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Financing technology-based small firms in Europe: what do we know?

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Abstract

This paper reviews the evidence on financing technology-based small firms (TBSFs) in Europe. European TBSFs finance new investments by relying primarily on internal funds, due to capital market failures induced by asymmetric information. European venture capital has caught up with US venture capital, but this is mainly because of the growth in UK venture investments. It is unclear whether European venture capital has been able to certify the quality and enhance the growth of funded companies. Compared with the NASDAQ, there is little development of trading in high-tech stocks in Europe: the so-called New Markets established in the 1990s collapsed in the wake of the Internet bubble crash. Public venture capital and research and development (R&D) tax incentives seem to have positively affected high-tech firms.

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Notes

  1. Moreover, theoretical work has shown that it may be optimal for banks to reveal information about the projects of their clients in order to reduce negative externalities on other borrowers (Agarwal and Elston 2001).

  2. An optimal capital structure has been shown to exist in the Modigliani–Miller framework with added frictions (corporate taxes, bankruptcy). See Bradley et al. (1984) and references therein.

  3. See also the model in Fazzari et al. (1988). Agency problems are implied by the separation between ownership and control (Jensen and Meckling 1976), but the associated costs may be less relevant to the financing of TBSFs, which are often closely held.

  4. If companies follow a pecking order, larger (past and current) profitability reduces the internal deficit and the demand for loans, implying a negative leverage–profitability correlation. Conversely, the target adjustment theory stresses that higher profitability is seen by the market as a signal of future growth opportunities, resulting in better access to loans. However, profits for firms with a short track record can be negligible.

  5. It is doubtful whether larger investment–cash flow sensitivities are suited to signal credit rationing, for further reasons. For instance, a large share of retained earnings in the capital structure may not be due to credit constraints: firms may want to keep some “reserve borrowing power” (Gertler 1988), especially if they are not endowed with “hard” collateral, or simply retain cash as precautionary saving (Kaplan and Zingales 1997).

  6. The test compares the goodness of fit of two alternative econometric models: a regression of the debt ratio on the deficit if internal funds (pecking order model of the coefficient is negative) and a regression of the debt ratio on a target debt ratio (target adjustment model if the coefficient is below 1). In fact, the test lacks statistical power if equity is a large proportion of capital or is in the middle of the financial hierarchy (Chirinko and Singha 2000).

  7. Here we define venture capital investments as investments in seed, early-stage and expansion projects, as in Beuselinck and Manigart (2007).

  8. VCs typically own a substantial fraction of the company, usually in the form of convertible securities (Hellmann 1998, Casamatta 2003, Cornelli and Yosha 2003, Kaplan and Strömberg 2003).

  9. See Kaplan and Strömberg (2003, 2004) on the importance of financial contracting for mitigating agency conflicts.

  10. Other indicators of firm performance—such as the hazard rates and the amount of funds raised—can be affected by venture capital. While we do not deny their importance, only Bottazzi and Da Rin (2002) have dealt with them; a much larger number of works has focussed on firm growth.

  11. See also Maula and Murray (2002), Katila et al. (2008) and Narayanan et al. (2009) for a comparison between corporate VC and independent VC.

  12. Endogeneity of venture capital investments and selection effects can be very relevant in this context. For instance, firms with poorer performance may be discouraged and self-select out of the venture capital market. Firms with high growth prospects may also be discouraged if they face adverse bargaining conditions. Furthermore, venture funding and innovative performance can appear to be positively correlated, because companies seeking venture capital may prefer to patent intensively prior to receiving VC in order to avoid leakage of reserved information to the venture capital firm.

  13. On the contrary, Kortum and Lerner (2000) find that US companies produce more patents also after receiving venture capital.

  14. The pioneer markets were the Compartiment Spécial, opened in France in 1977, followed by the Italian Mercato Ristretto (1978), the Unlisted Securities Market (USM) (1980, UK), the Third Market (1987, UK), and Bors 3 (Germany, 1982). The Netherlands, Norway, Sweden, Belgium and Spain also inaugurated markets based on the feeder principle (Posner 2004).

  15. Other stock markets based on the NASDAQ principle have been created in Europe since then: Euro.NM Belgium (1997), Euro.NM Amsterdam (1997), SWX New Market (Switzerland, 1999), Austrian Growth Market (1999), Nuevo Mercado (Spain, 2000), OMX First North (Nordic and Baltic Countries, 2003).

