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Entrepreneurial Finance & Private EquityLecture 1
Policymakers on entrepreneurship and innovation
United States
Give the economy all tools for successful innovation, from investments in R&D to the human, physical and
technological capital needed to perform that research and transfer innovations.
▪ Try to increase capital that is available for new US businesses
▪ Provide training and mentoring to entrepreneurs
▪ Create regional innovation clusters
▪ Protect small companies against collusion of incumbents
Europe
European commission: EU should become a smart, sustainable, and inclusive economy to deliver high levels of
employment, productivity and social cohesion.
▪ Innovation – 3% of GDP invested in R&D by 2020: Innovation Union and ensuring the financing of
innovation
▪ Europe lags behind US and China in technology
▪ EU sponsored financing vehicles → European Investment Fund and European Investment Bank
facilitate access to finance to start-ups and small companies via grants, credit guarantees and co-
investment schemes
Europe is in trouble and does not meet 2020 targets. They are lagging behind US and China in R&D growth.
This is true for most sectors, but especially technology sectors.
What to do?
Replicate Silicon Valley? → this is very unique and therefore difficult to do. It is considered the gold standard
entrepreneurship ecosystem in terms of technology, venture capital, talent, critical mass of ventures and
failure tolerance. There is a critical mass, regional clustering. Lots of big companies headquartered there.
Secrets behind the success is that it attracts entrepreneurs from over the globe. It is not just US focused, but
rather internationally. International inflow of talented people. Liberal immigration policy has been very
important. 25% percent of all venture-backed public companies are immigrant-founded nowadays.
Additionally, it has taken a massive generation-long investment in education.
, Sollution
▪ Make use of homegrown solutions using natural resources, geographic location or culture
o If you don’t have it, start investing in higher education → train them
▪ Formulate entrepreneurship friendly policies and programs
o Pass rules and regulations that are friendly for businesses
▪ Focus resources on those sectors that are deemed crucial
o Support high-potential entrepreneurs that address large potential markets
▪ Celebrate wins in media to inspire other start-ups
o Helps reduce the perception of entrepreneurial barriers and risks and highlight the financial
rewards
However, be careful not to flood the market with too easy money. Make sure they develop toughness and
resourcefulness. Flooding the market will also cause too many low-quality overvalued deals, which makes it
difficult for private investors to make money.
What is required to start an entrepreneurial revolution
Regulatory reforms
▪ Allowing entrepreneurs to quickly start over
▪ Reform unemployment protection from making termination difficult to providing support for
unemployed
▪ Simplify tax regime
▪ Lower minimum capital requirement
▪ Liberalize capital markets and facilitate access to finance for start-up companies
▪ Implement laws that protect investors
▪ Important that there are good laws to resolve insolvency
The court system is very important to enforce all these laws
There is a strong regulation between the ease of doing business and higher levels of entrepreneurship. Various
regulatory reforms have been introduced:
▪ Failure tolerance
▪ Labor law (shouldn’t be too strict)
Where does money come from for start-ups?
- 4Fs
- Venture capitalist or angel investor seed
- Crowd funding
- Government program
- Leasing
- Bank loan (you need to pledge your own assets as collateral)
- Trade credit (post sales)
- Sell accounts receivables (post sales)
- Series A, B, C, D (post sales)
,What role does finance play in achieving growth ambitions?
Financial sector provides the service of reallocating capital to the highest value use. This is crucial to economic
growth.
Financial development is extremely important in those areas where firms rely on external finance early on in
development. The need for external finance is identified as the difference between investments and operational
cash flows for US firms. Why are US firms a good benchmark for the need of external finance in the same
industries in other countries? It has a financial system that has the least frictions in the world (e.g., low
transaction costs). All demand will be met in such a system. They assume firms can obtain the finance that
they ask for. It is assumed that observed external financing is the same as the demand for external financing.
Finance plays an important role in impacting growth in size and in number of establishments. Well-developed
financial markets reduce the cost of external finance to firms and act as a lubricant for economic growth. How?
▪ Buyers and sellers meet (the financial sector acts as a broker)
▪ They are better in identifying investment opportunities, reducing investment in unproductive assets,
mobilizing savings and putting them in highest value use, boosting innovation, improving risk raking
because of diversification
▪ Banks transform short-term liabilities to long-term loans (the financial sector acts as an asset
transformer)
Economic growth is higher in countries with better financial systems, especially in those industries where
companies rely heavily on external financing.
The empirical approach says that growth is caused by the dependence of an industry on external finance times
the financial development in a country.
Different financial systems: Bank-based (Europe) vs Financial Market (UK, US)
More than half of US companies is bank-financed. Bank assets have become marketable and become a more
integral part of financial markets. Banks and markets interact and compete in providing finance. Both have a
positive impact on growth, but the impact of banks is lower when financial markets are well developed. Bank-
based systems give too much power to incumbent firms at the expense of innovation and renewal. They are
more focused on existing firms that have collateral. Truly path-breaking innovations are better facilitated in
financial market driven systems.
Financial markets are better in aggregating information which is crucial to assess pathbreaking innovations.
Banks may also obstruct innovations because it renders their information on the borrower obsolete. As a
result, there is less renewal and innovation in bank-based systems.
What about Venture Capital?
A venture capital is specialized in financial intermediary. Policymakers try to create a vibrant venture capital
and business angel market via tax breaks and subsidies. Venture capital contributes to patented innovation in
the US. However, there could be reverse causality between venture capital and innovation. Additionally, both
can be driven by a third variable (e.g., technological development). It is found that venture capital drives
innovation. However, is it patenting or innovation? Venture capitalists could simply fore firms they invest in to
protect their intellectual property. Alternatively, firms could protect their ideas by patenting before they seek
, venture capital to avoid expropriation. Venture-backed companies think venture capital is crucial. There are
direct and spillover effects (even more important).
What explains international differences in availability of Venture Capital
They require a well-developed stock market to be in place, as they need an exit market. They need to be able
to bring the firm public with an IPO. It is found that IPOs are the strongest driver of venture capital.
Government policies have a strong impact on venture capital. Early stage venture capital is negatively
impacted by labor market rigidities (e.g., difficult to fire workers).
Three elements required to engineer a venture capital market
▪ Capital
▪ Specialized financial intermediaries
▪ Entrepreneurs
Problem: simultaneity – none of these will work in isolation and for each of these to emerge you need to other
two to be present.
Who engineers this market? Government programs are commonplace. Governments try to provide capital
and act as specialized financial intermediary and risk crowding out private venture capital. Governments
cannot act as a substitute for specialized financial intermediary and address contracting problems effectively.
Therefore, programs are in place.
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