upsurge, though. Venture intensity in Italy and Belgium, for instance, has languished.
Table 3. Venture capital investments as a percentage of GDP
US
Europe
UK
Germany
France
Sweden
Italy
Belgium
Nether.
Spain
1990
0.05
0.01
0.11
0.04
0.06
0.02
0.02
0.04
0.07
0.02
1991
0.04
0.01
0.09
0.04
0.07
0.01
0.04
0.03
0.07
0.04
1992
0.06
0.01
0.08
0.03
0.06
0.01
0.04
0.08
0.06
0.03
1993
0.07
0.01
0.07
0.03
0.06
0.01
0.02
0.05
0.06
0.03
1994
0.05
0.04
0.09
0.03
0.06
0.05
0.02
0.05
0.09
0.02
1995
0.06
0.04
0.09
0.03
0.04
0.02
0.03
0.05
0.12
0.03
1996
0.12
0.05
0.09
0.03
0.06
0.11
0.04
0.05
0.13
0.04
1997
0.18
0.06
0.11
0.05
0.10
0.04
0.04
0.08
0.19
0.05
1998
0.21
0.09
0.16
0.07
0.07
0.06
0.06
0.10
0.24
0.05
1999
0.58
0.14
0.21
0.13
0.13
0.20
0.06
0.27
0.34
0.10
2000
0.78
0.17
0.38
0.30
0.10
0.21
0.07
0.10
0.80
0.08
Notes: Venture capital spending from EVCA and NVCA data. National GDP data from the International Financial Statistics of the IMF, GDP for Europe (EU-15) and for the US from the Monthly Bulletin of the OECD. Source: Authors’ calculations on EVCA and NVCA data.
17
Table 4 provides data on the sectoral distribution of venture capital investments.6 While differences in sectoral classifications make it difficult to closely compare EU and US patterns, some facts stand out. Most notably, manufacturing–which includes consumer and industrial products–plays a major role in Europe, but only a marginal role in the US. While this is partly due to the inclusion of MBOs in the European data, its lower propensity to high-tech investments is confirmed by the relevance of investments in agriculture and finance (’other’ in the table). The evolution of investment patterns is also telling. Europe is much less dynamic, and the relevance of investment in more advanced sectors has only begun in 1999. The US, instead, shows a more flexible investment attitude. For instance, the share of money put into biomedical companies has shrunk the last few years, which have seen a boom of computer investments, which include Internet-related companies.
6 Unfortunately data for Europe are inclusive of investments in MBOs, since a sectoral breakdown for venture investments is not published by EVCA. This may be one reason behind the predominance of investment in traditional sectors in Europe.
18
Table 4. Venture capital investment destination, by sector Europe Telecom
Computer
Manufacturing
Biomed
Electronics
Other
%
%
%
%
%
%
1991
2
6
56
6
3
27
1992
4
4
58
5
3
26
1993
1
6
59
6
4
24
1994
2
4
61
5
4
24
1995
5
7
56
8
4
20
1996
4
5
52
6
4
29
1997
6
7
51
7
5
24
1998
9
9
46
7
3
26
1999
12
11
50
7
2
18
2000
14
13
43
10
4
16
United States Telecom
Computer
Manufacturing
Biomed
Electronics
Other
%
%
%
%
%
%
1991
12
19
13
25
17
14
1992
21
12
8
22
10
27
1993
21
30
8
21
7
13
1994
17
18
9
23
10
23
1995
18
21
12
22
12
15
1996
15
27
9
20
7
22
1997
16
30
8
27
8
11
1998
16
36
8
17
11
12
1999
17
56
6
7
6
8
2000
17
58
7
6
8
4
Notes: European data in millions of euros (ECUs before 1999) and US data in millions of dollars. Biomed includes biotechnologies, medical technology and healthcare; Computer includes online and Internet start-ups; Manufacturing includes industrial products, consumer products, energy; Electronics includes computer hardware and semiconductors. Other includes agriculture and financial services. Source: Authors’ calculations on EVCA and NVCA data.
19
Table 5 shows another interesting difference between the structure of venture capital investments in the two economies. While Europe invests much less in venture capital than the United States, it supports a much larger number of companies, nearly twice as many. This means that the average amount invested per company is much smaller in Europe, where money is spread very thinly across companies.
Table 5. Venture capital backed companies US companies
EU Investments
EU companies
1991
1,088
5,615
n.a.
1992
1,294
5,088
n.a.
1993
1,150
4,422
n.a.
1994
1,191
4,459
n.a.
1995
1,325
3,891
n.a.
1996
2,002
4,081
n.a.
1997
2,697
5,044
3.967
1998
3,149
6,062
5,083
1999
3,969
9,470
7,335
2000
5,412
12,958
9,574
Notes: Data are counts of exits. Source: Authors’ calculations on EVCA and NVCA data.
An interesting way of looking at the evolution of the venture capital industry is also to consider the number of venture capital firms. A problem in this respect is that no standard definition or registry of venture capital exists. Therefore—unlike banks or brokers—one must resort to a subjective criterion to identify venture capitalists. What we did was to consider a venture capital firm as such if it belongs to EVCA, whose directories since 1990 are available.7 Based on this definition, Table 6 provides some interesting insights in the dynamics of the venture capital industry. The numerosity of venture firms confirms that Europe still has some way to go before boasting a venture capital industry as thick as in the US. The number of venture capital firms in Europe remains nearly half than in the US. It also interesting to notice that the high growth of the American industry has started at least 7
Despite contacting the major national venture capital associations, we could not obtain their pre-1999 directories.
20
in 1995, together with the growth wave in funding and investment. In Europe, instead, the number of venture capital firms almost doubled over just three years, raising again the question of what role the opening of Euro.nm might have played in this. Indeed, the five countries where a ‘new’ stock market opened accounted for almost half of the total growth in the number of EVCA members since 1997. Also the numerosity of venture capital firms is much greater in those countries with an active stock market for innovative firms. Italy is the only exception, with a small and less dynamic venture capital industry. Taken together with the difference in organizational structure (Jeng and Wells (2000)), funding sources and investment behavior, these numbers offer a picture of deep differences in the venture capital industries of the US and Europe. What might that mean for the financing of innovative companies is the object of the rest of this article.
Table 6. Venture capital firms, EU and US
US
EU
UK
Germany
France
Sweden
Italy
Belgium
Spain
Netherlands
1991
389
163
42
11
30
1
10
12
5
21
1992
397
161
38
15
29
2
12
11
6
20
1993
401
159
40
13
29
3
11
12
7
19
1994
400
162
42
15
27
5
11
14
8
17
1995
425
169
40
18
32
5
11
13
8
16
1996
460
176
42
20
31
4
13
13
8
18
1997
507
184
52
27
32
5
12
16
8
19
1998
547
210
61
36
33
7
12
17
10
25
1999
620
331
79
51
48
11
16
23
14
32
2000
693
424
90
75
59
22
19
30
17
33
Notes: Venture capital firms members of EVCA and NVCA. Source: Authors’ calculations on EVCA and NVCA data.
21
3.2
Venture capital in the winner’s circle: venture-backed companies on Europe’s ’new’ stock markets
Aggregate data provide an intriguing picture, but they raise more questions than they can answer. One is left with the impression that European venture capital has substantially developed over the last decade, but that it has also lost ground to the US industry in its ability to fund innovative start-ups. Aggregate data cannot tell us much about how effective European venture capital has become in nurturing fast-growing companies. Has the growth in the size of the industry corresponded to a growth in its ability to support the creation of innovative companies, or not? The only way to obtain a convincing answer is to turn to firm-level data. Here we face serious obstacles. While in the US commercial companies like VentureOne and Venture Economics have been gathering comprehensive and reliable data on venture partnerships and venture-backed firms since the 1970s, in Europe systematic data collection of this sort has begun only very recently. Therefore we cannot yet rely on adequate data for in-depth empirical inquiries. A number of studies conducted for industry associations portrait venture capital as conducive to job creation and to the growth of technologically oriented firms. Venture-backed firms are found to grow faster, create more jobs, and export more than established firms. For instance, between 1993 and 1997, British venture-backed companies increased employment by an yearly 24%, and sales by an yearly 40%. By comparison, employment at the hundred largest British listed companies grew by 7%, and sales by 15% (BVCA (1999)). On a European scale, between 1991 and 1995, employment at venture-backed companies grew by an yearly 15% and sales by an yearly 35%, as compared to 2% and 14% for the 500 largest European listed firms (EVCA (1996)). Suggestive as they are, these studies are based on a few ’stylized facts’ which are still to be rigorously tested.8 At least two problems make their findings unconvincing. First, they suffer from severe survivorship bias, since they only look at successful start-ups without considering the much large number of those which failed. A correct comparison should look at both winners and losers, taking into account that small and medium enterprises (SMEs) suffer from a high mortality rate (OECD(1998)). The contribution of SMEs to economic growth or net job creation is in fact far from obviously positive, and has been recently 8
Stimulating case studies on the difficult gestation of European venture capital in the 1980s and 1990s are provided by Becker and Hellmann (2000) and by Freeman (1998).
22
challenged in a series of studies (see Audretsch and Thurik (1999)). Second, these studies compare venture-backed firms with large firms, which are, by their nature, less dynamic (Davis, Haltiwanger and Schuh (1996)). A correct comparison should instead pit venturebacked against non-venture-backed start-ups. These studies, therefore, are unable to separate the effects of venture capital financing from those of being a (naturally fast-growing) startup, and risk to capture effects due to a spurious correlation between being a start-up and receiving venture capital. In other words, it could very well be that the purported vitality of European venture-backed firms is due to factors other than venture capital. A deeper analysis is therefore warranted, and our paper provides a first attempt in this direction. We do so by looking at the involvement of venture capital with companies which listed on Euro.nm between 1997 and 2000. Looking only at companies which make it to the stock market has the obvious limitation of disregarding what happens to those which are still private, or choose to remain so. However, in our case this limitation should not be too much of a concern. Start-ups which go public are arguably among the most successful ones, since the pecuniary and reputational rewards for founders and financiers are highest in this case. Founders can get a much higher valuation with a flotation than with an acquisition or a private placement. The ability to bring companies public is one of the key abilities venture capitalists boast about with institutional investors, since IPOs are the most lucrative exit from a venture investment, on average four or five times more profitable than acquisitions (Gompers and Lerner (1997)). Since venture capitalists are profit-seeking organizations we would expect them to bring as many of their portfolio companies public as possible, and since they crucially rely on reputation for their business, we would also expect them to select the most promising firms as investees. Therefore we might over-estimate the impact of venture capital on corporate growth by looking only at listed companies, a possibility we will return to in the interpretation of the data. An advantage of looking at Euro.nm listed companies is that they belong to a small number of high-tech industries, are of fairly similar age, and come from a small number of countries. This makes them a relatively homogeneous group of ’venturable’ companies where we naturally find a reliable control sample, avoiding sample design problems. Focusing on Euro.nm listed companies also gives the advantage of obtaining detailed information thanks to the tight disclosure requirements of Euro.nm, which makes companies disclose information not only for the years starting with the IPO, but also for the three pre-IPO years. Such breadth and depth of information can not be attained for private firms.
