19 augustus 2008 Eelco Bakker

(1)

(2)

E. Bakker – Master thesis Small Business & Entrepreneurship – Rijksuniversiteit Groningen

₂

Title:

Square One: The first step towards a home run Keywords:

Venture capital; student entrepreneurs; early-stage ventures; investment fund; finance gap

Author information: Eelco Bakker Student number: 1656325 Andries Veenstrastraat 23 8471 AW Wolvega M: +31(0)6 18260826 E: eelco_bakker@hotmail.com 19th_{August 2008} Rijksuniversiteit Groningen

Master of Business Administration, Specialization Small Business & Entrepreneurship

(3)

₃

Preface

This master thesis is the final step in completing my Master of Business Administration, a step on my educational path that has provided me with more knowledge and insight in small and medium-sized enterprises. During the first months of 2008 Bernd Mintjes

introduced me into the market of venture capital and financing, an item largely neglected during previous education. Instantly I was intrigued by the idea of starting an investment fund that aims at a specific group, student entrepreneurs.

From that day on, I studied literature on the subject and gained insight in this dynamic and interesting industry. Next to this theoretical approach I started to conduct interviews within the target group. This combination delivered a steep learning-curve because I started to see and understand how the student entrepreneur population operates and also how an investment fund could make a positive contribution within this market. Altogether I have had an interesting and joyful experience within this six months period.

The master-apprentice program gave an extra dimension to this research, providing for a more practical approach. Conversations with Bernd Mintjes (the master) regarding venture capital, the start of a new firm, dealing with external stakeholders and so on have all contributed to my learning experience. The final chapter of this research evaluates the project regarding the master-apprentice program.

Finally I would like to use this preface to thank a number of persons that were directly or indirectly involved in my research. First of all Bernd Mintjes for his multi-faceted role; as a supervisor from the RuG, a guide within Square One and also as the expert within the master-apprentice program. Secondly Marnix Pool, the managing-director of the RuG Houdstermaatschappij for providing workspace and interesting conversations within the office. Furthermore I would like to thank all entrepreneurs and experts that contributed to this research by taking the time to provide me with useful information. Finally I would like to thank family and friends for their contributions; checking my work and results and giving me time to relax when needed.

I sincerely hope you will enjoy reading this report.

Eelco Bakker

(4)

₄

PART 1 – THEORETICAL RESEARCH

2. Why do they exist? 19

2.1 Introduction 19

2.2 Information Asymmetries 20

2.3 Industry Effects 21

2.4 Conclusion 22

3. Venture Capital Gap 23

3.2 Market Failure 24

3.2.1 Supply-side Market Failure 24

3.2.2 Demand-side Market Failure 25

3.3 Regional Equity Gap 27

4. Investment decision process 30

4.2 Decision Criteria 30

4.3 Model of Decision-making 32

5. Entrepreneur vs Venture Capitalist 36

(5)

₅

5.4 Dealing with the Risk 39

PART 2 – FIELD RESEARCH

6. Student Entrepreneurs 41 6.1 Introduction 41 6.2 Interview Results 41 6.2.1 General Facts 41 6.2.2 Financial Needs 42 6.2.3 Non-financial Needs 45 6.2.4 Other Comments 47 6.3 Conclusion 47 7. External Analysis 49 7.1 Introduction 49 7.2 Partnerships 49 7.3 Market Developments 50 7.4 Alternative Financing 50 7.4.1 Loans 50 7.4.2 Investments 51 7.5 Comparable Initiatives 51 7.6 Conclusion 53

PART 3 – CONCLUSIONS & RECOMMENDATIONS

8. Conclusions & Recommendations 54

8.1 Conclusions 54 8.2 Recommendations 56 8.3 Implementation 58 8.4 Final Considerations 59 9. Master-Apprentice Program 60 9.1 Introduction 60

9.1.1 Description Master-Apprentice Program 60

9.1.2 Master 60

9.1.3 Apprentice 60

9.2 Results of the Project 61 9.3 Evaluation of the Project 62

(6)

₆

Abbreviations

BA – Business Angel

EVCA – European Venture Capital Association LBO – Leveraged Buy-Out

MBI – Management Buy-In MBO – Management Buy-Out

NOM – Noord-Nederlandse Ontwikkelings Maatschappij NVCA – National Venture Capital Association

NVP – Nederlandse Vereniging van Participatiemaatschappijen RHM – RuG Houdstermaatschappij

ROI – Return on Investment RuG - Rijksuniversiteit Groningen

SCA – Sustainable Competitive Advantage SQ1 – Square One

(7)

₇

Executive Summary

Background

This master thesis is the final product within my Msc BA with the specialization Small Business & Entrepreneurship at the Rijksuniversiteit Groningen. Square One is the organization where this research has been conducted, it is a new investment fund in the region of Groningen which specifically aims at student entrepreneurs. Growing attention for this subgroup of entrepreneurs and the idea that financing possibilities are not optimal for them created the need for a fund. An investment fund can deliver venture capital as well as guidance to this young group of entrepreneurs. Within this research their financial and non-financial needs are explored to get insight in the market. Supplemented with intensive literature research it was possible to give recommendations towards the fund management on how to enter and serve this market. This need for extra research has led to the following main question:

Which financial and/or non-financial needs can be identified within the student entrepreneur population in the region of Groningen that confirm the need for an investment fund; and if so, which strategy should this fund follow based on theoretical and empirical research to optimally fill in these needs?

Seven sub questions were answered in different chapters to come to a final answer for this question.

Method

Within this thesis a combination of theoretical and empirical research was used. Paragraph 1.3.6. reveals the conceptual model in which both are connected to each other. Chapters two till five describe theoretical elements that are of (in)direct influence on the fund strategy: information asymmetry, the venture capital gap, the decision-making process and the relationship between the entrepreneur and venture capitalist. The next step was to conduct empirical research. In total 22 interviews were conducted with student

entrepreneurs in order to gain insight in the market structure and opportunities and most importantly to detect the (non)financial needs of these entrepreneurs.

Results

Information asymmetry can be seen as the main reason that venture capitalists can exist next to traditional banks. The level of information asymmetry depends on several factors such as the sector a firm operates in and if it is high- or low-tech, the life-cycle stage, but most importantly the relationship between the entrepreneur and investor. When it is based on trust and openness, the chance on moral hazard or opportunistic behavior decreases. Next to that can be seen as the main influence on the possible existence of a financing gap, on the demand-side as well as on the supply-side. The first because entrepreneurs are not aware of the possibilities of venture capital and how to deal with business proposals towards investors. The latter because investors find the risk of investment to high since early-stage ventures have no track record. Currently it appears that demand-side failure is the main reason for a gap: ‘there is enough money but no brains to invest in’.

