the economics of small business finance the roles of private equity and debt markets in the financial growth cycle abstract this article examines the economics of financing small business in private equity and debt markets firms are viewed through a financial growth cycle paradigm in which different capital structures are optimal at different points in the cycle we show the sources of small business finance and how capital structure varies with firm size and age the interconnectedness of small firm finance is discussed along with the impact of the macroeconomic environment we also analyze a number of research and policy issues review the literature and suggest topics for future research

venture capitalists as principals contracting screening and monitoring there is a large academic literature on the principal agent problem in financial contracting this literature focuses on the conflicts of interest between an agent who is an entrepreneur with a venture that needs financing and a principal who is the investor providing the funds for the venture theory has identified a number of ways that the investor principal can mitigate these conflicts first the investor can structure financial contracts i e the allocation of cash flow and control rights between the entrepreneur and investor to provide incentives for the entrepreneur to behave optimally second the investor can engage in information collection before deciding whether to invest in order to screen out ex ante unprofitable projects and bad entrepreneurs and third the investor can engage in information collection and monitoring once the project is under way despite the large volume of theory empirical work has lagged behind in comparing the contracts and actions of real world principals to their counterparts in financial contracting theory in this paper we describe recent empirical work and its relation to theory for one prominent class of such principals venture capitalists vc s in our view vc s are real world entities that closely approximate the investors of theory vc s invest in entrepreneurs who need financing to fund a promising project or company vc s have strong incentives to maximize value but at the same time receive few or no private benefits of control although they are intermediaries vc s typically receive at least 20 percent of the profits on their portfolios see paul gompers and josh lerner 1999 in addition to being interesting from a theoretical perspective vc actions and contracts of are interesting from a practical perspective vc s have been extremely successful in the last several years i they have been associated with a number of the prominent corporate successes like ariba cisco ebay and yahoo ii they have generated substantial returns and wealth for their investors and iii they have raised and invested record amounts of money

determinants of the incidence and scale of seed capital investments by venture capital firms employing both behavioral decision making and agency theories our study seeks to identify those factors that influence a venture capital vc firm s decision to undertake seed capital investments and subsequently the scale of such activity using data on the investments made by 2949 vc funds raised worldwide between 1962 and 2002 we find investor age timing of investment and fund location to be of importance in addition the size of the fund and the existing number of portfolio firms exert opposite influences on the level of seed capital activity of the vc firm these results suggest that seed activity is a valuable source of market intelligence for leading vc firms seeking proactively to identify and invest in novel technologies

seigniorage revenue deficits and self fulfilling currency crises abstract this paper examines potential resolutions to the conflict between a fixed exchange rate and seigniorage revenue requirement of a stylized developing economy that gives rise to a currency crisis the government has an informational advantage and can decide when it is optimal to invoke an escape clause i e to drop the peg and float speculators must guess when the crisis will happen based on their assessment of the probability of collapse and this makes pegged exchange rate equilibria unstable

demand estimation in the presence of stochastic trend and seasonality the case of meat demand in the united kingdom if budget shares have stochastic trend or seasonality or both then demand equations based on the assumption of deterministic trend and deterministic seasonality will be mis specified we test this proposition by estimating a linearized almost ideal lai demand system for meat demand in the united kingdom using harvey s structural time series methodology we demonstrate that the model specification allowing for stochastic trend and deterministic seasonality performs best in terms of diagnostic tests and goodness of fit measures it is also shown that the model with stochastic trend is better at out of sample forecasting

