Venture Capital in Germany and the U.S.: Differences and the Influence of Culture

Abraham, Lars

Venture Capital in Germany and the U.S.: Differences and the Influence of Culture

Zusammenfassung

Inhaltsangabe:Introduction:
In todays modern economy a countrys or regions competitiveness lies in its capability to innovate. Whilst earlier old and established companies were reliable producers of innovation as well as jobs, that is changing. The big corporations are outsourcing and downsizing, and the new technologies are emerging from companies that did not exist 20 years ago.
This quotation taken from the Handbook of Research on Venture Capital points out the increasing relevance of the Schumpeterian growth regime of todays advanced economies which means that growth and wealth is unlikely to be maximized if most new business developments are carried out by old long-existing corporations. While in Europe only few global champions have been created in the past 50 years the United States economy seems to be capable of continuously creating great, leading-edge companies. Why is Europe lagging behind in enabling new ventures to become global champions? Why are successful high growth companies like Amazon, AMD, AOL, Apple, Cisco Systems, eBay, Genentech, Intel, Microsoft, Oracle, Sun Microsystems, Yahoo and recently Google all US based corporations and not of European or Japanese origin?
One reason is seen in the outstanding capability of the US economy to put innovative business ideas from individuals, universities and other research institutions into practice and thus create with the help of a well developed venture capital industry new global champions. A strong and sophisticated VC industry is widely recognised for providing a major contribution to turn innovation into (internationally) successful high-growth corporations and therewith foster economic growth.
Taking Germany as the largest economy in Europe this thesis will try to work out the main differences of the VC market in Germany - which is still considered as lagging behind - and its correspondent in the United States. While most of the previous comparative studies focus on single aspects of the VC market and the VC investment process this work will try to provide a brief but comprehensive empirical analysis of the entire venture capital investment process (from fundraising to exiting investments).
As business in general and the venture capital industry in particular is considered to be increasingly influenced by socio-economic and cultural factors this thesis draws special attention to differences related to the influence of culture on both VC markets. Hence it will be […]

Leseprobe

Inhaltsverzeichnis

Lars Abraham

Venture Capital in Germany and the U.S.: Differences and the Influence of Culture

ISBN: 978-3-8366-3755-8

Herstellung: Diplomica® Verlag GmbH, Hamburg, 2009

Zugl. Technische Universität Bergakademie Freiberg, Freiberg, Deutschland,

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Table of Contents

1. Introduction... 1

1.1. Initial Situation... 1

2. Venture Capital... 3

2.1. Disambiguation and Scope of the Thesis... 3

2.2. VC, Private Equity and the Growth and Finance Cycle of a Firm... 6

2.3. The Environment as Determining Factor... 13

2.4. The Venture Capital Investment Process... 15

3. An Introduction to Culture... 19

3.1. Relevance of Culture in Business... 19

3.2. Hofstede's Concept of Culture... 20

3.2.1. Criticism... 23

3.2.2. Power Distance... 25

3.2.3. Uncertainty Avoidance... 26

3.2.4. Individualism vs. Collectivism... 27

3.2.5. Masculinity vs. Feminism... 28

3.2.6. Long-Term Orientation... 29

3.2.7. Index Scores for Germany and the US... 30

3.3. Other Concepts of Culture... 31

4. Comparison of the US and German Venture Capital Market... 37

4.1. Previous Studies... 37

4.2. The Beginnings of Venture Capital... 38

4.3. The Venture Capital Markets Today... 40

4.3.1. Funding and Financing... 44

4.3.2. Selecting and Investing... 48

4.3.3. Developing and Adding Value... 53

4.3.4. Exiting and Performance... 56

4.3.5. Overall Aspects of the Venture Capital Markets... 60

4.3.6. Data Problems... 67

4.4. Early Stage Venture Capital and the Global Financial Crisis... 69

5. Venture Capital Demand, Entrepreneurship and Culture... 71

5.1. Entrepreneurship and Entrepreneurial Orientation... 71

5.2. Entrepreneurial Orientation and the Influence of Culture... 74

5.2.1. Selected Cultural Dimensions and Entrepreneurial Propensity... 75

5.2.2. National Culture and General Conditions of Entrepreneurship... 78

5.3. Is there an Archetype of an Entrepreneurial Culture?... 81

III

6. Concluding Remarks... ......... 86

References... 88

Data Appendix... 96

List of Abbreviations

ARDC

American Research and Development Corporation

Business Angel

BVK

Bundesverband Deutscher Kapitalbeteiligungsgesellschaften

- German Private Equity and Venture Capital Association e.V.