Decision-making within this specific market differs slightly from regular investment processes because student entrepreneurs not only lack business experience but also other relevant working experience and they usually do not have any assets. Therefore it is important to have a stronger focus on the entrepreneur and his skills in order to assess a business opportunity.

(8)

₈

attract financing for their plans since banks would not provide it. Therefore promotion of the fund might cause a raise in demand for venture capital.

Non-financial needs differentiate per life-cycle stage. General and financial support are regarded important in the first months or year. After that, when growth sets in, the entrepreneurs start to recognize the importance of legal and strategic support more and more.

Square One holds a strong position within the region because of its unique concept and strong partnerships. Targeting on student entrepreneurs is a new idea that has never been shown before, thereby creating some sort of a monopoly but also an increased risk since it is a non-proven concept. Luckily Square One already has strong partners in the region of Groningen that acknowledge the fund and give support by redirecting potential investment opportunities towards it. Altogether this fund can be a success but the expected strong start and abundance of good opportunities does not seem to be realistic. Building this fund means promoting the positive effects it can add to a firm; creating awareness and

investor-readiness is important.

Conclusions & Recommendations

Empirical research does not fully justify the start of an investment fund like Square One, mainly because there appears to be too little demand at the moment. But it can be expected that demand will rise as soon as students and existing entrepreneurs are fully aware of the existence of the fund and the benefits it can offer for their firm. This is a part of the information asymmetry that has to be overcome in order to attract high potential investments. A number of important recommendations are:

• Square One should start active promotion to gain awareness within the student (entrepreneur) population. Especially students with the intention to start a business need to be informed about the fund and its possibilities. It is important to use the strong partnerships to accomplish this promotion.

• Square One should consider taking a broader focus as to attract more investment opportunities. Empirical research did not fully justify the start of an investment fund that only focuses on seed- and start-up financing.

• Square One ought to think about approaching students in other cities in the

northern Netherlands. As described; the current population in Groningen might not offer enough opportunities for Square One to invest in.

• Square One has to pay above average attention to the assessment of

(9)

₉

1 – Introduction

1.1 Introduction

Historically, small firms and specifically start-ups have difficulties in attracting external financing. Several reasons can be appointed to this problem, but finding a concrete solution has proven to be difficult ((Storey, 1994) (Murray, 1999)). The existence of these so-called ‘finance gaps’ is on the one hand attributed to the supply-side of the market and on the other hand to the demand-side of the market. The first concerns commercial bankers, private investors, investment funds and so on that are not prepared to supply capital to these early-stage ventures. The latter concerns the ventures themselves which, according to several authors, are not well prepared for the process of attaining finance ((Murray, 1999) (Mason and Harrison, 2002) (Harding, 2005)).

Other crucial elements are the existence of regional differences in capital needs, decision-making criteria used by investors and the relationship between the entrepreneur and the person or firm that invests in his business. The first element explains the difference in gaps on a regional level caused by the industries and types of ventures present in a region. Decision-making criteria that are used by finance suppliers vary strongly and can also be the reason that certain start-ups are not able to attract finance. The relationship between the entrepreneur and the investor is particularly difficult in case of start-ups, because of its insecure and risky nature. During the decision-making process, as well as after the financing decision, this relationship can be a source of problems.

A core term within this research paper is information asymmetry. This concept is intertwined in all elements concerning the finance gap. Generally, it concerns the

difference in knowledge between the entrepreneur and the investor and the risks involved with this asymmetry. Especially in the case of start-ups there is usually more information asymmetry caused by the simple fact that the entrepreneurs firm does not have any historical records, thus creating a higher level of uncertainty. Next to that these start-ups usually do not have tangible and specific assets which are another incentive for traditional financers to raise their demands towards the start-up.

This research aims at the early-stage ventures in the region of Groningen that are led by students. An initiative to support these ventures in their seed or start-up phase is

presented by means of an investment fund, Square One. During the start of this fund some questions remained unclear, stressing the need for this research. First of all it is important to look into the possible existence of a finance gap as described above, providing the fund with a reason to exist. The next step is to think about procedures in dealing with

investment proposals, decision-making and the relationship with the entrepreneur taking in account the risks of information asymmetries. Maybe this group of start-ups requires a different approach then ‘regular’ start-ups.

It is important to first understand the raison d’être of VC firms, why do they exist next to institutional financers. The following step is to look into the existence of a venture capital gap. Square One will have a strong regional focus which can be justified by the existence of a gap on this level. The lack of such a gap in financing student entrepreneurs gives reason to doubt the need for a VC fund, so this is an important point to look into. Next to that this research will look into the decision making process of venture capitalists and how this can support the way Square One makes her investment decisions. Finally, a closer look is taken into the relationship between the entrepreneur and VC firm to optimize the fund management.

(10)

₁₀

same way? Within this research their needs are assessed, and other external factors that might influence the start of an investment fund are described. In this way a complete picture will occur of the situation in Groningen and if/how Square One can add positive value.

Square One and all parties involved are described in the following paragraph, after which the early-stage venture capital market is described shortly to illustrate the current situation. This chapter ends with the problem statement, including the main question, goal, methodology of the research and finally the conceptual model illustrating the elements studied.

1.1.1 Description Square One Fund B.V.

Square One Fund B.V. (SQ1) is an investment fund that aims to provide venture capital to student entrepreneurs in the northern Netherlands. As a business accelerator high

potential firms are chosen to invest in with the intention to exit after three to five years, depending on the financial situation of the entrepreneur. Square One will participate as a shareholder in these firms and use its network and expertise to coach these starting entrepreneurs. The intention of this fund is twofold; on the one hand it aims to get a good return on investment (ROI) and on the other hand it aims to stimulate entrepreneurship in the northern Netherlands.This creates a trade-off in dealing with new enterprises. SQ1 is prepared to give support to the entrepreneur but never has the intention to become the dominant party in the relationship. The main reason for this approach can be related to the background of the initiators of the fund, being educational, research oriented and aimed at innovation. Three parties started the fund and they each participate for equal parts in Square One. The RuG Houdstermaatschappij B.V. (RHM), HanzePoort B.V. and Stichting ir. G.J. Smid Fonds each participate with €250.000, creating a total of €750.000 to invest. Next to that the NOM attributes an equal part in each investment with a total of €250.000, giving the fund a total of €1.000.000 to invest.