limited attention and the role of the venture capitalist abstract this research analyzes the venture capitalist s incentives to maximize the profits of the entrepreneurs of ventures and the limited partners of a venture fund venture capital is a professionally managed pool of capital invested in equity linked private ventures entrepreneurs turn to venture capitalists for financing because high technology startup firms have low or negative cash flows which prevent them from borrowing or issuing equity in addition venture capitalists are actively involved in management of the venture to assure its success this solves the problem of startup firms that do not have the cash flows to hire management consultants venture capital contracts have three main characteristics 1 staging the commitment of capital and preserving the option to abandon 2 using compensation systems directly linked to value creation and 3 preserving ways to force management to distribute investment proceeds these characteristics address three fundamental problems 1 sorting the venture capital among the entrepreneurial ventures 2 providing incentives to motivate venture capitalists to maximize the value of the funded ventures and 3 providing incentives to motivate entrepreneurs to maximize the value of the ventures venture capitalists fund only about a dozen projects a year out of a thousand evaluated each project may receive several rounds of financing payoffs to vcs can be very high or be a complete loss the typical venture capital vc firm is organized as a limited partnership with the venture capitalists serving as general partners and the investors as limited partners general partner vcs act as agents for the limited partners in investing their funds vcs invest their human capital by placing their reputation on the line the goal is to begin to convert the investment into cash or marketable securities which are distributed to the partners vc management companies receive a management fee equal to a percentage usually 2 5 of the capital of each fund they also receive a percentage 15 30 of the profits of each fund called carried interest periodic reports are made by the vc firm to the limited partners usually these are only costs of managing the fund and so revenues are negative most contracts specify the percentage of time that the vc will devote to managing the fund the analysis of this research deals with the incentives of the vc who has limited attention to be allocated between improving current ventures and evaluating new ventures for possible funding the analysis shows that the vc as agent for both the entrepreneur and the general partners does not have the incentives required to maximize their profits the vc allocates attention among ventures and venture funds less frequently than required to maximize the entrepreneurs and limited partners profits however the vc does maximize the total profits of all ventures because the vc considers the opportunity cost of attention the vc s allocation of attention is efficient the implication of this result is that although the entrepreneurs and limited partners could be made better off with a different allocation of the vc s time this would be an inefficient use of the vc s time

finance for smes a u k perspective this paper provide an overview of recent trends in the financing of smaller businesses in the u k it refers in particular to the findings of a major recent programme of work in this area funded by the economic and social research council in which the author participated this programme included the first national survey to address these issues since the bolton report of 1971 as well as a range of projects covering the finance of ethnic businesses and hi tech firms as well as the market for informal venture capital on the basis of this work and of the results of more recent follow up surveyors it is concluded that the evidence for general equity or debt gaps in the u k is weak if anything sme funding was too easy in the boom of the late 1980s it is argued that consideration could be given to the promotion through seedcorn funding of sme co operative or mutual guarantee schemes to reduce information asymmetry in u k credit markets

why has the investment performance of technology specialist european venture capital funds been so poor abstract this paper seeks to identify and model the key parameters which impact on the commercial performance of a specialist technology focused early stage venture capital fund using both input costs and output expected values data provided by a number of specialist independent venture capital firms a spreadsheet model of a 10 year term fund is developed these figures are used to generate internal rate of return irr and net present value npv performance calculations for the investment commitments of both the institutional limited partners and venture capitalist general partner the generically defined model allows the user to address both conceptual and pragmatic questions regarding the relationship between fund structure and performance the model is further developed to determine the effect on fund performance of two venture capital related indirect state support schemes guarantee and leverage options iterative interrogations of the model demonstrate the sensitivity of economic returns to the scale of the investment activity state supported schemes mitigate but do not remove the negative performance consequences of small fund size a fund with under 15 million us 25 million or ecu21 million under management is of increasing economic vulnerability

estimating a demand system with nonnegativity constraints mexican meat demand a new information based approach for estimating systems of many equations with nonnegativity constraints is presented this approach called generalized maximum entropy gme is more practical and

determinants of required return in venture capital investments a five country study abstract using two complementary theoretical perspectives we develop hypotheses regarding the determinants of the return required by venture capitalists and test them on a sample of over 200 venture capital companies vccs located in five countries consistent with resource based theory we find that early stage specialists require a significantly higher return than other vccs when investing in later stage ventures consistent with financial theory we find that acquisition buyout specialists require a significantly lower return than other vccs when investing in expansion companies furthermore in comparison to specialists highly stage diversified vccs require a significantly higher return for early stage investments independent vccs require a higher rate of return than captive or public vccs in general higher required returns are associated with vccs who provide more intensity of involvement have shorter expected holding period of the investment and being located in the us or uk in comparison to those in france belgium and the netherlands

