11

VC, New Technology, and VC, New Technology, and Business DevelopmentBusiness Development

Dafna Schwartz Dafna Schwartz Ben-Gurion University, IsraelBen-Gurion University, Israel

dafnasch@som.bgu.ac.ildafnasch@som.bgu.ac.il

Regional Economies in a Globalising WorldRegional Economies in a Globalising WorldEnhancing Intellectual Capacity and InnovationEnhancing Intellectual Capacity and Innovation

Friday 21 November 2008, Cardiff UniversityFriday 21 November 2008, Cardiff University

22

The NeedThe NeedCountries implement various policy measures Countries implement various policy measures

to encourage the formation of a VC industry -to encourage the formation of a VC industry -for the development of start-ups. for the development of start-ups.

Hypothesis- there may be a market failure:Hypothesis- there may be a market failure:

The high risk that the first entrants into the VC The high risk that the first entrants into the VC industry face in a country with limited VCsindustry face in a country with limited VCs

The existence of positive externalities in the The existence of positive externalities in the VC industry (first entrants into the market VC industry (first entrants into the market may not be profitable but can help in the may not be profitable but can help in the creation of better conditions) creation of better conditions)

33

Our hypothesesOur hypotheses Government intervention can be effective in Government intervention can be effective in overcoming market failure by supporting the overcoming market failure by supporting the formation of a VC industry formation of a VC industry However, this policy may have an However, this policy may have an unintentional negative side effect in terms of unintentional negative side effect in terms of increasing regional inequalityincreasing regional inequalityThe reason – the special role of the venture The reason – the special role of the venture investors in the development of the start-upsinvestors in the development of the start-ups Therefore, a specific public policy for the Therefore, a specific public policy for the spatial distribution of such activities should spatial distribution of such activities should be considered.be considered.

44

The Objective:The Objective: To analyze the Israeli experience To analyze the Israeli experience

Israel has adopted a policy of supporting Israel has adopted a policy of supporting the formation of the VC industrythe formation of the VC industryThe emergence of the VC industry in The emergence of the VC industry in Israel is considered to be the most Israel is considered to be the most successful example of diffusion of the successful example of diffusion of the Silicon Valley model of VC outside of Silicon Valley model of VC outside of North AmericaNorth America (Avnimelech & Teubal, 2004a, b; Bresnahan et al., 2001; (Avnimelech & Teubal, 2004a, b; Bresnahan et al., 2001;

Carmell & de Fontaenet, 2004). Carmell & de Fontaenet, 2004).

Can be used as a case studyCan be used as a case study

55

From start-ups to successful companiesFrom start-ups to successful companies

Requires resources that start-ups are frequently Requires resources that start-ups are frequently lacking.lacking.Financial resourcesFinancial resources - difficulty obtaining in the - difficulty obtaining in the market. They are characterized by high risk market. They are characterized by high risk and lack of tangible assets- therefore debt and lack of tangible assets- therefore debt financing is usually not an option financing is usually not an option (Denis, 2004).(Denis, 2004). Non-financial resourcesNon-financial resources - the founders are - the founders are often the innovators who don’t have the often the innovators who don’t have the business and managerial skills, experience, or business and managerial skills, experience, or networks which are more crucial to their networks which are more crucial to their success success (Hung et al., 2002).(Hung et al., 2002).

66

Who are venture investors?Who are venture investors?

Investors (local and foreign) that invest in Investors (local and foreign) that invest in start-ups through equity :start-ups through equity :– Venture capital fundsVenture capital funds– Private investors (angels) Private investors (angels) – Investment companies Investment companies – Corporate venture companies Corporate venture companies

They provide financial and non-financial They provide financial and non-financial resourcesresources

77

The role of venture investorsThe role of venture investors

Act as entrepreneurs and managersAct as entrepreneurs and managers Select firms with growth potentialSelect firms with growth potential Improve the quality of the firm in Improve the quality of the firm in which they invest which they invest Improve accessibility to resources Improve accessibility to resources (own and external) (own and external) –– financial and financial and other resources other resources (Gompers & Lerner, 1999, 2001, 2005; (Gompers & Lerner, 1999, 2001, 2005; Sapienza, 1992; Elango et alSapienza, 1992; Elango et al.., 1995; Sapienza et al, 1995; Sapienza et al.., 1995; Jain, 1999; , 1995; Jain, 1999; Van Osnabrugge & Robinson, 2000; Brierly 2001; Allen, 2002; Brancomb Van Osnabrugge & Robinson, 2000; Brierly 2001; Allen, 2002; Brancomb & Auerswald, 2001; Lindstrom & Olofsson, 2001; Helman & Puri, 2002a, & Auerswald, 2001; Lindstrom & Olofsson, 2001; Helman & Puri, 2002a, b; Wang et alb; Wang et al. . 2002; Allen, 2003; Riquelme & Watson, 20022002; Allen, 2003; Riquelme & Watson, 2002).).