The fund management is arranged by a separate legal entity, SQ1 Beheer B.V., a firm in which Square One B.V. is 90% owner and Maxwell Group B.V. 10% owner. The latter is also responsible for day-to-day operations of the fund, including acquisition, talent scouting, the investment process and guidance of the entrepreneurs by means of SQ1 Beheer B.V.. The next paragraphs contain a description of the parties involved. Appendix 1 shows the organizational structure of Square One B.V. and SQ1 Beheer B.V.

RuG Houdstermaatschappij B.V.1

The RHM is founded in 1996 and brings capital, knowledge and a varied network of regional firms within reach of (high) potential young firms. Since then they participated in 40 companies, of which 22 participations are active at present. Most of these start-ups are spin-offs from the Rijksuniversiteit Groningen, based on ideas of scientists, medical

specialists or professors that are connected to this university. Two of them are investment funds in the region of Groningen, Noord Tech Venture C.V. (NTV) and Het Kennis Conversie Fonds B.V. (KCF). Both have a strong focus on technology start-ups.

HanzePoort B.V.2

Stichting Triade B.V. is a foundation connected to the Universitair Medisch Centrum

Groningen (UMCG). Their commercial activities are carried out by HanzeHolding B.V. which in turn executes three main activities: HanzeBorg B.V., HanzeAdministratie B.V. and

HanzePoort B.V.. The latter is one of the participants in SQ1. The focus of this organization generally lies on investment in (bio)medical technology. HanzePoort sees the need for further improvement of the medical health sector and thereby the need to move

1_{This section is partially based on the report: ‘Een kwestie van zaaien en oogsten’ by J.J. van der}

Mei, a graduate of the RuG.

(11)

₁₁

technological boundaries. For this reason HanzePoort offers financial services to

life-science organizations under favorable conditions. Stichting G.J. Smid Fonds

The Stichting G.J. Smid Fonds is an investment fund that aims to stimulate employment in the northern Netherlands by participating in technological and innovative organizations in this region. Together with the Kennis Conversie Fonds B.V. it already made investments in several start-ups. Now they also decided to participate in SQ1 to stimulate

entrepreneurship and employment under the student population of this region. NOM NV

The NOM describes itself as the investment and development agency for the northern Netherlands. It is an N.V. with the Ministry of Economics and the provinces Groningen, Friesland and Drenthe as shareholders. They are active on a broad terrain to stimulate the economy of the northern Netherlands, such as stimulating investments and innovation in the region and supporting firms that are in need of subsidies. NOM-Finance participates in Square One as a contracted co-investor as well as in the fund management.

Maxwell Group B.V.

This organization focuses on strategy, investing and innovation. Located in Amsterdam, Maxwell Group advises commercial and non-profit organizations but is also involved with innovative start-ups and educational programs on entrepreneurship. Square One asked Bernd Mintjes to manage the new investment fund in Groningen by means of SQ1 Beheer. This firm manages the fund capital and is partially owned by the Maxwell Group (10%). Other stakeholders

Several other parties are involved in Square One, divided into co-financers and

organizations that support the fund management. The Rabobank, Gemeente Groningen and the Provincie Groningen are prepared to support the fund management in the first years of existence. Marketing, fund management and inventory costs can be arranged by the use of this capital and SQ1 can focus all capital into start-ups or other high potentials. Appendix 1 shows a second more detailed organization chart which contains all the parties involved in Square One.

1.1.2 Early-Stage Venture Capital Market

Venture capital and private equity are often used as synonyms; the difference has been blurred by increased competition in the financial market. Traditionally venture capital can be seen as a part of a larger class of private equity, including LBOs, MBOs, MBIs and bridge investments. Traditional venture capital investors focus on start-up and early-stage

investments, whereas private equity firms provide financing to firms that are more mature in their lifecycle. Increased competition has forced both types of investors to expand their horizons in order to attract and capture new opportunities; this causes the blurred

difference between the two3_._{Appendix 2 shows several differences between VC and} Private Equity4_{. During this research the term venture capital will be used, because the} focus of Square One is completely on seed and start-up (early-stage) investments in student enterprises. This matches the definition of ‘classic venture capital’, used in the 90’s by the EVCA (1990):

“An organisational unit or person

• Who can prove substantial activity in the management of equity or quasi-equity financing for the start-up and/or development of small and medium-sized unquoted

(12)

₁₂

enterprises that have significant growth potential in terms of products, technology, business concepts and services;

• Whose main objective is long-term capital gains to remunerate risks; • Who can provide active management support to investees”

Contrary to the development of the market towards larger deals this fund will aim at seed and start-up capital on a regional level, a classic approach.

Venture capital has developed as an important source of finance for early-stage ventures, providing capital to firms that might otherwise have difficulty attracting financing (Green, 2004). These firms are typically small and young, plagued by high levels of uncertainty and large differences between what entrepreneurs and investors know. Moreover, these firms usually possess few (tangible) resources and operate in highly dynamic markets (Gompers and Lerner, 2001). For the firm venture capital is also a means of secure growth finance without the risks of loans secured on property. For the venture capitalist it represents a way of generating revenue from the growth of the business (Harding, 2000).

The size of VC-firms/funds varies from 5 till 250 million for MBOs. Small venture capitalist firms operate in a niche, provide smaller transactions and usually specialize in a certain market by using experienced VC managers from the industry5_{. Square One does not fit the} profile of these niche firms, with a total capital of approximately 1 million Euros it is significantly smaller then the regular niche venture capitalists. Square One plans to operate on the level of Business Angels (informal investors), between investments from FFFF (Friends, Family, Fools and Founder) and regular VC-funds.

Venture capital itself is a very young industry, which has undergone rapid changes in the last decade. It can be seen as an historically recent and predominantly American

innovation in financing.The venture capital industry in the US is often seen as a model for other nations by policy makers, academics and business owners. Yet, it is not possible to talk about a global VC market because of the difference market structure, size and age (Megginson, 2004). For this reason first the American early-stage VC market is discussed, followed by Europe, the Netherlands and the northern Netherlands specifically.

United States

After the Second World War the investment world started to professionalize threw means of venture capital firms6_{. Silicon Valley and New England are the leading regions in the US} regarding venture capital investment. These areas are a good example of the extreme organic growth of venture capital. Once a critical mass has been reached in a certain region, a new ecosystem will develop (NVCA, 2008).

