Venture Capital (Routledge Revivals)

International Comparions

Milford B. Green, Milford B Green

• Publisher: Taylor & Francis
• Year: 2012
• Print ISBN: 9780415611022
• eBook ISBN: 9781135728199
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

First published in 1990, this is the first text to offer a goegraphicand regional study of venture capitalism. Although the importance of this type of capitalism in creating and nurturing small firms has long been recognized, it does not have a uniform global character. Drawing on previously unused data, Green's book offers a geographic comparison which displays the diverse forms of venture capitalist markets from the well established to the newly emerging and the rapidly dissapearing.

1 Venture Capital: The Developing Literature

Rod B. McNaughton

Venture capital is unique as it plays an interstitial role between many actors that are individually of interest to researchers in several disciplines. Venture capital is related to such diverse topics as pension fund investment, corporate finance, leveraged buyouts, small business management, entrepreneurship, business incubators, technology transfer, and economic development. The study of the venture capital market itself is largely the domain of business and economic researchers who have shown concern for:

1. the investment decision-making behavior of venture capitalists,
2. the performance of venture capital portfolios, and
3. the availability and cost of venture capital.

The interest of researchers has followed that of the business community as a whole: when levels of investment are high, so is interest in venture capital research. There were many publications in the late 1960s and early 1970s, and a paucity throughout the late 1970s and early 1980s, followed by a recent increase. In part, this is the result of the introspective nature of the industry, which sponsors a significant amount of research in its efforts to lobby governments for legislative changes. The funding of this research is coordinated through national venture capital organizations, such as the Association of Canadian Venture Capital Companies, the National Venture Capital Association, and the National Association of Small Business Investment Companies. A second impetus for venture capital research comes from various government programs concerned with the adequate funding of small business, for example, the Technological Innovation Studies Program (TISP) in Canada, the Experimental Technology Incentive Program (ETIP) in the United States, and several US Senate Select Committees and Congressional Hearings on small business. The TISP, for example, has sponsored more than eighty research projects on entrepreneurship, technology, and small firms.

The latest round of venture capital research is distinct from earlier work in two respects: (1) the topics addressed are more specific and (2) a wider range of perspectives is employed. Of primary importance for economic geographers is the adoption of a spatial component into this research. The distinct regional biases in the venture capital market have not gone unnoticed. Tribus was one of the first to recognize regional variations in venture capital availability:

… supplies of venture capital are adequate, but the total supply is not distributed very evenly geographically. And we find that new entrepreneurs do not have access to all of the sources of capital.

(Tribus 1970: 52)

However, the literature throughout the 1970s was concerned with the geographic pattern of investment in the grossest of terms. Anecdotal descriptions (for example, Dominguez 1974) merely suggested the possibility of economic impacts arising from the concentration and regional parochialism evident in the market. It is only within the last 5 years that economic geographers have shown interest in the market, though a history of interest in capital flows extends back several decades.

This chapter provides a brief overview of recent empirical studies of the venture capital market. Particular attention is paid to the contributions of geographers, though a wider context is set by a discussion of research conducted by business researchers.

Spatial Perspectives

Research which explicitly addresses the spatial behavior of the venture capital market can be grouped into four categories: (1) locational studies of venture capital firms and their investments, (2) taxonomies of regional market structures, (3) market specialization, and (4) economic impact (Table 1.1). Most of this research concerns the large and highly developed American venture capital market, but the Canadian, UK and New Zealand markets are⁴ also explored. The literature progressed rather quickly from simple empirical descriptions to more sophisticated considerations of the relationship between location, decision-making, and economic impact.

Table 1.1 Summary of venture capital research

Author(s)	Year	Major finding(s)
Locational studies
Leinbach and Amrhein	1987	Regional concentration in United States
Mason	1987b	Investment concentrated in southeast United Kingdom
Florida and Kenney	1988a	Criticism of Leinbach and Amrhein 1987
Leinbach and Amrhein	1988	Response to Florida and Kenney 1988a
Florida and Kenney	1988b	Venture capital clusters near established financial and high-tech centers
McNaughton and Green	1987b	Regional concentration in Canada, investment flows are regionally biased
Perry	1988a	Investment concentrated in Auckland, New Zealand
Market taxonomies
McNaughton and Green	1987a	Markets can be grouped according to interconnections between states
Florida and Kenney	1988c	Three types of venture capital agglomerations: high-tech, financial, and mixed
Specialization Green and McNaughton	1988a	Market niches, strong distance-
		decay for investment
Green	1989	Diffusion of firms, market
		Specialization
McNaughton	1989	Specialization affected by
		competition in market
Economic impact
Florida and Kenney	1988d	Venture capital provides institutional setting for Innovation
McNaughton	1990	Venture-backed firms have above average financial performance

Locational Studies

Leinbach and Amrhein (1987) were the first to examine the regional availability of venture capital and its implication for small high-technology firms. They made two significant contributions: (1) a time series of the location of venture capital sources and (2) tabulation of regional flows of funds data. Leinbach and Amrhein noted a pronounced concentration of sources, with California, New York, Massachusetts, and Illinois accounting for over 75 per cent of the national total. The destination of funds showed an even more concentrated pattern, with the California/Southwest region receiving 45.7 per cent of the nation’s total, followed by New England with 15.3 per cent.