88

Main factors in the location of start-ups Main factors in the location of start-ups financed by venture investorsfinanced by venture investors

They are part of high-tech - therefore have They are part of high-tech - therefore have a tendency to cluster, primarily around a tendency to cluster, primarily around metropolitan locations and in the satellite metropolitan locations and in the satellite urban ring around the main metropolitan urban ring around the main metropolitan areaarea (Bar-El &. Parr, 2003; Capello, 2002; Cooke & Schwartz, 2003; Cooke 2004, Cooke 2005, (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, Cooke & Schwartz, 2008, Frenkel, 2001; Frenkel & Shefer, 2001; Schwartz, 2006; Schwartz& Bar-El, 2007, Mason & Harrison, 2002).2007, Mason & Harrison, 2002).

In addition, their location depends on the In addition, their location depends on the venture investors: capital provider, venture investors: capital provider, entrepreneurs and managersentrepreneurs and managers

99

Two main considerations in Two main considerations in the location of venture the location of venture

investments investments

Capital is highly mobileCapital is highly mobile

Entrepreneurship & management Entrepreneurship & management –– much lower mobility much lower mobility

1010

Proximity & Focalization are is importantProximity & Focalization are is important

Frequent contacts, cost of distanceFrequent contacts, cost of distance

Tacit knowledge: venture investors are Tacit knowledge: venture investors are viewed as tacit information brokers: they viewed as tacit information brokers: they acquire and create knowledge acquire and create knowledge

Asymmetric information and the need of Asymmetric information and the need of control control

Cooperation of several investors in each Cooperation of several investors in each start-upstart-up

Involvement of each investor in several start-Involvement of each investor in several start-ups ups

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Consequently, venture investors Consequently, venture investors prefer to invest close to:prefer to invest close to:

Agglomerations of start-upsAgglomerations of start-ups Agglomeration of venture investorsAgglomeration of venture investors Their own location (residence, office)Their own location (residence, office) The portfolio companiesThe portfolio companies Other investors’ portfolio companiesOther investors’ portfolio companies

Focal PlacesFocal Places

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In 1993 - In 1993 - The Yozma ProgramThe Yozma Program

Fund of fundsFund of funds– allocated $100 million – allocated $100 million 10 VC funds were formed, 10 VC funds were formed, A partner of a leading Israeli financial A partner of a leading Israeli financial institution with leading foreign venture institution with leading foreign venture investors investors The government's share is maximum 40% The government's share is maximum 40% Option to buy out the government's share at Option to buy out the government's share at a pre-determineda pre-determined price over a period of 5 price over a period of 5 years years In addition - invest directly in start-ups. In addition - invest directly in start-ups.

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The Yozma program proved to be The Yozma program proved to be extremely successfulextremely successful

10 10 VC funds were formedVC funds were formed

Major international venture investors Major international venture investors were attracted: USA, Germany, Japan, were attracted: USA, Germany, Japan, Netherlands, Singapore. Netherlands, Singapore.

9 funds bought out the government's 9 funds bought out the government's shareshare

15 direct investments - 9 enjoyed 15 direct investments - 9 enjoyed successful exits – IPOs or M&Asuccessful exits – IPOs or M&A

1414

Catalyst for the development of the VC industry: Catalyst for the development of the VC industry: (VC funds and others)(VC funds and others)

40200 120 110

300

640 650

1160

2710

1320

500

10

590

1640

9001100

0

500

1000

1500

2000

2500

3000

1991 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

$mil

Capital Raised by Israeli VC Funds by Year

1515

Catalyst for the development of young Catalyst for the development of young technology firms – start-ups (SU)technology firms – start-ups (SU)

50290

440590

1010

3090

1990

11401010

14701340

16201760

0

500

1000

1500

2000

2500

3000

3500

1991 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Capital raised by Israeli High-Tech Companies

51124 140

175231

260312

573642

357347404

565499520540

0

100

200

300

400

500

600

700

No. of Startup Creation

1616

Exits: IPO and M&AExits: IPO and M&ACapital Raised in IPOs of Israeli High-Tech Companies

