VC,%20New%20Technology,%20and%20Business%20Development%20Dafna%20Schwartz%20%20Ben-Gurion%20University,[e-mail]%20%20Regional%20Economies%20in%20a%20Globalising%20World%20Enhancing%20Intellectual%20Capacity%20and%20Innovation%20Friday%2021%20November%202008,%20Cardiff%20University

1
VC, New Technology, and Business
DevelopmentDafna Schwartz Ben-Gurion
University, Israeldafnasch_at_som.bgu.ac.ilRegion
al Economies in a Globalising WorldEnhancing
Intellectual Capacity and InnovationFriday 21
November 2008, Cardiff University

2
The Need

• Countries implement various policy measures to
  encourage the formation of a VC industry -for the
  development of start-ups.
• Hypothesis- there may be a market failure
• The high risk that the first entrants into the VC
  industry face in a country with limited VCs
• The existence of positive externalities in the VC
  industry (first entrants into the market may not
  be profitable but can help in the creation of
  better conditions)

3
Our hypotheses

• Government intervention can be effective in
  overcoming market failure by supporting the
  formation of a VC industry
• However, this policy may have an unintentional
  negative side effect in terms of increasing
  regional inequality
• The reason the special role of the venture
  investors in the development of the start-ups
• Therefore, a specific public policy for the
  spatial distribution of such activities should be
  considered.

4
The Objective To analyze the Israeli experience

• Israel has adopted a policy of supporting the
  formation of the VC industry
• The emergence of the VC industry in Israel is
  considered to be the most successful example of
  diffusion of the Silicon Valley model of VC
  outside of North America (Avnimelech Teubal,
  2004a, b Bresnahan et al., 2001 Carmell de
  Fontaenet, 2004).
• Can be used as a case study

5
From start-ups to successful companies

• Requires resources that start-ups are frequently
  lacking.
• Financial resources - difficulty obtaining in the
  market. They are characterized by high risk and
  lack of tangible assets- therefore debt financing
  is usually not an option (Denis, 2004).
• Non-financial resources - the founders are often
  the innovators who dont have the business and
  managerial skills, experience, or networks which
  are more crucial to their success (Hung et al.,
  2002).

6
Who are venture investors?

• Investors (local and foreign) that invest in
  start-ups through equity
• Venture capital funds
• Private investors (angels)
• Investment companies
• Corporate venture companies
• They provide financial and non-financial resources

7
The role of venture investors

• Act as entrepreneurs and managers
• Select firms with growth potential
• Improve the quality of the firm in which they
  invest
• Improve accessibility to resources (own and
  external) financial and other resources
  (Gompers Lerner, 1999, 2001, 2005 Sapienza,
  1992 Elango et al., 1995 Sapienza et al., 1995
  Jain, 1999 Van Osnabrugge Robinson, 2000
  Brierly 2001 Allen, 2002 Brancomb Auerswald,
  2001 Lindstrom Olofsson, 2001 Helman Puri,
  2002a, b Wang et al. 2002 Allen, 2003 Riquelme
  Watson, 2002).

8
Main factors in the location of start-ups
financed by venture investors

• They are part of high-tech - therefore have a
  tendency to cluster, primarily around
  metropolitan locations and in the satellite urban
  ring around the main metropolitan area (Bar-El .
  Parr, 2003 Capello, 2002 Cooke Schwartz,
  2003 Cooke 2004, Cooke 2005, Cooke Schwartz,
  2008, Frenkel, 2001 Frenkel Shefer, 2001
  Schwartz, 2006 Schwartz Bar-El, 2007, Mason
  Harrison, 2002).
• In addition, their location depends on the
  venture investors capital provider,
  entrepreneurs and managers

9
Two main considerations in the location of
venture investments

• Capital is highly mobile
• Entrepreneurship management much lower
  mobility

10
Proximity Focalization are is important

• Frequent contacts, cost of distance
• Tacit knowledge venture investors are viewed as
  tacit information brokers they acquire and
  create knowledge
• Asymmetric information and the need of control
• Cooperation of several investors in each start-up
• Involvement of each investor in several start-ups

11
Consequently, venture investors prefer to invest
close to

• Agglomerations of start-ups
• Agglomeration of venture investors
• Their own location (residence, office)
• The portfolio companies
• Other investors portfolio companies
• Focal Places

12
In 1993 - The Yozma Program

• Fund of funds allocated 100 million
• 10 VC funds were formed,
• A partner of a leading Israeli financial
  institution with leading foreign venture
  investors
• The government's share is maximum 40
• Option to buy out the government's share at a
  pre-determined price over a period of 5 years
• In addition - invest directly in start-ups.

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The Yozma program proved to be extremely
successful

• 10 VC funds were formed
• Major international venture investors were
  attracted USA, Germany, Japan, Netherlands,
  Singapore.
• 9 funds bought out the government's share
• 15 direct investments - 9 enjoyed successful
  exits IPOs or MA

14
Catalyst for the development of the VC industry
(VC funds and others)
Capital Raised by Israeli VC Funds by Year
15
Catalyst for the development of young technology
firms start-ups (SU)
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Exits IPO and MA
Capital Raised in IPOs of Israeli High-Tech
Companies
MAs of Israeli High-Tech Companies
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The location pattern of SU backed by venture
investors (Schwartz Bar-El 2007)

• We analyzed the location pattern of SUs in
  comparison to that of high-tech activities
• Our hypothesis This policy has an unintentional
  negative side effect in terms of regional
  inequality
• Start-ups backed by VC heavier concentration in
  comaprison with high tech activities. Tend to
  concentrate in the metropolitan urban center of
  the country in specific focal locations, leaving
  the peripheral districts far behind.

