VC, New Technology, and Business Development Dafna Schwartz Ben-Gurion University, Israel dafnasch@som. bgu. ac. il Regional Economies in a Globalising World Enhancing Intellectual Capacity and Innovation Friday 21 November 2008, Cardiff University 1
The Need Countries implement various policy measures to encourage the formation of a VC industry for the development of start-ups. Hypothesis- there may be a market failure: The high risk that the first entrants into the VC industry face in a country with limited VCs The existence of positive externalities in the VC industry (first entrants into the market may not be profitable but can help in the creation of better conditions) 2
Our hypotheses Government intervention can be effective in overcoming market failure by supporting the formation of a VC industry However, this policy may have an unintentional negative side effect in terms of increasing regional inequality The reason – the special role of the venture investors in the development of the start-ups Therefore, a specific public policy for the spatial distribution of such activities should be considered. 3
The Objective: To analyze the Israeli experience Israel has adopted a policy of supporting the formation of the VC industry The emergence of the VC industry in Israel is considered to be the most successful example of diffusion of the Silicon Valley model of VC outside of North America (Avnimelech & Teubal, 2004 a, b; Bresnahan et al. , 2001; Carmell & de Fontaenet, 2004). Can be used as a case study 4
From start-ups to successful companies Requires resources that start-ups are frequently lacking. Financial resources - difficulty obtaining in the market. They are characterized by high risk and lack of tangible assets- therefore debt financing is usually not an option (Denis, 2004). Non-financial resources - the founders are often the innovators who don’t have the business and managerial skills, experience, or networks which are more crucial to their success (Hung et al. , 2002). 5
Who are venture investors? Investors (local and foreign) that invest in start-ups through equity : – – Venture capital funds Private investors (angels) Investment companies Corporate venture companies They provide financial and non-financial resources 6
The role of venture investors Act as entrepreneurs and managers Select firms with growth potential Improve the quality of the firm in which they invest Improve accessibility to resources (own and external) – financial and other resources (Gompers & Lerner, 1999, 2001, 2005; Sapienza, 1992; Elango et al. , 1995; Sapienza et al. , 1995; Jain, 1999; Van Osnabrugge & Robinson, 2000; Brierly 2001; Allen, 2002; Brancomb & Auerswald, 2001; Lindstrom & Olofsson, 2001; Helman & Puri, 2002 a, b; Wang et al. 2002; Allen, 2003; Riquelme & Watson, 2002). 7
Main factors in the location of start-ups financed by venture investors They are part of high-tech - therefore have a tendency to cluster, primarily around metropolitan locations and in the satellite urban ring around the main metropolitan area (Bar-El &. Parr, 2003; Capello, 2002; Cooke & Schwartz, 2003; Cooke 2004, Cooke 2005, Cooke & Schwartz, 2008, Frenkel, 2001; Frenkel & Shefer, 2001; Schwartz, 2006; Schwartz& Bar-El, 2007, Mason & Harrison, 2002). In addition, their location depends on the venture investors: capital provider, entrepreneurs and managers 8
Two main considerations in the location of venture investments Capital is highly mobile Entrepreneurship & management – much lower mobility 9
Proximity & Focalization are is important Frequent contacts, cost of distance Tacit knowledge: venture investors are viewed as tacit information brokers: they acquire and create knowledge Asymmetric information and the need of control Cooperation of several investors in each start -up Involvement of each investor in several startups 10
Consequently, venture investors prefer to invest close to: Agglomerations of start-ups Agglomeration of venture investors Their own location (residence, office) The portfolio companies Other investors’ portfolio companies Focal Places 11
In 1993 - The Yozma Program Fund of funds– allocated $100 million 10 VC funds were formed, A partner of a leading Israeli financial institution with leading foreign venture investors The government's share is maximum 40% Option to buy out the government's share at a pre-determined price over a period of 5 years In addition - invest directly in start-ups. 12
The Yozma program proved to be extremely successful 10 VC funds were formed Major international venture investors were attracted: USA, Germany, Japan, Netherlands, Singapore. 9 funds bought out the government's share 15 direct investments - 9 enjoyed successful exits – IPOs or M&A 13
Catalyst for the development of the VC industry: (VC funds and others) Capital Raised by Israeli VC Funds by Year 14
Catalyst for the development of young technology firms – start-ups (SU) 15
Exits: IPO and M&A Capital Raised in IPOs of Israeli High-Tech Companies M&As of Israeli High-Tech Companies 16
