problem analysis lack of venture capital in italy richard boly

Lack of Venture Capital in Italy

Problem Analysis

By Richard Boly, Hoover Institution. Sept. 2008

Presenter

Presentation Notes

Problem: According to the Italian Private Equity and Venture Capital Association (AIFI) total investments in seed and early stage investments in Italy was only 66 million euros in 2007. These figures a far below the amount of VC European Venture Capital Association (EVCA) recorded in 2006 in Switzerland (euro 178 million), Germany (euro 264 million), Spain (euro 266 million), France (euro 536 million), and the UK (euro 4.24 billion). Attached is a diagram which is a compilation of dozens of discussions I have had with Italian and U.S. VCs, Italian start-up companies, academics, policy makers, and even Nobel Prize winning Economists Ned Phelps and Joe Stiglitz. I make no claim that this is a comprehensive or complete analysis, but I hope that it will spark meaningful discussions to help develop the VC and new venture ecosystem in Italy.


Few Large Companies to Provide Acquisition Exit and to Create a Demand for Innovative Products

and Services

Bonsai company model

Culture of elder leadership in companies

Possible to be “too successful” (“excessive

profits”)

Zero sum view of competitive environment

Problem Analysis

Going public requires open

books


Presenter

Presentation Notes

Culture of Elder Leadership in Companies: Start-ups with twenty-something founders and CEOs are common in the United States (Microsoft, Apple, Google, Facebook, etc.). In Italy, young company founders are a rare and not well known. One Italian entrepreneur told me he grew a beard to look older and gain credibility with investors. The view that a company, like family, is for life, is still prevalent in Italy. The idea that an entrepreneur’s role is to grow and spin off a company and then begin the process again (“serial entrepreneurs”) is still not widespread in Italy. Zero Sum View of Competitive Environment: In the new millennium (since 2001), Italy’s GDP has grown at the average annual rate of less than one percent. In a slow/no growth environment, if one company is succeeding, conventional wisdom says someone else much be losing. This view is also a symptom of an economic structure that favors “national champions” over dynamic competition. Even after deregulation, incumbent service providers often hold preferred, dominant positions. Going Public Requires Open Books: I have had several strong objections to this point. Some observers say this point promotes stereotypes and that serious enterprises have corporate governance with transparent and consistent accounting practices. Nonetheless, other observers have noted that some start ups have initially paid little attention to fiscal obligations prior to achieving profitability. Possible to Be Too Successful (“Excessive Profits”): Rapid growth is perceived by some sectors of Italian society with suspicion. It is not widely accepted in Italy that entrepreneurs, who take risks; work long hours; and succeed in providing innovative new products and/or services, jobs, and wealth for their investors should themselves be rewarded financially. Some people disagree strongly on this point, but I have heard enough Italian entrepreneurs grumble about this point that I have kept it. Bonsai Company Model : “Small is beautiful” developed in Italy partially as a response to tax and labor regimes, but it also as a consequence of economic policies which had positive outcomes in the past but which now must be rapidly reconverted in the face of globalization. Also, Italy suffers from what I call “the curse of the pretty big domestic market.” While entrepreneurs in Israel, Denmark and Nordic countries look to outward markets from day one, many Italian entrepreneurs grow first as domestic companies. Since external growth is not woven into the company DNA, it later becomes more challenging to enter foreign markets. Few Large Companies to Provide Acquisition Exit and to Create a Demand for Innovative Products and Services: In the United States, the majority of start-ups now exit via trade sale (acquisition by a bigger company). Since there are few large Italian companies to acquire start-ups, market valuation for start ups in Italy is lower and acquisitions harder to achieve. Also, in the United States, big companies are eager customers for innovative products and services that help them keep their competitive edge. Again, in Italy, fewer large companies means a weaker demand domestically for innovative companies’ products and services.



and Services




profits”)


Problem Analysis


booksLack of

entrepreneur rolemodels

Entrepreneur can access risk capital by leaving Italy to start

venture

Publish vs. patent culture

Finding a job if venture fails not

easy

Investors don’t know Italian R&D is cutting

edge

Italians Can More Successfully Launch VC Funds Outside of Italy


Presenter

Presentation Notes

Italian Investors Don’t Perceive Italian Technology as Cutting Edge: While there is a price premium for Italian design and style worldwide, Italian technology is underappreciated, especially within Italy. Tremendous success of Italian tech entrepreneurs abroad (Logitech, Genentech, Cadence, Synopsis, Funambol, etc.) as well as Italian tech companies (Eurotech) flies in the face of this misperception. Lack of Entrepreneur Role Models: Young, successful, Italian entrepreneurs exist, but are not celebrated as they are in the United States. The U.S. Embassy in Italy has sought to promote successful Italian entrepreneurs through the biweekly video webchat Face2Face: Capturing Creativity. We have also enthusiastically supported the creation of groups such as First Generation Network, which seeks to promote entrepreneurship and mentor the next generation of risk takers, and the business plan competition, Mind the Bridge. Publish Rather Than Patent Culture: Academic researchers often publish without first patenting, thus putting their discoveries in the public domain. Once a discovery is in the public domain it makes attracting investment on the discovery nearly impossible. Patents cost money and are not as highly rewarded in academia as are publications. We have sought to increase meaningful dialog between researchers and people interested in commercializing research. Entrepreneurs Can Access Risk Capital by Leaving Italy to Start Venture There are many examples: Logitech (Pierluigi Zappacosta and Giacomo Marini), Genentech (Roberto Crea, Genentech Founding Scientist and founder of Creagri and Bioren), Cadence and Synopsys (Alberto Sangiovanni Vincentelli), Funambol (Fabrizio Capobianco) Enzo Torresi, founder of five U.S. companies, and NicOx – France (Michele Garufi and Ennio Ongini) Italians Can More Successfully Launch VC Funds Outside of Italy Even on the VC side, Italians have left Italy to succeed: TLcom Capital LLP - London (Maurizio Caio, Giuseppe Curatolo, Mauro Pretolani, and Tomaso Tommasi di Vignano), Balderton Capital – London (Roberto Bonanzinga), Vedanta Capital – New York (Alessandro Piol), Noventi – Silicon Valley (Giacomo Marini, Simone Rizzi, Pierluigi Ferrero, and Pierluigi Zappacosta). Finding a Job If Venture Fails Is Not Easy: 2001 Nobel Prize Winning Economist Joseph Stiglitz told us that this is a big obstacle to risk taking. In the United States, “at will” employment creates a more dynamic labor market. So the “opportunity cost” of starting a new venture is lower, since if the venture does not succeed, the entrepreneur can easily find a job.