Leinbach and Amrhein also attempted to establish a theoretical justification for the geographic analysis of venture capital, suggesting that it contributes to the growing literature on behavioral approaches to industrial location. In addition, they predicted a role for venture capital research in the development of structural theories of external business environments.

Florida and Kenney (1988a) criticized Leinbach and Amrhein for their lack of attention to the structure of the venture capital industry, and for the use of highly aggregate data that obscured important characteristics of the market. In particular, they felt that Leinbach and Amrhein had overestimated the importance of government licensed Small Business Investment Corporations (SBICs), and had mistakenly portrayed informal investors (angels) as part of the institutional industry. Further, they pointed out that the geographic concentration observed in the market is in part a function of the concentration of potential investments and their technological environment. The aggregate nature of the data used by Leinbach and Amrhein hid the extreme concentration of sources in a few cities, and even in a few zip codes (Florida and Kenney 1988b). Florida and Kenney also felt that Leinbach and Amrhein left the impression that considerable long distance investment takes place, when much of this can be accounted for by deal syndication and branch office locations. Leinbach and Amrhein (1988) replied to these criticisms by agreeing that the use of more disaggregate data would have been desirable if they had been available, and reiterating the introductory and exploratory nature of the work.

McNaughton and Green (1987b, 1989) provided an exploratory examination of the geography of Canadian venture capital investment. Surveys were used of both venture capital investors and their portfolio investments. Venture capital firms were found to be highly concentrated in Toronto, and secondarily in Calgary and Montreal. In terms of investments made, Ontario and Quebec were found to be net exporters, while the Prairies provinces and British Columbia are net importers. Further, Canadian investment patterns showed extreme self-bias in the selection of regional investment location. Significant regional variations were also found in the industrial sector characteristics of portfolio firms.

McNaughton and Green postulated that these spatial characteristics are the result of aggregate-risk averse behavior by venture capitalists. The location of venture capital firms, and the location of investments, are variables that can be manipulated to maximize access to information. Increased access to business information minimizes uncertainty and reduces risk. The need for information accessibility constrains the activity space of venture capital firms and limits the distance over which investment transactions can take place.

A study by Mason (1987b) found that the availability of venture capital is also highly concentrated within the United Kingdom. The primary investment target is the southeast, already the most prosperous region of the United Kingdom. Little investment flows into peripheral regions, especially northern England, which lacks its own development agency (like those of Scotland and Wales) to help fill its equity gap. Mason provides two explanations for this concentration that can be generalized to the venture capital markets in other countries as well: (1) the problem is the lack of entrepreneurial prospects with good growth potential in peripheral regions or (2) the problem is the result of historical legacy, perpetuated by regional prejudice, lack of awareness of local investment opportunities, or the logistical difficulties of adequately monitoring investments in more distant locations.

Perry (1988a) investigated the spatial and sectoral distribution of venture capital in New Zealand using a survey of New Zealand Venture Capital Association (NZVCA) members. He found that the traditional role of venture capital in supporting high-technology firms is not met in New Zealand. Theatrical promotions and primary sector activities are the principal beneficiaries. Further, more than one-quarter of New Zealand venture capital funds are invested outside the country and do not contribute to the support of indigenous enterprise. As in other national settings, the spatial distribution of venture capital investment within New Zealand is highly concentrated: 32.4 per cent is invested in the Auckland economic heartland. Perry noted that the necessity of spatial proximity requires that the office locations of venture capitalists, not simply investment flows, will have to diffuse in order to serve more peripheral locations. He also recognized that improving the quantity of new ventures in these locations requires more than greater availability of capital. The necessary conditions for entrepreneurial take-off also include fundamental shifts in the socio-economic composition of these regions.

Market Taxonomies

In an attempt to present a spatially disaggregate evaluation of the organization and functioning of the venture capital market, McNaughton and Green (1987a) and Florida and Kenney (1988c) both presented market taxonomies. McNaughton and Green used a weighted blocking algorithm (WBLOC) to partition inter-state venture capital flows according to their degree of interconnectivity and strength of linkages. Three groupings of states were identified: (1) those with nationally oriented investment patterns (California, New York, and Massachusetts), (2) those with investment patterns that are dominated by their linkages with nationally oriented states (Connecticut, New Jersey, and Texas), and (3) those that invest only in themselves. This research provided clear evidence that the venture capital market is not integrated into a unified national system with equal availability at a spatially invariant price.

