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•A “deal flow” that provides potential investment opportunities for venture capitalists can only emerge if the financing needs of companies are addressed at an earlier stage, so as to make possible their development to more mature phases when other sources of funding become available.

The market failure in early-stage financing has been widely recognized and has prompted the emergence of a variety of policy interventions seeking to address the financing problems of early-stage companies (Box K2.5. and Figure 2.3.).15

Box K2.5. Addressing bottlenecks in early-stage financing

A key principle to observe when designing interventions in the area of early-stage financing is that policies should consider the various phases in the development of a company and their impact on financing needs. Focusing on a particular phase without due consideration to the financing difficulties that may arise earlier or later would only displace the problem without fully addressing it.

Mainstream

Venture

capital

Early-stage

Seed

Proof of Concept

POC

The ideal size for each of these categories of funding will vary from country to country

Figure 2.3. Funding requirements lifecycle

15 For more details see UNECE, Financing Innovative Development. Comparative Review of the Experiences of UNECE Countries in Early-stage Financing. Geneva and New York, 2007 and UNECE, Policy Options and Instruments for Financing Innovation: A Practical Guide to Early-Stage Financing. Geneva and New York, 2008.

48 Policy Options and Practical Instruments

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Modalities of intervention

These may include:

•Grant financing: This may be provided by different authorities, sometimes not in connection with innovation-related objectives but pursuing regional development strategies. The provision of resources may be monetary or may take the form of access to specific business services. In addition, some requirements regarding co-financing may be imposed.

•Guarantees: This allows businesses without sufficient security for commercial bank lending to obtain loans from participating banks that are guaranteed by the government, at least partially.

•Business angels support: Business angels are private investors who invest directly in private companies in return for an equity stake and perhaps a seat on the company’s board. Business angels make more and smaller investments than venture capital firms and are more active in the early stages of development. Interventions in this area can:

oFacilitate the dissemination of information and communication between business angels and companies; and

oProvide fiscal advantages to business angels investing in small unquoted companies. An example is the UK Enterprise Investment Scheme, which limits the liabilities from capital gains taxes arising from successful investments.

•Public or public-private venture capital fund: Funds invest in early-stage companies. In some cases, management is fully private while public resources are used to change the risk-reward ratios for private investors and encourage investments in early-stage companies.

Table 2.6. provides an overview of the different types of intervention to support early-stage companies.

Table 2.6. Taxonomy of types of support for early-stage companies

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Source: Wrigth, Mike et al. (2006), University Spin Out Companies and Venture Capital, Research Policy, Vol. 35, Issue 4.

Intervention in the area of early-stage financing can focus not only on the supply-side (the provision of financial resources), but also on the demand-side. Entrepreneurs can be supported in their efforts to become “investment ready”, thus facilitating acquiring external sources of financing. In addition, networking between investors and entrepreneurs can be encouraged. Box C2.7 contains examples of country experiences in early-stage financing.

Box C2.7. Country experiences in early stage financing16

Poland

The Polish National Capital Fund (NCF) Joint Stock Company started its activity in June 2007. The NCF is a fund of funds that supports PE/VC funds that invest in small and medium companies based in Poland and focus on innovative, R&D and high-growth projects. NCF investments are either equity investments or long-term debt financing. Additionally, NCF offers grants to cover part of the costs of preparing and monitoring a fund's investment portfolio. The funding mechanism of NCF assumes preferential treatment of investors who co-invest in NCF portfolio funds along with NCF. By the end of 2007, NCF had signed investment agreements leading to the creation of two venture capital funds. The two funds have a joint capitalization of PLN 100 million.

16 Source: Contribution by members of the UNECE Team of Specialists on Innovation and Competitiveness Policies (Poland, Portugal, Russian Federation).

50 Policy Options and Practical Instruments

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Portugal

Portugal launched the FINICIA programme at the beginning of 2006, which is focused on business start-ups and innovative small companies. It started as an Access to Finance Scheme and evolved into a holistic approach to the entrepreneurs’ detected needs, in terms of business planning support, financing schemes and management skills reinforcement. This business approach implicated a comprehensive network that includes IAPMEI (Institute for Medium and Small Enterprises Support and Innovation), Universities, Regional Authorities and Financial Institutions. FINICIA aims to create a local support network, bringing together through regional platforms, the supply and demand sides of venture capital financing and all the entrepreneurship development major players. These Regional Platforms seek to encourage innovation and entrepreneurship and facilitate technology transfer. The platforms include on the demand side: Universities, Incubators, Development Agencies and other regional partners, and on the supply side: Venture Capital Companies, for finance and support to emergent start-ups. During its implementation, 13 FINICIA regional informal networks have been created.

Russian Federation

The Foundation for Assistance to Small Innovative Enterprises (FASIE), manages the START programme, providing support to around 400 start-up projects per year originated in public research institutions. Matching private investments is required for the continuation of initial assistance. More than 25 regional venture funds have been created with 25% of investments from federal budget, 25% from regional budgets and 50% from private sources. The size of the funds ranges between $80 million and $400 million. The largest initiative is the Russian Venture Company, a fund of funds to which $1 billion of federal money has been allocated. Two venture funds ($100 million) have been formed so far under the RVC, with a state participation of 49%.

The policy instruments used for such intervention include:

•Consultancy and training courses (searching for investors, understanding the implication of various types of financing, preparing documentation);

•Exchange of experiences between investors (including conferences, seminars and workshops);

•Promotional and informational projects aimed at increasing the entrepreneur’s awareness of benefits and services offered by investors’ networks; and

•Creation, development and functioning of platforms associating investors and entrepreneurs who search for financing and training projects for potential investors, including business angels.