the changing landscape of entrepreneurial risk capital ... · the angel data challenge • if you...
TRANSCRIPT
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The Changing Landscape of Entrepreneurial Risk Capital:
Origins and Implications
Thomas Hellmann
Public Policy Forum on Venture Capital and Innovation Quebec City Conference
December 3rd 2013
Special thanks to Josh Lerner for his help with this presentation
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Entrepreneurial Finance: Before the Great Recession
Entrep’s Venture Capital Exits
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Strike #1: Demise of IPOs
Entrep’s Venture Capital Exits
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Strike #2: Returns to VC and PE
Entrep’s Venture Capital Exits
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US LBO performance: vintage year IRRs
Source: Harris, Robert, Jenkinson, Tim and Kaplan, Steven (2012) Private Equity Performance: What Do We Know? University of Oxford
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US VC performance: vintage year IRRs
Source: Harris, Robert, Jenkinson, Tim and Kaplan, Steven (2012) Private Equity Performance: What Do We Know? University of Oxford
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US LBO Vintage Year PMEs (simulated for VC, Preqin & CA)
Source: Harris, Robert, Jenkinson, Tim and Kaplan, Steven (2012) Private Equity Performance: What Do We Know? University of Oxford
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US VC Vintage Year PMEs (simulated for VC, Preqin & CA)
Source: Harris, Robert, Jenkinson, Tim and Kaplan, Steven (2012) Private Equity Performance: What Do We Know? University of Oxford
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Wide return distribution U.S. venture funds
Returns from inception to 12/31/12. Source: Josh Lerner’s analysis of Thomson/Reuters data. PROPRIETARY AND CONFIDENTIAL
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U.S. buyout funds
PROPRIETARY AND CONFIDENTIAL Returns from inception to 12/31/12. Source: Josh Lerner’s analysis of Thomson/Reuters data.
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…European private equity funds
-100%
-50%
0%
50%
100%
150%
200%
250%
300%
350%
400%
100thpercentile
90thpercentile
80thpercentile
70thpercentile
60thpercentile
50thpercentile
40thpercentile
30thpercentile
20thpercentile
10thpercentile
0thpercentile
. PROPRIETARY AND CONFIDENTIAL
Returns from inception to 12/31/12. Source: Josh Lerner’s analysis of Thomson/Reuters data.
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Inter-quartile ranges and medians for asset classes
-10%
-5%
0%
5%
10%
15%
20%
U.S.Fixed
Income
U.S.LargeCap
Equity
U.S.SmallCap
Equity
Non-U.S.Equity
HedgeFunds
RealEstate
U.S.VentureCapital
U.S.Buyouts
EuropeanPrivateEquity
Source: Josh Lerner, based on HBS Case study about Yale University Endowment Fund [2011] and Venture Economics.
PROPRIETARY AND CONFIDENTIAL
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Strike #3: Ent’ship Explosion
Entrep’s Venture Capital Exits
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Entrepreneurship Explosion
• Falling cost of starting a business oCloud-based computing oOutsourcing
• Lean Start-up Philosophy o Rise in social media
• Diminished corporate career prospects • Changes in academic entrepreneurship • Globalization of entrepreneurial efforts
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The Brave New World of Entrepreneurial Finance
Entrep’s Venture Capital Exits Entrep’s Venture
Capital Exits Accele-rators Angels Crowd-
funding
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Who are the New Kids in Town?
Entrep’s Venture Capital Exits Accele-
rators Angels Crowd-funding
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The Rise of Accelerators
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Where in the Gartner Hype Cycle?
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Some Open Issues with Business Accelerators
• Separate Substance from Hype
• What business models suitable for accelerators?
• What accelerator model works best?
• What role for financing?
