The role of matchmakers in the Dutch seed capital market
Master thesis, MSc BA Small Business and Entrepreneurship University of Groningen; Faculty of Economics and Business
Luc Lenferink s1646974 11th of September 2012
Preface
In front of you is the result of my thesis research. This Master thesis is the last part of my study Business Administration, specialization Small Business and Entrepreneurship. In this research I examined the role of matchmakers in the Dutch seed capital market.
Through this way I want to thank a few people for their help and participation in this research. Firstly, I want to thank in particular both of mine thesis supervisors Dr. Lutz and Drs. Mintjes for their advice and support during the thesis project. Secondly, I want to thank the employees of Investormatch and in particular Peter Rikhof for giving me the opportunity to perform an internship and get acquainted with the Dutch venture capital market and also for his help during the thesis research. As last, I want to thank all the seed fund managers who were prepared to make time available for an interview and were prepared to make use of their own network to find other interviewees.
Luc Lenferink
Content
Preface ...1
Executive summary ...4
1. Introduction ...6
2. Literature review ...9
2.1 Venture capital market ...9
2.1.1. Professional venture capital...9
2.1.2 Informal venture capital ...10
2.2 Seed capital...11
2.3 Inefficiencies & equity gap ...12
2.4 Matching organizations...13
2.5 Trust ...16
2.5.1 Risk ...17
2.5.2 Competence trust ...18
2.5.3 Definitions used in this research...21
2.6 Conceptual model ...22 3. Methodology ...24 3.1 Research design ...24 3.2 Sample...25 3.3 Data collection...26 3.4 Data analysis...26
4. Overview and history of seed funds ...27
4.1 Dutch seed fund ...27
4.2 Public policies in Europe ...31
4.2.1 Germany ...33
4.2.2 United Kingdom...34
4.2.3 France ...35
4.2.4 Northern Europe...36
4.2.5 Belgium ...36
4.2.6 Comparison between the Dutch and European seed capital schemes...37
5. Qualitative interviews ...40
5.1 Investment focus seed funds...40
5.2 Dealflow process seed funds ...40
5.3 Competence trust ...43
6. Discussion and conclusions ...46
6.1 Sub-question 1 ...46
6.2 Sub-question 2 ...48
6.3 Sub-question 3 ...48
6.4 Sub-question 4 ...49
6.7 Suggestions for further research ...56
6.8 Limitations...56
References...58
Appendix A Interview guide...62
Appendix B: Interview summaries...69
B1. Summary interview fund manager A ...69
B2. Summary interview fund manager B...72
B3. Summary interview fund manager C...75
B4. Summary interview fund manager D ...78
Executive summary
The subject of this thesis is the role of matchmakers in the Dutch seed capital market. What is the influence of matchmakers on the amount of promising investment proposals that seed funds receive. Also examined is the influence of competence trust on the relationship between matchmakers and seed funds. In this summary first the most important findings from the literature review are discussed. Secondly the findings from the case studies are discussed and finally the conclusions are discussed in short. The focus lies on the research question that is central in this research: Is there room for a matchmaker in the Dutch seed capital market?
Findings from literature
Research of Bureau Bartels (2003) indicates that there exists an equity gap in the capital market. This gap makes it difficult for starting companies to obtain finance. The Dutch government recognized the importance of starting companies for the Dutch economy and intervened in the capital market in order to diminish the equity gap. To make access to finance easier for companies in their seed- or start-up phase and to encourage private investors to invest in these companies, the Dutch government created the seed capital scheme. Secondly, the efficiency of the Dutch seed capital market and the influence of matchmakers on this market are discussed. Research of Mason and Harrison (1997) and Bureau Bartels (2003) indicates that venture capital markets work in an inefficient way and that capital markets can work more efficient by making use of matchmakers.
Findings from the case studies
The Dutch seed funds use different ways to obtain sufficient dealflow. First of all, the majority of the dealflow is forwarded to the seed funds by the entrepreneurs themselves. Secondly, the funds use several organizations, including consultants, banks, corporate finance organizations, accountants, other investors, universities and matchmakers. Thirdly, the seed funds are proactive and search for dealflow at conferences, network meetings and events. The fund managers spend about 20% of their time on obtaining dealflow. All seed funds already make use of matchmakers at this moment. The fund managers all indicate that the influence of matchmakers has a positive influence on the quantity of dealflow. However, the funds are less satisfied with the quality of the dealflow that is forwarded by the matchmakers.
positive influence on the amount of competence trust. This research shows that the concepts: reputation, the duration of the relationship and the ability to assess a business plan positively influence the relationship between the matchmaker and the seed fund.
All three concepts positively influence the level of competence trust of a matchmaker. The higher the level of competence trust, the more likely a seed fund will make use of that matchmaker. This can eventually result in a higher percentage of promising investment opportunities for the seed funds, which indicates that competence trust can improve the efficiency of the dealflow process of the seed funds. The research also shows that solidarity and the ability to assess the qualities of an entrepreneur have no influence on the level of competence trust and therefore do not influence the relation between matchmaker and seed fund.
Finally the research shows that there is room for a matchmaker in the Dutch seed capital market. Only there is no room for a matchmaker that is solely focused on Dutch seed funds, because the Dutch seed capital market is too small for a matchmaker that is only specialized in matching companies in their seed phase with seed funds. This because the majority of the dealflow that the seed funds receive is directly forwarded by entrepreneurs themselves. In addition the seed funds receive a part of their dealflow from other organizations e.g. banks and accountants. Only a relatively small part of the whole dealflow of all Dutch seed funds is being forwarded by matchmakers. Matchmakers have added value in the seed capital market in their current form. An important finding is that this added value can be enlarged. Therefore the matchmakers have to change their services. First the matchmakers have to invest in a relationship with the seed funds to be able to determine the exact investment focus of the seed funds. The funds spend a lot of time on screening business plans; therefore the funds find it very important that the matchmakers only forward business plans that match the investment focus of the fund.
1. Introduction
Start-ups are a constant source of innovation, dynamism and employment (Bureau Bartels, 2003). Therefore the Dutch government has a growing interest to stimulate start-ups. The specific emphasis of the government lies on stimulating innovative starters. The number one problem for this group is obtaining finance to start their company. The traditional sources of finance e.g. banks, are reluctant to finance these innovative starters. Banks perceive innovative starters as high risk, because they do not have a prove track record and therefore often refuse to grant loans to this group. The worldwide financial crisis creates extra reluctance. Banks tightened the regulations for granting loans, which further complicates the process of getting finance for innovative starters.