CAGR

Compound Annual Growth Rate

ERISA

Employee Retirement Income Security Act of 1974

ERP

European Recovery Programme

EVCA

European Private Equity & Venture Capital Association

GDP

Gross Domestic Product

GNP

Gross National Product

GEM

Global Entrepreneurship Monitor

IPO

Initial Public Offering

IRR

Internal Rate of Return

KfW

Kreditanstalt für Wiederaufbau

LBO

Leverage buyout

M&A

Mergers and Acquisitions

MBG

Mittelständische Beteiligungsgesellschaft

MBI

Management buy-in

MBO

Management buy-out

NASDAQ

National Association of Security Dealers Automated Quotation

NVCA

National Venture Capital Association

OECD

Organisation for Economic Co-operation and Development

Private Equity

SBA

Small Business Administration

SBIC

Small Business Investment Company

SBIR

Small Business Innovation Research

tbg

Technologie-Beteiligungsgesellschaft mbH

United States of America

Venture Capital

VCs

Venture Capitalists

WFG

Deutsche Wagnisfinanzierungsgesellschaft

List of Figures

Figure 1:

Equity financing within the growth and finance cycle [...]... 10

Figure 2:

Venture capital within the growth and finance cycle [...]... 12

Figure 3:

Underlying definition of venture capital... 13

Figure 4:

Environmental framework of the venture capital system... 14

Figure 5:

The venture capital process... 15

Figure 6:

Exchange relations between investor(s) [...]... 16

Figure 7:

Manifestations of culture at different levels of depth... 21

Figure 8:

Index scores of Hofstede's five dimensions [...]... 30

Figure 9:

US VC disbursements and proportionate early stage VC [...]... 41

Figure 10:

GER VC disbursements and proportionate early stage VC [...]... 42

Figure 11:

Absolute and relative size of the US and GER early stage [...]... 43

Figure 12:

Absolute and relative size of the US and GER early stage [...]... 43

Figure 13:

New venture capital funds raised relative to current GDP [...]... 45

Figure 14:

Early stage disbursements relative to current GDP, 1997-2007... 49

Figure 15:

Venture capital disbursements relative to funds raised [...]... 52

Figure 16:

German private equity and venture capital [...]... 53

Figure 17:

Venture capital divestments in the US, 1997-2007... 58

Figure 18:

Relationship between culture and entrepreneurship... 74

List of Tables

Table 1:

Characteristics of institutional venture capital [...]... 5

Table 2:

Venture capital and a firm's financing choices... 11

Table 3:

CAGR of early stage VC disbursements in Germany [...]... 44

Table 4:

CAGR of new VC raised in Germany and the US... 46

Table 5:

Sources of new funds raised... 47

Table 6:

VC investments in Germany and the US by stage... 49

Table 7:

VC investments in Germany and the US by industry group... 51

Table 8:

VC professionals in the US and PE professionals in Germany... 55

Table 9:

Divestments in Germany (by number of companies exited) [...]... 56

Table 10:

Divestments in Germany (by volume), 2001 and 2006... 57

Table 11:

Performance of private equity funds in the US and Germany... 60

Table 12:

US multiples as indicators of underdevelopment [...]... 65

Table 13:

Archetype entrepreneurial culture and dimensions [...]... 82

1. Introduction

1.1. Initial Situation

"In today's modern economy a country's or region's competitiveness lies in its

capability to innovate. Whilst earlier old and established companies were reliable

producers of innovation as well as jobs, that is changing. The big corporations are

outsourcing and downsizing, and the new technologies are emerging from companies

that did not exist 20 years ago" (Landström, 2007a, p. ix).

This quotation taken from the Handbook of Research on Venture Capital (Landström

(Ed.), 2007) points out the increasing relevance of the Schumpeterian growth regime of

today's advanced economies which means that growth and wealth is unlikely to be

maximized if most new business developments are carried out by old long-existing

corporations (Philippon & Véron, 2008). While in Europe only few global champions

have been created in the past 50 years the United States economy seems to be

capable of continuously creating great, leading-edge companies (Véron, 2008). Why is

Europe lagging behind in enabling new ventures to become global champions? Why

are successful high growth companies like Amazon, AMD, AOL, Apple, Cisco Systems,

eBay, Genentech, Intel, Microsoft, Oracle, Sun Microsystems, Yahoo and recently

Google all US based corporations and not of European or Japanese origin?

