Financing With Venture Capital: Advances in Knowledge Over the Last Ten Years and Research Avenues

3.1 The role of venture capital in economic development, legal structures and the provenance of investors

It is important to have the "lay of the land" of the venture capital market to be able to understand and review the mechanisms of its operations and to identify the factors likely to impede its efficiency or to prevent it from meeting its objectives. One would also like to measure the extent of the impact that it can have on job creation, on the rate of innovation and on the maintenance or growth of successful businesses.

Of the 564 occurrences identified, 43 per cent dealt with this topic of research. The distribution of research subjects by occurrence is presented in Figure 5.

Figure 5: Count of Studies on Topic 1

D

As found earlier, one will note the abundant literature on aspects that deal more directly with the structure of the market and on its impact on the economy in general (subjects 1.2 and 1.1 respectively).

These research subjects are presented in greater detail in the following paragraphs.

3.1.1 The impact on the economy, on job creation, on innovation and on performance

The various aspects of the impact of venture capital on the economy that were studied are:

• the venture capital industry in the economy: role of catalyst responsible for economic growth, contribution to job creation, etc.;
• regulatory and governmental aspects: support that the government should provide in the venture capital industry, etc.;
• the role of VC in innovation: involvement of VC beyond financing and in different phases of innovation projects, access to the stock market for innovative businesses, etc.

In summary, the role of VC in economic development and job creation is significant and seems corroborated in several countries in which the industry is relatively mature. VC also has a significant effect on the rate of innovation of businesses (measured in various ways) and even on the development of innovations that come out of university research centres. The role of VC is felt as much on access to the stock market for major funding as on the marketing of inventions.

An aspect that seems to have been studied less involves the stages of development of innovation and the role of VCC. Does the latter change according to the degree of maturity of the innovation? According to whether the innovation is radical or incremental? What about financing problems in the first phases of development? Several studies show that VC has an influence on job creation and favours business start-ups. But we know less about the start of innovative businesses and even less when a project comes out of a university or government laboratory.

We know that VC plays a major role in the financing of innovative projects but for what proportion of the projects? What is the rate of refusal of requests for financing for innovative projects and is this different from the rate of refusal for traditional projects? Is the role of VC complementary to that of the other players in the capital market or is it a substitute? How could governments play a greater role in the demand for financing and try to make VC more accessible and acceptable to entrepreneurs?

Few authors have dealt with the risk of innovation projects and the excessive consequences that they can have on innovative businesses. How are innovation projects evaluated and what financing conditions are offered to the businesses that are financed? Can financing by VC in these sectors reduce entrepreneurship on account of the replacement of executives of creative and innovative businesses? What are the consequences for innovation in a longitudinal perspective?

Finally, innovative businesses present challenges that are different from those of traditional businesses, and the evaluation of non-material assets poses research problems that need to be analysed. There is a link to be made here with the approaches to evaluation, a research field that is fairly well developed but exploited little within the context of VC, which poses different challenges.

3.1.2   The structure of capital supply (including private and public markets, the influence and control of governments on the supply of venture capital)

The structure of supply is the subject of research that has been documented most in the literature (138 occurrences). Access to quantitative information is certainly a factor that explains this, as does the interest of certain government or international bodies concerned with economic development. Among the research subjects that were studied were:

• the factors that are favourable to the growth of VC supply: regulatory aspects, taxation,government programs, etc.;
• competition on the venture capital market: competition among the VCC, competition between the VCC and business angels, competition between VC and the other means of financing, etc.;
• features of the markets: segmentation, maturity, unionization, etc.;
• complementarity: between public and private markets, to favour innovation and the startup of businesses, to ensure the sharing of risk, etc.;
• globalization and internationalization: consequences for the industry, effects on the businesses, use of the Internet, etc.