The first quarter of 2008 showed a decline in early-stage investments, compared to Q4 of 2007. Investments fell 17 percent to $1.7 billion divided over 330 deals, accounting for 36% of all deals closed. In total $6.4 billion was invested throughout 2007, divided over 1410 deals7_{. Although this concerns seed and/or start-up capital, the average deal had a size} between $3.6 and $5.7 billion, numbers that are not comparable to the Dutch situation. Europe

At the start of the sixties the UK was the first European country which introduced the concept of VC. Approximately twenty years later it established on the mainland of Europe, with the Netherlands being a leading party. The Lisbon Strategy (2000) is an example of

5_{Source: http://www.higherlevel.nl/columns.php?id=66, 07-04-2008} 6_{Source: http://www.higherlevel.nl/columns.php?id=66, 05-04-2008}

(13)

₁₃

this policy oriented approach, one that derives from intentions from the European Union to create a competitive and dynamic knowledge based economy within the member states. The EVCA reported on an all-time high investment of €71.6 billion in 2006, a 51.2% increase compared to 2005. Seed investments doubled creating a total amount of €197.7 million, and start-up investments more than doubled to €5.7 billion in 2006. Regarding all deals closed, the number of start-ups represented 25.8%, with 2,773 investments8_.

The Netherlands and northern Netherlands

Historically the Netherlands have a strong venture capital history, making it one of the most developed countries in Europe regarding the equity culture. In 1988 the Netherlands even exceeded, proportionately, the US in their share of seed and start-up financing (Aernhoudt, 2005). In the 90’s the market concentration increased, causing five funds account for 80% of all deals, thereby decreasing the focus on seed and start-up capital. The northern Netherlands are historically seen as a weaker region of the country. Early-stage entrepreneurs are mainly found in the west of the country, most often in the

business services sector (GEM, 2004). But the new European and Dutch policy regarding the Lisbon Strategy can work out great for the region. Investing in strong and not in weak points gives recognition for several strong sectors in the northern Netherlands. Water, energy, Life Sciences/Agribusiness and Sensor are four sectors in which this region excels9_. Examples are the Energy Valley community as an engine for the energy sector and the RuG, UMCG and Van Hall as innovators on Life Sciences. The presence of these educational and research centres already gives Groningen the status of ‘innovation region’10_{. The RHM (see} also: paragraph 1.1.1) is one of the leading investors in this region with a strong focus on technology based start-ups.

Seed- and start-up investments in the Netherlands grew from €24 million in 2005 up to €86 million in 2006, a rise from 1% to 4% in total invested capital. In 2005 these investments accounted for 10% of all the deals closed, in 2006 this number grew to 30% of all

investment. The average amount of capital invested grew from €0.7 million to €0.9 million11_{. Especially the IT and Biotech sectors display a strong growth in the past years,} recovering from the bubble burst in 2000.

Megginson (2004) concluded the following: “while relatively little detailed information is

available regarding European and/or Dutch venture agreements, they presumably contain many of the same features as their American counterparts and depend on similar

elements: (1) the experience and reputation of the entrepreneur; (2) the attractiveness of the portfolio company as an investment opportunity; (3) the stage of the company’s development; (4) the negotiating skills of the contracting parties; and (5) the overall state of the venture capital market.”

The main differences between the US and European VC markets arise from the different legal systems and the maturity. But the features mentioned above by Megginson (2004) show that VC firms act in almost the same way. This gives a profound reason to assume that literature based on the US situation is applicable to the European and specifically the Dutch situation. Since most literature on this topic regards the US or UK VC market or is published by US or UK authors, this outcome is important for the research in providing a reliable and useful literature study.

8_{Source: http://www.evca.eu/knowledgecenter/statisticsdetail.aspx?id=416, 17-06-2008} 9_{Source: NOM, Publication: Noord Nederland Piekt!}

10_{Source: http://www.groningen.nl/functies/pagfunctie.cfm?parameter=1640, 14-04-2008} 11_{Source: Nederlandse Vereniging van Participatiemaatschappijen, publication: Ondernemend}

(14)

₁₄

1.2 Problem Statement

The problem statement is created using the method of Baarda en De Goede (2001). This book looks into the important steps made whilst developing a problem statement. For example how to formulate your main question, what the goal of the research is and what methodology will be used to create optimal results.

Student entrepreneurship is a topic that receives growing interest in the region of

Groningen, from educational sides as well as from individual foundations or firms that see the need for supporting this group of entrepreneurs. All through history small firms have had difficulties to acquire financing threw institutional financing such as banks. Reports from MacMillan (1931) and the Bolton Committee (1971) confirm this ongoing trend (Murray, 1999). Venture Capital as described above is a relatively new form of financing which reached its heights during the dot.com period.

As an initiative to support and stimulate student entrepreneurship, three parties have decided to start a new venture capital fund that aims at this specific group of

entrepreneurs, Square One. This research will provide for important insights in the student entrepreneur population in the region of Groningen. Results from the theoretical approach combined with qualitative field research will be used to decide if and how this fund can be managed optimally.

1.2.1 Main question

Which financial and/or non-financial needs can be identified within the student entrepreneur population in the region of Groningen that confirm the need for an investment fund; and if so, which strategy should this fund follow based on theoretical and empirical research to optimally fill in these needs?

This research question will be answered by means of a desk research into the literature in this area, followed by field research in the region of Groningen. Approximately 25 student entrepreneurs will be interviewed during this period to visualize the needs they have on financial and non-financial areas. Presumably, this gives interesting insights when they are looking back at their time as a starting firm. In perspective, what did they miss and do they perceive other problems that can be avoided in the future? Finally, an external analysis is executed to visualize the environment Square One will operate in and the (dis)advantages that might be present herein.

1.2.2 Sub questions

The following sub questions are examined to answer the main question:

I. What factors create the need for an early-stage Venture Capital fund? II. What does the literature display about the (regional) Venture Capital gap

considering early-stage ventures?

III. What does the literature display about the process and decision making regarding investments in early-stage ventures?

IV. What does the literature display about the relationship between early-stage entrepreneurs and Venture Capital funds?

V. What are the (non-)financial needs of student entrepreneurs in the region of Groningen and does this create the need for an early-stage Venture Capital fund?

VI. What external factors and stakeholders influence the start-up and management of an investment fund in the region of Groningen?