Nowadays the most popular way to raise finance next to raising finance from friends and family are the informals (Bygrave and Hunt 2004 (in Riding 2008) and Landström 2007). There are two important reasons why starters approach informals (Bureau Bartels, 2003). The first reason is that there exists an equity gap in the market. This is the gap between what friends and family finance and where the financing of banks and professional venture capitalists starts. The second reason is that informals offer often next to providing capital also advice, guidance and their network to starters. According to Wetzel (1983) and Freear and Wetzel (1990) the great majority of start-ups seek external finance from informals.
But also the investments of informals are affected by the financial crisis. Research of Block and Sandner (2009) on the effect of the crisis on venture capital activity in the US indicated that the total volume of venture capital decreased due to the financial crisis. Next to this the number of financing rounds decreased. Research of Sohl 2009, (in Block and Sandner, 2009) sheds a more positive light on the venture capital market. While the total amount of venture capital invested indeed declined due to the crisis, the amount of deals remained constant. Sohl (2009) states that informals are in general less affected by the crisis than the professional venture capitalists. The conclusion is that the venture capital market as a whole decreased since the beginning of the crisis. Somewhat positive for starters is that firms in later stages of financing are hit harder than the firms in earlier stages of financing. And the fact that informals are hit less than professional venture capitalists.
Bureau Bartels (2003) the most important issue for entrepreneurs is the process of actually finding informals. Informals operate often very discrete and private, i.e. they often do not have a website where entrepreneurs can find them. So it is difficult for entrepreneurs to actually get in touch with informals. The process of finding an informal and the time it takes to get eventually to a deal is very time consuming. A second reason is that entrepreneurs find it difficult to produce a good and interesting business plan. They do not know which requirements informals seek for. The informals on the other hand argue that both entrepreneurs and their business plans are often of too low quality. Nooteboom et al. (1997) argues that this is the lack of trust between the informals and the entrepreneurs.
Informals experience different bottlenecks than the entrepreneurs. The most important issue is that they find it difficult to find entrepreneurs and business proposition of good quality. A second issue is that a lot of the business plans they receive do not match their personal investment profile. The conclusion of the report of Bureau Bartels (2003) is that the venture capital market does not function in an efficient way. Especially innovative starters experience difficulties with this. Benjamin and Margulis (2001) agree with the outcomes of Bureau Bartels (2003). The problem for informals is that there is not an efficient private investor market. This absence leads to underinvestment in this part of the market and contributes to the equity gap. Research of Mason and Harrison (2002) indicates that informals receive not enough dealflow. In other words, they want to invest more than they are able to due to shortage of good business propositions. Nicholson (in Mason and Harrison 2002) most strikingly states what the problem in the informal venture capital market is: ‘companies out there saying they cannot find money, and our angels saying that they can only place 10% of what they want to invest’.
Mason (2009) argues that small firms and technology based firms are a source of job creation, innovation and growth of productivity. However excess to finance for these firms is complicated due to market inefficiencies and as a result of this the equity gap. These problems are the greatest for starters and technology based companies. The EU (European Union) recognized this problem, and started intervening. The EU developed several policies to solve the market inefficiencies, from loans to supporting venture capital (Mason, 2009). The focus of these policies is on tech starters.
more effective due to the use of some kind of matchmaking initiative and through interventions by policy makers. These two solutions can remove barriers for small firms to obtain finance and reduce the equity gap. And eventually make the venture capital market more efficient.
The specific focus is on the matchmakers in the seed capital market. The seed capital market is a specific part of the venture capital market, in this part the Dutch government intervened in order to make the access to capital easier for creative- and techno starters in their seed or start-up phase. The government program is called the seed capital scheme. Several researches have shown that government intervention and the use and existence of matchmaking initiatives should improve the venture capital market efficiency as a whole. An interesting and until now underexposed subject in scientific research land is how seed funds perceive the influence of matchmakers. This research will focus on this unexplored area. The main question of this research is:
Is there room for a matchmaker in the Dutch seed-capital market?
To be able to answer this main question it is important to first explore where to place the seed capital scheme in the venture capital market. After that it is explored how the matching process takes places at this moment at the seed funds. How much effort this process costs the funds at this moment and how much they are willing to pay in the future to a third party. To be able to answer the main question, several sub questions are formulated.
1) How does the matching process of the seed funds work at this moment
2) How much effort does the dealflow process costs the seed funds at this moment (in time/money)
3) Do the seed funds collaborate with matchmakers at this moment
4) Can the efficiency of the matchmaking be improved by increasing competence trust 5) How much money are seed funds willing to pay for partially transferring the efforts of
2. Literature review
2.1 Venture capital market
Before starting the research on the specific area of seed capital, it is important to first define the risk capital market in its entirety. Because than it is possible to position seed capital in the market of venture capital. In this first part of the literature research the focus lies on how the risk capital market is divided.
When the personal funds of an entrepreneur and possible extra funds provided by friends and family are used, the entrepreneur has to attract external risk capital to be able to further invest in his company. Wetzel (1983) argues that the external risk capital market consists of at least three parts: the public equity market, the professional venture capital market and the informal venture capital market. The public equity market is better known as the stock market.
In this research the focus lies on the venture capital market. According to Mason and Harrison (1999) venture capital can be defined as providing finance to an organization by an investor. These organizations are not quoted and are often high growth potentials. The majority of the investments of venture capitalists are equity oriented. The earnings for the investors take usually the form of capital gained through an exit, instead off capital gained through dividend income. Venture capitalists mainly invest the early stages of the companies’ life cycle. To be compensated for the risks, venture capitalists seek high returns. Landström (2007) states that the venture capital market can be subdivided into three different components: the institutional-, corporate-, and informal venture capital market. Wetzel (1983) describes broader categories and takes the institutional and corporate venture capital market together. For this research a sharp distinction between those last two categories is not necessary, therefore the institutional- and corporate venture capital market are taken together. In the next part the professional- and informal venture capital market are discussed.
