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VENTURE capital is widely viewed as ‘good’ capital: it takes risks, promotes innovation, actively engages with company management and often invests for the long term.
As the US National Venture Capital Association (NVCA) says in its 2016 yearbook: “Venture capital has enabled the US to support its entrepreneurial talent and appetite by turning ideas and basic science into products and services that are the envy of the world.”
Of the 1,339 US public companies founded since 1974, 42pc have been backed by venture capital. Those VC-funded companies now account for 63pc of market capitalisation and 85pc of research and development among that post-1974 cohort.
Three of the country’s five biggest companies by market capitalisation today were funded by venture capital at an early stage: Apple, Google and Microsoft. The venture capital industry remains just as ambitious to fund a new generation of start-up tech companies.
While established companies in public markets are returning money to shareholders on a massive scale, venture capitalists in private markets are still investing in the future. Publicly listed US companies bought back $568.9bn of shares over the past year. That compares with the $59.1bn that venture capital funds invested in 2015, the second highest level in history.
Venture capital also has its drawbacks. Too much VC money has lately been invested in start-up companies with daft ideas, inflating some private market valuations beyond any meaningful measure and eroding margins for sounder businesses
“The public markets have never been shorter term. The time horizon for private markets has never been longer,” says one leading Silicon Valley venture capitalist.
At first glance, it would seem that Europe could desperately do with more of that kind of patient, risk-taking capital to spur innovation. As a recent paper from the French prime minister’s office noted, France — and by extension Europe — needs more ‘yollies’ (young leading innovators). Younger firms tend to have higher growth potential, create more jobs and raise productivity. They help renew a country’s economic fabric.
There is certainly a striking contrast in the scale and speed of wealth generation between the US and France. At $1.55tn, the combined market capitalisation of Apple, Google (now Alphabet), and Microsoft is greater than that of the entire CAC 40, containing France’s most valuable public companies. Europe could surely benefit from more adventurous venture capital to help its yollies.
But all is not quite so simple as it seems. For a start, Europe’s VC industry does not do a bad job, according to a paper by two academics from the London School of Economics, whose data set included 12,315 European and 23,483 US venture capital investments.
Contrary to perceived wisdom, the two researchers found there was no difference between the likelihood or profitability of initial public offerings between European and US deals from comparable years — even though US companies were prepared to pay more than European ones for trade sales.
The biggest determinant of success in both markets, though, was long-term expertise in the industry. Serial entrepreneurs and investors were more successful on both sides of the Atlantic. Overall, there remains a far greater wealth of experience in the US.
But some successful European entrepreneurs-turned-investors, such as Niklas Zennstrom, co-founder of Skype, are helping to redress the balance.
Venture capital also has its drawbacks. Too much VC money has lately been invested in start-up companies with daft ideas, inflating some private market valuations beyond any meaningful measure and eroding margins for sounder businesses. As the cycle has turned down, some of the much-vaunted unicorns (private tech companies with valuations of $1bn or more) are turning into unicorpses.
Moreover, as the NVCA acknowledges, much of the success of US venture capital stems from external factors: access to good science from world-class universities, protection of intellectual property rights and a skilled workforce drawn from around the world.
Professor Mariana Mazzucato, author of The Entrepreneurial State, has also highlighted the extraordinary role that the US government has played in fostering private sector growth. Public sector organisations such as Darpa, the defence industry body, and the National Institutes of Health have pumped billions into early stage research and proved to be remarkable engines of innovation.
Europe has a lot to do to emulate the success of the US in all these areas, not just in terms of VC funding. Capitalist success is about far more than the success of capital.
Published in Dawn, Business & Finance weekly, April 18th, 2016
