Against the backdrop of an ever-changing financial landscape sometimes characterised by an abundance of funding and startup opportunities, but usually characterised by down rounds and decreasing valuations, leading to funding, investment and liquidity gaps, venture capital has taken on a new uncertainty and complexity.
Venture capital should not exclusively – or even primarily – be defined in terms of providing risk capital and advice to founder-entrepreneurs. Such an approach to venture capital, often described in terms of a venture capital cycle, seems to represent the conventional wisdom in most recent discussion. According to this perspective, the solution to the funding, investment and liquidity gaps is for new sources of capital – be they government, corporate or crowd – to step in and provide founder-entrepreneurs with money, capacities and connections that allows them to start, scale and grow their businesses.
These ingredients are necessary but not sufficient to maximise the economic potential of startups. Clearly we need something more. Recently, alternative forms of finance and a new breed of venture capital providers have emerged which focus more on collaborations and the process of building long-term relationships constructed around sharing, mutual trust and respect (partnering) than making money (venturing). Online platforms, such as AngelList, play an important role in encouraging these collaborative models. Some investors have labelled this process venture capital 2.0.
Reforms that relax rules and regulations governing initial public offerings (IPOs) should attract new venture capital 2.0 investors and high volumes of business. However, the growth rates for new segment listings in Europe and the US have stalled recently, casting doubts on the usefulness of the IPO route for both young firms and investors, suggesting that a renewed focus on so-called private IPOs (late-stage funding rounds), followed by a trade sale or public IPO, is necessary to accommodate the preferences of entrepreneurs and investors.
The past two decades have seen an array of policy and regulatory measures attempting to replicate the success of the world’s most successful venture capital ecosystem, Silicon Valley in California. We are all aware of the success stories of entrepreneurs who started their businesses, and developed their innovative ideas, in garages and basements and built them into global market leaders. The Silicon Valley model, however, is not easily replicated. Indeed, an account on the measures introduced by governments around the world does not examine how the specific characteristics of Silicon Valley – the interactions among both public and private capital providers – can help turn innovative ideas into vibrant companies. For instance, policy initiatives that focus only on early-stage venture capitalists could crowd out the supply of risk capital in the later stages of a startup company’s development.
Consider the case studies and empirical research that show that tax incentives encouraging individual investors to pour money into special venture capital vehicles reduce the supply of other, relatively more informed venture capital investments. This phenomenon is particularly strong if not all players in the ecosystem are likely to benefit from the regulation, or are exempted from strict regulations.
Recent evidence suggests the funding or investment gaps in the venture capital cycle are likely to be filled partially by alternative financing channels, or non-market, non-bank sources, internal finance and alternative external finance, and new types of investors, such as micro-venture capital funds and crowdfunding platforms. To investigate these claims, we illustrate the use of trading platforms and analyse the likelihood that they can bridge the liquidity gap in the venture capital cycle and reduce the fragmentation of the venture capital industry.
As it happens, profound changes in the venture capital ecosystem, particularly the increase in time from inception of the startup to its first equity investment and to the eventual exit, have arguably led to a liquidity gap in the cycle. With regard to the gaps in the venture capital cycle, we also show the extent to which corporate venture capital increasingly has the potential to contribute significantly to high-growth small and medium-sized exterprises and also create more liquidity in the cycle. This implies that the new collaborative venture capital models are likely to provide an effective basis for financing innovative firms. One of the features of these new models is that corporations have increasingly become anchor investors in early-stage venture capital funds that invest in both related and apparently unrelated industries.
Our final claim is that government involvement in the venture capital cycle, through public-private co-invested funds in certain sectors, can provide important support for early-stage to growthstage startups. Successful government-sponsored funds, such as Germany’s High-Tech Gründerfonds, confirms the network creating capabilities of these initiatives result in productivity effects for large corporations, venture capitalists as well as entrepreneurs.
Abstract from an article published in Lex Research Topics in Corporate Law & Economics, working paper 2016-2