P bli fi iPublic venture financing
Esperanza LasagabasterService Line Manager of Innovation and EntrepreneurshipService Line Manager of Innovation and Entrepreneurship
Innovation, Technology & Entrepreneurship Practice
The World Bank GroupSeoul, April 2013
Agendag
• Why focus on start ups?
• Financing innovative start ups
• Lessons from past public interventions
• What is the potential of crowdfunding?
• Conclusions
2
Which firms create jobs?
• Traditionally, public policy focused on all SMEs but ….
• Increasing number of studies on developed and developing countries suggest that young firms create a disproportionate high number of net jobsnumber of net jobs‐Haltiwanger et al. (2010) in the United States‐Deschryvere on FinlandDeschryvere on Finland‐ Iavocone (2010) on Indonesia‐ Freund (2012) on Morocco
• Young firms are more volatile with higher rates of job creation and destruction.
• Importance of focusing on both the entry process and the subsequent post‐entry dynamics (first 10 years)
3
• Entrepreneurial growth comes from a complex venture ecosystem ….
Regulations
Finance Entrepreneur
Ideas and inventions
Access to world marketsmarkets
Risk taking Skills, t l t
gculture talent,
expertise
4
Agendag
• Why focus on start ups?
• Financing innovative start ups
• Lessons from public interventions
• What is the potential of crowdfunding?
• Conclusions
5
Financing innovative start upsFinancing innovative start ups
• Financing of start ups and its subsequent growth needs to be considered as a continuum.
• Investors are needed in all stages. Gaps along they way can ifl h l d l ll f d h Thstifle growth or lead to closure—valley of death. There can
be more than one “valley of death”.
• Start ups cannot take off on flimsy business plans or too weak financial foundation, as there will be limited capital in l t dlater rounds.
A typical market for innovative start upsA typical market for innovative start ups
Exit through IPO or trade sale
optio
ns Global funds
Finance o
Incubators, Accelerators,
Business angels, venture funds
PRE‐SEED SEED EXPANSIONSTART‐UP
, ,proof of concept, etc.
Higher Risk Declining Risk
Public finance Private FinancePublic finance Private Finance
Financing innovative entrepreneurs: is there a rationale f i i ?
• Information asymmetries are more “acute” for innovative start ups
for government intervention?y p
oInnovation projects are riskier than physical investment projects—both commercial and technological risk. P i t t d t h “ f t i f ti ” b t t h l i loPrivate actors do not have “perfect information” about technological or production frontier.
oTechnological development can take a long time and resources (e.g., g p g ( gbiotechnology) before product is market ready
oReluctance of innovative entrepreneur to share the idea with potential investor due to appropriability probleminvestor due to appropriability problem
• Difficulty of using intangible assets (Intellectual Property) as collateralcollateral
• Experience building“Fi t ” di d t
8
o “First mover” disadvantage
• Counter cyclical role
Agendag
• Why focus on start ups?
• Financing innovative start ups
• Lessons from public interventions
• What is the potential of crowdfunding?
• Conclusions
9
Lessons from public interventions to spur Venture Capital
• Entrepreneurship does not occur in a vacuump po Need to foster the entire ecosystem (e.g., Singapore)
oOften too much emphasis on finance but the “deal flow” is equally or more important
oEnabling regulatory framework needs to be in place
oEntrepreneurial programs for university students and at earlier stages can be developed
oMechanisms to facilitate commercialization of researcho Intellectual property
10
o Technology transfer offices o Incubation
Lessons from public interventions to spur Venture Capital• What is the evidence on the performance of VC funds?
• Financial returns have been typically lower for public fundsyp y po Various studies on Canada
oLerner et al. (2011) showed a private‐public gap in return for US and UK funds, but the gap has narrowed over time
o Publicly‐backed funds in the pre‐bottom bubble period heavily underperformed private funds (returns were 20 percentage points lower in th UK) ti th t i l t d i i d ( d ti ithe UK) suggesting that in later years design improved (e.g., reduction in restrictions)
o Differences in public‐private performance remain after controlling for stage of financing, industry and investor hubs. Such differences could be due to constraints imposed on managers or inability to retain the most talented ones
11
constraints imposed on managers or inability to retain the most talented ones
Lessons from public interventions to spur Venture Capital• What is the evidence on the performance of VC funds (part II)?
• Financial returns are not the only or most relevant performance indicator.
• Other public policy objectives (e.g., value creation) are more important. Evidence on these indicators is more scarce and mixed.
o Evidence on UK publicly‐backed VC funds suggest that recipients would not have undertaken their investments without public support
oA World Economic Forum study (2010) found that companies with moderate public VC support outperformed in terms of value and patent creation those
h h blwith just private support or heavy public support.
o An analysis by Brander et al (2009) on Canada’s VC industry suggests that
12
o An analysis by Brander et al. (2009) on Canada s VC industry suggests that privately‐backed funds outdid publicly‐sponsored ones in terms of value creation and patents.