robust financial contracting and the role of venture capitalists we derive a role for inside investors such as venture capitalists in resolving various agency problems that arise in a multistage financial contracting problem absent an inside investor the choice of securities is unlikely to reveal all private information and overinvestment may occur an inside investor however always makes optimal investment decisions if and only if he holds a fixed fraction contract where he always receives a fixed fraction of the project s payoff and finances that same fraction of future investments this contract also eliminates any incentives of the venture capitalist to misprice securities issued in later financing rounds in this article we develop a model of financial contracting with multiple investment decisions and show how conflicts of interest and informational asymmetries can be effectively resolved by an inside investor i e an investor who not only provides capital but also works closely with the firm monitors it frequently and is generally very well informed about the firm s prospects and investment opportunities venture capitalists are obvious examples of inside investors and their function has been an important motivation for this article banks especially in japan and germany are also involved in monitoring and can be viewed as playing the role of inside investors in this article we examine the potential benefits of inside investors in a context where there are no restrictions beyond limited liability on the type of financial contracts that can be written we address a basic financial contracting problem involving an entrepreneur who has an idea for a project but does not have sufficient capital to fund it an important assumption is that there are several stages in the project s development and that a decision must be made at each stage whether the project should be continued or abandoned if the project is continued the amount of additional capital to be invested must also be determined we assume that the entrepreneur as an insider observes private information about the project s profitability at each stage this information is not

staging of venture capital investment a real options analysis this paper uses contingent claims analysis to investigate the staging decision of venture capitalist vc in a principal agent framework venture capital investment opportunities are modeled as real options with multiple volatilities and the entrepreneur s incentive is assumed to maximize the probability of getting funded in the next financing round two celebrated formulae in the option pricing literature are generalized to evaluate these real options we find that staging not only gives the vc a waiting option but also mitigates the agency problem of the entrepreneur undertaking too conservative activities moreover we find that the vc tends to stage her investment when the expected growth rate of the venture s market value is lower however the risk free interest rate is not an important factor in the staging decision our model also provides a good explanation for existing empirical evidence on the staging of venture capital investment

why do venture capital firms exist theory and canadian evidence executive summary this paper investigates the role of venture capitalists we view their raison d etre as their ability to reduce the cost of informational asymmetries our theoretical framework focuses on two major forms of asymmetric informa tion hidden information leading to adverse selection and hidden ac tion leading to moral hazard our theoretical analysis suggests four em pirical predictions 1 venture capitalists operate in environments where their relative efficiency in selecting and monitoring investments gives them a comparative advantage over other investors this suggests strong industry effects in venture capital investments venture capitalists should be prominent in industries where infor mational concerns are important such as biotechnology computer software etc rather than in rou tine start ups such as restaurants retail outlets etc the latter are risky in that returns show high variance but they are relatively easy to monitor by conventional financial intermediaries 2 within the class of projects where venture capitalists have an advantage they will still prefer projects where monitoring and selection costs are relatively low or where the costs of informational asymmetry are less severe thus within a given industry where venture capitalists would be expected to focus we would also expect venture capitalists to favor firms with some track records over pure start ups

a model of venture capitalist investment activity the paper describes the activities of venture capitalists as an orderly process involving five sequential steps these are 1 deal origination the processes by which deals enter into consideration as investment prospects 2 deal screening a delineation of key policy variables which delimit investment prospects to a manageable few for in depth evaluation 3 deal evaluation the assessment of perceived risk and expected return on the basis of a weighting of several characteristics of the prospective venture and the decision whether or not to invest as determined by the relative levels of perceived risk and expected return 4 deal structuring the negotiation of the price of the deal namely the equity relinquished to the investor and the covenants which limit the risk of the investor 5 post investment activities the assistance to the venture in the areas of recruiting key executives strategic planning locating expansion financing and orchestrating a merger acquisition or public offering 41 venture capitalists provided data on a total of 90 deals which had received serious consideration in their firms the questionnaire measured the mechanism of initial contact between venture capitalist and entrepreneur the venture s industry the stage of financing and product development ratings of the venture on 23 characteristics an assessment of the potential return and perceived risk and the decision vis i vis whether to invest the modal venture represented in the database was a start up in the electronics industry with a production capability in place and seeking 1 million median in outside financing there is a high degree of cross referrals between venture capitalists particularly for the purposes of locating co investors factor analysis reduced the 23 characteristics of the deal to five underlying dimensions namely 1 market attractiveness size growth and access to customers 2 product differentiation uniqueness patents technical edge profit margin 3 managerial capabilities skills in marketing management finance and the references of the entrepreneur 4 environmental threat resistance technology life cycle barriers to competitive entry insensitivity to business cycles and down side risk protection 5 cash out potential future opportunities to realize capital gains by merger acquisition or public offering the results of regression analyses showed expected return to be determined by market attractiveness and product differentiation r2 0 22 perceived risk is determined by managerial capabilities and environmental threat resistance r2 0 33 finally a discriminant analysis correctly predicted in 89 4 of the cases whether or not a venture capitalist was willing to commit funds to the deal on the basis of the expected return and perceived risk the reactions of seven venture capitalists who reviewed the model s specification were used to test its validity