One reason is seen in the outstanding capability of the US economy to put innovative

business ideas from individuals, universities and other research institutions into

practice and thus create with the help of a well developed venture capital industry new

global champions (Maula et al., 2005). A strong and sophisticated VC industry is widely

recognised for providing a major contribution to turn innovation into (internationally)

successful high-growth corporations and therewith foster economic growth (see Gaida,

2002; Kortum & Lerner, 2000; Romain & VanPottelsberghe, 2004b; Weitnauer, 2007).

Taking Germany as the largest economy in Europe this thesis will try to work out the

main differences of the VC market in Germany - which is still considered as lagging

behind (Bygrave & Quill, 2007; Pfirrmann et al., 1997) - and its correspondent in the

United States. While most of the previous comparative studies focus on single aspects

of the VC market and the VC investment process (Fetzer, 1991; Gaida, 2002; Jessen,

2002; Ortgiese, 2007) this work will try to provide a brief but comprehensive empirical

analysis of the entire venture capital investment process (from fundraising to exiting

investments).

As business in general and the venture capital industry in particular is considered to be

increasingly influenced by socio-economic and cultural factors (Gaida, 2002; Pfirrmann

et al., 1997) this thesis draws special attention to differences related to the influence of

culture on both VC markets. Hence it will be possible to improve understanding of

socio-economic and cultural aspects like different attitudes towards entrepreneurship

and the willingness to take risks.

2. Venture Capital

2.1. Disambiguation and Scope of the Thesis

The National Venture Capital Association (NVCA) of the U.S. defines venture capital as

"money provided by professionals who invest alongside management in young, rapidly

growing companies that have the potential to develop into significant economic

contributors" (NVCA, 2008). A venture capitalist can be described as: "The manager of

private equity fund who has responsibility for the management of the fund's investment

in a particular portfolio company. In the hands-on approach (the general model for

private equity investment), the venture capitalist brings in not only moneys as equity

capital (i.e. without security/charge on assets), but also extremely valuable domain

knowledge, business contacts, brand-equity, strategic advice, etc." (EVCA, 2008).

According to Landström (2007b) the venture capital market can be divided into three

different submarkets: informal venture capital, corporate venture capital and

institutional venture capital. Corporate and institutional venture capital compose the

overall formal venture capital market as complement to the informal venture capital

market (Landström, 2007b).

Informal Venture Capital

In the past this type of venture capital has been regarded as equivalent to business

angels, angel capital or as Ortgiese (2007) put it angel investors. A business angel

(BA) or angel investor can be defined as "a wealthy individual who invests in

entrepreneurial firms. Although angels perform many of the same functions as venture

capitalists, they invest their own capital rather than that of institutional and other

individual investors" (Lerner, 2000, p. 515). Landström (2007b) considers business

angel as a narrow definition of a greater informal venture capital market by including

other informal investors which in contrast to angel investors contribute relatively small

amounts of money and do not take an active role in the object of investment as well as

family and friends. By also including non-equity investments like loans and even gifts

Bygrave & Quill (2007) further enlarge the concept of informal venture capital or as

they name it informal investment.

To sum up informal venture capital or angel capital can be characterised as any kind of

investment where the sponsor usually a private individual invests directly in

unquoted high-risk, high-return, high-growth entrepreneurial ventures.

Corporate Venture Capital

This segment of the venture capital market comprises equity or equity-linked

investment activities where the investor is a captive intermediary of a non-financial

corporation (Landström, 2007b; Ortgiese, 2007; Schefczyk, 2006). Thus the sponsor of

the venture capital fund is an established corporation or a subsidiary of a corporation

(Landström, 2007b; Ortgiese, 2007). Another major factor is that corporate venture

capitalists besides monetary returns also pursue strategic goals like access to sales

and resourcing markets, windows on technology, additional R&D capacities, and a

more flexible organisation of business activities (Schefczyk, 2006).

Institutional Venture Capital

Due to a large number of different classifications and definitions in literature it is not

easy to find a generally accepted definition of institutional VC (Landström, 2007b;

Schefczyk, 2006).