(15)

₁₅

1.2.3 Goal

This research is executed in behalf of SQ1 Beheer B.V., the managing partner of the fund. Drs. Bernd Mintjes was asked by the participants in the fund12_{to start-up and manage} Square One. Throughout the start-up phase several conditions arose that need to be considered whilst doing the research:

• The fund will focus on student entrepreneurs in the northern Netherlands. This target group is described as followed: “Entrepreneurs at College and University level that are still in study or have received their degree maximally two years ago, that are considered high potential”;

• Square One is a business accelerator of student enterprises with the intention to exit successful investments thereby creating new financial impulses for the fund. This needs to result in a revolving character to create continuity;

This results in the following goal:

Providing for strategic recommendations towards the management of Square One so that the fund can have a revolving character and provide a valuable contribution to student entrepreneurship in the region of Groningen.

1.2.4 Conditions & Limitations

Conditions and limitations provide insights in the feasibility of this research. It concerns demands from the participating parties as well as demands from the Rijksuniversiteit Groningen regarding this thesis. The conditions and limitations are:

1. This research has a maximum duration of six months, starting from March 1st_until August 31st_2008;

2. The master thesis must meet the requirements as provided for by the Faculty of Economics and Business Administration from the Rijksuniversiteit Groningen; 3. Next to the requirements above, the ‘Master-Apprentice program13_{’ needs to be}

considered. This project gives an extra dimension to this research by creating knowledge transfer between the so called ‘master and apprentice’ and if possible vice versa (see: chapter 9);

4. The author will receive a compensation for his research as corresponded in advance;

5. The constituent will provide for a workspace and facilities needed to realize this research.

1.3 Methodology

Research methodology is divided into six sections, partially based on the techniques used by Baarda en De Goede (2001) and Emans (2004). It starts with the several sources of information used during this research and ends with a conceptual model that describes the foundation of the research.

1.3.1 Sources of information

The following sources are used to acquire information: • Venture Capital literature;

• Qualitative research within the student entrepreneur population of Groningen; • Experience from the ‘master’ within the ‘master-apprentice program’;

• Study from other similar funds that consist in other regions.

(16)

₁₆

The first source of information is considered most important regarding the theoretical framework that needs to be built. A review of existing literature shows that there is no specific literature to be found regarding investment funds that focus on student

entrepreneurs. Essentially all literature on venture capital can be useful, because decision making or the relationship with the entrepreneur do not depend on the fact that this entrepreneur is still a student or not. Examples of relevant literature are: scientific

magazines, review-articles, books and reports. Information from the student entrepreneurs themselves gives a good view of the current situation in this region. Combined with

literature on this topic it will be possible to build a good strategy for the fund. The experience from the ‘master’ relates to Venture Capital, investment decision making, guiding young entrepreneurs and building a new business. Studying other funds can give an insight in how these funds are managed and what they offer to their participants, the student entrepreneurs. Off course this is a global comparison, since there are major differences in regions and student population, which each ask for a different approach.

1.3.2 Research type and design

This research starts from point zero, without the intention of formulating hypotheses or developing a theory regarding student entrepreneurship. More importantly, understanding the needs from entrepreneurs in the region of Groningen will lead to a solid foundation for Square One. A qualitative descriptive approach is most suited for this research, using interviews and experts to gather information. General theory regarding venture capital will be used to develop a framework on which the results can be founded.

By taking a qualitative approach certain (dis)advantages can be distinguished. A strong advantage concerns the possibility for the interviewer to dig deeper when he/she is not satisfied with the answer, something that is impossible using e.g. an inquiry. This is especially important when student entrepreneurs need to think about problems they face or possible solutions they can provide for. Potential problems/disadvantages are dealt with in paragraph 1.3.4., based on Emans (2004).

1.3.3 Population

Square One will focus on the northern Netherlands in the long run, but starts in the region of Groningen. All student entrepreneurs that run their business in this region are to be seen as the population. As a rule, every entrepreneur that has finished his study less than two years ago still counts as a student entrepreneur. The reason for this choice is twofold:

1. When research is conducted using only student entrepreneurs that actually are enrolled in a study, chances are this group is too small;

2. Next to that it is important to interview a number of more experienced student entrepreneurs. These persons are better able to look back and see what their needs actually were, without the (over)optimistic view that starting entrepreneurs might possess.

In total a sample of approximately 25 entrepreneurs will be interviewed; a reasonable number considering the estimated amount of student entrepreneurs (according to our definition) of 100 in total.

1.3.4 Interviewing methodology

(17)

₁₇

freely (Emans, 2004). Since this research partially concerns questions relating financing, debt and their firm-history this appears to be a good choice.

The following steps are made during the interview:

• Introduction interviewer personally (background, study etc.) • Introduction about SQ1 (background, founders, goals etc.) • Explain the structure of the interview

• Mention anonymity

• Start with introductory questions (name, age of company, size, sector etc.) • Starting the interview

• Ending the interview (do they have questions?)

• Explain follow-up (summary of results will be sent to interviewees)

Appendix 3 shows the interview structure that is used during this research. A number of questions have answering possibilities written underneath, these are not multiple-choice. These categories are used by the interviewer to write down answers more rapidly. Next to that these categories can be used during data-analysis.

During the interview it is important to evaluate the completeness of answers and to determine if they are satisfying. Probing is used to create a fuller answer, but a good opening question is the first step (Emans, 2004). It may also be important to summarize the answer; thereby making sure the answer is written down as the interviewee means it.

1.3.5 Data-analysis

The data collected from the interviews will be analyzed as a group, no individual outcomes are mentioned. It is important to look at global outcomes, for example how many student entrepreneurs need significant seed or start-up capital or how many of them expect to use external equity to finance growth. This view can create a complete picture of the needs that are present and thus if there is a need for an investment fund like Square One. It is also important to see if these findings coincide with general theory on the subject. During the next step input will be generated for the fund strategy and more detailed results are needed. Specific results about the needs of the student entrepreneurs regarding financing or guidance are taken in consideration. Next to that the theories about investment

decision processes and the relationship between the entrepreneur and VC-firm are useful to prepare for a strategy.

1.3.6 Conceptual Model

Three core elements are the building stones of this conceptual model; information asymmetry (theoretical framework), the student entrepreneur population and external factors and stakeholders (empirical research). Direct or indirect, they are of influence on the strategy Square One should follow to optimally serve the market. The next few paragraphs describe the expected relations between these core elements and the other elements in this model.

First of all information asymmetry; differences in knowledge and information can cause asymmetry between two parties. Consequences are that, for example, the relationship between the entrepreneur and venture capitalist is influenced throughout the total

(18)

₁₈

Secondly, the element of the student entrepreneur population. This is the first part of empirical research, being a series of interviews with student entrepreneurs. In total approximately 25 entrepreneurs will be interviewed regarding their financial and non-financial needs in the past, present and future. Fund strategy, the relationship with the venture capitalist but also market conditions are influenced by this core group. The size, needs and strategies of the target group are important to assess opportunities and to determine a fund strategy.

