Access to Finance: Impacts of Publicly Supported Venture Capital and Loan Guarantees

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1 Access to Finance: Impacts of Publicly Supported Venture Capital and Loan Guarantees Authors : Dr. Ronnie Ramlogan & Dr. John Rigby Presented by : Arslan Austin Innovation IV SS 2014

2 Introduction Innovation Policy Access to finance Rationale - Facilitate innovation and to hedge Market Failure Modes of Financial access Equity - Venture capitalism Great potential for growth Equity Stake High risk Early launch phase Debt Relatively inexpensive way Low risk businesses

3 Operational mechanisms of financial support Angel investors Seed Funding Mezzanine Management Buy-out/ Management Buy-in Other government equity investment Improving investor readiness Promoting investor activity Tax schemes (enterprise investment scheme venture capital trusts) Direct Loans Indirect Loans Hybrid fund - government subsidized equity investments.

4 Rationales for Public Policy Intervention Venture Capital Support: Market Failures Equity rationale - Demand Side Fail to present as an investable opportunity Ownership and control conflicts Equity rationale Supply side Risk and uncertainty to predict success Historical legacy of poor investment decision Pre-launch VS Post launch investment for greater returns Small VS. Large firms for greater returns against investment Information asymmetry of risk bearing between firms and investors Thin Markets to remove information asymmetry Positive Externalities limited correction possibilities.

5 Rationales for Public Policy Intervention Market Failures and Loan Guarantees Supply Side Credit market failure Inadequate funds availability Information asymmetries Principal agent problem Collateral Signaling for risk Demand Side Business plan, managerial tasks. Still, preferences are for debt against equity avoiding adverse selection An Institutionalists rationale Operational legal system What if, the credit institutions are state owned? Improves market efficiency against Market failures But, Weak monitoring Refrain from aggressive collection Crowding out of private investment

6 The review of measures Publicly Supported Venture Capital: How effective are these initiatives? Access to finance Increased Yet, evidence shows stickiness of venture capital Policy should target regional disparities and local conditions Policy should consider both supply and demand side number of firms Impacts within the Firm: Productivity, Employment, Turnover, Exports Employment increase case of Japan and Canada Co-investment has had greater effect on turnover than on employment High technology firms had a greater impact on employment Venture capital investors by conditioning the firms decrease internationalization Public VS Private venture capital No significant results

7 The review of measures Publicly Supported Venture Capital: How effective are these initiatives? Innovation impact Private funds generate innovation and higher employment. Funding to high technology firms Operational inability in case of Australia Innovation VS. Invention impacts Funding are irrelevant for innovation these are network and creativity capabilities Prerequisite signaling for safe investment leading to innovation Quantification of Innovation patents only? Systematic Impacts The wider impacts Development of operational capital market case of Israel Overall system is altered supply side problems reduced/removed Business Angel Networks most risk takers are being supported Complementary factors require consideration Skills, experience, capacity building and framework conditions.

8 The review of measures Loan Guarantees: How effective are debt? In general, Supporting SME s growth by financing assurance Additionality impacts - availability of credit for firms 70% increase in UK. Also, employment, survival rate and growth for firms The assessment of performance in absence of additionality impacts counter facts Does the intervention bring about improved access in credit markets for SMEs? 75% of firms that received credit would not have qualified for loans in the credit market. Also evident for Italy, Japan, France and UK.

9 The review of measures Loan Guarantees: How effective are debt? Does the extra access to credit impact on firms performance? Relaxation of the credit constraints resulted in the growth of beneficiary firms, both in terms of employment (4.6%) and output (5.8%) The policy had a positive effect on the growth of sales, employment and wage levels. Firms experience a 25% higher employment growth rate in the short run (0-2 years) and, if they survived (0-6 years), 16% in the long run. To what extent do schemes affect default rates? A high default rate raises concerns about whether there are inefficiencies Moral Hazard Increased from 6% in the first two years after the guarantee to 29% over the long term. Users experienced lower profitability higher probability of financial problems Schemes not only reduce risk exposure but may distort banks incentives to screen and monitor firms investment decisions.

10 Lessons and Conclusions In general For SME s For direct and indirect impacts on innovation rates Venture Capital Distortions for natural market selection process Not many schemes promote innovation directly rather, employment and turnover Supply side systematic impacts solving market failure of funds availability Demand side systematic impacts increase in number of firms No evidence available for long term impacts of innovation due to funding facilitation Credit guarantees No direct impact on innovation Mixed evidence for productivity and sales Quantification issues Hence, VC support schemes would target firms at the pre-market and more risky phase than credit guarantees. Yet, lack of studies is an limitation to be conclusive.

11 Thank you for listening!

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