According to Mason & Harrison (1999) "the institutional VC industry comprises full-time

professionals who raise finance from pension funds, insurance companies, banks and

other financial institutions to invest in entrepreneurial ventures. Institutional venture

capital firms take various forms: publicly traded companies, captive subsidiaries of

large banks and other financial institutions, and independent limited partnerships"

(p.16). In contrast to corporate venture capital firms institutional VC firm's solely reward

is a potential capital gain (Landström, 2007b).

While informal venture capital is invested directly by the fund sponsors institutional

venture capital is invested indirectly via professional intermediaries the venture

capitalists.

Table 1 provides an overview of the main characteristics of the three identified

submarkets of venture capital:

Table 1:

Characteristics of institutional venture capital, informal venture capital and

corporate venture capital

Institutional venture

capital

Informal venture

capitalist / BA

Corporate venture

capital

Source of funds

Primarily institutional

investors who act as

limited partner

Investing their own

money

Investing corporate

funds

Legal form

Mainly limited

partnerships

Private individuals

Subsidiary of a large

company

Motive for investment

Equity growth

Intrinsic rewards

Strategic and

equity growth

Investment Experienced

investors

Experience varies

Experience within

industry / technology

Large

investment

capacity

Limited investment

capacity

Large investment

capacity

Extensive

due

diligence

Limited time for due

diligence

Extensive due

diligence

Monitoring

Formal control

Informal control

Corporate control

Source:

Based on De Clercq et al. (2006), Landström (2007b), Mason & Harrison (1999)

This thesis focuses on institutional venture capital provided by professional venture

capital firms.

As indicated above institutional VC can be found in different organisational forms,

usually depending on the source of funds and the ownership structure. On the basis of

Mason & Harrison (1999) one can identify three different organisational forms of

institutional venture capital firms

Independent limited partnerships, in which the general partner (the VC firm)

raises capital from the limited partners (usually institutional investors like

While Mason & Harrison (1999) consider captive venture capitalists as firms funded by banks

and other financial institutions, Landström (2007b) also includes those funded by non-financial

organization (so-called corporate VC). For a clear differentiation between institutional and

corporate VC (as indicated above) the author considers captive VC firms funded by non-

financial organisation (e.g. industrial firms) as corporate VC which is not subject of this work.

pension funds, insurance companies and banks, but also wealthy private

investors).

Captive venture capital firms, which are captive subsidiaries mainly funded by

the internal resources of affiliated banks or other financial institutions.

Government venture capital organisations, which are financed and controlled by

government institutions.

2.2. VC, Private Equity and the Growth and Finance Cycle of a Firm

While in Europe the definition of institutional venture capital is usually considered

synonymous with private equity and hence also covers later stage investments such as

funding of management buy-outs and turnaround financing (Landström, 2007b), in the

US the term venture capital is narrower and defines venture capital as "a segment of

the private equity industry which focuses on investing in new companies with high

growth potential and accompanying high risk" (Thomson Financial, 2008, p. 63). In

German literature Schefczyk (2006) argues that it would be useful to apply a

conceptual model with private equity as superordinate concept and venture capital as a

sub-segment of an overall private equity market, but due to a lack of consensus within

VC research he employs the terms venture capital and private equity synonymous as it

is still common use. In contrast to Schefczyk (2006) Weitnauer (2007) and BVK

(2008a) apply a concept similar to the US considering private equity as generic term for

any kind of non-public (private) equity investment also including equity financing of

mature companies with less risk potential and usually higher investment volumes as

well as management buy-outs

(MBOs), management buy-ins (MBIs) and leverage

buyouts (LBOs)

According to BVK (2008a), EVCA (2008), NVCA (Thomson Financial, 2008) and

Weitnauer (2007) the author considers venture capital as a segment of an overall

private equity market which focuses on equity financing of new ventures with high

growth potential.

Leveraged buyout (LBO): The acquisition of a firm or business unit, typically in a mature

industry, with a considerable amount of debt. The debt is then repaid according to a strict

schedule that absorbs most of the firm's cash flow.

Management buy-out (MBO): A European term for an LBO initiated by an existing management

team, which then solicits the involvement of a private equity group.

Management buy-in (MBI): A European term for an LBO initiated by a private equity group with

no previous connection to the firm.

(according to Lerner, 2000, p. 518-519)

For further exemplification it seems to be useful to employ the concept of the growth

and finance cycle of a firm

as it is widely accepted and applied in business practise by

professional venture capitalists (Jessen, 2002; Ortgiese, 2007).

