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Per Strömberg Stockholm School of Economics

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Per Strömberg Stockholm School of Economics

  1. 1. Presentation Nordic European Public Investor Workshop November 23, 2011 23 The case for Public VC Investment and its problems Per Strömberg, g, SIFR, Stockholm School of Economics www.sifr.org
  2. 2. Why is it so difficult to get enough early- early stage financing? • Financing frictions / agency problems – Because of agency and informational asymmetries, p difficult for an external financier to be compensated • Externalities of entrepreneurship and innovation p p – Benefits from entrepreneurial firms to the economy are larger than the monetary returns to investors g y – E.g. R&D, spillovers 2
  3. 3. The Th savior: th VC market? i the k t? • VCs overcome agency problems by providing expertise together with capital – Sophisticated screening monitoring and contracting screening, monitoring, • Kaplan & Strömberg (2001, 2003, 2004) – Operational and strategic value-added value added • Hellmann & Puri (2002) • Does it work? – Good for companies? – Good for investors? 3
  4. 4. Ample evidence that VC investment creates value f i t t t l for companies p • VC-backed companies add value to companies through strategy development, professionalization, HR – Hellmann & Puri (2002), Kaplan & Strömberg (2004) • VC-backed companies grow faster and take products faster to market compared to similar non-VC-backed startups non VC backed – Hellmann & Puri (2000) • VC-backed firms innovate more – Kortum & Lerner (2000), Mollica & Zingales (2007) • VC value-added increases likelihood of firms going public – Sorensen (2007) – Majority of “real” IPOs are VC-backed (Kaplan, Sensoy, Strömberg, 2009) 4
  5. 5. What about investor returns? • The market for early-stage venture capital is by and early stage large considered to be in a crisis • Returns disappointing post-bubble • Fundraising down • Especially in Europe, but similar discussion in the U.S. • In 2000, close to 100 private independent VC funds , p p active in Sweden • In 2011, two are left… 5
  6. 6. VC fundraising (U.S.) as % of market Source: Private Equity Analyst
  7. 7. IRR, Venture, Preqin , , q 70,0% 70 0% 60,0% 50,0% 50 0% 40,0% 30,0% 30 0% Median 4th quartile 20,0% 1st quartile 10,0% 10 0% 0,0% 198 198 198 198 198 198 198 198 198 198 199 199 199 199 199 199 199 199 199 199 200 200 200 200 200 200 200 200 200 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 -10,0% 10 0% -20,0% Vintage Year • Source: Preqin, author calculations. 1055 funds.
  8. 8. From Jenkinson (2009) 8
  9. 9. Why is not early-stage VC y s o ea y s age C delivering returns? • Suffered from huge inflow of inexperienced capital during internet boom – Kaplan, Martel, & Strömberg (2007) • Longer-term structural problems: – Mismatch between fund horizon and firm gestation period – Mismatch between economically viable fund sizes and efficient i ffi i t investment amounts i start-ups t t t in t t 9
  10. 10. Pre VC Pre-VC financing crucial for VC model • VC investment horizon to short to build company from start-up to IPO – VC outperformance concentrated in periods with hot IPO markets – can take companies public quickly – Especially in investment-intensive industries like life-science, cleantech • Hard to put enough money at work in seed investment – Bad effort-return trade-off for both GPs and LPs effort return trade off – Exacerbated by increasing economies of scale in asset management industry • VC investment requires reasonably developed idea – Bhid (2000) Bhide – Kaplan, Sensoy, & Strömberg (2009) 10
  11. 11. A case for government intervention to solve pre-VC financing gap 1. Indirectly through subsidies and tax policy – Best way to finance a new venture is with founder’s own money • Encourage private savings and investment e g lower capital gains tax investment, e.g. • Incentive compatible subsidies! – Also important for angels and FFF 2. Indirectly through government Fund-of-Fund initiatives – Improving the economics of independent early stage funds early-stage – New source of capital as large pension funds leave VC market • Again, importance of incentive compatible subsidies g p p • Brander, Du, Hellmann (2010): these methods seem to work – Government involvement correlated with venture success 11
  12. 12. A case for government intervention to solve pre-VC financing gap 3. Direct-investing 3 Direct investing government VC funds – Arguably an important part of the mix – But hard to get right • Lerner (2010) “Boulevard of broken dreams” • Brander, Du, and Hellmann (2010) – Led to a lot of skepticism towards government VC initiatives • Problem: – Many Government VC models try to replicate private VC without sufficiently accounting for institutional constraints (and advantages) 12
  13. 13. How can we get the G C o ca e ge e GVC- model to work better? • The importance of investment focus – For private VC-funds, industry and geography-focus seems correlated with success l t d ith • Specialized industry knowledge necessary for value-add • Limited geography needed to be close to companies – For GVCs, it seems to be the opposite • Performance of International GVCs > National GVCs > Regional / Local GVCs (Brander et al 2010) • Similarly, governments ability to pick winning industries notoriously b d (L t i l bad (Lerner, 2010) – Why? • Too much money chasing too few deals • Value-added expertise harder to build and retain 13
  14. 14. How can we get the G C o ca e ge e GVC- model to work better? • Be realistic regarding ability to build value-added expertise p – GVCs will never be able to compete with private market in incentives and compensation levels – Building in-house expertise is possible, but will have to use it in a more efficient / less labor-intensive way private VC i t VCs • Focus on in pre-investment screening rather than extensive post-investment support –I t d t Instead: team up with t value-added private ith top l dd d i t investors 14
  15. 15. How can we get the GVC- model to work better? • How to impose investment discipline in a GVC structure p p – Deep pockets and long-term horizon can be a curse • Especially hard for re-investment decisions – Throwing good money after bad – Or: excessive risk-aversion • H i li it d f d and substantial personal fi Having limited funds d b t ti l l financial stake is i l t k i key for investment discipline in private VCs – How can we recreate investment discipline without financial incentives? • Investment mandates that avoid reinvestment decisions – Limitations on participation in future rounds or syndication requirements • Culture that encourages collective responsibility for investment decisions 15
  16. 16. How can we get the G C o ca e ge e GVC- model to work better? • Manage political risks – Crucial for maintaining long-term horizon in a short- long term short term political environment – Can politicians accept: p p • Entrepreneurs and co-investors getting rich? • GVC not investing when they do not see opportunities? • Decent compensation to successful investment professionals? • Below-market returns? Below market 16
  17. 17. Do we need that the government makes money on early-stage k l t initiatives? • Conflict of goals in government-sponsored VC initiatives: – ”Sh ld i ”Should invest t promote l t to t local start-up activity” l t t ti it ” – ”Should get at least a risk-adjusted market return” • If these investments would make a sufficient risk- adjusted return, we would not need th government t dj t d t ld t d the t to promote it! – I e if the government needs to intervene we should I.e. intervene, not expect a market return on investment • But: strong need measure social benefits and 17 externalities of early-stage financing!
  18. 18. Thank Th k you! ! • Homepage: www.sifr.org • E mail: per stromberg@sifr org E-mail: per.stromberg@sifr.org

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