Finally; external factors and stakeholders influence the strategy and specific market conditions, as well as the student entrepreneur population. Especially in the case of Square One, the regional environment can be of strong influence. Dealing with this external environment might ask for a change in strategy, to make better use of these elements. Partners of the fund are treated as external factors within this research since their knowledge and skills are not fully internal. Square One has not yet developed strong internal skills, but makes use of the stakeholders’ knowledge and expertise.

Figure 1 - Conceptual model

Part 1 of this research deals with the theoretical side, being the concepts of market failure and the overall influence of information asymmetry. Part 2 starts of with empirical

research within the student entrepreneur population of Groningen. After that, several other external factors are discussed in order to create a complete picture.

As a result both theoretical and empirical knowledge can be used to formulate recommendations towards the management of Square One. For example; theoretical knowledge about dealing with information asymmetry can be converted to this specific situation and context. The same goes for empirical knowledge that provides insight in the market conditions and demands. Both elements are important to create a complete advice on how to manage the fund.

(19)

₁₉

PART 1 – THEORETICAL RESEARCH

The theoretical research that will be presented in this part is divided into four chapters. Chapter two describes literature on information asymmetry and the industry effects that create the need for venture capital firms. The third chapter gives a deeper focus on the venture capital gap. This concerns the existence of financial gaps, market failure on the demand and supply side and the existence of a regional equity gap. Chapter four then looks at the investment decision process. Which factors influence the choice a venture capital firm makes to invest or not and what process of decision making can be used. Chapter five, finally, looks into the relationship between the entrepreneur and the venture capital firm. Important factors are information asymmetry, moral hazard and the agency theory. Every chapter ends with a conclusion applied to the situation of Square One. How can this information from several literature sources be used to structure and/or manage the fund?

2 – Why do they exist?

This first part of the theoretical framework deals with sub question one which considers the raison d’être of Venture Capital firms:

• “What factors create the need for an early-stage Venture Capital fund?”

A first step in understanding the Venture Capital industry is a review on why firms backed by venture capitalists find it difficult to arrange their financing needs through the

traditional institutions. According to Gompers and Lerner (2000) a variety of factors limit the possibilities for some of the most potentially profitable and exciting firms to turn to bank loans or other forms of traditional financing. They sort these difficulties into four main factors: uncertainty, asymmetric information, the nature of the firms’ assets and the condition in the relevant and financial and product markets. Firm’s financial choices are determined by these four factors at any time, which can change in a rapid and unpredicted way.

Uncertainty, being the first of these four problems, is caused by the multiple potential outcomes for the firm and her products. Being in their development; start-up firms have plenty of possible outcomes for their new research program or product. Next to that, the behaviour of the incumbent firms or other new competitors is uncertain. These levels of uncertainty make it hard for the company and even harder for investors to predict how the company will perform in the future (Gompers and Lerner, 2000).

Asymmetric information is the second factor; paragraph 2.2 takes a closer look at this phenomenon. Each party involved has a different level of knowledge about the product or the company. The entrepreneur being the founder can for example exploit this advantage and thereby mislead the investor ((Gompers and Lerner, 2000) (Storey, 1994) (Wright, 1998)). Especially start-ups deal with higher levels of information asymmetry.

The third factor influencing the firms’ financial strategy is the nature of its assets. More traditional firms that have tangible assets such as buildings, machines or other physical inventory may find it easier to obtain financing. Trade secrets or strong market knowledge are intangible assets; when these are the most important assets it will be much more difficult to attain outside financing from traditional sources (Gompers and Lerner, 2000). Especially early-stage ventures have problems since they are dealing with this lack of resources and assets, making it harder to attain financing.

(20)

₂₀

or in some cases less difficult to gain external financing, depending on current conditions. Chapter three will also look into market effects and failure.

Paragraph 2.2 deals with the second factor, information asymmetries, and paragraph 2.3 takes a closer look at the industry effects that influence venture capitalists existence. The latter can be linked to factor four, market conditions. At the end of the chapter the applicability of this information for Square One will be examined.

2.2 Information asymmetries

Information asymmetry and the agency problem are present at all levels of investment and financing. Banks for example, deal with this problem by checking the track-record of a firm or its management. The same problems occur when they are dealing with start-ups, but ironically there is no history of actions and results to be checked. Venture capitalists have to deal with the same lack of information, but are better able to do so. This leads to the conclusion that the key distinction between venture capitalists and mainstream corporate finance relates to the problem of information asymmetries ((Amit et al, 1998) (Wright, 1998)).

New and radically changing firms are characterised by the problems of asymmetry between insiders and outsiders. Amit et al. (1998) also hypothesize that information asymmetries are the key to understanding this market. There are two major forms of asymmetry, the so called ‘hidden information’ and ‘hidden action’ that create a market failure in

entrepreneurial financing. The first occurs when one party knows certain relevant

information while the other party is unaware of these facts. An entrepreneur for example often knows much more about the product and which direction he wants to go with it. Or he might overstate the chances of success for his product. This creates a risk for investors in distinguishing good and bad ideas or products. When a market is flooded with low-quality projects a phenomenon called adverse selection appears (Amit et al., 1998). It depends on the quality of investors and their decision making procedures how much of these risky endeavours will be funded.

The latter form of asymmetry (hidden action) occurs when one party cannot observe relevant actions taken by the other party. For example, an investor might not be able to observe the behaviour of the entrepreneur and if he is making good decisions or that he is just in it to make ‘fast money’. This problem leads to ‘moral hazard’, because the

informed party might act out of self interest, thereby increasing the disadvantage for the other party ((Amit et al., 1998) (Storey, 1994)). It is also noted that when a venture capitalist has a large share in the start-up, the efforts in maximizing profitability by the entrepreneur will drop.

Both these problems can occur in every financing situation, but they seem to appear more in entrepreneurial finance. This can be explained by the fact that large established firms can use existing assets as collateral in financing agreements and have also built a stronger reputation. Next to that larger firms are analyzed by independent parties and the

information found is often spread out towards a large group of investors (shareholders). Such company information is not readily available for early-stage ventures since there are usually no external investors. For this reason the entrepreneur as an ‘insider’ is likely to be significantly better informed about his business than any ‘outsider’ such as a venture capitalist or bank (Storey, 1994).