23
3.2.1
Euro.nm: Europe’s ’new’ stock markets
Euro.nm was created in the spring of 1997 as an alliance of the newly born ’new stock markets’ of the stock exchanges of Amsterdam (Nieuwe Markt), Brussels (Euro.nm Brussels), Frankfurt (Neuer Markt), and Paris (Nouveau March´e, which had opened in March 1996). In June 1999, Milan’s Nuovo Mercato completed the ranks of the alliance. The stated purpose of Euro.nm was to attract dynamic, innovative companies with high growth potential by offering them suitable admission and trading rules, along the lines of what Nasdaq does in the US (Euro.nm (1999)). Euro.nm offered admission criteria and listing requirements appropriate for young companies with bright prospects but no established track record, willing to accept tight disclosure rules in order to attract investors (see Box 3). Box 3: Euro.nm admission and listing criteria • Shareholder equity (pre-IPO): at least 1.5 million euros • Age: at least three years (waiveable) • IPO volume: at least 5 million euros and 100,000 shares. At least half of the IPO volume must come from a capital increase
• IPO prospectus according to international standards • Lock-up: existing shareholders must lock-up their holdings for at least 12 months after the IPO (6 months on the Neuer Markt)
• Free float: at least 20% of the nominal capital must be floated • Only ordinary shares with no restrictions to negotiability can be floated • At least one sponsor (an investment bank regulated by the stock exchange) must be designated by the firm to coordinate the listing process
• Timely release of annual and quarterly reports and of price sensitive information
The listing rules of Euro.nm were less restrictive than those in use for ’traditional’ exchanges, and thus more appropriate for dynamic new ventures. However, listing on Euro.nm was more demanding than listing on a traditional exchange in terms of disclosure require-
24
ments. The Neuer Markt, which adopted the strictest rules, required prospectuses and annual reports to be published also in English, acceptance of the German Takeover Code, and compliance with international accounting standards (IAS or US-GAAP). Euro.nm closed in December 2000 after the merger of the Paris, Amsterdam, and Brussels stock exchanges into Euronext, but its constituent markets have continued their activity independently. In Bottazzi and Da Rin (2001) we analyse the evolution of Euro.nm and provide an assessment of its contribution to the financing of European innovative firms. Tables 7 and 8 provide an overview of the structure and evolution of Euro.nm in terms of total number of listings and funds raised.
Table 7. Euro.nm summary statistics
Number of IPOs (of which in the data set) Total capital raised Capital raised at IPO
Nouveau
Neuer
Nieuwe
Euro.NM
Nuovo
Euro.nm
March´e
Markt
Markt
Brussels
Mercato
567
165
333
15
15
39
(511)
(157)
(306)
(6)
(6)
(36)
41,618
7,986
26,673
470
225
4,633
29.4
10.1
38.2
5.7
8.1
44.0
Notes: The number of IPOs includes 16 financial companies which we exclude from our data set. Capital raised in millions of euros. Capital raised at IPO: median values. Source: Authors’ calculations.
More than half of the IPOs occurred on the Neuer Markt, almost a third on the Nouveau March´e, while the Nuovo Mercato attracted almost as many companies as the Neuer Markt in its first eighteen months. Our sample closely replicates the market composition of the population, apart for the two smaller markets–which are under-represented. Notice that the Neuer Markt accounts for a larger share of capital raised than of listed companies. Therefore, the (median) amount of capital raised at IPO is far larger on the Neuer Markt than elsewhere.9 Table 8 summarises the evolution of IPOs on Euro.nm. It is worth noticing that IPOs on the Belgian and Dutch markets has tapered off with time, and that the Neuer Markt shows a robust and uninterrupted growth pattern, unlike the uneven growth of the Nouveau March´e.
9
The large amount of capital raised on the Nuovo Mercato is due to a small number of very large telecom companies.
25
Table 8. Number of IPOs on Euro.nm Nouveau
Neuer
Nieuwe
Euro.NM
Nuovo
Euro.nm
March´e
Markt
Markt
Brussels
Mercato
1996
18
18
—
—
—
—
1997
44
20
17
5
2
—
1998
103
43
46
8
6
—
1999
182
32
138
1
5
6
2000
220
52
132
1
2
33
Total
567
165
333
15
15
39
Source: Authors’ calculations.
3.2.2
The data set
We develop a unique, hand collected data set with information from the listing prospectuses and annual reports of companies which went public on Euro.nm since its inception to December 2000. We obtained the listing prospectuses and annual reports in several ways. Whenever possible, we downloaded electronic copies from the company (or stock exchange) web site. For prospectuses which were not electronically available, which was often the case for earlier years, we contacted the issuing company by phone, fax, or e-mail. In some cases we photocopied the documents at the relevant stock exchange. Overall, we collected 527 prospectuses out of 567 IPOs which took place in the sample period, or 92% of the total. We also collected 1,790 annual reports, about 94% of the total. Listing prospectuses are valuable for studying the role of venture capital in innovative companies because they contain detailed information on the financial and business situation of the company. Such information is not confined to the IPO year, but extends back in time, up to the three previous years. We use prospectuses and annual reports also to derive quantitative information on several financial and business variables. For each company we collect all the available data for pre-IPO years from the issuing prospectus, which usually contains data for the preceding three years. We also collect data for all the available post-IPO years from annual reports. Each company in the data set is assigned to a sector through a procedure we describe in the Data Appendix, which also contains a detailed description of the data collection process and a list of the variables we use in this study and of their definition. Our final data set, which does not include sixteen companies in financial services, consists of
26
511 companies.10 Finally, we collect data about financing from venture capitalists and their involvement with these companies. We put particular care in extracting relevant information from our sources. This turned out to be an extremely time-consuming task which required careful search of each single prospectus and cross-checks with several other sources.11 The process of identification of venture capitalist was made particularly difficult by the fact that, unlike for banks, no standard identification criterion is available. We were able to collect data on the extent of ownership and on the timing of venture capital financing, while the exact amount of funding generally remains undisclosed. The details on the construction of the venture capital data set can be found in the Data Appendix. 3.2.3
Venture-backed companies on Euro.nm
The first question one wants to ask is what was the actual involvement of venture capital with companies listed on Euro.nm. The answer is that venture-backed companies constitute a substantial part of Europe’s new public companies: The first two rows of Table 9 show that nearly 40% of the listed companies were backed by at least one venture capitalist. This proportion is higher for companies listed on the Nouveau March´e than for those listed elsewhere. The proportion of listed companies which receive venture finance has doubled since the opening of Euro.nm, a trend which is most noticeable in Germany, a fact we will return to. Notice also that no company listed in Amsterdam or Brussels was backed by a venture capitalist. This is at odds with the numbers in Table 3, where these two countries were shown to have a relatively high venture capital intensity. One possible explanation is the long tradition of listing on Nasdaq of Dutch companies (Blass and Yafeh (2000)), which might be helped by venture capitalists to go through a more expensive listing in the more established American market. Ease of access to Nasdaq could also explain the overall dismal performance of the Nieuwe Markt. More difficult to explain is instead the lack of venturebacked companies on Euro.nm Belgium, and a Parisian dominance cannot be invoked: only one Belgian companies is found on the Nouveau March´e.
10
Companies in the financial services sector are not considered because their financial structure, funding requirements and strategic behavior differ substantially from those of industrial and (non-financial) services companies. 11 We are grateful to our research assistants for the enthusiasm they put in this demanding and tedious job.
27
Table 9. Venture capital and Euro.nm listed companies
Nouveau
Neuer
Nieuwe
Euro.NM
Nuovo
Euro.nm
March´e
Markt
Markt
Brussels
Mercato
Without VC
292
68
186
6
6
26
With VC
219
89
120
0
0
10
VC before Euro.nm
67
27
34
0
0
6
VC after Euro.nm
130
41
86
0
0
3
(VC entry date unknown)
22
21
0
0
0
1
Notes: With (without) VC identify companies which received (did not receive) venture capital financing. Before (after) Euro.nm identifies companies which received venture capital financing before (after) the opening of the ’new market’ they list on. The last row lists companies for which we could not ascertain the date of venture capital financing. Source: Authors’ calculations.
3.2.4
Venture capital and Euro.nm listed companies
We then want to know the extent to which European venture capital has been involved with listed companies. Table 10 documents that the involvement of European venture capitalists with Euro.nm has been substantial. We look at the number of venture capital firms financing companies listed on Euro.nm. In the second column we list the number of venture capitalists firms, and in the third those which also finance at least one listed company. The first row shows the total number of EVCA members, plus the members of the French, German, or Italian venture capital associations which are not also EVCA members. The other three rows show the number of national association members, which includes both EVCA members and members of the national association only. These constitute the largest sets of professional venture capitalists we could identify at the European or national level. Nearly one third of the ’core’ group of European venture capital firm was involved with companies which listed on Euro.nm. This represents a substantial involvement, given that about 70% of Europe’s venture capital firms have been members of EVCA since less than three years and therefore may not have had enough time to take investee companies to the stock market. The lower proportion recorded at the national level is due to the fact that a small number of venture capitalists with international reach (often US or UK based) finance a very large number of companies. These are European but not French, German, or Italian association members.
28
Table WA-2 in the Web Appendix shows that the sectoral composition of venture capital investments is very close to the sectoral structure of Euro.nm, except for a slightly lower involvement with Media & Entertainment and a higher involvement with Biomed.
Table 10. Venture capital firms and Euro.nm Venture capital
of which:
firms
financing a listed company
European
601
172
German
152
42
French
153
40
Italian
73
6
Notes: European venture capital firms are members of the European Venture Capital Association (EVCA) and of national venture capital associations. German, French and Italian venture capital firms are members of the respective national venture capital associations (and possibly also of EVCA). Source: Authors’ calculations.