2.1.1. Professional venture capital
Napp and Minshall (2011) describe corporate venture capital investments as equity investments made by large corporations in entrepreneurial organizations. Further they argue that there is overlap between institutional- and corporate capital. First of all the form of investment is equity oriented. Second the goal is to gain capital through an exit. However there are some differences between corporate and institutional venture capital. The main difference is that in corporate venture capital the total pool of money is raised by a company or a subsidiary of this company and that those are the only limited partners. While by institutional venture capital the money is raised by individual investors (clients of insurance companies, banks).
2.1.2 Informal venture capital
‘The boundaries between the different parts of the venture capital market are vague and often overlap’ (Wetzel, 1983). In addition to the vague boundaries it is difficult for starters to find external finance, due to the invisibility of the market. Informals fill the equity gap between on the one hand friends and family and on the other hand professional venture capital (Bureau Bartels, 2011). Generally informals invest in the early stages of a companies' life cycle. Avdeitchikova (2008) argues in her article that there is still no widely used definition of what informal capital is. Earlier researches from e.g. Landström (1993) and Riding (2005) disagree about whether money invested by friends and family should be included in the term informal venture capital. Further there is disagreement whether virgin angels should be included or not and if all people who made at least one investment should be included in the definition or not. According to Mason and Harrison (2000) informals are private individuals who invest a part of their capital directly into unquoted companies.
In this article the definition of Avdeitchikova (2008) is used, because this is the most detailed definition. Informals are ‘private individuals who invest risk capital directly in unquoted companies in which they have no family connection’. Excluded are virgin investors and investors only investing in companies of family members.
2.2 Seed capital
According to Benjamin and Margulis (2001; p.31) ‘The seed stage describes ventures in the idea phase or in the process of being organized’. Important is that the company is in the development stage and not started with commercial activities yet. The European trade association for business angels, seed funds and other early stage market players (EBAN) describes seed funds and early stage venture funds, as those who invest up to €0,5m.
The focus of this research lies on how the matchmaking takes place between Dutch seed funds and entrepreneurs that are seeking finance. In the following part the co-investment schemes are explored.
Mason (2009) and Hayton et al. (2008) describe in their researches that the newest policy on the area of start-up capital are the so called ‘co-investment schemes’. The public sector Scotland developed a co-investment policy in recognition of the equity gap in the £0m to £0,5m range for the post seed phase, but the pre-institutional capital phase. Important to notice in this research is not the range or the phase where the policy is intended for, but the working of the co-investment scheme itself. The idea of this co-investment is to increase the investment in an area where an equity gap exists. The government creates an incentive to accomplish this by co-investing. The amount of money that a private investor is willing to invest in company is matched by public funding from the government. Of course this co-investing is restricted to rules which are determined by the government. But the starting point is that the private investor and the co-investment fund act on the basis of equality. Mason (2009) argues that there are two types of co-investment funds. The difference between the two is based on how they operate. The passive funds are the first type. In this case, private investors with approved investment funds have the lead. Any investment that fits the restrictions can be automatically qualified for government co-investment, without interference of the government. The second type of fund is the active fund in which the government has more control and can participate in investment decisions. So when a co-invested fund intends to invest in a company, they first have to discuss this with the government.
raise the maximum amount of capital that can be co-invested to £1m. This because during the time the co-investment fund existed, it became clear that the equity gap was larger than was expected initially.
2.3 Inefficiencies & equity gap
Harrison & Mason (2000) state that business angels are not able to find enough interesting investment opportunities. This implies that they are willing to invest more than is possible at this moment. On the other hand Wetzel (1987) argues that it can be very difficult for especially starters to find and attain external funding in the early stages. The two researches show that it is both for the investors as well as the entrepreneurs difficult to find the other party.
Rea (1989) states that it is important to reduce the uncertainty in interactions between entrepreneurs and investors. Further Rea states that the matching could be much more efficient if the expectations of the entrepreneur and the investor were matched better at the beginning of the process. Timmons & Gumpert (1982) agree that the venture capital market works inefficient: ‘Venture capitalists are highly selective and fund relatively few proposals’. The vast majority of interviewed venture capitalists invest in less than 5% of the proposals they assess. Rea (1989) argues that venture capitalists are disappointed about the quality of the business proposals they receive. Many do not meet the requirements of the venture capitalists. These researches all indicate the fact that the venture capital market works in an inefficient way. According to Lange et al. (2003) the inefficiency problem seems to focus on two problems. The high search costs of informals to find interesting business propositions. The second problem is that the informal market is characterized by discretion; the result is that entrepreneurs find it difficult to get in touch with informals. Several organizations took advantage of the inefficiencies in the informal capital market and entered the market and started offering matchmaking services to both entrepreneurs and informals (Harrison and Mason, (in Lange et al. 2003)).
Olde Meule (2012) agrees with the research of Harrison and Mason and argues that matching initiatives can reduce and overcome information asymmetries between entrepreneurs and investors. In other words, matchmakers can improve the efficiency of the venture capital market.
is an important factor in deciding whether or not to invest in a project. So assessing al the business plans is an important factor in the investment process. According to Mason & Harrison (2002) business angels networks (BANs) increase the efficiency of the business angel market. Further they state that such networks can increase the efficiency by educating the entrepreneurs. Making them understand the requirements and expectations of the investors. This research is supported by Aernoudt (2005); his research underlines the fact that there is an information gap to fulfill for business angels as well as the entrepreneurs. He concludes that matchmaking initiatives should be encouraged, because they will improve the efficiency of the market. Research of Bureau Bartels (2003) indicates the potential importance of matchmaking initiatives. A large majority of entrepreneurs in the seed- and start-up phase experience the obtaining of finance as extremely difficult. Specifically the process of finding an informal is difficult for the entrepreneurs.
It is clear that the venture capital market works inefficient. A matchmaker can be able to overcome a lot of information uncertainty between investors and entrepreneurs. The effect should be that a matchmaker will make the market more efficient. But what is not explored yet, is the fact if investment funds are willing to work with matchmaking initiatives and if it is viable to start such an initiative. This research focuses on this unexplored area.