M&As of Israeli High-Tech Companies

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The location pattern of SU backed by The location pattern of SU backed by venture investors venture investors (Schwartz & Bar-El 2007)(Schwartz & Bar-El 2007)

We analyzedWe analyzed the location pattern of SUs in comparison the location pattern of SUs in comparison to that of high-tech activitiesto that of high-tech activities

Our hypothesis:Our hypothesis: This policy has an unintentional This policy has an unintentional negative side effect in terms of regional negative side effect in terms of regional inequalityinequality

Start-ups backed by VC – heavier concentration Start-ups backed by VC – heavier concentration in comaprison with high tech activities. Tend to in comaprison with high tech activities. Tend to concentrate in the metropolitan urban center of concentrate in the metropolitan urban center of the country in specific focal locations, leaving the country in specific focal locations, leaving the peripheral districts far behindthe peripheral districts far behind. .

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DatabaseDatabaseStart-up information:Start-up information:*)*)

All the start-ups that were financed by All the start-ups that were financed by venture investors, 1995-2004.venture investors, 1995-2004.

1,239 start-ups, 30,000 employees, $11B 1,239 start-ups, 30,000 employees, $11B

Employment dataEmployment data::**)**)

total employment in all sectors (ET) total employment in all sectors (ET)

employment in high-tech sectors (EHT) employment in high-tech sectors (EHT)

Sources: Sources: *)*) IVC information base IVC information base **)**)CBSCBS

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Districts and sub-districtsDistricts and sub-districts

6 districts:6 districts:

• 2 periphery: Southern, Northern2 periphery: Southern, Northern

• 4 centers: Tel Aviv, Central, Haifa, 4 centers: Tel Aviv, Central, Haifa, JerusalemJerusalem The core: Tel-Aviv is the The core: Tel-Aviv is the metropolitan urban center; The metropolitan urban center; The Central district is the ring around it.Central district is the ring around it.

1515 sub-districts sub-districts (8 (8 –– centers, 7 centers, 7 –– periphery) periphery)

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The Spatial distributionThe Spatial distribution::

For each district i we calculated its For each district i we calculated its share:share: in total employment (%ETi)in total employment (%ETi) in employment in high-tech in employment in high-tech (%EHTi)(%EHTi) in employment in start-ups in employment in start-ups backed by venture investors backed by venture investors (%ESUi).(%ESUi).

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Location quotients,Location quotients, For each district i the ratio of For each district i the ratio of::

The share of employment in The share of employment in high-techhigh-tech with that of with that of total employmenttotal employment((%EHTi/%Eti)%EHTi/%Eti)

The share of employment The share of employment in start-upsin start-ups with the share with the share in high-techin high-tech

((%ESUi/%EHTi)%ESUi/%EHTi)

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Distribution and location measures by districtsDistribution and location measures by districts % ET% ET% EHT% EHT% ESU% ESU%EHT/%EHT/

%ET)%ET)

%ESU/%ESU/

%EHT%EHTSouthernSouthern12.212.29.59.52.32.30.780.780.250.25NorthernNorthern13.713.79.69.68.88.80.700.700.910.91CentralCentral21.921.932.632.637.137.11.491.491.141.14Tel AvivTel Aviv27.727.729.929.936.536.51.081.081.221.22JerusaleJerusalemm10.910.97.47.48.08.00.680.681.091.09HaifaHaifa13.713.711.011.07.37.30.800.800.670.67TotalTotal100100100100100100

Central+T.ACentral+T.A(50%)(50%)(63%)(63%)(74%)(74%)

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High tech and SU High tech and SU ConcentrationConcentration

Heavy concentration of Heavy concentration of high-techhigh-tech in and in and around a metropolitan districts, low levels around a metropolitan districts, low levels in the peripheral districtsin the peripheral districts

The distribution of The distribution of venture investmentsventure investments is is even moreeven more concentrated than that of concentrated than that of high-tech activityhigh-tech activity

Districts with the relatively higher activity Districts with the relatively higher activity of high tech enjoy an even higher level of of high tech enjoy an even higher level of concentration of start-ups. concentration of start-ups.

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A special pattern of concentrationA special pattern of concentration

Highest relative attraction of venture Highest relative attraction of venture investments to urban centers in the proximity investments to urban centers in the proximity of Tel Aviv (Tel Aviv + Central districts):of Tel Aviv (Tel Aviv + Central districts):73% of all start-up employment compared to:73% of all start-up employment compared to: 63% for high-tech 63% for high-tech 50% for total employment.50% for total employment.