Figure 3 examines the distribution of venture capital investments. It plots the number of venture capital firms which finance 1, 2-4, 5-9, or more than ten listed companies. Only 24 venture capitalists (out of 172) finance more than five companies, and only eight more than ten. This reflects the fact that many European venture capital firms are still very young, and have not had the time to get many companies public. Information in the Web Appendix shows that it is the larger venture capitalist with an international presence who tend to support the largest number of listed companies. Figure 3 about here Figure 4 looks at the other side of the coin, namely the number of venture capital investors by company. It shows that syndication of venture investments is not very common in Europe, unlike in the US (Lerner (1994b)): More than half of the 219 venture-backed companies only had one venture capitalist. Figure 4 about here Another way to look at the involvement of venture capitalists with listed companies is to look at their equity holdings, which we examine in Table 11. While fairly volatile, holdings are far from negligible. Moreover, these numbers are likely to under-estimate the involvement
29
of venture capital, since in many case ’bridge financing’ from specialised intermediaries is used in the wake of the IPO to increase the equity base. Venture capitalists often sell part of their stakes at this stage, but we are not able to see these transactions. The table also show that at the time of going public, venture capitalists sell only about 40% of their holdings, and remain involved with the company after it has gone public. As a comparison, Barry et al. (1990) find that US venture capital firms had a higher average pre-IPO equity stake (32%) and sold about a third of it. European venture capital thus seem to have lower shareholdings.
Table 11. Equity holdings by venture capital firms Pre-IPO
Post-IPO
Mean
St.Dev.
Min
Max
Mean
St.Dev.
Min
Max
Neuer Markt
10
17
0
100
6
9
0
43
Nouveau March´e
14
18
0
85
8
12
0
53
7
14
0
46
4
9
0
32
Nuovo Mercato Source: Authors’ calculations.
Our last piece of information comes from Table 12, which lists the nationality of venture capital firms and investee companies. Reported numbers are counts of investments by venture capital firms (row) in a certain country (column). One would expect venture capitalist to invest in firms geographically close to them, given their need for constant interaction with their investees. Several studies based on US data document the fact that venture capitalists tend to invest in the proximity of their headquarters (Lerner (1995)). The table confirms that this is the case for our sample, as the vast majority of investments is made within a venture capitalist’s own national borders, as one can see by looking at the diagonal in the table. The only seeming exception is represented by venture capital firms with an international reach, and American venture capitalists which invest in Europe. But this impression is deceptive, since both categories possess local offices in several countries.
30
Table 12. Venture capital and investee companies, by nationality Investee companies Venture Capitalists
Germany
France
Italy
Israel
US
Others
134
3
0
0
2
1
France
2
139
1
0
1
0
Italy
0
0
10
0
0
0
Israel
2
4
0
5
0
0
US
11
9
1
0
2
1
International
44
32
2
0
1
1
UK
5
9
2
0
0
0
Others
5
1
0
1
0
5
Germany
Notes: Others includes venture capitalists from Austria (5 investments), Denmark (1), Ireland (1), Netherlands (8), South Korea (1), Switzerland (5). Source: Authors’ calculations.
3.2.5
Which companies are venture-backed?
Before proceeding to the analysis of the effects of venture capital we want to know which characteristics of a firm are associated with receiving venture capital financing. Theory predicts venture capital to be associated with young, innovative companies that, being at an early stage of development, are characterised by low profitability and a small amount of sales.12 We have seen in Table 2 that European venture capitalists have been increasing their early stages investment. Therefore we expect our findings to conform to the predictions of the theory. We estimate a probit regression in which the dependent variable is a dummy variable that takes value one if a company has obtained venture capital financing. The independent variables are measured before the arrival of the first venture capitalist (’preVC’).13 Unfortunately we cannot use in this analysis all the companies in the data set, since there are some missing observations, and since 30 companies, i.e. 14% of the venture-backed 12 We are not aware of any statistical study of the determinants of venture financing for the US, except for Hellmann and Puri (2000), who look at a sample of venture-backed start-ups and find that those which pursue more radical innovations are more likely to attract venture capital. 13 For non venture-backed firms, we use the average of the pre-IPO values. We also experimented with alternative measures, such as measuring variables in the years before the average date of entry of venture capital in venture-backed companies, but we found no substantial difference in the results. Hence we stick to the simpler pre-IPO measure.
31
companies in our sample, have received venture capital funding before they started reporting accounting information. Still, this leaves us with 359 companies. Table 13 reports the probit regression results. We find that sales negatively affect the probability of obtaining venture capital financing, while leverage has a positive effect, although it is not statistically significant. We control for sectors of activity, but these are found to have no effect.
Table 13. Probit regression–dependent variable venture capital
Independent Variables Sales(preVC) Leverage(preVC)
Marginal increase
Log likelihood
z-statistic
in probability - 0.003
-0.01
0.117
0.34
1.482
-0.45
-1.131
Constant Number of obs.
Coefficient ***
-2.651
349 -184.82
W aldχ2 (7)
19.74
P-value
0.006
Notes: ‘preVC’ denotes variables measured before the arrival of a venture capitalist. Significance levels are indicated by * (10%), ** (5%), and *** (1%). Huber-White corrected standard errors are used to obtain robust estimates.
Our findings are consistent with a view of venture capital getting involved with firms which are still at a very initial stage of development and are therefore not yet able to sell: A marginal increase in sales decreases the likelihood of receiving venture financing by 0.3%, an economically small but statistically highly significant result. The positive effect of leverage is consistent with a view of venture capital as an important source of financing. In other words, the ’hard’ side of venture capital goes well along its ’soft’ side. Alternative (unreported) specifications have considered the level of debt, its maturity, the amount of assets and a national market effect as possible determinants of venture financing.14 We have done so to check if companies whose debt is mostly short-term might be more credit 14
The national effect is measured through dummies which take value one for companies listed in France, Belgium, Italy, and the Netherlands. As in all other regressions, the latter three never turn out to be significant, also due the low number of observations.
32
constrained and might therefore look more aggressively for venture financing. A dummy that takes care of the national effect was also used to capture the higher proportion of French venture-backed companies. All these variables turn out to be statistically insignificant, and in all specifications the quality of the fit worsens. We also expect venture capital to be involved with more highly innovative companies. To check for this prediction we control for the natural proxy for innovativeness, R&D intensity, measured as the ratio of R&D to assets.15 This reduces the number of observations to 101, since few companies disclose R&D expenditure. The reported R&D figures are however reliable, since they are voluntarily disclosed in the IPO prospectuses as a signal of the company’s quality and are not a legally required item of the accounts. All the tables with the results of our statistical analysis where we control for R&D can be found in the Web Appendix. We find that a higher R&D intensity makes a company less likely to receive venture capital financing (see Table WA-4 in the Web Appendix), but the result is not statistically significant. The amount of sales remains the driving force behind obtaining venture financing, and industry controls are all significant.16
3.3
The impact of Euro.nm on venture capital
We conclude our statistical portrait of venture capital in Europe by taking a dynamic view of its involvement with the ’new’ stock markets. A close inspection of the listing data reveals in fact that something is changing in the involvement of venture capital with listed companies. We have seen in Table 6 that venture firms are growing fast in Europe. This is good news, for at least two reasons. One is that numerosity is a sign of maturity. The second is that a large part of Europe’s venture capitalist are what the jargon defines ’captives,’ i.e. subsidiaries of industrial companies or financial institutions (typically banks). Captives are not the most aggressive among venture capitalists (Hellmann, Lindsey and Puri (1999)). An important change seems however to be taking place, with a new breed of US-style, independent, venture capital firms entering the market and possibly changing the way venture capital operates in Europe. Table 9 above shows a suggestive piece of information in this respect. Of the 197 venture15
Our results do not vary if we control for R&D expenditure. The finding that R&D has a negative (albeit statistically weak) effect is only apparently at odds with the theory, however, since we are measuring variables before the arrival of the venture capitalist. The result is in fact consistent with venture capital selecting companies at an early stage of development, when R&D intensity is still low. However, one could conceivably think of alternative interpretations, for example that companies whose R&D intensity is higher are less credit constrained and therefore less likely to look for venture financing. 16
33
backed firms in our sample for which we could identify the entry date of a venture capitalist, two thirds received venture financing after the opening of Euro.nm. Interestingly, this proportion is higher in Germany, whose Neuer Markt is considered the most dynamic of the ’new’ markets. Table 14 provides further evidence that Euro.nm may really be having an effect on the European venture capital industry. Here we define a start-up as venture-backed (’VC-backed’) if it receives venture finances within six months from its foundation. These are arguably the companies where a venture capitalist has most chances to use its ’soft’ side: It is much easier to affect strategy and management in a new firm than in a five years old one. There are 50 VC-backed start-ups, which we divide into those which were born before the opening of Euro.nm (pre-Euro.nm, 20 companies) and those which were born after it (post-Euro.nm, 30 companies). The number of VC-backed start-ups clearly increases after the opening of Euro.nm. We take this evidence as a suggestive indication of the positive effect of Euro.nm on venture capital. We also notice differences across markets, as the positive effect seems to be much stronger in France than in Germany or Italy. No venture-backed companies are listed in Amsterdam and Brussels.
Table 14. Cohorts of venture-backed companies Born VC-backed Total Neuer Markt
pre-Euro.nm
post-Euro.nm
120
31
16
15
Nouveau March´e
89
18
3
15
Nuovo Mercato
10
1
1
0
Source: Authors’ calculations.
Table 15 further refines this evidence. We count all venture-backed start-ups and partition them by the year of listing on Euro.nm. The relative figures can be read in the second column of the table. Then, in the third column, we count those venture-backed companies which were also born such. This way we can measure how many companies were created with the help of a venture capitalist. Several things are worth noticing. First, the number of venture-backed start-ups, whether born such or not, increases over time. In particular, the number of born venture-backed start-ups more than doubles each year. Moreover, the proportion of venturebacked companies which are born such doubles in 2000. Our data set also shows that six of the 28 companies which were born venture-backed in 2000 had a ’young’ venture capitalist,
34
i.e. one which had become a member of EVCA at most two years earlier. Between 1996 and 1999 only two such cases had occurred. Overall, these figures suggest a picture of increasing involvement of European venture capitalists with companies which have the potential to list, and an increasing importance of venture capitalists in the creation of innovative start-ups.
Table 15. Euro.nm and new venture-backed companies VC-backed
born VC-backed
1996
7
1
1997
12
3
1998
35
6
1999
72
12
2000
93
28
Total
219
50
Source: Authors’ calculations.