2.4 Matching organizations
According to Bureau Bartels (2003) it is important to stimulate and optimize the market for informals. In their report they make several recommendations to do so. Their main recommendation is to make use of intermediate organizations, which act as intermediary between entrepreneurs and informals. The purpose of such an organization is to make the matches between informals and entrepreneurs. Teten and Farmer (2010) state that matching organizations are part of a greater whole, the intermediaries. Intermediaries are considered as a third party that brings entrepreneurs and investors in touch with each other.
possibility to access projects in need of financing. Both researches agree on the fact that the goal of a matching organization is to increase the dealflow of the informals and to make the access to finance for entrepreneurs easier.
Two third of the informals, interviewed in the research of Bureau Bartels (2011) use BANs to receive more business propositions from entrepreneurs. One third of the informals actually realizes more deals due to the use of BANs. Mansson and Landström (2006) agree with these outcomes. They conclude that BANs are very important in the venture capital market because their existence leads to more business proposals for investors. This research emphasizes the importance of BANs.
On the other hand there are also negative research results about matchmaking initiatives. Research of Bureau Bartels (2003) indicates that there are also informals that occasionally to never receive a matching business proposal from matchmakers. According to the research there are three reasons of this dissatisfaction amongst informals. The first reason is that the quality of the entrepreneurs is poor. The second reason is the poor quality of the business proposals. The last reason is that the business proposals do not fit the profile of the informal. Lange et al. (2003) agrees with these findings and states that many informals complain about matchmakers. The first criticism focuses on the lack of selectivity of the business propositions delivered by the matchmakers and the second criticism concentrates on the poor quality of the business propositions provided by the matchmakers. The result of this criticism is that matchmakers have to improve their services and show the informals their added value.
There are different types of matchmakers active in the Netherlands. Rikhof and Mulder (2011) argue that there are five different sorts of organizations that offer services to entrepreneurs who seek finance. The first group is the Dutch banks, e.g. Rabobank, ABN AMRO and van Lanschot Bankiers created a special informal investing service for their clients. This service is only for the clients that are looking for business proposals to invest in. The banks bring the entrepreneurs in contact with their clients that are willing to invest. The banks offer these services to starters, growing companies and also to organizations that have to deal with management buy in or management buy out. The banks have no specific branche focus and offer their services to each entrepreneur that seeks finance.
several Dutch incubators e.g. Yes!Delft, New Energy Docks and Dnamo. Each incubator usually focuses on a particular branche.
The third group is the BANs that bring entrepreneurs and investors into contact. BANs consist of a group of informal investors that organize network- and information meetings where informals and entrepreneurs can meet each other. At some meetings there is the possibility for entrepreneurs to pitch their idea. BANs have not the actual matching of entrepreneur and informal as goal, but the bringing into contact of entrepreneurs and informals. Regional development agencies have the same goal as BANs but offer their services only in their region. There are also online platforms like Next Stage that bring entrepreneurs and investors into contact with each other.
According to Rikhof and Mulder (2011) the fourth and fifth groups are both intermediaries that act on behalf of the entrepreneur. They actively search for investors that are willing to finance a specific business proposal. The intermediaries can be divided into two groups; the matchmakers and the capital searchers. Matchmakers guide the entrepreneurs during the first part of the funding process. Their goal is to match the entrepreneur with an informal, after the match the services of the matchmaker will end. So the matchmaker does not assist the entrepreneur during the negotiations with the investor. In the Netherlands there are different matchmakers active; Investormatch, KplusV, MatchInvest, Investeringsplein and Kapitaalplaza. Al these matchmakers have no specific focus area and basically try to match each business proposal they receive. From starters to companies that look for growth financing and from companies in the technology branche to companies in the industry sector. Capital searchers like Credion and Mindhunter on the other hand guide the entrepreneurs during the whole process. They also assist the entrepreneur with valuing their business, assist them during the negotiations with the investor and help them with the contractual part of the funding process.
2.5 Trust
The main purpose of matchmaking initiatives continues to be the matching of the supply and demand of finance for start-ups and early stage businesses (Lange et al., 2003). According to Lange et al. (2003) it is of major importance for matchmakers to improve their services by gaining confidence, trust and credibility from the informals. According to Nooteboom et al. (1997) ‘trust is the glue that keeps business partners together’. In later research, Nooteboom (2004) provided evidence that the opposite of trust, distrust creates more distrust and is a threat to the relation between business partners. The research also indicates that trust operates as a source for cooperation. Doney et al. (1998) add to this that trust is valuable in improving relationships between firms and that trust decreases transaction costs between parties. Next to this, trust contributes to a successful long term relationships between firms because trust reduces the perceived risk in a relationship (Das and Teng, 2001). So it is evident that trust plays an important role in the relationship between two parties. Interesting to examine is if trust influences the relationship between the use of matchmakers and the dealflow of informals.
It is important to first define trust. Mayer et al. (1995) state that trust is: ‘The willingness of a party to be vulnerable to the actions of another party based on the expectation that the other will perform a particular action important to the trustor, irrespective of the ability to monitor or control the other party’. In other words one party takes the risk to make itself vulnerable to another party. Doney et al. (1998) agrees with this definition. In the case of informals and a matching organization, the informal takes a risk to trust the matching organization to deliver them suitable business propositions of good quality. Requirements for gaining trust and confidence are carefully meeting the selection criteria of the informals and select business propositions more selective. Nooteboom et al. (1997) use a slightly different definition of trust. According to them, trust may refer to the capacity of the other party to perform according to the intentions and expectations of what is agreed beforehand or the intentions of the other party not to defect the relation. Nooteboom et al. (1997) add to this that: ‘an individual trusts someone if he or she believes the other is likely to cooperate even if the latter is not coerced to do so and has no direct material interest in doing so’.
Nooteboom et al. (1997) argue that trust is a subjective concept and that in the same situation, each individual can perceive trust in a different manner. So trust is the subjective perception of one party that the other party will not misuse this trust in the relationship. Research of Hirschman (1984) indicates that trust can grow over time. A positive experience makes the trust in the other party greater, and makes the probability to cooperate again in the feature also greater. Important to notice is that Hirschman (1984) states that a negative experience has a much greater impact on trust than a positive experience. It takes a lot of time to rebuild a relationship where one party disappointed the trust of the other party.
Harrison et al. (1997) argue that trust can be interpreted as: ‘a means of speeding decision making and negotiations by reducing transaction costs between individuals in organizations under conditions of risk’. So trust plays an important role in lowering transaction costs involved in structuring a deal between investor and entrepreneur.