and Services




profits”)


Problem Analysis


booksLack of

entrepreneur rolemodels


venture



easy


edge


Thin stock market Bankruptcy

law better, but still punitive

Banks controlcapital markets

Skepticism that Transactions Are

Transparent

Lack of quick, non-judicial

dispute resolution


Presenter

Presentation Notes

Thin Stock Market : The Italian stock market is relatively small compared to many G20 countries (e.g. market capitalization/GDP). Also, equities are a smaller portion of Italian investors’ investment portfolio than in most G20 countries. This makes exit (and valuation) via public offering less attractive. Even high fliers on the Italian exchange, such as Geox, have the majority of their shares held by foreign investors. Bankruptcy Law Better, But Still Punitive: Still a sense of “one strike and you are out.” Failure not viewed as a learning experience. Banks Control Capital Markets: Banks are great at lots of things, but not at investing risk capital. Their management and shareholders expect them to take risks based on established, not potential value of a borrower. Banks as active participants in providing risk capital is a result of a vacuum in the marketplace. Skepticism that Transactions Are Transparent: Trust is an essential element of new venture funding, but as Prof. Luigi Zingales demonstrated in his study on the low-level of Italian investment in equity markets, trust of regulators and markets is low in Italy. This makes it harder to do handshake deals or quickly arrive at term sheets for a deal. On the other side, many Italian private equity (leverage) investors invest with a minority share. Recent successes of this type include Marazzi and Ferretti. Such investing requires significant trust and are much less common in the United States. Lack of quick, non-judicial dispute resolution: Time to market is essential in many high growth companies. Getting caught up in a multi-year legal case could be fatal. Alternative dispute resolution is not widespread.


Overly riskaverse

investors

Thin stock market

Lack of entrepreneur role

models

Bankruptcylaw better, but still punitive





venture


Transparent


dispute resolution



easy


profits”)


Problem Analysis


books

Italian Money Managers not comfortable

with VC Investments


edge


and Services



Presenter

Presentation Notes

Italian Money Managers Not Comfortable with VC Investments: Money managers in Italian pension funds, insurance companies, banking foundations, and other institutional investors do not have extensive experience investing in many alternative asset vehicles, such as seed, early stage, venture, private equity, etc. This general lack of comfort with alternative assets doubly penalizes Italy because institutional investors achieve lower returns, which gives them fewer resources for their constituents and shareholders. It also reduces resources available to start ups. Overly Risk Averse Investors : Pre-euro, Italian households were accustomed to high yield, low tax government BOTs. Once Italy joined the euro, yields on government obligations declined dramatically (a good deal for the Italian Treasury). Italian household continued to chase high yields, which led them to risky bonds (Parmalat, Cirio, Argentine sovereign debt, etc.). The resulting defaults cost Italian savers billions of euros, and have made them even more risk averse.


Overly riskaverse

investors

Thin stock market

Lack of entrepreneur role

models

Lack of new ventureecosystem No tax benefit

for venture investment

Bankruptcylaw better, but still punitive





venture


Transparent


dispute resolution



easy


profits”)


Few angel investors

Problem Analysis


books

Italian Money Managers not comfortable

with VC Investments


edge

Moral hazard of non-market-

based government seed capital


and Services



Presenter

Presentation Notes

Moral hazard of non-market-based, government seed capital: Warren Buffet, an incredibly successful investor, has said senior executives can build shareholder confidence by investing their own money in the company they run. He called it having “skin in the game,” that is to say, a vested interest in the outcome. The evaluation of the viability of a new venture by an external third party (i.e. a government employee) is much different than the evaluation of a prospective investor. Few Angel Investors: The largest source of external seed and early stage capital in the United States are angel investors. Angel investors are successful entrepreneurs, who invest their money and expertise in new ventures. Increasingly, angels are organized in groups or networks to increase deal flow and share due diligence. According to the University of New Hampshire, Center for Venture Research, angels invested 26 billion dollars of their own money in 2007. Italian Angels for Growth, an initiative born out of the Partnership for Growth, has increased private sector risk capital in Italy by ten percent in jus one year. No Tax Benefit for Venture/Angel Investment: In EVCA’s December 2006 “Indicators of Tax and Legal Environments Favoring the Development of Private Equity and Venture Capital and Entrepreneurship in Europe,” showed that France, Greece, Portugal, and Spain had all vaulted past Italy. It is not that Italy had become worse, but rather that the other countries had taken practical, concrete steps to improve the environment for risk capital.

problem analysis lack of venture capital in italy richard boly

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