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Crowdfunding
• Explosion of platforms
• Proliferation of non-equity platforms
• In Europe some equity platforms
• Fall 2013: SEC proposal on Crowdfunding
• Uncertain impact on financing landscape
• Keynote and Panel on Crowdfunding
• Case Study on Angellist
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Biggest New Kids in Town
Professional Angels
Angel Networks
Angel Funds
Angel Syndicates
and other…
Angels
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Angel market as big as VC market
• \
Source: OECD, 2011. Financing High-Growth Firms: The Role of Angel Investors
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Angel Market appears to be stable
Estimates of US Angel Market 2010 2011 2012
Investment ($B) $20.1 $22.5 $22.9
Number of Companies ('000) 62 66 67
Active Investors ('000) 265 318 268
Average Investment size ($K) $76 $71 $85
Source: Center for Venture Research, University of New Hampshire
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NACO Data on Canada • 2012 saw more investments, but at smaller amounts.
Source: NACO 2012 Report on Angel Investing Activity in Canada
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Structure of the Iceberg: Relative Share of Amounts Invested
Source: Hellmann, Schure and Vo, 2013, “Angels and Venture Capitalists: Substitutes or Complements?” Working paper, University of British Columbia
51.5%
10.7%
37.8%
0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
120.0%
Angel FundsRepeat AngelsOne-time Angels
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Returns to Angel Investing: Recent evidence from BC
Source: Dan Vo, 2013, The Geography of Angel Investment, PhD Thesis, University of Victoria
Median return:
0%
Mean return:
10%
AIRR means Annualized Internal Rate of Return
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Returns by Type of Angel
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
20.0%
One-timeAngels
RepeatAngels
AngelFunds
9.6%
18.4%
5.7% Warning:
ALL Data on Angel Investing is Problematic.
Especially Returns!
Source: Dan Vo, 2013, The Geography of Angel investment, PhD Thesis, University of Victoria
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The Angel Data Challenge • If you are not counted, you don’t count!
o Particularly in public policy circles!
• Venture Capital Bad Role Model o Underreporting at the bottom / at the top
o Dysfunctional dynamics
• Transition from Bronze Age to Digital Age o Online data collection
o Social Media
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Transformation of VC
Entrep’s Venture Capital Exits
Entrep’s Venture Capital Exits Accele-
rators Angels Crowd-funding
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Trends in US VC Fundraising
7.4 10.6
14.2 19.8
51.3
100.5
38.6
21 19.1 22
30.8 31.9 31.2 25.3
16.4 13.8 18.8 19.7
0
20
40
60
80
100
120
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Amounts Raised ($B)
Source: NVCA
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PROPRIETARY AND CONFIDENTIAL
0%
5%
10%
15%
20%
25%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
US
$ Bi
l. Emerging Market Private Equity as % of Global Volume
Fundraising Investments
Source: Josh Lerner, EMPEA
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Changes in VC Landscape • Rise of Micro-VC Funds and Angel Funds
o Fireside chat about FFVC • Reliance on Government Funding (outside US)
o Second Day of PPF • LPs looking for new structures
o Panel on Institutional Investors’ View • Changes in Fee Structure
oGPs make various types of concessions
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Recent Evidence on GP Compensation
• David Robinson and Berk Sensoy (2013) o “Do Private Equity Fund Managers Earn their Fees? Compensation, Ownership,
and Cash Flow Performance” Forthcoming, The Review of Financial Studies
• Examine relationship between fees, carried interest and fund performance
• No statistical relationship between fees and performance
• Statistical relationship between carried interest and performance o No significant correlation for VC o Positive significant correlation for Buyouts
• Authors interpretation: LPs-GPs market are functioning
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Gaps in the system
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The Three Gaps
Sectorial Gap Refinancing Gap
Patience Gap
Entrep’s Venture Capital Exits Accele-
rators Angels Crowd-funding
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Source: NACO 2012 Report on Angel Investing Activity in Canada
Accelerator Companies What sectors?
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Sectorial Gap • Accelerators suitable for “Lean start-ups”
o Market Validation Key o Use of Social Media o UN Conference Track 1
• What about science-based start-ups? o Significant technology development o Challenging market validation (B2B; B2G) o University Accelerators
• Alternative approaches in the life sciences o UNConference Track 2
• Other orphaned sectors / business models? o Clean Tech o Service business & Non-innovative (e.g. Roll-out, Roll-up) o …but software also affects all sectors
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The Refinancing Gap
Entrep’s Venture Capital Exits Angels
Conventional View: Stepping Stone Logic
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The Refinancing Gap
Entrep’s
Venture Capital Exits Venture
Capital
Alternative View: Parallel Universes
Angel (Syndicates) Early Exits
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Do Angels and VC mix?