2.5.1 Risk
The role of trust in a relationship is to reduce the perceived risk. According to Das and Teng (2001) there are two sorts of risks; relational and performance risk. Das and Teng (1996) state that relational risk is the probability of not having a satisfying cooperation with the other party. This risk results from opportunistic behavior of one party i.e. cheating, hidden agenda’s and distorting of the cooperation. Performance risk is the probability that objectives are not met despite of the good cooperation between the two parties. The reasons of not achieving the objectives can be diverse, i.e. changing policies, entrance of new competitors or just bad luck. Nooteboom et al. (1997) argue that there are two dimensions of trust. The first is competence trust which relates to the ability of the other party to perform according to the intentions and expectations of what is agreed upon beforehand. Liu et al. (2008) agree with the research of Nooteboom et al. (1997) and state that competence trust is the belief that one organization has in the expertise of the other organization to successfully perform the agreed job. The second dimension is intentional trust which relates to the intentions of the partner not to defect the relation. In earlier research Nooteboom (1996) used slightly different dimensions of trust, competence trust and goodwill trust. But in essence intentional trust and goodwill trust are equivalents of each other.
et al. (1997) competence trust is an important form of trust in the relation between an informal and a matchmaker. This because the performance risk is perceived to be the most important form of risk in the relationship between matchmaker and investor. Research of Sichtman (2007) has shown that indeed trusting the competences of an organization has a positive impact on the trust in that organization, which leads to a reduced performance risk.
2.5.2 Competence trust
Das and Teng (2001) state that competence trust will reduce the perceived performance risk. Competence trust relates to the ability of one party to successfully perform the agreed job. The basis for this trust lies in the resources and capabilities of a firm. The combination of these resources and capabilities leads to the expertise of that firm. The combination of this expertise and the reputation of the firm lead to a high probability of achieving the agreed objectives. This in turn leads to a low performance risk.
Important is to know how to build and maintain competence trust. Das and Teng (2001) state that organizations can achieve competence trust through proactive collecting of information about the other organization and sharing information about their own organization as well. Information can be acquired through either direct contact with the other company or by engaging in network activities. With this sharing and collecting of information, the organization becomes known in the market, other organizations become aware of them. In this way the organization starts building a reputation in the market. This reputation is a strategic asset and leads to an increase of competence trust (Das and Teng, 2001). Bachmann and Inkpen (2011) agree with the research of Das and Teng and state that an organization’s reputation is important in attracting other organizations to cooperate or connect with them. The higher the reputation of an organization, the higher the probability that another organization will engage in a relationship with that organization.
Bülbül (2012) agrees with this research and states that indeed experience, reputation and trustworthiness increase the competence trust of an organization.
According to Liu et al. (2008) solidarity is the second dimension which enhances competence trust. Solidarity is the sharing of the same norms and values and sharing of the same relational goal. Solidarity between two organizations has a positive influence on competence trust (Liu et al., 2008). In this research it is important to determine what the important norms, values and goals are in the relationship between matchmakers and informals.
Informals expect a sufficient amount of promising business proposals from matchmakers. Therefore it is important to determine the criteria that informals find important when considering an investment opportunity. In this research the focus lies on criteria that can be influenced by a matchmaker. The most important investment criterion for informals is the return on investment on the long term (Bureau Bartels, 2003). In order to estimate the return on investment, investors are interested in the quality of the investment opportunity (Olde Meule, 2012). This quality is based on two dimensions; the quality of the entrepreneur and the quality of the business model. Lahti (2011) adds to this that the quality of the entrepreneur is the most important dimension, more important than the business model. Research of Mason and Stark (2004) indicates that informals spend much time with entrepreneurs after they have invested in their business proposals and that informals therefore find the quality of the entrepreneur very important.
assessing the qualities of the entrepreneur. They can screen and assess the motivation and market knowledge of the entrepreneur, before bringing the entrepreneur in touch with the informal. By acting in this way, the matchmakers can link only the entrepreneurs with a certain level of entrepreneurial quality with informals. In this way the informals can only spend time on the entrepreneurs with a certain quality level and improve their efficiency.
The second dimension on which informals base the quality of the investment opportunity is the quality of the business model. Mason and Stark (2004) investigated what investors look for in business plans. When informals assess a business plan they attach value to four criteria. The most important criterion is the financial considerations. These considerations relate to the financial structure of the organization, the value of the business, the likely rate of return and the exit strategies (figure 1). The second most important criterion is het market criterion, which relates to the potential market growth, competition and entry barriers. The next criterion is the quality of the entrepreneur and / or management team of the company, this criterion corresponds with the background, expertise and the qualities of the entrepreneur. This criterion is considered to be the same as the quality of the entrepreneur measured with the competence model of Driessen. Therefore it will not be explored again at this point. The last important investment criterion of informals is the investor fit. This relates to the fit between the background, expertise and market knowledge of the informal and the investment opportunity and the fit between the preferences of the informal and the investment opportunity.
Matchmakers should be able to deal with these criteria. These organizations can assess the market and financial considerations and the fit between the investor and the investment opportunity. The assessing of the entrepreneurs could take place during interviews with the entrepreneurs. They can even educate the entrepreneurs about which parts of their business plans are important to the investors. Further they can educate the entrepreneurs how to adept their business model and point out the most important components of the model.
2.5.3 Definitions used in this research
In this research it is expected that the concepts: reputation, duration of the relation, solidarity, ability to assess the quality of the entrepreneur and the ability to assess the quality of the business plan determine the level of competence trust and therefore influence the relation between matchmaker and seed fund.
To define reputation, the research of Das and Teng (2001) is used. An organization can build a reputation through sharing information about their own organization and collecting information about other organizations in the market. By acting in this way the organization becomes known in the market. In this research reputation is defined as the extent to how well known an organization is in the market.
The research of Liu et al. (2008) is used to define the concept: duration of the relationship. In this research the duration of the relationship is defined as the length of time between the moment that two organizations work together for the first time and the moment that they work together for the last time.
The research of Liu et al. (2008) is also used to produce a definition of solidarity. In this research solidarity is defined as sharing the same norms and values.