Venture capitalists typically take a more active and interventionist role in decision making (Wright, 1998). One of the conclusions of Amit et al. (1998) is as follows:

“Venture capitalists are those investors who become skilled at selecting good projects in environments with hidden information and are good at monitoring and advising

(21)

₂₁

Many well-known firms, including technological leaders such as Microsoft and Intel,

received venture capital financing during early-stage development. But venture capital in total provides only a small share of entrepreneurial finance and is much less used than bank financing (Bettignies and Brander, 2007). Furthermore, VC is usually concentrated in a few high potential sectors such as software, biotechnology and telecommunications which account for half of the total VC investment. Only a few papers have focused on the choice of the entrepreneur for venture capital instead of bank financing ((Bettignies and Brander, 2007) (Elitzur and Gavious, 2003)).

Authors all focus on the moral hazard problem mentioned above, but Bettignies and Brander (2007) consider the existence of a double moral hazard provided by the entrepreneur and the VC firm as well. The first is mentioned above and concerns the unverifiable effort of the entrepreneur in this relationship. The latter concerns the input of the VC firm, in which the ‘effort’ provided cannot be verified legally and the VC firm might provide too little effort. Bank finance on the other hand leaves an entrepreneur with full ownership and control, avoiding this moral hazard issue. This gives reason to suggest that the VC firms managerial input is the main incentive to use this type of financing. So, the desire for venture capital by an entrepreneur depends largely on the ability of the VC firm to attribute their management skills into the new firm. Bettignies and Brander (2007) conclude that a VC firm cannot exist purely as a financial intermediary. If a VC firm cannot offer relevant managerial contributions, banks will be preferred for financing.

A trade-off can be found in the relationship between the VC firm and the entrepreneur. With venture capital finance both the entrepreneur and the investor provide an effort that influences the venture’s performance. These efforts are unobservable and create the mentioned moral hazard. The important trade-off is that a higher share in the company by the VC firm creates a greater effort from their side, but at the same time weakens the effort incentives for the entrepreneur.

Chapter four focuses on the relation between venture capital firms/managers and the entrepreneur. An important theory is that of ‘agency problems’, which relates to

information asymmetries. Not only does this influence the decision making process, but it is an ongoing element in the relation between these two parties. The whole concept of information asymmetries is connected to the majority of literature examined in this

research. It relates to the venture capital gap, market failure, the decision making process but also to the relationship mentioned above.

2.3 Industry effects

Venture capital firms can in fact invest in all possible sectors, varying from biotechnology to web hosting. A vast majority of literature on venture capital focuses on the market of tech-based or high tech firms that play a crucial role in the economy. Why is this the case? One explanation is the existence of information asymmetries, as mentioned by Amit et al. (1998). This factor suggests strong industry effects in venture capital investment, because venture capitalists should focus on industries where informational concerns are important (Gompers and Lerner, 2000). It will optimize the advantage they have compared to regular financing institutions that are less efficient in selecting and monitoring good investments (Mason and Harrison, 2004). Biotechnology, computer soft- and hardware or a new

production technique for molding are all examples of high-tech investment opportunities. Restaurants, retail-outlets or a copy-shop are relatively easy to monitor by conventional investors. This theoretical approach assumes that venture capital funds use their ability to deal with strong information asymmetry and thereby invest more in tech-based firms. But empirical evidence contradicts this assumption of strong levels of high-tech

(22)

₂₂

Harrison, 2004)). Several reasons can be appointed that explain the existence of this

problem. First of all investors usually lack specific technological experience which creates the information asymmetries mentioned above. One might say that VC funds are better suited to handle this problem, but it appears that too high a level of asymmetry makes the investors reluctant to invest in these firms despite of the high potential returns. This problem in assessing technological risk and future returns from R&D is especially severe in the case of new companies. Their lack of ‘track record’ can be seen as another cause of information asymmetry (European Commission, 2004).

The second reason for diminishing investments in high-tech firms is the rapid development of new technologies that makes existing technology useless. Finally, the nature of the owners/managers of the firm influences the decision made by investors. Strong technical skills are no determinants for success, since most of these owners lack business skills (Storey, 1994).

Summarised; the theory about information asymmetry appoints investments in high-tech firms as logical, based on the ability of VC funds to deal with this problem. Empirical evidence shows that investors avoid high-tech investments for several reasons, perceiving the risk as too high. But what is true about this perceived risk? Mason and Harrison (2004) examined the performance of investments made by business angels in technology and non-technology firms. They concluded that the performance of investments made in tech-based firms indicates no higher risk then non-technology investments. This is confirmed by the fact that survival rates of high-tech firms are higher than the small business sector as a whole. No significant difference can be seen in ROI in technology or non-technology firms, but each sector/industry demands for a different approach in monitoring, guiding and advising as venture capitalists. More about the relationship between the fund and the entrepreneurs can be found in chapter 4.

2.4 Conclusion

First of all these findings stress the need for Square One not only to invest in

entrepreneurs, but also to provide guidance and coaching. That is an important point where Square One can offer surplus value compared to institutional bankers. If this effort is clear to the entrepreneurs, they will also try to ‘make the best of it’ and not fall back into hidden action that soon. An open and honest relationship lowers the double moral hazard problem and enhances the chances for success. Situations where Square One needs to deal with hidden information and hidden action will occur for sure, it is important how one deals with it. For example; too high a share might cause entrepreneurs to provide less effort, an interesting and useful finding.

(23)

₂₃

3. Venture Capital Gap

This chapter illustrates literature that deals with the second sub-question: • “What does the literature display about the (regional) Venture Capital gap

considering early-stage ventures?”

Reading historical data about small business strengthens the idea that, over a long period of time, many issues remain remarkably similar. This is best shown in the area of small business financing ((Storey, 1994) (Murray, 1999)). The continuity of this problem can well be illustrated by a range of almost identical quotes from research in the past 75 years (Murray 1999):

“It has been represented to us that great difficulty is experienced by the smaller and medium sized businesses in raising the capital which they may from time to time require, even when the security is perfectly sound. The expense of a public issue is too great in proportion to the capital raised, and, therefore, it is difficult to interest the ordinary investor (Macmillan, 1931).

We have found that small firms have suffered and still suffer a number of genuine disabilities, by comparison with larger firms, in seeking finance from external sources (Bolton, 1971).

Less progress appears to have been made in meeting the needs of those requiring relatively small amounts of money or seeking seed corn and early-stage finance (Wilson Committee, 1979).

The major commercial banks in most countries are reluctant to get involved in innovation financing...SMEs often suffer from both financing difficulties, at least at critical stages of their development, and structural weaknesses in their

management capacity (EC First Action Programme, 1997).”