  16. The EASDAQ, whose data are not reported here, fared poorly even in those early years.

  17. See the “TechMARK eligibility guidance” (http://www.londonstockexchange.com/techmark).

  18. The German stock exchange was re-structured in two segments: Prime Standard and General Standard. Although the former inherited the Neuer Markt information disclosure rules, it includes companies from the main market along with previous Neuer Markt members. In 2005, Deutsche Börse created a further segment, Entry Standard, specifically targeting SMEs. While successful—market capitalization was about 9.5 billion Euros as of October 2007, with 109 listed companies—this segment has mainly attracted companies in the financial and real-estate sectors (source: Deutsche Börse).

  19. By the end of 2006, the number of listed firms on Alternext was 72, and the cumulated amount of capital raised was 527.642 million Euros (source: Euronext Paris Statistics). Such successful performance might, however, be the outcome of fiscal subsidies and financial guarantees awarded by the French Ministry of Finance to TBSFs listed on the Alternext market (Faulconbridge et al. 2007).

  20. Some evidence of competition between exchanges has been detected in Pagano et al. (2001, 2002), who explore the differential success of European and US main stock exchanges using data on cross-listings.

  21. The Société du Nouveau Marché was the market authority. The Agence Nationale de Valorisation de la Recherche (ANVAR) was the national agency for promoting research; then replaced by Oséo-ANVAR.

  22. Besides the heavy involvement of the Small Business Administration in the SBIC program, one can also mention the role played by the Angel Capital Electronic network (renamed Active Capital), and the support of the National Institutes of Health to US biotechnology.

  23. The Kredit Für Wiederaufbau (KFW, “credit for reconstruction”) and Deutsche Ausgleichsbank (DtA) through its subsidiary, the public bank Technologie-Beteiligungsgesellschaft (TBG). These two institutions merged in 2003.

  24. For instance, the Science Enterprise Challenge programme, active since 1999, involves a network of universities and promotes the creation of tight links between the business and research communities. Other measures, such as the Small Firms Loan Guarantee Scheme (SFLG), are more directly targeted at overcoming market failures which cause high-tech small firms to be credit-rationed.

  25. Among them, one could mention Caisse des Depôts et Consignation (CDC) Entreprise, which is the major institutional investor for French technological venture capital, and the Agence Nationale de Valorisation de la Recherche (Oséo-ANVAR), the national agency for promoting research.

  26. For instance the Law on Research and Innovation of July 12, 1999 promotes the transfer of knowledge towards companies and the creation of new innovating companies.

  27. The main state initiatives were the following: to establish equity stock companies, to set new regional VC firms (with private investors) and to provide capital to new funds (Sunley et al. 2005).

  28. This programme awarded monetary prizes to the regions offering the best regional commercialization networks of biotechnology (Casper 2000, Dohse 2000, Lehrer and Asakawa 2004).

  29. In Italy, public support to TBSFs is also provided by the Italian Business Angel Network (IBAN), established in 1999, which includes eight Business Angel Networks (BANs) distributed across Italian regions. The capital shares of these BANs are typically held by the regional authorities, regional development agencies and private banks.

  30. Riding (2008) found that it could be counterproductive for public policy to encourage non-competent informal investors.

  31. For instance, according to Tamasy (2007), public incubators only produce weak effects on the decision of individuals to start a business.

  32. The authors conducted a study on ten European countries (Belgium, Finland, France, Ireland, Italy, Norway, The Netherlands, Spain, Sweden and the UK), using data on public VC investments from the annual statistics of EVCA.

  33. Outside Europe, the most cited examples are Israel (Avnimelech and Teubal 2006), Canada (Ayayi 2004) and more recently India (Dossani and Kenney 2002).

  34. Bebchuk and Roe (1999) discuss the role of efficiency, rent-seeking and interest group politics in giving rise to path dependencies in corporate ownership and governance structures. More general reflections on path dependencies in the economy may be found in David (1994) concerning the role of history in shaping expectations and the interrelatedness among the elements of complex organizations.

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Acknowledgments

Financial support by the European Commission (Dynamics of Institutions and Markets in Europe—DIME, 6th Framework Programme) is kindly acknowledged. We are grateful to Giovanni Dosi, Marco Da Rin, Dorothée Rivaud-Danset and conference participants in Paris (ENEF 2009) and Amsterdam (EAEPE 2009) for helpful comments and suggestions.

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    Valérie Revest & Alessandro Sapio

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Revest, V., Sapio, A. Financing technology-based small firms in Europe: what do we know?. Small Bus Econ 39, 179–205 (2012). https://doi.org/10.1007/s11187-010-9291-6

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