The Growth and Finance Cycle of a Firm

As a high-growth company's demand of equity is not constant over time in quantity

and structure different stages of a firm's development have been identified. Sahlman

(1990) determined five stages of a firm's growth life cycle: Seed Stage, Start-up Stage,

Early Stage, Expansion Stage and Later Stage. On the basis of the NVCA (Thomson

Financial, 2008) and Ortgiese (2007) each stage can be described as follows:

Seed Stage

In this initial stage a relatively small amount of capital is provided to an inventor

or entrepreneur to prove a concept and to qualify for start-up capital. This may

involve product development and market research as well as building a

management team and developing a business plan, if the initial steps are

successful. The company, even if already founded, is usually structured

informally and much of the commitment by the entrepreneurs is undertaken on

a part-time basis, while the founders hold down another job. To develop the

product or service, the founders often use their limited personal funds as well as

funds of friends and family. This is a pre-marketing stage.

Start-up Stage

This stage provides financing to companies completing development stage and

may include initial marketing efforts. Companies may be in the process of

organising or they may already be in business for one year or less, but have not

sold their products commercially. Usually such firms will have made market

studies, assembled the key management and a board of directors, developed a

business plan, and are ready to conduct business. As the limited funds

available to the entrepreneurs will be exhausted by this stage, outside funding is

necessary. Due to still high levels of uncertainty and business risks debt

An elaborate illustration of the growth and finance cycle can be found in Nathusius (2003, p.

88 et seqq.).

financing is usually not available and equity financing by VC companies or

business angels are often the only option of founders to obtain the funding for,

and successfully realise their projects.

Early Stage / Other Early Stage

Other early stage financing includes an increase in valuation, total size, and the

per share price for companies whose products are either in development or are

commercially available. The new venture may already generate revenues and

hence the risk of failure decreases. Usually the business is less than three

years old. Additional equity financing in a higher quantity is invested by venture

capitalists, if the management team has proven to be skilled, and the capability

of the product or service stands against competition. This includes the first

round of financing following a company's start-up phase typically by an

institutional venture capital fund. Seed and start-up financing tend to involve

angel investors more than institutional investors. The networking capabilities of

the venture capitalist are used more here than in more advanced stages.

Expansion Stage

This stage involves working capital for the initial expansion of a company that is

already producing and shipping and has growing accounts receivables and

inventories. It may or may not be showing a profit. Usually by now, the business

is more than three years old. Some of the uses of capital may include further

plant expansion, marketing, working capital, or development of an improved

product or service. Key executives may be added to the management team and

possible replacements can occur, if the existing new venture team is not

capable of handling the new challenges effectively. Additional institutional

investors are more likely to be involved along with initial investors from previous

rounds. The venture capitalist's role in this stage evolves from a supportive role

to a more strategic role.

Later Stage

Capital [usually at considerably higher volumes; note from the author] in this

stage is provided for companies that have reached a fairly stable growth rate;

that is, not growing as fast as the rates attained in the expansion stages. The

product or service is widely available and the company generates constant

revenue. Again, these companies may or may not be profitable, but are more

likely to be than in previous stages of development. Other financial

characteristics of these companies include positive cash flow. Furthermore, the

company's investment decisions tend to get somewhat closer to those of

established corporations.

The first three stages or often summarized as Early Stage Financing (Schefczyk, 2006;

Thomson Financial, 2008; Weitnauer, 2007). Therefore nowadays the third stage is

often termed Other Early Stage (Thomson Financial, 2008) or First Stage Financing

(Jessen, 2002). Other authors only distinguish between seed stage and start-up stage

within early stage financing (BVK, 2007; Schefczyk, 2006). Capital provided to finance

new ventures within their early stages of development can be characterised as classic

venture capital (Jessen, 2002) which is subject of this work. In a broader sense the

term venture capital also includes expansion stage financings (EVCA, 2008;

Weitnauer, 2007).

To also incorporate different financial structures this five-stage model of a firm's growth

life cycle has been enlarged (inter alia Schefczyk, 2006). Schefczyk (2006) identified

eight characteristic financial stages: Seed, Start-up, Expansion, Bridge, MBO/MBI,

LBO, Replacement Capital, and Turnaround

. Whereas Bridge Financing as interim

capital provided to achieve an exit for the investors (through initial public offering (IPO)

or trade sale

) can be incorporated within Sahlman's (1990) originally five-stage

model between expansion and later stage the others remain typical later stage private

equity activities which are usually not separated into different sub-stages (Jessen,

2002; Weitnauer, 2007).