There have been several attempts to overcome the financing problem, and the sums of capital that nowadays form the ‘equity gap’ are much more modest than seventy years ago. Nevertheless the same issues still exist, being a consequence of the very nature of small firms, uncertainty (Heger et al., 2005).

This concept of a ‘gap’ can be defined as unwillingness on the part of suppliers of finance to supply it on the terms and conditions required by small firms (Storey, 1994). In most cases it is difficult to distinguish between financial markets that are working well, so that ‘good projects’ are supported and ‘bad projects’ neglected, and financial markets that fail to provide resources to small businesses. This is confirmed by Murray (1999) who reports on the critical and alarming finding that especially the most promising and more innovative early-stage ventures, creating more patents and employing more knowledge workers, experience most financial difficulties.

Several sources can be appointed that create these difficulties for small businesses in attracting capital (OECD, 2006). One reason may be an incomplete range of financial products on the domestic market which can be found in regulatory rigidities and/or gaps in the legal framework. Another, more frequently used proposition relates to the earlier described information asymmetry. The monitoring difficulties such as asymmetry and the principal/agent problems might force a financial supplier to choose for a certain, smaller, range of products. What follows is a group of potential borrowers that have no access to capital.

(24)

₂₄

the reasons; another can be brought back to the simple fact that the quality of business proposals is below standards, thereby making it a logical choice for investors not to participate in a project.

Paragraph 3.2 focuses on both sides of market failure as a reason for the finance gap. The regional equity gap will be handled in paragraph 3.3. This regional focus is important considering the nature of Square One.

3.2 Market Failure

According to Storey (1994) the term ‘gap’ is primarily used by non-economists. He prefers to use the term ‘market failure’ instead, because even when the market is working perfectly there will always be firms or markets with an unsatisfied demand for finance; in that sense there will always be some kind of gap. Storey (1994) gives three definitions of market failure and thus financial constraints that small growing firms oppose: supply-side, demand-side and total market failure. The pecking-order theory is often used to describe the behavior on the demand-side and the risk-return relationship to describe the supply-side behavior. Next to these two elements, other factors influencing failure are described in detail below.

3.2.1 Supply-side Market Failure

When there is a failure on the supply-side of the market, investment proposals are generally turned down for reasons that are not connected to the proposal itself, but because the firm has a lack of ‘track record’ (Storey, 1994). Early-stage financing has changed since the bubble burst in 2000, investors are more critical and do not take as much risk as they did in these ‘glory-days’. They slowly start to withdraw from this early-stage market and focus on safer later-early-stage investments. This fled to more secure

financing created a gap in the first stage which needs to be filled ((Pollock and Scheer, 2002) (Aernhoudt, 2005) (European Commission, 2004)).

Apart from this tensioned risk-return relationship another phenomenon that causes the venture capitalists to focus more on later-stage investments is the ongoing market concentration. Looking at the Dutch venture capital market it can be noticed that five large funds account for 80% of all deals closed. The same development was seen in the US in the 90’s, where fund size increased and therefore investing smaller amounts in start-ups is seen as less profitable. The costs of due diligence, auditing en monitoring are not

related to the size of the investment, making a smaller investment less preferable

((Aernhoudt, 2005) (Murray, 1999)). Less risk, higher returns on investment and lower costs for activities like monitoring make large investments much more attractive for investors. When the ROI on seed or start-up investments outgrows other types of investments, such as MBOs, then it can increase its share in total investment. Looking back at the last twenty years the EVCA concluded that the return on MBO investments was approximately 9.6%, against 2.3% for seed and start-up stage investments. Overall there is a lack of investments in start-up and early growth phases as well as a lack of small investments (Mason and Harrison, 2003).

In Europe, for example, the financing of MBOs is the most important category of venture capital, whilst in the US this lower risk business is not marked as venture capital at all. The equity gap created by this shift towards larger and more secure deals, according to

Aernhoudt (2005), needs to be filled by business angels. These informal investors become more and more important in financing seed, start-up and second round phases.

(25)

₂₅

structure, level of entrepreneurship and culture and demographics. The next paragraph elaborates on this regional aspect of venture capital and also the role of government policy herein.

The following figure 2 presents the paradox present in this market. In the segment where suppliers of venture capital are not interested in, the demand for external capital is higher. During the later growth phases, when venture capitalists become more interested in investing, the management of these firms are less willing to attract external financing, and thereby sharing ownership.

Figure 2 - Supply and demand for risk capital according to development stage (Aernhoudt, 2005) This figure confirms the idea that start-ups have difficulties in finding external financing. It is a sellers’ market where a>b (see figure 2), which results in higher requests on return from those venture capitalists that do operate in this segment. Ironically, entrepreneurs which are equity-minded in their start-up thus have difficulties finding external finance under normal conditions. According to Bannock (2001) only one in three thousand starters in Europe close a deal with a venture capitalist, whereas one in ten could be considered as a venture capital backed firm with good opportunities.

Next to that, when venture capital markets are booming VCs are looking for projects in the expansion phase, firms are less eager in sharing ownership with these investors. This creates a buyers’ market where c>d, and venture capitalists need to lower their conditions concerning the investment. Still they prefer to look for larger deals in the expansion phase of a firm, mainly because of the lower relative monitoring costs.

3.2.2. Demand-side Market Failure

Currently, a shift is visible in the opinion of researchers and experts about the cause of the equity gap. More and more they acknowledge that the assumption of the supply-side causing the gap is contradicted by empirical evidence. Weaknesses on the demand-side are supposedly of stronger influence on this gap ((Mason and Harrison, 2002) (Harding, 2005)). The demand-side concerns the inability from firms to make proper use of the available financial opportunities, either through lack of knowledge, poor managerial skills or an inadequately presented proposal (Storey, 1994).

19 augustus 2008 Eelco Bakker

2

3

Preface

4

Table of contents

PART 1 – THEORETICAL RESEARCH

5

PART 2 – FIELD RESEARCH

PART 3 – CONCLUSIONS & RECOMMENDATIONS

6

Abbreviations

7

Executive Summary

8

9

1 – Introduction

10

11

12

13

14

15

16

17

18

19

PART 1 – THEORETICAL RESEARCH

2 – Why do they exist?

20

21

22

23

3. Venture Capital Gap

24

25

₂

₃

₄

₅

₆

₇

₈

₉

₁₀

₁₁

₁₂

₁₃

₁₄

₁₅

₁₆

₁₇

₁₈

₁₉

₂₀

₂₁

₂₂

₂₃

₂₄

₂₅