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Database

• Start-up information)
• All the start-ups that were financed by venture
  investors, 1995-2004.
• 1,239 start-ups, 30,000 employees, 11B
• Employment data)
• total employment in all sectors (ET)
• employment in high-tech sectors (EHT)
• Sources ) IVC information base )CBS

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Districts and sub-districts

• 6 districts
• 2 periphery Southern, Northern
• 4 centers Tel Aviv, Central, Haifa,
  Jerusalem
• The core Tel-Aviv is the metropolitan urban
  center The Central district is the ring around
  it.
• 15 sub-districts (8 centers, 7 periphery)

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The Spatial distribution

• For each district i we calculated its share
• in total employment (ETi)
• in employment in high-tech (EHTi)
• in employment in start-ups backed by venture
  investors (ESUi).

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Location quotients, For each district i the
ratio of

• The share of employment in high-tech with that of
  total employment
• (EHTi/Eti)
• The share of employment in start-ups with the
  share in high-tech
• (ESUi/EHTi)

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Distribution and location measures by districts
ESU/ EHT EHT/ ET) ESU EHT ET
0.25 0.78 2.3 9.5 12.2 Southern
0.91 0.70 8.8 9.6 13.7 Northern
1.14 1.49 37.1 32.6 21.9 Central
1.22 1.08 36.5 29.9 27.7 Tel Aviv
1.09 0.68 8.0 7.4 10.9 Jerusalem
0.67 0.80 7.3 11.0 13.7 Haifa
100 100 100 Total
(74) (63) (50) CentralT.A
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High tech and SU Concentration

• Heavy concentration of high-tech in and around a
  metropolitan districts, low levels in the
  peripheral districts
• The distribution of venture investments is even
  more concentrated than that of high-tech activity
• Districts with the relatively higher activity of
  high tech enjoy an even higher level of
  concentration of start-ups.

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A special pattern of concentration

• Highest relative attraction of venture
  investments to urban centers in the proximity of
  Tel Aviv (Tel Aviv Central districts)
• 73 of all start-up employment compared to
• 63 for high-tech
• 50 for total employment.
• But not necessarily to all main centers
  (Jerusalem, Haifa)
• Venture investments refrain from locating in
  peripheral regions, but not necessarily from all
  of them

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The concentration of start-ups is distributed in
a few focal points

• We divide the districts into their sub-district
  and apply the same parameters to the smaller
  geographical units
• The concentration of start-ups is distributed in
  a few focal points, mostly in the center of the
  country.
• Sub districts with relatively high share of start
  ups Petah Tikva and Tel Aviv, Rehovot, Sharon,
  Hadera and Yizre'el.

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Distribution by sub-districts
LQ(ESU/ EHT) LQ(EHT/ET) ESU EHT ET
1.09 0.68 8.0 7.4 10.9 Jerusalem
0.18 0.37 0.2 1.4 3.7 Zefat,Kin,Golan
1.62 0.90 7.3 4.5 5.0 Yizreel
0.31 0.76 1.2 3.7 4.9 Akko
0.52 0.98 5.4 10.2 10.4 Haifa
2.68 0.23 2.0 0.8 3.3 Hadera
2.57 0.52 5.6 2.2 4.2 Sharon
1.53 1.79 22.1 14.4 8.1 Petach-Tiqva
0.42 2.26 3.6 8.7 3.8 Ramla
0.78 1.26 5.8 7.4 5.8 Rehovot
1.22 1.08 36.5 29.9 27.7 Tel Aviv
0.23 0.71 0.9 3.8 5.4 Ashkelon
0.26 0.84 1.5 5.7 6.8 Beer-Sheva
27
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Summary and Conclusion

• We tested the effectiveness of government policy
  in encouraging the formation of VC industry. The
  findings show
• Yes It is possible!
• Such policy is effective and may act as a
  catalyst for the creation of VC industry and for
  the development of start-ups.

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The policy has an unintentional negative result -
increase in the regional gap

• Heavy concentration of venture investments in
  comparison to high-tech activity
• Pattern of concentration in a few focal places,
  with no necessary continuum between them.
• This location behavior may lead to changes in the
  future geographical mapping of high-tech activity
  and possibly to the increase of regional gaps.

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The Location Factors

• When making a location decision, every firm
  considers the macro-regional factors and its
  micro-business specific needs
• Start-ups are high-tech activities, and are
  influenced by the same macro-regional factors
  that lead to concentration
• The location considerations of start ups are
  influenced also by their investors since their
  role is not merely a financial capital provider
  they also play an important role in
  entrepreneurship and management of the start-ups

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Policy implications

• Still, focal places in the periphery may under
  certain conditions offer a potential for SU
  activity
• The existence of externalities generated by SU
  activity justifies the involvement of public
  policy
• Joint public programs with venture capital
  investors,
• with a focus on specific concentrated locations
  in the periphery that have a potential of growth.
• Examples of programs that may be considered
  regional venture capital fund, technological
  incubators