Overview of the Innovation Finance Architecture Colombian Innovation Finance Training

16 Mar 2015

Dr. Yannis PierrakisSenior Lecturer in Entrepreneurship and Innovation

Kingston University

Source: Business Growth and Innovation (NESTA, 2009).

6%

YesYesNo No No

Product Innovation

Process Innovation

Wider Innovation

Did innovation take place 2002 – 2004?

Average annual employment growth rate (2004-07)

5%

4%

3%

2%

1%

0%

Yes

Innovation seems to matter

Innovative business

• Breakthrough idea or technology– Solves a problem– Creates new needs– Improves the cost equation – Runs fast– Often IP protectable (especially for biotech)

• Not a ‘conventional business’

How such companies can be funded?

• Personal savings• Grants• Loans• Mortgages• Credit cards• FFFs• Business Angels• Venture Capital• Crowdfunding• ….

Innovation requires resources, it’s an investment. How is this investment funded?

VC

Financing innovation

How such companies can be funded?

• Personal savings• Grants• Loans• Mortgages• Credit cards• FFFs• Business Angels• Venture Capital• Crowdfunding• ….

INNOVATION FINANCE

Why innovation finance?

• The high-growth innovative firms often require significant capital up-front and this is very hard to obtain from conventional sources of debt finance.

• They tend to have intangible assets, and show a significant delay before generating revenue making than a high risk investment.

• Only a small proportion of businesses (3%) receives venture capital finance

Why innovation finance?

• VC backed firms are responsible for a disproportionate number of patents and new technologies (Kortum and Lerner 2000, Mann and Sager 2007)

• Bring more radical innovations to market faster than lower growth businesses that rely on other types of finance (Hellmann and Puri 2000; Gompers and Lerner 2001)

Limited PartnersPension Funds

Insurance CompaniesFamily Offices

High net-worth individuals

EndowmentsFund-of-fund

Govt.

10-Year timeframe

VC

First 3-5Years

Exit timeReturns to LP

How the venture capital model works

Venture capital

VC & BAs backed companies

Business Angels

• Business Angels– Individuals with lots of cash– Have knowledge of the industry – Typically invest at the very early stage in exchange

of equity – Provide hands on support to the start up– Wide network of contacts

12

Types of VC funds

• Private – Institutional venture capital funds, formal business entities with full time professionals

• Corporate – Subsidiaries of large corporations (e.g. Intel Ventures)

• Public – Funds established by the Government that invest solely public money

• Hybrid – Funds established as a partnership between the Government and private funds

• Angel groups – A fund formed by a team of business angels

How such companies can be funded?

• Venture Capital– High risk capital that invests in high risk and high

growth companies– Hands on involvement with the company

• Comes in stages– Pre-seed– Seed– Early stage (Series A)– Late stage & Expansion (Series B, C etc.)

How does it work?

• A typical VC fund portfolioStatus

Company 1 DeadCompany 2 DeadCompany 3 DeadCompany 4 ZombieCompany 5 ZombieCompany 6 ZombieCompany 7 x1Company 8 x2Company 9 x3Company 10 x15

Limited PartnersPension Funds

Insurance CompaniesFamily Offices

High net-worth individuals

EndowmentsFund-of-fund

Govt.

10-Year timeframe

First 3-5Years

Exit time

Returns to LP

VC

15

The selection process

Opportunity introduction

Initial screening

Due diligence Negotiating Funding

• 6 in 1000 business plans get funded on average• 5% of business plans are read beyond the executive summary • 10% of proposals pass initial screening• 10% of pre-screened proposals pass due diligence & receive funding (source: 1000ventures.com)

VC deal terms

• Investment for a portion of the company• Liquidation preference• Interest rate• Management stock option pool

17

Case study: Amazon.com

Dec-97 Loan & Boand Issue $326m bond issued

May-97 IPO 3 million shares are offered, raising $49.1m

Jun-96 Venture Capitalists 2 VC funds invest a total of $8m

May-96 Family Founder's siblings invest $20,000

Dec-95 Angel Syndicate

20 angels invest $46,850 each on average, for a total of $937,000

Aug-95 Business Angels 2 angels invest a total of $54,408

Feb-95 Family Founder's father and mother invest a combined $245,000

Jul-94 Founder Jeff Bezos starts Amazon.com, he invests $10,000

Pros & Cons of VC finance

• – Finance for your idea (unlikely through the banks)– Connections with industry experts– Identifies and ‘corrects’ your weaknesses

• – Requires to give up significant equity – Outsiders get involved with your company– Raising capital requires significant efforts and time

VC vs Bank finance

Banks VC funds• Collaterals are needed (tangible assets) • Need to show high growth potential

(intangible assets)

• Credit score and cedit risk assessment is very important

• Credit score is not so important

• You keep all the equity • You give up significant portion of the business

• Banks do not get involved in the way you run your company

• VC funds are actively involved in the way the company is run

• You continue to run the company • Your position as CEO maybe at risk

• Detailed examination of the companies finance and forecasts

• Basic financials are adequate

• Banks aim to make a 'modest' profit • VC funds aim to make significant profit

• Banks do not provide additional help • VC money is 'smart money'

• Venture Capital investments in the US, UK and continental Europe

VC activity

• Number of Venture Capital backed companies in the US, UK and continental Europe

VC activity

Where do VC funds invest?

Internet

Biotech &

Health

care

Communication &

Elec

tronic

Consumer

Business

Industr

ials

Other

Industries

Business

Servi

ces (o

ther)

Energ

y

Finan

cial S

ervice

s0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

UKUSEurope

Prop

ortio

n of

inve

stm

ents

Company development & IF funding stages

Crowdfunding

IPOs or M&A

Grants

Business Angels

Private Equity

Private VC

VCTs Public VC

Business Angel

Networks

IF landscape in the UK

Crowdfunding

AIM

• Alternative Investment Market (AIM)• Early stage businesses, venture capital-backed

companies and more established businesses may join AIM to help raise the capital necessary for expansion

• AIM launched on 19 June 1995 and has raised almost £24 billion (thousand million) and has helped more than 3,000 small-medium-sized companies raise equity to support their growth

Further reading

• Reshaping the UK economyhttp://www.nesta.org.uk/publications/reshaping-uk-economy