There are good reasons to greet this evidence with optimism and hope. Several studies have recently analyzed the relationship between venture capital and stock markets. Black and Gilson (1998), for instance, offer a conceptual framework for analyzing the interplay between venture capital and capital markets, while Michelacci and Suarez (2000) develop an elegant formalization of the link between business creation and equity markets. Both studies emphasise the complementary role of stock exchanges and venture capital. In this view, venture capital and stock exchanges are more than simple sources of finance. Venture capital contributes effective oversight of new ventures, selecting and supporting valiant entrepreneurs and promising new ventures. Such support facilitates the growth of these ventures and accelerates their arrival to equity markets. In turn, active and liquid stock markets make IPOs affordable for companies and attractive for investors, creating a complementarity similar to that modeled by Pagano (1993). The American experience with Nasdaq, which was created in 1971 to provide an equity market for high-tech companies, is certainly suggestive in this respect. Over the 1990s about 6,500 companies listed on Nasdaq, the American stock exchange focussed on high-technology industries which in December 2000 listed over 6,000 companies with a capitalization above five billion dollars. Many of these companies had been backed by venture capital, among them successful ones such as Amazon, Cisco Systems, Dell Computers, Intel, Microsoft, and Yahoo!. The evidence we provide in this paper will show that for Europe this road is still very long, but we are probably moving in the right direction.
35
4
Venture capital and the financing of European innovative companies
We now turn to the core of our analysis. Our goal is to provide a rigorous assessment of whether European venture capital helps select and nurture the most dynamic innovative companies, so as to provide guidance for informed policy. In Section 2.3 we have seen that venture capital is expected to provide valuable support to investee companies, and that it is indeed found to do so in the US. Does European venture capital also provide the companies it finances with ’hard’ and ’soft’ support able to make them the ’superstars’ among innovators?
4.1
Null and Alternative Hypotheses
We start by setting forth our conjectures on the effects of venture capital financing on the following key aspects of corporate evolution: • The timing of the listing decision. This decision is a crucial one in the life of an innovative company. Going public helps future growth and financially rewards financiers
and founders. Our first null hypothesis is that venture capital does not play any role on the process of going public, i.e. that venture capital neither speeds up nor slows down the IPO process. There are at least two alternative hypotheses. The first is that venture capitalists speed up the decision to go public. This would be the case if venture capitalists invested to reap a capital gain and therefore push for a quick IPO to cash in and turn to new ventures, or if they enabled companies to mature faster. NVCA (1988) indeed claims that, between 1992 and 1996, US venture-backed companies were 70% more likely to become listed than other start-ups. Alternatively, venture capital might lengthen time-to-listing (TTL) because it invests in younger firms and waits for them to mature. In this case a venture capitalist, by ensuring adequate financing, would bring a company public only when its potential has been fully brought out, or when the cycle in the IPO market may ensure a high valuation of the company. • The amount of funds raised at IPO. The amount of capital raised is important to deter-
mine the amount of resources a growth-oriented company can rely on for its investments. Our second null hypothesis is that venture capital does not affect the amount raised at
IPO. There are at least two alternative hypotheses. First, ’certification’ from a venture capitalist may reassure investors even when financial results do not still reflect the full potential of the company. In this case venture capital would increase the amount raised,
36
which would also be the case were venture capitalists patient enough to wait for a ’hot’ IPO market. But if venture capital ’pushed’ firms to the market, its eagerness to exit quickly could be detrimental for the amount of funds raised, both because investors would be suspicious of venture-backed companies and because the IPO might happen during a ’cold’ market. • The post-IPO corporate growth, measured by sales and employees. Our third null hy-
pothesis postulates that the post-IPO growth of a listed company is ’venture capital neutral,’ i.e. that is there is no relation between the post-IPO growth and the presence of a venture capitalist. Venture capitalists might indeed be attracted by the innovativeness of a firms, which could be unrelated to employment or sales. We take the IPO as a turning point in the life of these companies, because it provides them with the financial
resources necessary to fully unfold their business potential. Again we have some plausible alternative hypotheses. The first alternative is that venture capital favors sales and employment growth through its ability to connect the firm with potential clients and suppliers and to attract addition funding. NVCA (1998) claims that US venturebacked companies created jobs at a 55% faster pace than other start-ups between 1992 and 1996, and Brav and Gompers (1997) find them to yield higher stock returns in the five years after listing. If that were indeed the case we would have a very nice piece of evidence to support the presumption of a positive macroeconomic effect of venture capital. An opposite alternative would see venture capital as detrimental to growth if its main goal is to realize a ’quick and dirty’ capital gain at IPO and then leave the company to its own fate.
4.2
Evidence on the timing of the IPO
In this section we test the effect of venture capital on a crucial strategic decisions of Euro.nm listed companies: When to go public. To explore this issue we compute a variable, time-tolisting (TTL), defined as the amount of time elapsed from a company’s foundation to the date of its IPO. For companies born before the creation of Euro.nm we must take into account that they could not access stock markets until Euro.nm was open. For these companies, that represent 80% of our sample, we compute TTL as the difference between the calendar date at which a company went public and the date at which the ’new’ market it lists on was created, a date which differs across countries. The model we test can be written as: TTL = f(leverage, ROA, age, venture capital)
37
where we measure financial variables at IPO and control for country and sector of activity. We use a parsimonious semi-parametric model for the analysis of the timing of that decision, i.e. a Cox proportional hazard model (see Kiefer (1988)), which we can write as: n 0 o h(t) = h0 (t) exp β X
where h(t) is the hazard rate that measures the risk of the event ’go public’ happening at every instant, which depends on some independent variables Xi , while h0 (t), the ’baseline’ hazard function, measures the risk of going public were all Xi equal to zero. The Cox proportional hazard model has the notable advantage of not imposing any restriction on the baseline hazard rate h0 (t) in providing estimates of the coefficients β, since we are interested in estimating the hazard ratio. Let us define the ’risk set’ Ri as the set of firms which may decide to go public at time ti . The hazard ratio is the probability that firm i goes public at time ti , conditional on the same firm being in the risk set at ti :
P
n 0 o exp β Xi
j∈Ri
exp {β 0 Xj }
If all firms were the same, the hazard ratio would be equal to the number of firms gone public in an interval of time divided by the number of firms who were at risk of going public in the same period. Firms, however, are not the same. They differ with respect to the explanatory variables Xi which affect the probability of going public. If a unit increase of an independent variable affects the hazard ratio by increasing its value above one, we infer that the effect of the variable is to increase the probability, or risk, of the event ’go public’ on Euro.nm. Table 16 reports the hazard ratio estimates, which are obtained using robust standard errors. We look at the effect of venture capital, controlling for the return on asset (ROA) and for leverage, both measured at IPO, for sectors of activity, and for country dummies. As in the other regressions, we also try a different specification which uses the venture capitalists’ shareholdings size as a measure of their influence. Since in all cases we find no significant difference in the results obtained, we report the simpler dummy specification. Finally, we control for age at IPO since this variable might introduce a bias as firms differs in their stage of maturity at the time of the creation of Euro.nm. In other words, older firm may be readier for going public than newborns. We take care of this possibility by controlling for the age of the firms at the creation of the ’new markets’ through a variable which interacts the company’s age with the calendar year of its listing.
38
Venture capital turns out to have little effect on TTL: The hazard ratio is 1.05, meaning that venture capital increases TTL, but it is not significant. Also ROA and leverage do not significantly affect TTL. The age of the company at the creation of the ’new markets’ is instead always statistically significant, but it leaves the hazard ratio virtually unchanged. Companies listed on the Nouveau March´e have a TTL which is about 60% longer than elsewhere. Finally, companies in all sectors of activity, except the traditional one, have a hazard ratio which is close to 0.3 and highly significant.
Table 16. Cox regression–dependent variable time—to—listing Independent variables
Hazard ratio
t-statistic
Venture capital
1.05
0.61
Leverage(atIPO)
0.89
-0.48
ROA(atIPO)
1.00
0.18
France
0.36
***
-8.71
Age*97
1.00
***
7.32
Age*98
1.01
***
8.24
Age*99
1.00
*
1.60
Age*100
0.99
***
Number of obs.
488
Log likelihood
-6.37
-2,460.57
W aldχ2 (13)
233.67
P-value
0.00
Notes: All variables are measured at IPO. Age times year is the age of the company interacted with a dummy for year of listing. Significance levels are indicated by * (10%), ** (5%), and *** (1%). Huber-White corrected standard errors are used to obtain robust estimates.
When we control for R&D expenditure as a way to focus on the most innovative companies in our sample, we confirm these results, except that now venture financing increases TTL, albeit still without statistical significance, casting some doubts on the robustness of our previous estimates (see Table WA-5 in the Web Appendix).
4.3
Evidence on the amount of funds raised
We know that an important role of venture capital is the provision of financing. Does this also imply that venture-backed companies are able to raise more money from the public markets?
39
To answer this question we collect information on the amount of funds that companies raise at IPO and we try to understand whether venture capital influences it. Table 17 reports the results from our regression, which employs robust standard errors. Given the high variability of our data we choose an estimation method that performs an initial screening and eliminates gross outliers and performs the regression iteratively, weighting the observations by absolute residuals.17 The dependent variable is the amount of funds raised. Given the high variation in firm size, which arguably influences how much capital a company can raise, we normalise it by dividing it by assets (measured at IPO). We use assets and not sales because the latter would be a poor measure of the size of these innovative companies, which still need time and money to invest to fully express their commercial potential. Sales, instead, may be a good measure of the extent to which an innovative company has matured. We then use sales (divided by assets) as a regressor, along with the presence of a venture capitalist, the return on asset (ROA), leverage, and age, all measured at the time of the IPO. As in the previous regressions we control for country and sectoral effects.
Table 17. Robust regression–dependent variable amount of funds raised over assets Independent variables
Coefficient
t-statistic
Venture capital
0.633
***
2.411
Sales/Assets
0.096
***
3.465
Leverage(atIPO)
1.399
*
1.787
ROA(atIPO)
1.627
***
32.389
Age
-0.004
***
-3.650
France
-1.799
***
-6.104
2.984
***
3.714
Constant Number of obs.
470
F (11, 458)
144.61
P-value
0.000
Notes: All variables measured at IPO. Significance levels are indicated by * (10%), ** (5%), and *** (1%). Huber-White corrected standard errors are used to obtain robust estimates. 17
The method is based on Cook’s D.
40
The results are interesting. Companies that have higher sales (over assets), and therefore are probably more mature, are able to raise a higher amount at IPO: An increase of 10% of sales (over assets) brings an additional 1% increase in the amount raised (over assets). A similar result holds for companies whose ROA and leverage are higher: A 10% increase in either of these ratios carries an increase of 16% and 14%, respectively, in the amount of funds raised (over assets). Companies listed on the Nouveau March`e are characterized by a markedly lower ability to raise funds–they raise about 180% less than other companies. Older companies also raise less capital, but only marginally so. Venture capital has a positive and significant role: venture-backed companies raise on average 60% more than the others, a result we will come back to. Sectors of activity are found to play no role. When we control for the R&D intensity some of the above results change (see Table WA-6 in the Web Appendix). Sales (over assets) become only marginally significant and lose much of their economic impact. Venture capital also becomes statistically insignificant, while the negative effect of age and of France persists. Overall, these results refuse our null hypotheses that venture capital has no influence on the dimension of the IPO, a results that is consistent with the idea that the ’hard’ side of venture capital is very important.