Figure 1 tries to illustrate the identified stages of a firm's growth and finance cycle and

this work's underlying concept of VC as a submarket of an overall private equity

market.

Replacement Capital (also: Secondary Purchase): Purchase of existing shares in a company

from another private equity investment organisation or from another shareholder or

shareholders.

Turnaround (also: Rescue): Financing made available to an existing business which has

experienced trading difficulties, with a view to re-establishing prosperity.

(EVCA, 2008; Schefczyk, 2006)

Trade sale: The sale of company shares to industrial investors (EVCA, 2008).

Figure 1:

Equity financing within the growth and finance cycle of a new firm

Se ed

Start-u p

Expansion

Bridge

Later stage

MBO / MBI

- LBO

- Replacement

- Turnaround

other Private Equi ty**

Venture Capital

Clas sic V enture Capital

Publ ic Equi ty (after IPO)

Private Equity*

Public Equity

Going Public

Going Private

Note: *

classic VC (= early stage VC)

**All those later stage activities are usually undertaken by so-called PE investors whereas VC

investors focus on earlier stages

Source:

Based on Weitnauer (2007, p.9)

It is important to bear in mind that this model refers to an archetype of a new firm's

development and that in reality the identified stages are not free from overlapping and

often characterised as rather complex issues with smooth transitions (Jessen, 2002).

Especially some MBO/MBI, turnaround and replacement PE investments are likely to

occur at earlier typical VC stages as well (Schefczyk, 2006). Nevertheless as already

mentioned above this stage model proved to be beneficial to illustrate different capital

needs along the growth life cycle of a firm and is widely accepted in research and

business practise (Jessen, 2002; Ortgiese, 2007)

Venture Capital and other Sources of Corporate Finance

To understand the specific characteristics and contribution of VC it is useful to outline

the venture capital concept in its relation to other sources of capital. A firm can raise

capital from internal and external sources and combines equity with debt capital.

Jessen (2002) illustrates VC as a particular, temporary form of institutional equity

financing:

A detailed discussion about the stage model's applicability for new ventures can be found in

Hansen & Bird (1997).

Table 2:

Venture capital and a firm's financing choices

Sources of funds

Legal status

Internal financing

External financing

Equity financing

(liable equity)

Self-financing

Equity capital financing

e.g. Venture Capital

Debt financing

(creditor capital)

Provision financing

Credit financing

Source:

Jessen (2002, p.68)

As a new entrepreneurial venture is likely to generate no revenues it has to finance

itself from external sources at first. Credit financing is usually not available because of

an extraordinary high risk of failure and the fact that a seed or start-up stage company

can not offer any assets as physical securities (Schefczyk, 2006; Weitnauer, 2007).

Therefore new firms have to rely on what Bygrave & Quill (2007) call the 4 Fs: the

founders themselves, family members, friends and foolhardy investors (e.g. business

angels). These are typical sources of finance for new ventures in their seed stage and

sometimes early start-up stage (Ortgiese, 2007). As these financial resources are

limited and credit financing is still not accessible new ventures heading the start-up

stage often face the so-called equity gap (Schefczyk, 2006). This is where the venture

capital system comes into play. To address the high-risk high-return characteristics of

equity investing of new ventures in their early stages venture capital investments

exhibit certain attributes to reduce down side and increase upside potential. Hence

based on Jessen (2002) and Schefczyk (2006) one can figure out the following

characteristics of venture capital which clearly distinguish VC financing from other

forms of traditional equity financing:

Liable equity for a limited period of time (usually 5 to 10 years)

Investment in high-growth, innovative, early stage small and medium-sized

businesses (normally as minority stake)

Higher-than-average return on investment in the form of capital gain after exit

rather than regular (dividend) payments

Representation on the board and span of control beyond capital share and

intensive operational involvement (mentoring)

High likelihood of total loss based on single investment level

As a company grows and reaches expansion stage it will now be easier to receive debt

capital (Jessen, 2002; Weitnauer, 2007). Some ventures may also be capable of

entering the public equity market via IPO and thus broaden their equity base for further

expansion (Jessen, 2002). However typically early stage venture capitalists exit their

investments after bridge stage via IPO or trade sale (Weitnauer, 2007). Finally after

continuing in being successful a company may reach later stage and is now able to

access the full range of debt and equity financing like well established enterprises do

(Jessen, 2002). Based on Jessen (2002) figure 2 tries to incorporate different sources

of funds into the growth and finance cycle of a firm.