the capital gap for small technology companies public venture capital to the rescue in this paper we analyze effectiveness of public intervention for fostering private venture capital market in spain we use a sample obtained from venturexpert database consisting of 755 investments made by 83 spanish public and private venture capitalists that closed at least one fund between 1997 and 2008 we compare the investments undertaken by private and public investors before and after public venture capital programs were started we found that spanish venture capital market has rapidly developed in the last 10 years and that this development coincides with the establishment of public policies for encouraging technology entrepreneurship we also found that other factors such as previous experience of investors and size have also contributed to fostering more high risk investments these results may encourage governments in other countries to start or keep working to promote private venture capital investments

recovering output specific inputs from aggregate input data a generalized cross entropy approach for multiproduct firms data on aggregate input usage are typically available but data on activity specific inputs are not the present study proposes a generalized cross entropy approach to estimate activity specific input allocations that are consistent with the aggregate information the proposed method does not require behavioral assumptions e g profit maximization but does accommodate behavioral restrictions as well as nonsample information about the plausible factor shares across enterprises monte carlo experiments using simulated data for multifactor multiproduct firms are used to evaluate the performance of the proposed method

food consumption dynamics a nonparametric approach using maximum entropy estimation we model dynamic consumer choice in a stochastic optimal control framework and show conditions under which observable market share data possess the markov property using 30 years of annual aggregate milk consumption data differentiated by fat content maximum entropy is used to estimate nonstationary transition probabilities showing how consumer tastes and preferences have changed over time the maximum entropy approach allows for the estimation of a 4 4 transition probability matrix for each year of the sample results suggest that skim milk was an absorbing state over most of the sample but that the trend toward skim milk has decelerated and possibly reversed itself since 1998 our approach provides a useful complement to existing parametric approaches to demand analysis when data are limited or the problem is ill posed

determinants of venture capital firms preferences regarding the industry diversity and geographic scope of their investments abstract competition is intensifying in the venture capital industry in the u s the number of venture capital firms vcfs tripled from 1980 to 1989 supplier power in the form of institutional investors such as pension funds continues to grow foreign venture capital has grown to the extent that commitments to foreign vcfs exceeded domestic commitments in both 1988 and 1989 further alternative sources of financing for entrepreneurs such as individual investors angels corporations and strategic alliances are increasingly viable options vcfs face pressure to seek lower risk investments improve rates of return and provide value to new venture development surprisingly few scholarly studies have begun to investigate the strategies vcfs are aiming to implement in order to deal with this increasing pressure building on the premise that decisions regarding product market scope are a key component of firm strategy hofer and schendel 1978 this study examined 169 domestic vcfs in order to identify factors that might explain variations in preferences regarding the industry diversity and geographic scope of their investments the sample drawn from california massachusetts and texas represented about 27 of all u s based vcfs in 1987 the year in which the data were gathered in terms of the total size of investment portfolio the average for these 169 vcfs was 69 8 million which is statistically indistinguishable from the u s average of 65 million results indicate that 1 vcfs specializing in early stage ventures prefer less industry diversity and narrower geographic scope relative to other vcfs 2 corporate vcfs i e those owned by non financial corporations prefer less industry diversity but broader geographic scope relative to non corporate vcfs 3 larger vcfs prefer greater industry diversity and broader geographic scope than do smaller vcfs and 4 provision of small business investment companies sbic financing by the vcf has no impact on preferences regarding industry diversity but is associated with a preference for narrower geographic scope one implication of these results is that vcfs in the u s are not homogeneous as regards the intended product market scope of their portfolios this in turn holds implications not only for vcfs but also for their suppliers limited partners buyers entrepreneurs and policy makers vcfs can no longer rely on haphazard investment schemes they need to attract investors by virtue of the benefits offered by their portfolio strategy and they need to attract superior investments via offering valueadded services and know how potential investors in venture capital will want to examine for example the impact on risk and return of investing smaller amounts in several vcfs at one extreme versus making one large investment in a very diversified vcf at the other extreme the results of this and other studies suggest that outcomes timing magnitude and riskiness of returns of choosing such alternatives will vary widely and will depend in great part on the strategies of the vcfs involved it will not be possible for investors to make wise choices without a full examination of their own objectives and of the profiles of vcfs entrepreneurs with the most attractive ventures have alternative sources of financing to consider and should weigh the benefits of being financed and supported by various vcfs as part of the vcfs portfolios knowing a vcf s preferences regarding product market scope improves their chances of approaching and selecting the right fit and for those entrepreneurs with a narrower set of options such knowledge may make the difference between receiving and not receiving financing in a timely manner finally policy makers may be able to make use of knowledge of the forces that influence the investment strategies of vcfs presently concerns for policy makers may include the gap in seed capital increased foreign presence in the u s market and the export of promising innovative technology via alliances with foreign firms all of these factors are influenced by the strategies pursued by vcfs as they jockey for position in the increasingly competitive venture capital market