Driessen (in Olde Meule, 2012) developed a model to assess the entrepreneurial competences of an entrepreneur. The model consists of the four dimensions: knowledge, motivation, capabilities and characteristics. Olde Meule (2012) argues that investors consider the knowledge and motivation dimension as most important indicators of the quality of an entrepreneur. In this research are only the two most important dimensions; the knowledge and motivation dimension are used to observe the matchmakers ability to assess the quality of an entrepreneur. The level of need for achievement is used as indicator for the motivation dimension. And the market knowledge of an entrepreneur is used as an indicator for the knowledge dimension.
financial considerations, the market, the entrepreneur or the management team and the investor fit. So for a matchmaker it is important to be able to assess these components in a business plan. In this research only the financial considerations, the market and the investor fit are used to observe the ability of the matchmaker to assess the quality of a business plan. That is because the entrepreneur/management team component is used as a separate concept in this research. The descriptions of Mason and Stark (2004) of the three components are also used in this research (figure 1). The financial structure of a business, the value of the business and the likely rate of return and exit strategies are used as indicators of the financial considerations component. The potential market growth, the competition and entry barriers are used as indicators for the market component. The relation between the investor’s background and the investment opportunity and the investor’s preferences are used as indicators for the investor fit component.
The eventual efficiency of the dealflow process is explored based on the amount of promising investment opportunities that the seed fund receives.
2.6 Conceptual model
Figure 2 Conceptual model
To be able to explore the current dealflow process of the seed funds and to explore if seed funds already make use of matchmakers or not, questions are developed. These questions can be found in appendix A.
- Questions 1 till 4 are about the current dealflow process of the seed funds
- Questions 5 till 10 are about the influence of matchmakers on the dealflow process of seed funds
In this research it is expected that competence trust acts as a mediator on the relation between the matchmaker and the amount of promising investment opportunities that a seed fund receives through these matchmakers. This relation is shown in the conceptual model with the number 2. Finally it is expected that the level of competence trust is determined by several factors. First it is expected that the reputation of a matchmaker has a positive influence on the amount of competence trust that other organizations have in the matchmaker. Second it is expected that the duration of the relationship between a matchmaker and a seed fund has a positive influence on the amount of dealflow. Further it is expected that the degree of
solidarity between matchmaker and seed fund has a positive influence on the amount of competence trust. It is also expected that the ability of a matchmaker to assess the qualities of an entrepreneur has a positive influence on the level of competence trust. The motivation and knowledge of an entrepreneur are the two dimensions which determine the quality of an entrepreneur. The ability to assess the quality of the business plan is the last concept of which is expected that it has a positive influence on the amount of competence trust. The financial- and market considerations together with the investor fit, determine the quality of a business plan. Eventually it is expected that these five concepts have a positive influence on the relationship between the matchmaker and seed fund.
- Question 11 and 14 are about the relation between reputation and competence trust - Question 12 is about the relation between duration of the relation and competence
trust
- Question 13 is about the relation between solidarity and competence trust
- Question 15 till 23 are about the relation between the ability to assess a business plan and the amount of competence trust
- Question 24 till 26 are about the relation between the ability to assess the entrepreneur/ management team and the amount of competence trust - Questions 27 and 28 are about possibilities to enhance competence trust
- Questions 29 till 31 are about the willingness of seed funds to partially transfer the efforts for attaining dealflow to matchmakers
3. Methodology
3.1 Research design
The purpose of this research is to explore if the dealflow process of the seed funds could work more efficient with the help of matchmakers. The starting point is that making use of
matchmakers improves the amount of promising investment opportunities for seed funds. The focus lies on the role of competence trust between these matchmakers and the seed funds. Expected is that competence trust has a mediating role on the relationship between the seed fund and the matchmaker. Trust is the glue that holds a relation between these two
seed fund, a case study is conducted. In order to get a theoretically underpinned answer on the main and sub questions a case study is conducted that is supported by scientific literature. ‘A case study is a research strategy which focuses on understanding the dynamics present within single settings’ (Eisenhardt, 1989). Because this research focuses solely on the population seed funds in the Netherlands, the case study is a suitable research strategy. An advantage of using a case study according to Eisenhardt (1989) is that it increases the possibility of
generating new theory. Because combining data of different cases forces an investigator to re-examine their perceptions. Emans (2004) is used to operationalize the concepts of the
conceptual model. The definition of Das and Teng (2001) is used to operationalize the concept: reputation. The definitions of Liu et al. (2008) are used to operationalize the concepts: duration of the relationship and solidarity. The researches of Driessen (in Olde Meule, 2012) and Olde Meule (2012) are used to operationalize the concept: ability to asses the quality of an entrepreneur. The research of Mason and Stark (2004) is used to
operationalize the concept: ability to asses the quality of a business plan.
3.2 Sample
This research focuses on the seed funds in the Netherlands. The criterion used to determine a seed fund, is whether the Dutch government has approved a fund as a seed fund.
AgentschapNL is responsible for approving the seed funds in the Netherlands. According to this organization there are 34 approved seed funds in the Netherlands, so the whole research population consists of 34 seed funds. Only the fund managers of the seed funds are used as respondents in this research. The funds and their managers are found through contact with AgentschapNL. In this research the seed funds are divided into five groups, this division is based on the investment focus of the funds. The different investment focuses that are created in this research are: sustainable technologies, sustainable solutions for safety, mobility and logistics in the transport sector, business-to-business ICT, sustainability in sport and
3.3 Data collection
The data is collected through qualitative research. This qualitative research is conducted through five in depth semi structured interviews with five different seed fund managers. For these interviews an interview guide is developed1. The interview guide consists of open ended questions, so that the interviewees can come up with their own answers. When the answers are not sufficient enough or do not contain enough information, probing is used to gain additional information about a certain subject. All the interviews are taken in a similar way, which means that all the interviewees are asked the same questions. The interviews are also recorded so that it is not necessary to completely write down the answers of the interviewees during the interview. Furthermore taping creates the opportunity to listen back the answers that the interviewees have given. To receive honest answers and not socially desirable
answers and to guarantee confidentiality, complete anonymity is agreed upon beforehand. So the data received during the interviews is processed anonymously.
3.4 Data analysis
The first step is to transcribe the recorded interviews. Notes that are taken during the interview and the recordings of the interviews are the two sources of information for the transcriptions. The first step is to transcript each interview independently of the other interviews. For the reliability of the research it is important to use quotes from the interviewees to substantiate the findings. The second step is to analyze the data of each separate interview and link this data with the theory discussed in the literature review.
are discussed per concept. Also the relations between these concepts are grouped and discussed per relation.