4.4
Evidence on corporate growth
We now examine how venture capital affects corporate growth. A first piece of evidence comes from a systematic comparison of how venture-backed and non venture-backed companies behave. Table 18 reports the results of two tests. A Wilcoxon test looks at the difference in the medians of several variables pre- and postIPO, where pre- and post-IPO are defined as the periods of (up to) three years before and after the IPO. We run this test for both venture-backed and non venture-backed companies. A Kruskal-Wallis sign-rank test looks instead at whether the medians of several variables differ in statistically significant manner between venture-backed and non venture-backed companies, within the pre- and the post-IPO periods. Table WA-3 in the Web Appendix reports descriptive statistics for all reported variables, so as to facilitate comparisons of ’pre’ and ’post’ values. Bold figures in Table 18 show, those median values which differ significantly across time and within the venture-backed and not venture-backed groups of companies. Underlined figures show instead, within the pre- and post-IPO periods, those median values which are statistically significantly different between the two types of company. Let’s concentrate first on how variables differ across time. Here we find that virtually all
41
variables vary significantly, with the only notable exception of profitability for venture-backed companies. This results confirms that listed companies do invest and grow substantially after the IPO, and that this does represent a turning point of their evolution. Things become more varied when we look at differences between venture-backed and non venture-backed companies. Before the IPO venture and non venture-backed companies do not differ systematically. We find statistically significant differences in three variables: profitability and sales, both of which are lower for venture-backed companies, and R&D intensity, which is instead higher (as one would expect from our probit estimate). After the IPO, non venture capital firms become significantly bigger in terms of assets, debt and equity, although both types of companies show the same level of leverage. We also find a systematic difference between venture-backed and non venture-backed companies in terms of sales (which we interpret as a sign of maturity), employees, capital expenditure, intangible assets–venture capital being linked to lower values.
42
Table 18. Venture capital and corporate growth
Assets Debt Equity EBITDA Leverage ROA Sales Employees Capex Foreign sales (%) Intangible assets R&D R&D intensity
Pre-IPO
Post-IPO
no VC
7.1
59.3
VC
6.2
42.8
no VC
4.7
18.1
VC
3.5
11.5
no VC
1.2
35.6
VC
0.9
24.5
no VC
0.8
3.2
VC
0.2
0.4
no VC
0.8
0.3
VC
0.8
0.3
no VC
0.11
0.07
VC
0.05
0.01
no VC
9.3
36.4
VC
5.6
22.9
no VC
77
210
VC
54
170
no VC
0.6
7.0
VC
0.4
4.9
no VC
0.01
0.00
VC
0.03
0.01
no VC
0.2
8.0
VC
0.2
4.0
no VC
0.8
3.3
VC
0.8
3.4
no VC
0.1
0.05
VC
0.2
0.06
Notes: For each variable we report the average of its median values for the (up to) three years before (Pre-IPO) or after (Post-IPO) the IPO. In the upper row we report the medians for non venture-backed companies (no VC), in the lower row those for venture-backed companies (VC). Bold values indicate a statistically significant (at 5% confidence level) difference of medians across time. Underlined values indicated statistically significant (at 5% confidence level) differences between venture-backed and non venture-backed companies. Source: Authors’ calculations.
43
Although the analysis of Table 18 is suggestive, it can not be considered conclusive. We need to control for other characteristics of the firms in order to ascertain the true impact of venture capital financing on corporate growth. We thus turn to a more formal analysis, where we look at the effect of venture backing on the growth of employment and sales after the IPO. The model we have in mind is very simple: the capacity of an innovative firm to grow is a positive function of its ability to invest, which can be financed either from revenues or from external finance (debt or equity). Age, an indicator of the stage of corporate development, is also relevant since we expect younger companies to grow faster. We therefore estimate the following model: employment (sales) growth = f(ROA, leverage, age, foreign sales, venture capital) and we control for country and sector of activity. As before, we adopt an estimation method which eliminates gross outliers and employs robust standard errors. Notice that we add a new dummy, whose value is one when a company declares in the IPO prospectus its willingness to expand the market for its products outside of the domestic domain. We believe the willingness to export to be a characteristics of more dynamic companies, since expanding beyond one’s natural realm requires the ability to sell truly innovative products and services. In Table 19 we report our results. The dependent variable is the growth of employment in the period of (up to) three years after the IPO. Note that the dimension of our data set decreases both because not all companies report employment data and because we cannot compute post-IPO employment growth for companies which went public in 2000. We are then left with 270 observations. The results confirm our intuition. Relatively older companies and those whose return on asset (ROA) and leverage are higher, increase their employment most. Leverage, in particular, is not only statistically but also economically significant: A 1% increase in leverage means a company creates 121 jobs in the post-IPO period. Companies listed on the Nouveau March´e experience a decrease of 51 units in employment, while the foreign sales dummy has a statistically insignificant effect. Venture capital plays no role, as it implies a slight decrease in employment, which is however statistically insignificant.18 Sectors of activity are also not significant. 18
In alternative, unreported, specifications we control for capital expenditure, the level of debt (relative to asset) and its maturity, but this worsens the statistical significance of individual variables and of the regression.
44
Table 19. Robust regression–dependent variable employment growth Independent variable
Coefficient
t-statistic
Venture capital
-8.93
-0.548
ROA(atIPO)
16.56
***
2.375
121.48
***
2.623
Leverage(atIPO) Foreign sales
10.58
Age
0.10
France
-51.47
Constant
50.35
Number of obs.
270
F (11, 258)
3.90
P-value
0.695 * ***
1.836 -2.602 1.055
0.000
Notes: All independent variables measured at the time of the IPO. Significance levels are indicated by * (10%), ** (5%), and *** (1%). Huber-White corrected standard errors are used to obtain robust estimates.
We then control for R&D expenditure (at IPO), as reported in Table WA-7 in the Web Appendix, where our sample almost halves. To avoid an issue of simultaneity and of reverse causality we control for R&D at IPO. Since R&D expenditure includes expenditure for labor in R&D it is highly plausible that the latter variable is significant in explaining employment growth. In fact this turns out to be the case: one million euros of additioinal R&D expenditure creates an additional 11 jobs. Leverage and the France dummy remain significant and retain (even increase) their size and sign, while ROA becomes insignificant. Interestingly, the foreign sales dummy now becomes statistically significant, and negative: for companies with high R&D expenditure the willingness to expand abroad is detrimental for employment growth. Again, venture capital does not seems to be relevant and retains its negative effect on job creation. We finally turn to the post-IPO sales growth. Table 20 reports our estimates, which are based on a sample of 316 companies. The results do not differ much from those for employment growth. Older companies with a high ROA and leverage experience a higher increase in sales: A 1% increase in ROA results in almost 8 millions of additional postIPO sales, and a similar increase in leverage creates 13 million euros of sales, albeit with scant statistical significance. The new result is that the intention to expand their product
45
market in foreign countries does contribute to sales: Export-oriente companies enjoy almost 7 million euros more of revenue than purely domestic players. French companies significantly grow less also in terms of sales: Their post-IPO turnover is almost 10 million euros lower than elsewhere. Venture capital financing remains ineffective: Venture-backed companies sell almost 5 less millions than others, but the result is marginally statistically significant. Sectors of activity continue to hold no effect.
Table 20. Robust regression–dependent variable sales growth Independent variables
Coefficient
t-statistic
-4.68
-1.542
Venture capital ROA(atIPO)
7.73
Leverage(atIPO)
***
13.19
5.603 1.508
Foreign sales
6.80
**
2.302
Age
0.03
***
2.676
-10.05
***
-2.768
France Constant
7.69
Number of obs.
316
F (11, 304)
6.63
P-value
0.870
0.000
Notes: All independent variables measured at the time of the IPO. Significance levels are indicated by * (10%), ** (5%), and *** (1%). Huber-White corrected standard errors are used to obtain robust estimates.
Controlling for R&D expenditure undertaken at IPO, we reduce the sample to 143 companies. Table WA-8 in the Web Appendix shows that R&D expenditure turns out to be relevant again: R&D performing companies enjoy 2 million euros of sales more than non performing ones. Age and leverage retain their positive effect on sales, while ROA and France become insignificant. The intriguing result is that venture capital does finally play a role: Venture-backed companies decrease their sales by almost 8 million euros after IPO. Before turning to an overall interpretation of these results and of their meaning for the role of European venture capital, we need to tackle some limitations of our analysis. Our results could indeed suffer from two possible selection biases, on both observable and unobservable variables. We thus turn to some robustness checks.