Lessons from public interventions to spur Venture Capital
• Balancing the supply push with the demand pullg pp y p po Let the market provide directionoYozma program (Israel): used matching private funds to determine where
bli t h ld d l li d i t f dpublic support should go and also relied on private fund managers
Ali i ti• Align incentives oTransactions on commercial termsoShare risks and losses with private investorsoShare risks and losses with private investors oMight subsidize the upside but not the downside
13
Lessons from public interventions to spur Venture Capital
• Long lead timesgoPrograms should have the time horizon necessary to prove merits and not focus on short‐term returns V t f d h lif f b t 10 d ib t VC i d t illoVenture fund has a life of about 10 years and a vibrant VC industry will typically take longer
• Problems with too large or small initiatives• Problems with too large or small initiativeso Too large could crowd out rather than leverage private financing or too many funds chasing few “deals”
oToo small undercapitalized funds tend to underperform o Relative high overhead and insufficient funds to back companies through
development (e g evidence from UK public funds)development (e.g., evidence from UK public funds)o Changed strategy of Danish Growth Fund
14
Lessons from public interventions to spur Venture Capital• Do not micromanage
oExcessive restrictions on VC funds or entrepreneurs could affect the firms’ and VC’s performance (e g on geographical locations)VC’s performance (e.g., on geographical locations)
oEvidence from Lerner et al. (2011)
• Exit strategies are critical to successful VCs• Exit strategies are critical to successful VCs•Big returns are typically done through IPOs not trade sales•Development of capital marketsDevelopment of capital markets
• Evaluation of initiativeso Monitoring and evaluation can reduce “principal‐agent” problemso Monitoring and evaluation can reduce principal agent problemsoCompare publicly supported firms and venture funds to peers (financial performance, revenues, job creation)
oConsider randomization or regression discontinuity to understand impact
15
What is the potential of crowdfunding?p g
• Why focus on start ups?
• Financing innovative start ups
• Lessons from public interventions
• What is the potential of crowdfunding?
• Conclusions
16
What is the potential of crowdfunding?• Crowdfunding: raising funds for a project through small to
medium investments from several other people
p g
medium investments from several other people
• Types of crowfunding:yp go For profit: equity or lendingo Not for profit: reward or donation
• Crowfunding portals or platforms act as intermediaries b i dbetween investors and entrepreneurs
• 452 crowfunding platforms (April 2012) mainly in the US and• 452 crowfunding platforms (April 2012), mainly in the US and Western Europe
17• Estimated US$2.8 billion raised in 2012
More than 450 platforms are active worldwide
250
Crowdfunding Platforms by Country
191200
250
150
ber o
f CFPs
100
Num
b
44
29 2821 20 18 17 12
6 6 6 6 6
0
50
0
April 2012 Crowdfunding Industry Report
18
April 2012 ‐ Crowdfunding Industry Report
Growth in worldwide funding
US$2 8063000
Total Funding through CFPs
US$2,806 (estimate)
2500
3000
US$1 470
2000
of US$
US$854
US$1,470…
1000
1500
Millions o
US$53061%
72%500
02009 2010 2011 2012
19
Source: Crowdfunding industry report (2012)
Enabling Regulatory Landscape (US case)• While US is leading in crowdfunding, growth for equity and
lending stifled by lack of regulatory framework until ….
g g y p ( )
lending stifled by lack of regulatory framework until ….
• JOBS Act (2012): Legislation that that seeks to facilitate ( ) gfunding for start ups and small businesses and protect ordinary investors from fraud
• Securities and Exchange Commission (SEC) is still in the l kirulemaking process
• Legislators recognize the need for some degree of• Legislators recognize the need for some degree of experimentation and careful monitoring
20
• JOBS Act—key provisions for crowdfundingEnabling Regulatory Landscape (US case)JOBS Act key provisions for crowdfunding
o Limits on funds raised (US$1 million per year)( $ $o Limits on investors (US$2,000 or 5% of income < US$100,000 in
income; 10% of income for those above)
o Transactions made through brokers or “funding portal” registered with SEC
P t l l i t b t i t t d io Portals‐‐less requirements but no investment adviceo Responsible for providing relevant factual information from
issuers and other third partiespo Can only release funds once “target amount” is raised
o Disclosure: Annual reports and different levels of auditso Disclosure: Annual reports and different levels of auditso Accountability: Issuers (and control persons) are subject to liability for
statements made and use of funds
21
o Relationship to other capital raising initiatives (SEC to define rules)
Conclusion• Start ups are important for job creation and
renewal of economies
• Public interventions to foster Venture Capital have been mixed: bee ed:o Balance the demand pull and pusho Need to align incentiveso Need to align incentives
• The potential of crowdfunding is still untested• The potential of crowdfunding is still untested
• Financing is not enough need to promote entire22
• Financing is not enough, need to promote entire entrepreneurial ecosystem
Thank you