4. Overview and history of seed funds
4.1 Dutch seed fund
In the Netherlands the government started a co-investment scheme called the seed capital scheme led by AgentschapNL in 2004. The goal of the Dutch government is to stimulate and mobilize the bottom of the venture capital market in such a way that capital is provided to creative- and tech starters. The Dutch government believes that starters with a technological perspective (tech starters) and creative starters are especially important for creating an innovative and competitive economy. Tech starters translate research outcomes into new products and services. Tech starters have an important contribution to the increased productivity of the Netherlands. Furthermore tech starters have shown more growth potential than regular starters. The lack of sufficient risk capital for the early life stages is an obstacle for the tech starters to start their company.
Investors do not invest in tech- and creative starters very often, because these investments are considered as high risk investments. Moreover the profits are considered low especially when this is compared to the long investment period. To attract investors to invest in tech- and creative starters, the Dutch government created the seed capital scheme. The seed capital scheme is a proactive action from the government, because it significantly increases the amount of capital available for tech- and creative starters.
these investment decisions and will only check the investment requests against the general conditions. To be sure that the seed funds invest their capital in the tech- and creative starters mentioned by the government, the selection procedure for becoming a seed fund is very strict. The government developed several general conditions which have to be met by the seed funds.
The first condition is that the seed funds can only invest in creative or tech starters in their seed or start-up phase. Requirements for a creative starter are that it has to be a company in their starting phase or in the seed phase, preparing to launch a new creative invention or application of an existing creative concept. The concept concerns the sale and delivery of products, processes or services. Requirements for the tech starter are that it has to be a company in their starting or seed phase, preparing to launch a technical invention or application of an existing technology. The concept concerns the sale and delivery of products, processes or services. To assure that a company is in its seed- or start-up phase, the company cannot be registered longer than 5 years at the Dutch chamber of commerce.
Another condition is that the provision of capital to tech- or creative starters takes the form of taking shares in the company, possibly in combination with a subordinated loan. The seed fund can invest a minimum of €0,1m and a maximum of €2,5m at a time. Especially in this capital range till €2,5m, starters perceive difficulties in getting finance. The seed capital scheme provides capital precisely in this phase. The average total funding per tech- or creative starter cannot be higher than €0,8m. This means that when a fund invests in two different companies during the lifetime of the fund, and they invest €1m in company A, they can invest a maximum of €0,6 in company B. Otherwise they end up with a higher average total funding per company than €0,8m. In addition a fund can only invest a maximum of €0,5m every six months in a company. So when a seed fund wants to invest €1m in one company, they have to do this in phases.
reason to extend the investment period is when the business of the tech- or creative starter would be greatly harmed by enforcement of the deadline for disinvesting the participation.
The fourth condition applies to the repayment of the government loan. The government developed a favorable repayment scheme to convince investors to invest in tech- and creative starters. It was necessary that the risk-reward ratio became favorable enough for investors to invest their money in these starters. Several repayment conditions are compiled. Repayment of the loan only takes place if the investment produces income. In this case the definition of income is: all benefits that a seed fund receives in exchange for their participation which can be expressed in money. Including dividends, interest, repayments, options, the price at which the participation is sold, the price at which the fund the participation has purchased or repaid and the liquidation benefits. Repayment of the loan starts at the moment that the company starts generating income. From the moment that the investment starts generating income, the division of income between the fund and the government is 80/20 in favor of the fund. The government chose this division to create a favorable risk-reward ratio for the investors. This 80/20 division remains unchanged until the moment that the investors recovered their initial investment in the starter. Than the second stage of repayment starts. From this moment on, the division of income is 50/50, this is based on the fact that in principle the government wants to see its loan repaid, but on the other hand it must still be interesting for the private investors to keep generating income. This second phase ends at the moment that the government recovered its initial loan in the starter. When the government recovered its investment, the third stage begins. Again the division of the income is 80/20 in favor of the fund. The government chose the 80/20 ratio again to stimulate the private investors to put their efforts in the start-up so that they reach the attractive third stage. This division lasts until the funds exits the investment in the company. In practice, not every investment will last until the last stage.
The core of the seed capital scheme is that on the one hand through leverage the volume of venture capital for creative- and tech starters will be increased. And on the other hand the risk for the informals will be lowered due to the interest free loan and the above mentioned repayment scheme. Repayments only take place as far as the participation
by AgentschapNL. The total amount of investable capital in these funds is about €230m, what indicates that the government co-invested with favorable loans around €115m.
The government knowingly gives the private investors a lot of space to establish the fund and to choose the investments they want. The government on the other hand expects that the funds live up this responsibility and do not make abuse of this freedom. Examples of this abuse can be making new investment to cover loses or risks from earlier investments, the selling of shares to related parties at artificially low prices or unusual high administrative costs of the fund. To assure this the government developed a few basic rules for the fund in order to prevent abuse.
1) Seed funds must have the legal status of a joint stock company, a private limited company, a general partnership or a limited partnership. This legal status of the fund gives the government certain guarantees regarding the financial statements and regarding the personal liabilities of the directors of the fund. The seed funds are also closed end funds, which mean that they can only invest in accordance with the seed capital scheme.
2) The ex ante evaluation of the investors and their intentions is an important mean for the government to determine the reliability of the fund. The investors who want to start a seed fund have to write a fund plan. This is an extensive plan in which the investors have to explain how they will provide capital to the starters. In which branche they want to invest, in which phase of the life cycle, the geographical focus, their investment strategy, how they will guide and support the starters after the investment, exit strategies and the administrative costs of the fund.
3) At least three mutually independent parties, all without a majority stake have to participate in the fund. This prevents that one vote can be decisive, if at least two parties have to support an investment decision it reduces the probability that the fund will or can make abuse of the fund.
4) Funds which are granted with a governmental loan have to provide the government with information about obtaining and terminating a participation, but also provide information annually. Furthermore the government has the possibility to send a representative to the fund meetings to listen to the fund directors. If such a meeting gives rise to ambiguities, the government is allowed to request extra information or may send an accountant to carry out an investigation.