The structure of VC supply has been studied widely and several international comparisons exist. Among the factors that influence the evolution of VC supply, we will mention the influence of public authorities, which can take various forms: the taxation system, various laws and regulations (including investor protection and international barriers to capital flow). Another significant factor is the size and level of development of the stock markets and opportunities for reserved fundraising available to rapidly-growing businesses. The American economy, which prefers a market based on stock markets and private businesses, has a more dynamic VC than those of economies based on financial institutions (Germany, Japan), or that of Canada, which is characterized by the strong presence of governments. The situation of the American market is explained by, among other things, its high level of maturity (compared with other economies) characterized by large sums available for investment that allow for the specialization of certain VCC and the presence of "VC funds of funds". This maturity of the market is also reflected in the knowledge and expertise that one finds in the VCC and which can ensure better investments. Also, large VCC work mostly alone whereas the small VCC, either in the United States or elsewhere, tend to unionize or to create various associations among themselves or with the governments. However, there are few studies that suggest an optimal structure of the market. A lack of consensus on the measures of success or of performance, and difficulties in international comparisons, are probable reasons for the lack of writing on this subject.

As for the actual structure of the VC market, the competition among VCC, between the VCC and financial angels and between the VCC and the banks has also been analysed. Certain authors suggest a segmentation of the markets whereas others come to the conclusion of a possible complementarity of these means of financing. Segmentation, if that is the case, could lead to disadvantageous conditions for SME and a need for intervention on the part of the government.

We also find several studies that discuss the role of public authorities in the financing of innovation, a role that can be complementary to that of VCC. Given the new trends in the economy, other studies will be required to better understand the synergy that two complementary partners can create in the financing of promising projects, the importance of their intervention and the impact on public finances.

What seems to have been dealt with less in the literature is the place of venture capital as an "alternative" source of financing for entrepreneurs.

3.1.3   Legal structures: VCC objectives and mission

The financial interventions of risk capital companies vary according to their mission and their legal structure. Some want to promote the creation or preservation of jobs, others regional development, and one group will only be interested in financial returns. Their mission influences the interventions by these companies as well as the overall return of their portfolio. This situation can be better understood by also looking at how the markets of other countries are organized and who dominates them, as some companies' financial return problems are directly transferred to the requesting businesses that hold out the most promise and, in their financing contracts, that have to take on the burden of businesses that are most likely to fail. One can then understand why venture capital is seen by many entrepreneurs as the capital of last resort and that very few thriving companies go that route to finance certain expansion, innovation or export projects. Such an understanding will also allow us to better situate the public financing institutions and the role of the State in this field.

The subjects dealt with include:

• relations between VC, governments and financial areas: concentration of the market and competition, government support, financial incentives, etc.;
• the behaviour of VCC according to their legal structure: the choice of investment, exit methods, rates of return; financing contracts, etc.

Some studies examined the scope of workers' funds and their particularities, namely their choice of investment. Several studies have compared VCC that are said to be "independent" to other forms of VCC (subsidiaries of financial institutions, of companies, etc.). A frequent conclusion is that the legal structure of the VCC has a real effect on the types of projects that are chosen, the rates of return that are required, exit methods, etc. This fundamental aspect of the venture capital market deserves to be the subject of a synthesis to allow the identification of gaps in this market and to focus on the possible actions of public authorities. It is also in this context that the role of pension funds in the VC industry should be analysed. It would also be desirable to have international studies to compare the efficiency of the Canadian market which, because of the size of workers' funds, could possibly identify anomalies that could hinder its development. The social role of these funds can prevent them from financing certain projects that other companies, whose aim in terms of return is strictly financial, would accept.

3.1.4 The balance between supply and demand in venture capital

Examining the balance between the demand for financing and supply is necessary to identify ways the market could be improved so that investors and businesses can both benefit from their relationship. Venture capital is accused of not playing its role in the financing of innovation projects, and in several industrialized countries, but it is not clear why. Is the problem on the demand side or is it just that the supply is poorly formulated and not adapted to the needs of the companies concerned? One could equally review and question the role of a public market (stock market) for the financing of small entrepreneur-led companies. This goes against the philosophy of entrepreneurs, which could explain why this means of financing is not used very much.

These elements have been dealt with in a number of documents and the following emerges:

• the evolution and structure of supply financing: the use of various securities, the optimum financing combination, the influence of the maturity of the market, etc.;
• the demand for financing: business start-ups, access to the market by more mature businesses, etc.;
• balance between supply and demand: excessive supply, the influence of economic growth, the influence of the domestic market and the provenance of investors (domestic or foreign), etc.

Discussions on venture capital supply are more numerous than those on demand and the needs of entrepreneurs (some consultants' statistical reports but few scientific studies). It is, therefore, not possible for now to affirm that supply and demand are perfectly harmonized, which should be a major line of research.