Figure 2:

Venture capital within the growth and finance cycle of a new firm

'equity gap'

Seed

Start- up

Expansion Bridge

Later stage

Ve nture Cap ital

own funds*

Public Equity

anticipation of

risk and profit

subsidies

Business Angel

other Pr ivate Equity

Debt Financing

risk

profit

* funds from founders, family and friends

Source:

Based on Jessen (2002, p.130); Schefczyk (2006, p. 26)

Again, as already mentioned above, also this stage model and the corresponding

financing resources are not free from overlapping and can merely be regarded as

typical for the financing of the growth progress of a new firm as the chosen source of

financing is largely dependent on the particular case (Bygrave & Quill, 2007).

Furthermore recently increased relevance of hybrid financial instruments like

mezzanine capital

also for early stage financing (AltAssets, 2003; Schefczyk, 2006)

remains unconsidered as it is not purpose of this work.

Mezzanine capital: a layer of financing that has intermediate priority (seniority) in the capital

structure of a company. For example, mezzanine debt has lower priority than senior debt but

usually has a higher interest rate and often includes warrants (Thomson Financial, 2008).

2.3. The Environment as Determining Factor

As Staehle (1999) considers all enterprises as open, socio-technical systems involved

in regular exchange processes with their natural and social environment an analysis of

an industry or market can not neglect environmental factors. According to Staehle

(1999) Jessen (2002) conceives venture capital as purposive, social institution in terms

of an open, goal-orientated and socially integrated system. This once more goes back

to the concept of institutional venture capital as financing provided by profoundly

institutionalised professional intermediaries (see also chapter 2.1.). Thus concluding

with regard to the above mentioned characteristics the following final definition of

venture capital can be applied for the purpose of this work:

Figure 3:

Underlying definition of venture capital

Ventu re Capital

A goal orientated social institution,

providing liable equity for a limited period of time

(5 to 10 years),

investing in high-growth, innovative, early stage small and

medium-sized businesses (typically as minority stake),

aiming at higher-than-average returns on investment in the form

of capital gain after exit rather than regular (dividend) payments,

including representation on the board and span of control

beyond capital share and intensive operational involvement

(mentoring),

facing a high likelihood of total loss based on single investment

level.

Source:

Based on Jessen (2002, p. 67)

To incorporate environmental conditions into the concept of an enterprise or industry

Staehle (1999) distinguishes between general and special environmental factors or as

Grant (2002) phrases it macro-environment and micro-environment. The general

environment is usually less influenceable by a single corporation or venture capitalist

and consists of economic, political and legal, social psychological, cultural, and

The term Mezzanine can be misleading as especially in the US it is also used synonymous with

bridge financing (see figure 1) to describe a pre-IPO round of financing (Lerner, 2000).

technological influencing factors (Staehle, 1999). Special environmental factors also

referred to as task environment are the resourcing market, the money and capital

market, the sales market, and the labour market (Staehle, 1999) and are characterised

by direct interaction with a higher degree of persuasibility (Jessen, 2002). Although the

separation between these two categories of environmental factors is beneficial for

structuring further analysis on environment related influences it is important to know

that these factors are overlapping and interfering each other both between and within

each category (Jessen, 2002).

To sum up the interrelation between the institutional venture capital system and the

environmental framework is illustrated in figure 4.

Figure 4:

Environmental framework of the venture capital system

Venture Capital

Sys tem

resourcing

market

labour

m arket

m oney and

c apital

market

sales

market

political and legal factors

psy

cho

log

ica

ltur

ica

l f

act

facto

socia

l and

micro - environment

macro - environment

Source:

Based on Jessen (2002, p. 73) and Staehle (1999, p. 625)

At this point no in depth description of each environmental factor will be undertaken

with respect to the limited scope of this thesis

. As this work draws special attention to

cultural factors influencing the venture capital markets this environmental framework

will be reverted to in the coming chapters particularly with respect to the possible

effects of social psychological and cultural factors onto the task environment of classic

(early stage) venture capital.

2.4. The Venture Capital Investment Process

As indicated in chapter 2.1. institutional venture capitalists act as professional

intermediaries investing third party funds into new high-growth ventures. Therefore they

raise funds from its investors, provide cash to promising innovative new ventures,

receive equity and pass back the return to the investor after harvesting their

investments (Gompers & Lerner, 2004; Landström, 2007). Figure 5 gives an overview

of the general VC investment process.