6) The disinvestment of the participation may not harm the interest of the government. The disinvestment must be under normal market conditions and there should not be any conflicts of interest. This might be the case when the shares are sold to one of the original investors.
The Dutch government considered three different variants of seed capital schemes. The first option is that the government provides investors with warranties, de second option that the government directly invests in tech- and creative starters and the last option is the co-investment option, in which the government co-finances co-investment from investors in tech- and creative starters. The Dutch government had several arguments to choose the
co-investment scheme option. First of all the co-co-investment scheme is considered the best option to increase the number of investors in the Netherlands and also the best way to increase the size of the capital market in the Netherlands. A second reason is that the co-investment scheme creates a leverage effect, so that private investors are encouraged and have an
incentive to invest in tech- and innovative starters. Furthermore the government does not only share in the risks of an investment but also in the profits.
Every year Tornado Insider, a research institute commissioned by the EU examines the European capital market. These researches also specifically focus on the Dutch capital market. The first Tornado Insider research is conducted in 2005, each next year a follow-up research is conducted. Therefore it is now possible to compare the figures of all these years. This is specifically interesting for the investments made by seed funds in these years. According to Tornado Insider (2012) the impact from the seed funds on the Dutch capital market are quite large. In 2005 the share of the seed funds on the whole market was still small with 2%. Within three years seed funds were involved in almost one third of all the
investments made by Dutch investors. This figure remained almost unchanged; in 2011 the seed funds were involved in 30% of all deals in the Netherlands.
4.2 Public policies in Europe
difficulties in attaining finance. These categories are tech-, creative- and innovative companies, SMEs and organizations in economically inferior regions. The EU support is focused on making the access to finance easier for these categories of companies and at the same time attracting private investors to invest at the same time.
Already in 1988 the EU created policies to enhance the amount and access to finance for new companies (Murray, 1994). The EU created the European Seed Capital Fund Network, the objective of this network was to stimulate and encourage investments made by private investors in starting companies. The EU did this by providing financial incentives to new created seed funds in Europe (Murray, 1994). The success of these funds was mixed. According to Murray (1994), the EU succeeded in creating new sources of seed capital and thereby the increase of private investments in tech- and innovative starters, but on the other hand the funds remained very small eventually resulting in a relative small impact on the whole EU seed capital market. In 1996 the EU started a new European investment fund; the European Investment Fund (EIF) (McGlue, 2002). This fund provides finance to venture capital funds in EU countries on a commercial basis. A precondition is that these funds have to invest their money in new and young companies that otherwise fail to obtain sufficient capital for succeeding their company. According to McGlue (2002) the EU wants to increase the investments for companies in their start-up or seed phase of the business life cycle. So the companies that operate in the equity gap. The majority of the EU support for the venture capital funds is in the form of equity contributions.
Di Giacomo (2004) divides public policies in two groups; grant aid and non grant aid. Grant aids include subsidies and gifts and do not have to be returned to the government. Non grant aids comprise guarantee systems and equity- and credit based products the difference is that these aids have to be returned to the government. The EU encourages the development of non grant aid policies. But also the EU developed restrictions with regard to the policies of member states, i.e. it is not allowed to favor certain firms or industries. But within this restrictions member states can develop their own policies.
et al. (2007) makes a slightly different subdivision, according to this research there are four groups of measures which a government could take to intervene in the venture capital market: tax incentives, vouch for companies, co-investment schemes and subsidies for creating BANs.
In this article the focus lies on public policies that provide funding to independently managed investment funds, which will invest this capital in tech- and creative starters. So the intervention that Aernoudt et al. (2007) names co-investment schemes. This because the seed funds in the Netherlands are a form of a co-investment scheme. The public policy of the Netherlands regarding the improvement of access to finance is compared with policies of other European countries. Countries as the UK, France and Germany are already must longer active in the venture capital market than the Netherlands. According to Di Giacomo (2004) the public policies in European countries differ from each other. The UK, France and Germany develop more and more policies where they directly invest, other countries like the Northern European countries and the Netherlands developed policies in which they try to encourage the investments of private investors (Di Giacomo, 2004). The Southern European countries do not have well developed policies to improve the access to finance for start-ups. Di Giacomo (2004) argues that Germany is the most active country in Europe on the area of venture capital policies, but that the UK capital market is the largest. More recent research of Aernoudt et al. (2007) indicates that more and more countries develop policies to directly interfere in the venture capital market. The rationale of this is that they try to create leverage, by diminishing the risk for the private investors. The most recent form of intervention is the co-investment scheme (Aernoudt et al., 2007).
4.2.1 Germany
One of the schemes developed by the Germans is the technology investment company, which can be seen as the German seed capital scheme (Aernoudt et al. 2007). The goal of this scheme is to improve the access to finance for tech- and innovative starters. The investment procedure of this scheme is to co-invest with private investors. These private investors act as lead investors and are responsible for managing the investment and advising the companies. The government knowingly chooses a passive role in which they do not have control over the company where they co-invested public money in. These investments can either be loans or subsidies. The seed scheme co-invests up to €0,5m in an individual starter. The most important restriction is that the government finances up to a maximum of 25% of the companies’ value, this means that other investors or the entrepreneur have to finance the remaining 75%.
4.2.2 United Kingdom
According to Di Giacomo (2004) the UK venture capital market is in amounts the largest in Europe. The UK policies have three focus areas. The main focus area is making the access to finance for starters easier. The next focus lies on reducing the geographic differences in the country with respect to the access to finance. And their last focus point is ‘encouraging’ and showing investors that it is profitable to invest in start-ups. In order to support these policies the UK developed nine regional capital funds. These funds are funded with public money and managed by professional venture capital managers. An important outcome is that the UK government found out that the best way to solve the equity gap is through local or regional solutions. Nowadays the objectives of the UK government are to provide funds to the target companies, to make them able to grow and create jobs. And at the same time convince private funds or investors through leverage to invest in the same target groups. The UK tries to do this by creating alliances between the public funds and the private investors.
The UK developed different co-investment funds among others the London Seed Capital, the Capital Fund Programme (Aernoudt et al., 2007 & Martin et al. 2003), the Enterprise Capital Fund and the Scottish Co-investment Fund (Hayton et al., 2008 & Martin et al., 2003). The current policy of the UK government is thus to co-invest in young