46
4.5
Robustness checks
In the previous sections we have tried to evaluate the impact of venture capital financing on the companies listed on Euro.nm. The ’evaluation problem’, as it is known in the econometric literature, is the problem of correctly measuring the effect of a ’cure’–such as a policy reform or a training program–on some variables (see Blundell and Costas Dias (2000)). The problem in evaluating a cure is that both observable and unobservable variables may be present, which might bias the estimates if not properly accounted for. In our case the correct approach to assess the effect of venture capital (the ’cure’) should look at certain companies and compare their reaction when they do and when they do not receive venture financing. Unfortunately this is not possible as our companies are either venture-backed or non venture-backed, and receiving venture capital is not a random event. The issue is then how to construct the right counterfactual. In the impossibility of obtaining experimental data, different methods of evaluation have been adopted by researchers. We consider two different methodologies. One approach is known as the matching method, and mainly addresses the issue of bias due to incorrect control for observable variables. The second approach is known as the difference in differences method, and it is particularly useful in removing unobservable individual effects and common macro effects. We thus re-evaluate the effect of venture capital assessing whether our previous estimates are subject to these biases. 4.5.1
The ’matching’ method
What we have tried to measure in our analysis is the effect of being venture-backed on sales and employment growth, on the amount raised at IPO, and on the time-to-listing. Denote any of these variables with Y . The analysis then entails measuring the average effect (τ ) of venture capital on venture-backed companies: i i /i V C) − E(Ynvc /iεV C) τ = E(Yvc
(1)
where the first element on the right hand side measures the expected value of vetnure capital on variable Y conditional on company i being venture-backed, while the second term measures the expected value of the same variable, were company i without venture capital. The problem is that this last term is not observable: It is impossible to see the characteristics of venturebacked companies in the absence of venture capital. In other words we lack a proper control sample. Being backed by venture capital is in fact not random, as we have observed when
47
we have estimated the probability of receiving venture financing. As a consequence, the assignment process to venture capital might be determined by (observable) variables (Xi ) that potentially affect the outcome Y as well. If that effect turned out to be important, our previous estimates might be biased and our conclusions flawed. To exploit the information we get about Y from non venture-backed companies, that act as our control sample, we assume that, conditional on Xi , the value of Y (time to listing (TTL), amount raised at IPO, sales or employment growth) and the fact of being venture-backed are independent. Under this assumption equation (1) can be re-written as:19 i i τ = E(Yvc /i V C, Xi ) − E(Ynvc /iεNV C, Xi )
(2)
We can now estimate equation (2) non parametrically. In order to correctly measure the effect of venture capital we need to estimate the two terms on the right hand side of equation (2), matching each venture-backed company with a non venture-backed company with the same characteristics Xi . In other words, we need to find a way to compare observations with similar Xi . Only in this case the different behavior of the two companies can be correctly attributed solely to the presence of venture capital. When Xi is high dimensional the estimation strategy may become unfeasible. Still, one can resort to matching companies not on the values of Xi but on a function of Xi . We do this through the ’propensity score’ method, which we illustrate in detail in the Web Appendix. We then proceed to estimate the average effect of being venture-backed, taking into account that by using the matching method we reduce the bias due to specification error but possibly at the cost of losing efficiency. In other words we could obtain estimates with a lower statistical significance. Table 21 reports the estimates obtained with this method for our four variables. The estimated values of τ provide measures of the effect of venture capital different from those we obtained in the previous sections. Venture capital is now found to slightly (but statistically significantly) increase TTL. As regards the average effect of venture capital on the amount raised at IPO the matching method suggests a negative effect, casting some doubts on the positive effect of venture capital which we found in Table 17. However, this method confirms our finding of a negative effect of venture financing on the post-IPO growth of sales and employment. The standard errors of amount raised, employment and sales growth (but not that ot TTL) in fact become considerably larger, but, as we observed, this is not surprising 19
This assumption is known in the literature as ’conditional independence.’
48
for this type of estimates. Overall, we conclude that the inference from our regression analysis may not be robust to possible specification biases with respect to observable variables in the case of TTL and amount raised. In the case of sales and employment growth, instead, we find reasons to remain confident on the robustness of our findings.
Table 21. Nonparametric stratification estimates: Average effect of venture capital τ Time-to-listing
0.42
Amount raised (over assets)
t-ratio ***
5.276
-10.19
0.639
Employment growth
-21.478
0.434
Sales growth
-36.678
0.513
Notes: Significance levels are indicated by * (10%), ** (5%), and *** (1%).
4.5.2
The ’difference in differences’ method
Another popular method of evaluation is called ’difference in differences’ (DID), and is helpful in addressing possible evaluation biases due to the effects of unobservable variables which could be driving the difference in behavior of the two groups we are trying to compare, venture-backed and non venture-backed companies. The name of the DID estimator comes indeed from the fact that it compares the difference in the average behavior before and after the IPO for the eligible group (venture-backed companies) with the behavior before and after the IPO of the control group (non venture-backed companies). Notice that we compare behaviour around the IPO since we need to pin down the effect of venture capital (the ’cure’) on how treated and untreated companies react to a common external shock (the IPO). We can apply the DID estimator only in the case of employment and sales growth, since time-to-listing and amount raised only occur at IPO. We indicate the estimator with θDID , which measures the growth of venture-backed in excess to that of non venture-backed companies. Abstracting from any regressor besides venture capital indicator, we write: C C θDID = (YtV1 C − YtV0 C ) − (YtNV − YtNV ) 1 0
49
(3)
where Y V C and Y N V C are the mean values of the variables for the venture-backed and the non venture-backed companies, respectively, and ta 0 and t1 represent the pre- and post-IPO periods. Under the assumptions of common time effects across groups and of no composition changes within each group, θDID measures the average effect of the IPO by removing the unobservable individual effects and common macro effects. In fact, by differentiating the mean value of Y inside the brackets we eliminate the common individual effect without affecting the common time effect, which can be eliminated by differentiating the two brackets. Table 22 shows the results of the DID estimator for the post-IPO growth in employment and sales for the two groups of companies. Our estimated effects confirm the sign of the coefficient of our previous estimates, as well as that of the stratification estimator, although both their value and their significance is now higher. There are two possible weaknesses of the DID estimator. One is due to the lack of control for unobservable (temporary) individual specific components that might influence the behavior of the two groups. The DID estimator might then over-estimate the effect of the cure. This is a possible an explanation of the higher values in Table 22 than in Table 21. A second weakness of the DID estimator is that the assumption of common macro effect across companies. If the two groups have some characteristics which distinguish them and make them react differently to the common shock, we may get inconsistent estimates.
Table 22. Difference in differences estimates: Average effect of venture capital θ Employment growth
-106.38
Sales growth
-127.18
t-statistic *
-1.84 -1.08
Notes: Significance levels are indicated by * (10%), ** (5%), and *** (1%).
4.6
Venture capital in Europe: An assessment
We are now able to provide an initial assessment of the role of venture capital in Europe, and of its ability to contribute to economic growth and job creation. We should consider several elements in turn. First, we have seen that European venture capital has grown substantially over the last few years. The amount of money invested in innovative companies and the number of venture
50
capital firms have increased fast. Wide differences remain across national economies, and the gap with the United States is far from closing, but the European venture capital industry is certainly expanding fast. This is hardly surprising, since the industry appears to be highly profitable: The internal rate of return for three year old investments was in 2000 a hefty 29.2%, and that for ten year old ones a remarkable 15.6%, according to the European Venture Capital Association (EVCA (2001)). Second, we have documented that the involvement of venture capital with companies listed on Europe’s ’new’ stock markets has become substantial, and might have started a virtuous circle whereby easier exit through an IPO encourages venture investments, which in turn nurture companies which can soon list and support the growth of stock markets. Intriguingly, we have seen that the number of venture-backed listed companies which were born with the financing of a venture capitalist increases year after year, as does its proportion over all venture-backed firms. Third, we have focused on the effect of venture capital on some of Europe’s most successful innovative firms, those which made it to list on one of the ’new’ markets. Here we can apply a more formal statistical analysis and sharpen our arguments. On the basis of the theoretical literature, and of empirical studies of US venture-backed firms, we have explored the effect of venture capital on the timing of the listing of investee companies, and on their ability to raise funds at IPO, to generate revenue, and to create jobs. Venture capital appears to yield uncertain influence on the timing of IPOs. We also find that it helps companies raise more capital at IPO, but this result does not seem robust to possible biases in the analysis. From this we conclude that the ability of venture capital to ease credit constraints in Europe is very important but still confined to the earlier stages of a firm’s life, when financing may be crucial for its very coming into existence. In fact, the number of venture-backed companies has more than doubled after the opening of Euro.nm, reaching almost 10,000. It is suggestive to compare this result with what Hellmann and Puri (2000) find for a sample of Silicon Valley firms. They argue that that the role of venture capital in front of less radically innovative companies is precisely the provision of funds at early stages, rather than speeding up their maturation. We also find that venture-backed companies do not generate more sales or create more new jobs than others. On the contrary, when we restrict our sample to the more innovative companies, those which perform R&D, the venture-backed ones appear to increase their sales less than the others. Robustness checks to detect possible biases in our analysis confirm that these findings are indeed robust, and that venture-backed companies are not the ’superstars’
51
among those listed on Europe’s ’new’ stock markets–at least in terms of sales and employment growth. While we cannot eliminate all reasonable doubts on the possibility of selection biases, the empirical evidence we uncover does support the idea that venture-backed listed companies are not systematically different from non venture-backed companies, and that they do not grow faster, either before or after the IPO. We interpret this finding as suggesting that the role of venture capital in Europe is somewhat different than in the United States. The provision of early stage financing, which has grown very fast in the past three years, seems to be crucial to allow innovative start-ups to overcome credit constraints, which are arguably tighter in the old continent. Whether the lack of a systematic association with the most successful innovative companies is due to the immaturity of European venture capital or to a lack of ’superstars’ among European firms we cannot say at this stage.20 A sensible objection to our interpretation is that the unselective high valuation of companies listed on Euro.nm might have masked the true value of being venture-backed. This is a fortunate time to look at this possibility, since stock valuation on Europe’s ’new’ stock markets have fallen sharply since mid 2000. One may conjecture that the true value of venture-backed companies would only show up once the market becomes more selective. While a thorough analysis of the determinants of valuation goes well beyond the scope of this paper, we can provide some telling information. Figure 5 plots a simple (unweighted) stock price index of all the companies in our sample, which we divide into venture-backed and non venture-backed ones. One can readily see that there has been no systematic under-valuation of venture-backed companies, and that the behaviour of the two indices is quite similar.21 Since our data go through June 2001, we consider it unlikely that extremely high valuations of high-tech companies in the late 1990s may have obscured the true value of being venture financed. On the contrary, this pattern appears at first sight in contrast to the results of Brav and Gompers (1997), who find that in the five years after going public venture-backed companies growth outperform similar non-venture-backed companies. 20
One should also consider that venture capital firms are (successful, it seems) profit-driven organizations, not public bodies. Hence, one may expect them to contribute to corporate growth and job creation only inasmuch as this make them richer. 21 Moreover, the standard deviation of the index of venture-backed companies is about one and a half times that of non venture-backed companies, i.e. the former are more volatile, suggesting more uncertainty on part of investors. A rank-sign test accepts the hypothesis of equality of the medians of the two series, but not of the variances.
52
Figure 5 about here Another possible objection to our interpretation is that main role of venture capital is to bring companies up to the levels required for listing, thus helping those which would not be able to qualify for an IPO without external help. In this case, the value of venture capital would result in high growth of investee companies after its arrival but before the IPO. Unfortunately, the nature of our data set prevents us to test directly for this possibility, since for the companies in our sample the time between the arrival of the venture capitalist and the IPO is too short to allow any statistical analysis.22 However, indirect evidence suggests that this conjecture may not hold to a closer scrutiny. First, the listing requirements of Euro.nm do not constitute a tight barrier, and are in fact far from binding for most of the companies which go public on Euro.nm. Second, the financial structure of listed companies varies widely, so that not even ’de facto’ minimum standards seem to characterize these IPOs (Bottazzi and Da Rin (2001). Finally, we find that firms which receive venture capital are characterised by a low level of sales (see Table 13), but also that the sales and earnings of venture-backed companies remain lower than those of non venture-backed firms in the three years before IPO (see Table 18). This would not be the case if the main task of venture capital were to bring investee companies to pass a hurdle or to reach the same performance of more aggressive competitors. While the nature of our data clearly makes it difficult to distill truly conclusive results, ours is clearly a piooneering attempt and we have to make do with available data. For instance, we cannot obvserve the instrinsic quality of investee companies, nor the actual behaviour of venture capitalits to assess if some of them may be more effective than others in nurturing innovative businesses. Still, we believe that we have constructed a solid interpretation of what venture capital is presently doing in Europe, and that this hard evidence may contribute to more informed policy decisions.