Source: Hellmann, Schure and Vo, 2013, “Angels and Venture Capitalists: Substitutes or Complements?” Working paper, University of British Columbia
Table shows the percent of companies that receive funding from different combinations of angels and VCs
64% 62%
18% 15%
7% 23% 10%
1%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
By First Round By Last Round
No Angel nor VCAngel and VCVC - No AngelAngel - No VC
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Evidence on Angels & VCs: Financing Path
• Angel companies get more angel funding
• VC companies get more VC funding
• Few transitions from angel to VC
• Very few transitions from VC to angel
• Stronger separation for one-time angels
• Weaker separation for angel funds
Based on: Hellmann, Schure and Vo, 2013, “Angels and Venture Capitalists: Substitutes or Complements?” Working paper, University of British Columbia AND
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Evidence on Angels & VCs: Performance
oMixing angels and VCs associated
with weaker performance
• May not be causal!
oConflict of interest at board level
oEvidence far from conclusive! Based on: Brent Goldfarb, Gerard Hoberg, David Kirsch and Alexander Triantis 2013, “Are Angels Different? An Analysis of Early
Venture Financing” Working Paper, University of Maryland
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Hold-up problem between Angels & VCs
• Moderated by angel education • Moderated by VC competition • Moderated by angel co-investments • Moderated by reputation / relationships • Moderated by use of convertible note?
VC Round Valuation Preferences
Angels hold equity
Angels hold convertible note
Founders High High Angels High Low VCs Low Low
Based on: Hellmann and Thiele, 2013, “Friends or Foes? The Interrelationship between Angel and Venture Capital Markets?” Working paper, University of British Columbia
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Avenues for cooperation • Repeat relationships
o Formal and informal
• Angels need deeper pockets
o Syndication
o Dynamic funding management
• VC funds buying out angels
o Increasingly common for founders
o Are LPs open?
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The Patience Gap • Two Models of Experimentation • Quick resolution
o Many independent trials o Early signals informative o Quick termination of losers o Patience is a vice!
• Slow resolution o Many sequential trials o Early signals uninformative / misleading o Tolerance for failure needed o Patience is a virtue!
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Evidence from Life Science Research
• Howard Hughes Medical Institute (HHMI) Grants o Rewards long-term success o Tolerance for early failure
• National Institutes of Health Grants o Short review cycles o No tolerance for failure
• Effect on research performance o HHMI recipients have more publication “flops” o HHMI recipients have more publication “hits” o HHMI recipients generate more novel research
Based on: Pierre Azoulay, Joshua Graff Zivin and Gustavo Manso, “Incentives and creativity: evidence from the academic life sciences” The Rand Journal of Economics42.3 (Fall 2011): 527-554.
Path-breaking innovation requires long-term horizons & tolerance for failure!
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Evidence from VC • Financing risk: Availability of follow-on funding
o Less financing risk in “hot” VC markets
• How does this affect VC deal selection? • Evidence on hot market deals
o Lower probability of IPO o Higher valuation in case of IPO o Successes are more innovative (more patents, more citations)
• Effects strongest for most experienced VCs
Nanda, Ramana, and Matthew Rhodes-Kropf. "Investment Cycles and Startup Innovation." Journal of Financial Economics 110, no. 2 (November 2013): 403–418.
Reduction in financing risk encourages experimentation
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Does the new market structure foster experimentation?
• New Kids In Town well-suited for “quick resolution” experimentation
• Traditional VC model (sometimes) well-suited for “slow resolution” experimentation
• New Kids In Town seems poorly suited for “slow resolution” experimentation o Funding of complex technologies o Funding of capital intensive projects
• Yet New Kids in Town give ample inspiration!
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The Three Gaps
Sectorial Gap Refinancing Gap
Patience Gap
Entrep’s Venture Capital Exits Accele-
rators Angels Crowd-funding
What role for government?