But not necessarily to all main centers But not necessarily to all main centers (Jerusalem, Haifa)(Jerusalem, Haifa)

Venture investments refrain from locating in Venture investments refrain from locating in peripheral regions, but not necessarily from peripheral regions, but not necessarily from all of themall of them

2525

The concentration of start-ups is The concentration of start-ups is distributed in a few focal pointsdistributed in a few focal points

We divide the districts into their sub-district We divide the districts into their sub-district and apply the same parameters to the and apply the same parameters to the smaller geographical unitssmaller geographical units

The concentration of start-ups is The concentration of start-ups is distributed in a few focal points, mostly in distributed in a few focal points, mostly in the center of the country. the center of the country.

Sub districts with relatively high share of Sub districts with relatively high share of start ups: Petah Tikva and Tel Aviv, start ups: Petah Tikva and Tel Aviv, Rehovot, Sharon, Hadera and Yizre'el. Rehovot, Sharon, Hadera and Yizre'el.

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Distribution by sub-districtsDistribution by sub-districts% ET% ET% EHT% EHT% %

ESUESULQ(EHT/ET)LQ(EHT/ET)LQ(ESU/LQ(ESU/

EHT)EHT)

JerusalemJerusalem10.910.97.47.48.08.00.680.681.091.09

Zefat,Kin,GolanZefat,Kin,Golan3.73.71.41.40.20.20.370.370.180.18

Yizre’elYizre’el5.05.04.54.57.37.30.900.901.621.62

AkkoAkko4.94.93.73.71.21.20.760.760.310.31

HaifaHaifa10.410.410.210.25.45.40.980.980.520.52

HaderaHadera3.33.30.80.82.02.00.230.232.682.68

SharonSharon4.24.22.22.25.65.60.520.522.572.57

PetachPetach--TiqvaTiqva8.18.114.414.422.122.11.791.791.531.53

RamlaRamla3.83.88.78.73.63.62.262.260.420.42

RehovotRehovot5.85.87.47.45.85.81.261.260.780.78

TelTel AvivAviv27.727.729.929.936.536.51.081.081.221.22

AshkelonAshkelon5.45.43.83.80.90.90.710.710.230.23

Beer-ShevaBeer-Sheva6.86.85.75.71.51.50.840.840.260.26

2727

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Summary and ConclusionSummary and Conclusion

We tested the effectiveness of We tested the effectiveness of government policy in encouraging the government policy in encouraging the formation of VC industry. The findings formation of VC industry. The findings show:show:

Yes – It is possible! Yes – It is possible!

Such policy is effective and may act as Such policy is effective and may act as a catalyst for the creation of VC a catalyst for the creation of VC industry and for the development of industry and for the development of start-ups.start-ups.

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Heavy concentration of venture Heavy concentration of venture investments in comparison to high-tech investments in comparison to high-tech activityactivity– Pattern of concentration in a few focal places, Pattern of concentration in a few focal places,

with no necessary continuum between them.with no necessary continuum between them.

This location behavior may lead to changes This location behavior may lead to changes in the future geographical mapping of high-in the future geographical mapping of high-tech activity and possibly to the increase of tech activity and possibly to the increase of regional gaps.regional gaps.

The policy has an unintentional negative The policy has an unintentional negative result - increase in the regional gapresult - increase in the regional gap

3030

The Location FactorsThe Location Factors

When making a location decision, every firm When making a location decision, every firm considers the macro-regional factors and its considers the macro-regional factors and its micro-business specific needsmicro-business specific needs Start-ups are high-tech activities, and are Start-ups are high-tech activities, and are influenced by the same macro-regional influenced by the same macro-regional factors that lead to concentrationfactors that lead to concentration The location considerations of start ups are The location considerations of start ups are influenced also by their investors – since influenced also by their investors – since their role is not merely a financial capital their role is not merely a financial capital provider: they also play an important role in provider: they also play an important role in entrepreneurship and management of the entrepreneurship and management of the start-upsstart-ups

3131

Policy implicationsPolicy implicationsStill, focal places in the periphery may under Still, focal places in the periphery may under certain conditions offer a potential for certain conditions offer a potential for SUSU activity activityThe existence of externalities generated by SU The existence of externalities generated by SU activity justifies the involvement of public policy:activity justifies the involvement of public policy:– Joint public programs with venture capital Joint public programs with venture capital

investors, investors, – with a focus on specific concentrated with a focus on specific concentrated

locations in the periphery that have a locations in the periphery that have a potential of growth.potential of growth.

– Examples of programs that may be Examples of programs that may be considered: regional venture capital fund, considered: regional venture capital fund, technological incubatorstechnological incubators