5
Conclusion
Venture capital is growing fast in Europe, and its influence on European entrepreneurial firms is increasingly important. Without financing from venture capital many of today’s most dynamic start-ups could have never come into existence, and a non negligible number of the companies which list on Europe’s ’new’ stock markets would probably never have made 22
The median time between the arrival of a venture capital and the IPO is only 16 months.
53
it. Venture capital is therefore understandably high on the policy agenda, both at EU and national levels. The presumption is that venture-backed firms are particularly dynamic, and able to create jobs and wealth. An effort to create suitable conditions for the development of this form of financial intermediation then seems warranted. We provide the first attempt at a rigorous assessment of this policy stance. We ask ourselves what role does venture capital really play in Europe. We find that the industry is expanding fast, but that the sums invested are growing less than in the US. Since venture capital plays a crucial role for the creation of innovative start-ups in a continent where capital markets are particularly unsupportive of non established businesses, the public concern for fostering the supply of funds to industry appears justified. However, studies for the US also suggest that it is probably the demand, rather than the supply of venture funds to be constraining the rise of the industry (see Gompers and Lerner (1998)). We then look beyond the supply side to the ability of European venture capital to deliver more than pure financing. Our results show that in Europe venture capital is not systematically associated with particularly dynamic companies, whether we look at sales growth, at new employment, or at stock market performance. The limitations of our data make us stop short of a final answer, but they resonate well with an increasing body of evidence that European venture capital lacks more more human than financial resources. For instance, recent case studies show that in the 1990s German venture capital suffered from a lack of qualified, experienced professionals (see Becker and Hellmann (2000)). In an insightful survey study, Freeman (1998) finds that lack of human resources is cited by respondents–insiders to the industry–as a major problem for the maturation of the German venture capital industry. We mentioned the relative stock market under-perfomance of venture-backed companies in Europe, as compared to the United States, which might be another indication of an immature industry. This interpretation, while still tentative, would also be consistent with the need to learn its ropes by this still very young industry. After all, American venture capital matured over a much longer period, which was not always a bed of roses. Other facts point to this direction. For instance, in 2000 the number of investee companies per venture firm in Europe was three times as large in Europe as in the United States (23 to 8). Since effective nurturing requires an intense and close relationship with investee companies, beyond a certain threshold the quality of the ’soft’ side of venture capital might well fall. To us, these facts and the evidence we uncovered suggest that creating the conditions for a more mature venture capital industry should be a high priority for European and national policy-makers.
54
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Data Appendix We collect our information from all available issuing prospectuses and annual Reports or Euro.nm listed companies. Data are codified for all available years prior to the IPO (from prospectus information, which typically contains information for the three years before listing), as well as for all available years after the IPO (from subsequent annual reports). Some companies choose to end their fiscal years in a month different from December. In these cases if the company’s fiscal year ends between January and June we consider it as ending the previous December, otherwise we consider it ending the following December. For the year 2000 in the few cases where the annual report was not yet issued at the time of writing, we rely on end-year official announcements of results. Since 1999 most information is reported in euros. For earlier years we use monthly averages of the exchange rate between the ECU and national currencies to obtain an euroequivalent. For subsequent years we use euro conversion rates. Financial and business variables We codify several financial variables: assets, debt, equity, and Ebitda (earnings before interest, taxes, depreciation and amortization), from which we compute leverage (debt divided by debt plus equity) and ROA (return over assets, computed as Ebitda over assets). Ebitda is a common measure of a firm’s profitability which does not depend on its financial policy and tax regime. We computed the amount of capital raised at IPO as the issue price times the number of shares sold at IPO, except those sold by existing shareholders, but including the amount of greenshoe actually used. The amount of shares issued under the greenshoe over-allotment option is taken from the web site of the stock exchange for the German and Italian markets, and for the French market until the end of 1999. For French IPOs in 2000 we contacted directly issuing companies. We take from the prospectus and annual reports information about a company’s business and strategy. We codify the following variables: Sales (total revenue from sales of goods and services), Employees (at year end), Capex (capital expenditure), Foreign sales share (share of foreign sales over total sales), Intangible assets (the stock of goodwill, patents, software and advertising), and R&D (current expenditure in research and development. From these data we can compute R&D intensity (R&D over Sales). Patents would be a natural measure of a firm’s innovation strategy. Unfortunately, the nature of the data makes it difficult to use them sensibly since patent applications take about 18 months to be released by the European
Patent Office, so we are only starting to get patent data for the post-IPO period. Sectoral attributions Each company in the data set is assigned to a sector. The procedure we use is based on the sectoral attribution of Datastream, which are derived from the classification of the Financial Times. We use the following seven sectors: BIOMED, FINSER, ITSIS (comprising Internet, IT services, and software), MEDIA & ENTERNAINEMENT, TECHNOLOGY, TELECOMMUNICATIONS, and TRADITIONAL (products and services). We also employ an alternative sectoral classification, following the sectoral attributions introduced in May 2000 by the Neuer Markt, and we obtain very similar results as the one we report in the main text. The Neuer Markt assigns each company to the sector which generates the largest share of its earnings. For companies listed in markets other than the Neuer Markt we attribute sectors by looking at the business description contained in the issuing prospectus, and we augment the Neuer Markt classification with two further sectors: Manufacturing (other than high-tech products) and (traditional) Services. The nine resulting sectors are: Biomed (which includes biotechnology—pharmaceutical products and services based on applications of genetics—and medtech-medical goods and health care services), Financial services (banking, insurance and brokerage, usually provided through the internet), Industrial Services (innovative services for industrial firms), ITSIS (infrastructure for the internet, internet services, IT services, internet, software), Manufacturing (goods other than high-tech), Media and entertainment, Services (marketing services, wholesale and retail distribution, business consulting, logistic services), Technology (high-tech products and services), and Telecom. Venture capital data In order to identify venture capital financing we could not rely on a simple procedure. A venture capital firm is not a bank, which can be readily identified as such. Since no license or professional registry exist, one must resort to a number of ’identifying conditions.’ For each company we proceeded to identify from the listing prospectus the venture capitalists which provided financing, starting from a pool of more than 300 ’candidates,’ i.e. financiers which were not founders, nor individuals, friends and families, or strategic partners (i.e. other companies). For each company we used the information about its ownership structure at the time of the IPO, which lists all its shareholders and details their holdings before and after the IPO. This helped us identify which venture capitalist have been involved with the company, and the extent of their shareholdings. A potential limitation of relying on data at IPO is that a venture capital might have already exited the company. This turns out to be a rare event, since the venture capital can profit much more by remaining until IPO. Moreover,
the US experience shows that when a venture capital sells before IPO, it usually sells to another venture capitalist, in which case the presence of a venture capitalist at IPO would still show up. Direct inspection of the history section of all prospectuses revealed that a venture capitalist exited before IPO only in a couple of cases. The process of identification of venture capitalist consisted of several steps. First, We identified venture capitalists by using the directories of the European Venture Capital Association and the directories of the British, Belgian, Dutch, French, German, Italian, Israeli, and US national venture capital associations. The venture capitalists members of one of these association form our ‘tier 1,’ or core, group of venture capitalists, and they total 123. We then proceed to using other sources in order to identify venture capitalists which are not members of an association. Using online directories of venture capitalist (mainly at regional level), web sites, IPO prospectuses, and press sources we check if each ’candidate’ is defined as an ’actual’ venture capitalist. These ’self declared’ venture capitalists form our ’tier 2’ group, which comprises 75 more venture capitalists. Overall, our sample reveals that 198 venture capitalists were involved with companies listed on Euro.nm. Ten of these were national branches of international venture capital groups, like 3i group, the British private equity and venture capital firm. We report the results we obtain using the broader definition of venture capitalist (i.e. those falling in either tiers), as our results do not change if we restrict the definition to the core. For each venture capitalist we measure from the prospectus the share of equity held at IPO and the amount which is sold at that time. Finally, we then looked at information about the date of entry of venture capitalists, i.e. the date at which they first contributed funds to the company. If more venture capitalist are involved with a company, we use as date of entry that of the first of them which got involved with the company. The entry date could often be identified from the company’s own history description. In all the other cases we directly contacted the company. Overall, we could assign the entry date in 90% of the cases. Price data We take our price data from Datastream. We collect price data for all the companies in our data set, excluding the sixteen ones in the financial services sector. We use daily closing prices, which are corrected for stock splits and changes in nominal value of the underlying stocks. Definitions of the variables The following is a list of definitions for all the variables we use. AGEIPO is the age of a company at the date of its IPO. To determine a company’s date
of birth we employ the earliest evidence of business activity in the listing prospectus, which need not coincide with the date of incorporation. In fact, several companies were born as partnerships or limited companies before incorporating. TIME-TO-LISTING (TTL) is the time elapsed from a company’s foundation to its IPO. For companies born before the opening of the Euro.nm market in which they list, TTL is the time elapsed from the opening of the Euro.nm market and their IPO. Two companies which went public in the same month but which are listed in two different markets may then have two different TTL, since different markets opened at different times. VC is a dummy variable that takes the value 1 if a company has received venture capital financing, and 0 otherwise. AMOUNT measures the capital raised at IPO. It equals the issue price times the number of shares sold at IPO (except those sold by existing shareholders, but including the greenshoe). BIOMED, FINSER, ITSIS (comprising Internet, IT services, and software), MEDIA & ENTERNAINEMENT, TECHNOLOGY, TELECOMMUNICATIONS, and TRADITIONAL (products and services), are dummy variables which take the value 1 if the company operates in that industry and 0 otherwise. We use the following financial variables: ASSETS is current total asset. DEBT is the sum of commercial and financial debt. EQUITY is total shareholders’ equity. EBITDA is earning before interest, taxes, depreciation and amortization. DEBT-TO-EQUITY is DEBT divided by EQUITY. LEVERAGE is DEBT divided by DEBT plus EQUITY. ROA is EBITDA over ASSETS. We use the following variables which reflect a company’s business situation and strategic choices: SALES is total revenue from sales of goods and services. EMPLOYEES is the total number of employees at year end. CAPEX is capital expenditure, i.e. investment in tangible and intangible fixed assets. FOREIGN SALES SHARE is the share of foreign sales over total sales.