Florida and Kenney (1988c) presented their taxonomy based on the reasons for the concentration of venture capital investors. Venture capital complexes were found to exist in three distinct types of area: (1) those with high concentrations of financial resources, (2) those with high concentrations of technology-intensive small businesses, and (3) those with both. New York and Chicago are examples of the first type, San Francisco is an example of the second, and Boston is an example of the third. This research showed that the relationship between technology-oriented and financial-oriented venture capital complexes is symbiotic. While a local venture capital industry is not necessary to facilitate high-technology business formation, the existence of well-developed venture capital networks provides incentives for entrepreneurial start-ups. Venture capitalists were shown to act as both catalyst and capitalist, providing the networks, contacts, linkages, and resources necessary to launch new enterprises.

Market Specialization

Green (1989) and Green and McNaughton (1988) investigated interurban differences in the specialization of venture capital investment preferences. Green developed a market specialization model that helps to explain the development and diffusion of the venture capital industry. This model postulates that the industry began with a few firms located in the largest urban centers that acted as training grounds for future venture capitalists. These initial firms had a spatial monopoly, which in turn implied constraints on the firms’ operational areas. As associates left and formed their own firms, the erosion of the monopoly market led to a search for distinct market niches. Niches were created by manipulating three major components: (1) firm location, (2) industrial sector specialization, and (3) funding stage specialization.

New venture capital firms found that, at least temporarily, they could gain a spatial monopoly by establishing themselves in second and third order urban centers. Within these centers, specialization became the norm in order to reduce information gathering requirements and because of limited capital pools. Linkages to larger investment pools were maintained through personal contact networks that include the more established firms in first order centers. These established firms were able to expand either by syndicating with the new firms in lower order centers or by opening their own branch offices.

The results of an empirical analysis of interurban variations in venture capital investment characteristics found that most centers display a high degree of regional bias in their investment preferences. New York is an exception in that its investment patterns are nationally oriented. Los Angeles and, to a lesser degree, San Francisco and Boston specialize in seed capital. Most centers specialize in start-up, early growth, and leveraged buyout financing. San Francisco specializes in the computer sector, and Minneapolis in medical related ventures. Houston and Dallas specialize in resource related ventures.

McNaughton (1989) pursued the topic of investment specialization further, investigating differences in levels of specialization between US and Canadian urban markets. He outlined a’ model which emphasizes the role of differential access to information in developing aggregate patterns of specialization. He hypothesized that the degree of specialization evident in a market is determined by the competition between firms for projects and information. In large markets there is greater information about projects; there is also greater competition for projects. Large markets are less idiosyncratic, and venture capitalists must specialize in order to organize, interpret, and use available information. Specialization results in the creation of a distinct market niche. In small markets there is less information, and fewer projects from which to choose. Small markets must specialize in order to generate enough expertise to make satisfactory decisions. There is little competition in these markets, and firms have a partial spatial monopoly.

Empirical testing of this hypothesis in both US and Canadian urban markets led to the confirmation of Bygrave’s (1987, 1988) findings that the relationship between concentration and uncertainty in the US venture capital market follows a U-shaped curve. Generally, in large markets where there are many transactions, venture capitalists must specialize in order to organize, interpret, and use all available information. In small markets, where there are few transactions and little information, venture capitalists must specialize in order to generate expertise. In markets of intermediate size, venture capitalists need not specialize to the same degree in order to use properly available information.

Economic Impact

Geographers, and others, have also studied the performance and economic impact of venture capital investments, and of small high-technology firms in general. It is clear from the related literature that the economic value of these firms is multi-faceted and must be measured by several variables. Bollinger et al. (1983) isolated the following key variables: revenues, expenditures on taxes, research and development (R&D), exports, and employment generation. McNaughton (1990) designed and administered a survey that collected information on these key variables from Canadian firms that had received venture capital funding between 1980 and 1987. The results s...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright
• Contents
• Illustrations
• Tables
• Contributors
• Preface
• 1. Venture capital: the developing literature
• 2. Preferences for US venture capital investment 1970–1988
• 3. Venturing on the ‘Third Coast’: recipient firms in the Central States
• 4. Regional patterns of venture capital investment
• 5. What do we know about the geography of US venture capitalists?
• 6. The rise and fall of venture capital in New Zealand
• 7. Venture capital in Canada
• 8. Venture capital, the equity gap and the ‘north-south divide’ in the United Kingdom
• 9. Asian venture capital: financing risk opportunities in the Pacific Rim
• References
• Index