Figure 5:

The venture capital process

INVESTOR

NEW VENTURE

C APITALIST

VENTU RE

Returns

Equity

Cash

Fundraising

Source:

Landström (2007, p. 6); Gompers & Lerner (2004, p.11)

To address the complexity of investing in innovative new ventures independent

institutional venture capitalists usually separate their activities into two different units: a

A detailed description of the general and special environmental factors can be found in:

Steinmann/Schreyögg (2002, p. 160-169).

management entity and an investment company (Schefczyk, 2006). This enables the

venture capitalist to better align to the management and mentoring needs of new

ventures and to invest in a larger range of promising portfolio companies

simultaneously and therewith reduce the risk of a total loss of funds (Schefczyk, 2006;

Fetzer, 1991). The following figure 6 illustrates the exchange relationships with

investors and portfolio companies usually applied by independent venture capital firms.

Figure 6:

Exchange relations between investor(s), VC firm and portfolio companies

Portfolio

companies

Management

entity

advice and

assistance

management

Investment

company

Investor(s)

capital

funds

contract

capital gain

payout

products

Venture capital firm

Source:

Schefczyk (2006, p. 14)

Fetzer (1991) identified four different phases of activities undertaken during the venture

capital process. According to Ortgiese (2007) they can be described as follows:

1. Fundraising

At the very beginning of its activities a venture capital company raises money from

investors and launches a fund which will then be closed for the investment period

typically ten years. Therefore according to figure 4 the venture capitalist accesses

the private and public money and capital market. Typical investors are pension

funds, insurance companies, banks, university endowments and family offices of

wealthy individuals. It is crucial to provide potential investors with a proven track

record of well performing portfolio companies to obtain further capital.

2. Selection

At this stage the venture capital firm accesses its sales market (see figure 4) and

this involves deal generation, screening, valuation and due diligence activities as

well as deal structuring. During deal generation established VC companies rely on

a broad network within the entrepreneurial community and are typically able to

afford a reactive approach while younger venture capitalists need to actively seek

for promising business ideas and entrepreneurial talent. After generating a

sufficient number of interesting business plans venture capitalists review them

usually according to three main criteria: viability and novelty of the innovative

project; integrity, record of accomplishments and leadership skills of the

entrepreneur/management team; and the potential of high returns as well as

possible exit strategies. Typically only 25% of business plans received are chosen

for further valuation and due diligence (Schefczyk, 2006). This investment valuation

process is aimed at achieving an agreement on the price for the deal. Due diligence

activities often include site visits and deeper analysis of additional documents

provided by the target company. To reach deal approval the venture capitalists has

to align the interests of the investor with those of the entrepreneurial venture. Thus

in order to achieve enough incentives for cooperative behaviour various

mechanisms are included in the terms of the deal. Usually these terms include

staging of investment into several rounds, covenants specifying the right to control,

rights to change the new venture's management if needed, buy back agreements,

and warrants to make acquisitions.

3. Monitoring and Adding Value

Out of 100 business plans received only one to three new ventures reach this

phase and are chosen to be funded and supported in their further development

(Fetzer, 1991; Pfirrmann et al., 1997; Schefczyk, 2006). Monitoring activities

include the implementation of regular formal (e.g. board meetings, workshops) as

well as informal (e.g. telephone calls, e-mails, informal meetings) reporting

mechanisms to limit the downside risk to the capital provided and to protect the

value of the new venture. The second aspect of active involvement is targeted at

maximising the upside potential through providing valuable advice, information and

Details

Seiten
Erscheinungsform: Originalausgabe
Jahr: 2009
ISBN (eBook): 9783836637558
DOI: 10.3239/9783836637558
Dateigröße: 602 KB
Sprache: Englisch
Institution / Hochschule: Technische Universität Bergakademie Freiberg – Wirtschaftswissenschaften - Fakultät 6, Studiengang Betriebswirtschaftslehre
Erscheinungsdatum: 2009 (Oktober)
Note: 1,0
Schlagworte: entrepreneurship germany hofstede culture

Autor

Lars Abraham (Autor:in)

Venture Capital in Germany and the U.S.: Differences and the Influence of Culture

Zusammenfassung

Leseprobe

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Autor

Lars Abraham (Autor:in)