INTANGIBLE ASSETS equals the capitalized amount of goodwill, patents, software and advertising. R&D is current expenditure in research and development. R&D INTENSITY is R&D over ASSETS.
Web Appendix Contents This Appendix we provide additional information to that provided by the main text. Part 1 provides two additional descriptive tables about venture capital investments in Europe. Part 2 provides four additional regressions, which we comment in the main text, where we control for R&D or R&D intensity. Part 3 provides additional explanations on the econometric techniques used to perform our robustness checks.
Part 1: Additional descriptive statistics Table WA-1. Frequency of venture capital investment Venture capitalist
Nationality
Number of investees
3i Group
INT(UK)
27
Apax Partner
INT(UK)
12
Galileo Partners
F
12
Gold-Zack AG
D
12
Technologie-Beteiligungsgesellschaft
D
12
ABN Amro Ventures
INT(NL)
10
BNP Developpement
F
10
Financi´ere Natexis
F
10
INT(US)
9
INT(F)
8
Soffinova Partners
F
8
TBG-Technologie-Beteiligungsges.
D
8
Banexi Ventures Partners
F
7
Dassault Developpement
F
7
CDC Innovation
F
6
Sofimac Partners
F
6
Techno Venture Management Gmbh
D
6
Commerz Beteilugungsgesellschaft
D
5
Concord Effekten AG
D
5
DEWB-Deutsche Effekten und Wech.-B.
D
5
IKB Beteiligungsgesellschaft
D
5
Atlas Ventures Group de Rothschild
Venture Capitalist
Nationality
Number of investees
Knorr Capital Partner AG
D
5
TechnoStart GmbH
D
5
INT(SIN)
5
AXA
F
4
Bank Austria
A
4
Banque de Vizille (Group CIC)
F
4
INT(UK)
4
F
4
Schroeder
INT(UK)
4
Thompson Clive & Partners
INT(UK)
4
Alpinvest
F
3
BUWB Bayerische
D
3
CEA Capital Partner GmbH & Co. Beteiligungs KG
D
3
Europ@web (Groupe Arnault)
F
3
TFG Venture Capital AG
D
3
UCA Unternehmer Consult AG
D
3
Financiere Vecteur
F
3
LBB Beteiligungsgesellschaft
D
3
Paribas
F
3
Partcom SA (group CDC)
F
3
Private Equity Partners
I
3
Sal. Oppenheim jr. & Cie.
D
2
S-UBG AG
D
2
INT(US)
2
Alta Berkeley
US
2
Apollo Invest
F
2
BayBG Bayerische
D
2
BB-Kapitalbeteiligungsges.
D
2
bmp AG
D
2
BW-Venture Capital
D
2
DG-Private Equity
D
2
Epicea SA
F
2
IBB Beteiligungsgesellschaft
D
2
Vertex Management LTD
HSBC Private Equity IRDI de Midi
Advent International
Venture Capitalist
Nationality
Initiative and finance
Number of investees
F
2
KB Partners, LLC
US
2
Mivtah Shamir
IL
2
Pechel Industries
F
2
Pino Venture Partners
I
2
Saarl¨andische Kapitalbeteiligungsges.
D
2
SNBV Partecipations
F
2
Sogginove (groupe Societ´e Generale)
F
2
Sopromec
F
2
TechnoStart GmbH
D
2
Transconnect GmbH
D
2
Value Management & Research
D
2
Ventech
F
2
Venture-Capital Baden-Wuerttenberg
D
2
WeHaCo Kapitalbeteiligungs GmbH
D
2
West-LB
D
2
Other venture capitalists with one investment
122
Notes: INT stands for ’international,’ i.e. a venture capitalist with active offices in more than three countries. In brackets the nationality of the headquarters. Source: Authors’ calculations.
Table WA-2. Venture capital, sectoral specialization Euro.NM
VC-backed
%
%
Biomed
8
12
Traditional (manufacturing and services)
4
3
ITSIS (IT Services, Internet, Software)
57
53
Media & Entertainment
10
8
Technology
16
17
5
7
Telecommunications Source: Authors’ calculations.
Table WA-3. Corporate growth: descriptive statistics Pre-IPO Mean
Median
Min
Max
S.D.
Obs.
113
7
0
44,823
2,082
463
Debt
28
4
0
7,967
370
462
Equity
72
1.3
0
28,213
1,383
416
EBITDA
5.8
0.5
-18.1
1,679
79
456
Leverage
0.7
0.8
0
1
0.2
414
ROA
0.1
0.1
-6.1
5.1
0.7
455
Sales
52
7.5
0
12,344
576
463
Employees
141
68
0
1,538
216
413
Capex
1.8
0.6
-2.8
37
4
342
Foreign sales (%)
0.2
0
0
1
0.3
282
Intangible assets
2.6
0.2
0
30.8
8.6
372
2
0.8
0
17.4
3
156
0.8
0.1
0
20
1.7
158
Assets
R&D R&D intensity
Post-IPO Assets
195
53.1
0.2
13,187
1,013
355
Debt
64.2
14.9
0.2
5,194
302
354
Equity
123
33.5
0
7,959
616
350
EBITDA
-17.1
1.8
-7,035
338.9
379
352
Leverage
0.4
0.3
0
1
0.2
349
ROA
5.1
0.04
-140
1.853
99.5
349
Sales
121
30
0
18,287
967
360
Employees
399
194
10
3,210
553
332
Capex
37.7
6.3
-96
3,860
235
293
0.2
0.1
0
1
10.3
147
Intangible assets
39.5
6
0
2249
162
299
R&D
13.8
3.3
0
731
65.6
152
0.4
0.1
0
32
2.6
152
Foreign sales share (%)
R&D intensity
Notes: For ease of comparability, we drop 34 companies with negative equity values in the preIPO period, and three companies with negative values in the post-IPO period. Source: Authors’ calculations.
Part 2: Statistical analysis, controlling for R&D In the tables ’preVC’ indicates variables which are measured before the arrival of the venture capitalist, while ’atIPO’ indicates variables which are measured at the time of the IPO. Significance levels are indicated by * (10%), ** (5%), and *** (1%). Huber-White corrected standard errors are used to obtain robust estimates.
Table WA-4. Probit regression–dependent variable venture capital Independent
Marginal increase
Variables
Coefficient
z-statistic
-0.05
-0.15
-0.736
-0.006
-0.02
0.221
0.75
in probability
R&D intensity(preVC) Sales(preVC) Leverage(preVC) Constant
-3.04
Number of obs. Log likelihood W aldχ2 (7) P-Value
*
-1.816 1.522
***
-4.688
101 -54.02 8.7 0.001
Table WA-5. Cox regression–dependent variable time—to-listing Independent variables
Hazard ratio
t-statistic
R&D(atIPO)
1.00
Venture capital
0.83
-1.22
Leverage(atIPO)
1.07
0.17
ROA(atIPO)
1.00
-1.30
France
0.34
***
-5.56
Age*97
1.01
***
7.29
Age*98
1.01
***
6.31
Age*99
1.00
*
1.70
Age*100
1.00
***
Number of obs.
186
Log likelihood
-752.98
W aldχ2 (14)
194
P-value
0.00
***
7.01
-3.13
Table WA-6. Robust regression–dependent variable amount of funds raised over assets Independent variables
Coefficient
t-statistic
R&D intensity(atIPO)
-0.005
-0.424
0.065
1.574
0.49
1.241
Sales/Assets Venture capital Leverage(atIPO)
2.717
**
2.327
ROA(atIPO)
-1.184
***
-3.416
Age
-0.005
***
-2.510
France
-1.883
***
-4.165
3.642
**
2.010
Constant Number of obs.
180
F (12, 167)
4.07
P-value
0.000
Table WA-7. Robust regression–dependent variable employment growth Independent variable R&D(atIPO) Venture capital ROA(atIPO)
Coefficient 11.59
t-statistic ***
-27.94
-1.134
-7.82
-0.256
Leverage(atIPO)
185.51
***
Foreign sales
-46.11
*
Age France Constant Number of obs.
4.037
0.03 -69.68 77.12 117
F (11, 105)
-4.43
P-value
0.000
2.948 -1.829 0.811
***
-2.548 1.204
Table WA-8. Robust regression–dependent variable sales growth Independent variables R&D(atIPO)
Coefficient
t-statistic
2.04
***
5.041
Venture capital
-7.90
***
-2.435
ROA(atIPO)
-3.90
*
-1.366
Leverage(atIPO)
18.10
**
2.015
Foreign sales
-1.22
Age France
0.03
-0.343 **
2.351
-1.10
-0.301
Constant
9.54
1.263
Number of obs.
143
F (11, 131)
5.31
P-Value
0.000
Part 3: The stratification estimator Here we discuss the implementation of the stratified estimation method we use in our robustness checks. When the dimensionality of the vector Xi becomes unwieldy, one possibility is to make use of the ’propensity score’ method, i.e. to estimate the probability (p(Xi )) of obtaining venture capital conditional on observables Xi . Observations with the same propensity score will then have the same distribution of the full vector of observables Xi . This methodology entails a two step strategy: We first estimate the propensity score, and subsequently the conditional average of the variable venture capital. In order to estimate the average effect of venture capital we need first to estimate the propensity score for each observation of our sample. We use a probability model where we introduce the following covariates (Xi ), which we measure at IPO: return on assets (ROA), sales, the dummy for foreign sales,, and controls for country and sector of activity. Then, following Dehejia and Wahba (1998) we stratify the estimated propensity scores for venture-backed and non venture-backed firms into five blocks (’bins’) of equal score range (0-0.2,..,0.4-0.6). Ideally we would like to have the same frequency of venture-backed and non venture-backed firms in each bin. We check whether we succeed in balancing the covariates within each stratum by testing for the equality of the first and second moments of covariates within each stratum. If there are no differences we accept that specification. Otherwise we split the block and test again. Six observations for venture-backed companies are discarded since their propensity scores were lower than the minimum value of the propensity scores associated to non venture-backed companies. The stratification estimator is then nothing more than a weighted average of the difference in means for the variable Y, across the discrete bins produced by the propensity score estimation: X X X 1 1 1 NV C( YiV C − YiNV C ) τ= V C NV C b b N Nb Nb iεV C iεNV C b
b
where VCb and NVCb are the sets of VC backed and non VC backed observations in each bin V C the corresponding numeber of observations. The relative variance can also and NVb C ,NN b
be computed as:
V ar(τ ) =
1 NV C
"
V
ar(YiV C )
# XNV C NV C NV C b b + V ar(Yi ) N V C NbN V C b
