Venture capital may soon be called mature capital, as a recent report found that smaller startup companies are seeing less VC funding than more established companies. The report came from a joint United States Department of Commerce and European Commission working group on venture capital. The findings call for more public sector and policy maker involvement in the VC process.
“Small firms need investment capital but the market has failed to provide it — public sector support is needed,” the report stated. “The work of the group confirmed that there is a fundamental market failure in the provision of early-stage financing in both the U.S. and the EU. Venture capital funds are concentrating on larger and larger deals, leaving the small and risky early-stage deals aside.”
That is due to the more attractive returns and lower risks that come with later-stage investments in more established firms and in buyouts of larger companies, the report said, warning that this can become a self-reinforcing cycle.
“Because few venture capital funds are active in the seed and early stage area, they don’t have any longer the necessary knowledge to operate there. The few remaining seed funds and the business angel investors cannot by themselves cover the demand for equity investments. The recognized benefits from the birth and growth of innovative small firms to the economies are such that public sector measures are justified to overcome this market failure in seed and early stage investments.”
Overall, the working group believes the VC industry is healthy, reporting recent total VC investment in the U.S. was $20.5 billion and in Europe $13.4 billion. Nevertheless, the report concluded that: “The discussions made it clear that each country needs to develop its own approach to venture capital, suitable to its market conditions. The policy goal, however, is common: providing growing companies with the benefit of large liquid venture capital markets.”
The joint report calls for three action items to correct the current situation. First, policy cooperation on venture capital on a cross continent basis. “Leading players are competing globally for funds and investing where return potential is high. The benefits for economic growth that venture capital brings make it essential that policy-makers recognize impediments, like administrative regulations about establishment and taxation rules, to venture investment and take action to facilitate cross-border investments. This policy process should take place in a global context, learning from best practices irrespective of their provenance.”
The U.S./EC’s second recommendation is a VC handbook for policy makers. Hopes for the handbook are that it would be forward-looking in nature, pointing to industry trends and penitential opportunities, helping to buck the cyclical venture capital industry.
And the third action item noted in the report is a resource center for policies on venture capital to facilitate VC investments and to spread information about investment conditions. To do so, the report’s parties believe that the VC industry and the public sector could cooperate to provide information about the prevailing rules, regulations and documents on venture capital on a country-by-country basis.
(Source: VC Seed Money on the Down Slope, By Suzanne Deffree -- 10/10/2005, Electronic News)