how venture capital firms differ abstract four potential sources of differences between venture capital vc firms were examined venture stage of interest amount of assistance provided by the vc vc firm size and geographic region where located through a questionnaire 149 venture capitalists provided data about their firms about what they look for in evaluating an investment and about how they work with a portfolio company following an investment firms were divided into four groups based on venture stage of interest the earlier the investment stage the greater the interest in potential investments built upon proprietary products product uniqueness and high growth markets late stage investors were more interested in demonstrated market acceptance there were no differences by stage regarding the desired qualities of management however after the investment was made earlier stage investors attached more importance to spending their time evaluating and recruiting managers earlier stage investors sought ventures with higher potential returns a 42 hurdle rate of return for the earliest stage investor versus 33 for the late stage investor late stage investors spent more time evaluating a potential investment however after the investment was made there was little difference in the amount of time spent assisting the portfolio company there were however differences in the significance that vcs attached to particular post investment activities firms were split into three groups based upon the amount of time the vc spent with a portfolio company after an investment was made as lead investor the most active group averaged over 35 hours per month per investment and the least active group averaged less than seven hours the difference in assistance provided was not strongly tied to differences in investment stage of interest there were major differences in the importance the vcs attached to their post investment activities not surprisingly high involvement vcs viewed their activities as more important based upon the amount of capital they managed firms were also split into three groups average fund size varied from 278 to 12 million dollars the larger firms had more professionals and managed more money per professional the large firms provided the least and the medium sized firms the most assistance to portfolio companies large firms also made larger individual investments even though they invested over half their funds in late stage investments whereas smaller firms focused on the earlier stages the large firms were still a major source of early stage financing there were no differences between geographic regions in the proportion of investments where the venture capital firm served as lead investor there were however major regional differences in investment stages of interest also differences were observed between regions that were not a result of differing size and investment stage

technology entrepreneurship and path dependence industrial clustering in silicon valley and route 128 silicon valley and route 128 have been the centers of innovation and commercialization for the electronics computer and data communications industries in the postwar period however since the 1960s silicon valley has grown more rapidly and from approximately 1985 through 1995 route 128 experienced retarded growth their success had diverged dramatically in the last decade the most common explanations for this divergence are differing cultures interfirm relations or and internal organizational style organization this paper builds upon path dependent and dominant design explanations of technical and industrial change arguing that the technological trajectories of the industries underlying the two regions were different and this led to their differential destinies to explain the dynamics of the two regions and analytical separation is made between the economy of the existing firms and a separate economy of institutions that evolved to nurture new firm formation copyright 1999 by oxford university press

structural change in the demand for meat economists have long thought that shocks in the economy sometimes lead to permanent changes in behavioral relationships hence supply or demand elasticities estimated from econometric models may change over time the source of such structural change may be technological adoption a shift in consumer preferences or an institutional change one way to handle this problem in linear models is to allow the parameters to change as the situation changes so that the model provides a local approximation of the behavioral relationship this approach is an attractive way to deal with structural change problems econometricians have extended the classical