The location pattern of SU backed by venture investors (Schwartz & Bar-El 2007) We analyzed the location pattern of SUs in comparison to that of high-tech activities Our hypothesis: This policy has an unintentional negative side effect in terms of regional inequality Start-ups backed by VC – heavier concentration in comaprison with high tech activities. Tend to concentrate in the metropolitan urban center of the country in specific focal locations, leaving the peripheral districts far behind. 17
Database Start-up information: *) All the start-ups that were financed by venture investors, 1995 -2004. 1, 239 start-ups, 30, 000 employees, $11 B Employment data: **) total employment in all sectors (ET) employment in high-tech sectors (EHT) Sources: *) IVC information base **)CBS 18
Districts and sub-districts 6 districts: • 2 periphery: Southern, Northern • 4 centers: Tel Aviv, Central, Haifa, Jerusalem Ø The core: Tel-Aviv is the metropolitan urban center; The Central district is the ring around it. 15 sub-districts (8 – centers, 7 – periphery) 19
The Spatial distribution: For each district i we calculated its share: in total employment (%ETi) in employment in high-tech (%EHTi) in employment in start-ups backed by venture investors (%ESUi). 20
Location quotients, For each district i the ratio of: The share of employment in high-tech with that of total employment (%EHTi/%Eti) The share of employment in start-ups with the share in high-tech (%ESUi/%EHTi) 21
Distribution and location measures by districts % ET % EHT % ESU %EHT/ %ET) %ESU/ %EHT Southern 12. 2 9. 5 2. 3 Northern 13. 7 9. 6 8. 8 Central 21. 9 32. 6 37. 1 0. 78 0. 70 1. 49 0. 25 0. 91 1. 14 Tel Aviv 27. 7 29. 9 36. 5 Jerusale m 10. 9 7. 4 8. 0 Haifa 13. 7 11. 0 7. 3 1. 08 0. 68 0. 80 1. 22 1. 09 0. 67 100 100 (50%) (63%) (74%) Total Central+T. A 22
High tech and SU Concentration Heavy concentration of high-tech in and around a metropolitan districts, low levels in the peripheral districts The distribution of venture investments is even more concentrated than that of high-tech activity Districts with the relatively higher activity of high tech enjoy an even higher level of concentration of start-ups. 23
A special pattern of concentration Highest relative attraction of venture investments to urban centers in the proximity of Tel Aviv (Tel Aviv + Central districts): Ø 73% of all start-up employment compared to: Ø 63% for high-tech Ø 50% for total employment. But not necessarily to all main centers (Jerusalem, Haifa) Venture investments refrain from locating in peripheral regions, but not necessarily from all of them 24
The concentration of start-ups is distributed in a few focal points We divide the districts into their sub-district and apply the same parameters to the smaller geographical units The concentration of start-ups is distributed in a few focal points, mostly in the center of the country. Sub districts with relatively high share of start ups: Petah Tikva and Tel Aviv, Rehovot, Sharon, Hadera and Yizre'el. 25
Distribution by sub-districts % ET % EHT % ESU LQ(EHT/ET) LQ(ESU/ EHT) Jerusalem 10. 9 7. 4 8. 0 0. 68 1. 09 Zefat, Kin, Golan 3. 7 1. 4 0. 2 0. 37 0. 18 Yizre’el 5. 0 4. 5 7. 3 0. 90 1. 62 Akko 4. 9 3. 7 1. 2 0. 76 0. 31 Haifa 10. 4 10. 2 5. 4 0. 98 0. 52 Hadera 3. 3 0. 8 2. 0 0. 23 2. 68 Sharon 4. 2 2. 2 5. 6 0. 52 2. 57 Petach-Tiqva 8. 1 14. 4 22. 1 1. 79 1. 53 Ramla 3. 8 8. 7 3. 6 2. 26 0. 42 Rehovot 5. 8 7. 4 5. 8 1. 26 0. 78 Tel Aviv 27. 7 29. 9 36. 5 1. 08 1. 22 Ashkelon 5. 4 3. 8 0. 9 0. 71 0. 23 Beer-Sheva 6. 8 5. 7 1. 5 0. 84 0. 26 26
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Summary and Conclusion We tested the effectiveness of government policy in encouraging the formation of VC industry. The findings show: Yes – It is possible! Such policy is effective and may act as a catalyst for the creation of VC industry and for the development of start-ups. 28
The policy has an unintentional negative result - increase in the regional gap Heavy concentration of venture investments in comparison to high-tech activity – Pattern of concentration in a few focal places, with no necessary continuum between them. This location behavior may lead to changes in the future geographical mapping of hightech activity and possibly to the increase of regional gaps. 29
The Location Factors When making a location decision, every firm considers the macro-regional factors and its micro-business specific needs Start-ups are high-tech activities, and are influenced by the same macro-regional factors that lead to concentration The location considerations of start ups are influenced also by their investors – since their role is not merely a financial capital provider: they also play an important role in entrepreneurship and management of the start-ups 30
Policy implications Still, focal places in the periphery may under certain conditions offer a potential for SU activity The existence of externalities generated by SU activity justifies the involvement of public policy: – Joint public programs with venture capital investors, – with a focus on specific concentrated locations in the periphery that have a potential of growth. – Examples of programs that may be considered: regional venture capital fund, technological incubators 31
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