* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Download Samuele Murtinu
Interbank lending market wikipedia , lookup
History of private equity and venture capital wikipedia , lookup
Socially responsible investing wikipedia , lookup
Mark-to-market accounting wikipedia , lookup
Private equity wikipedia , lookup
Systemic risk wikipedia , lookup
Private equity secondary market wikipedia , lookup
Private equity in the 2000s wikipedia , lookup
Corporate venture capital wikipedia , lookup
Environmental, social and corporate governance wikipedia , lookup
Systemically important financial institution wikipedia , lookup
Investment banking wikipedia , lookup
Investment management wikipedia , lookup
Private equity in the 1980s wikipedia , lookup
History of investment banking in the United States wikipedia , lookup
Investment fund wikipedia , lookup
Entrepreneurial Finance Samuele Murtinu Catholic University of Milan – Institute of Economic Policy [email protected] 1 Introduction • New Technology-Based Firms (NTBFs) are defined as small businesses whose products or services largely depend on the application of scientific and technological knowledge (Allen, 1992) • Positive impact on static and dynamic efficiency, and economic growth Characteristics • Rich endowments of intangible assets • Lack of ‘‘hard’’ assets and collateral • Short track record • Founders with science/technology backgrounds but limited financial and marketing expertise 2015 – Samuele Murtinu Innovation and finance Schumpeterian competition (Schumpeter Mark I technological regime) • Entrepreneurial firms play a fundamental role in innovative activities, as they generate novelties which disrupt the quasi-rents • Creative destruction process (Nelson and Winter 1982; Kamien and Schwartz 1982; Breschi et al. 2000) Role of finance • Rate and direction of technical change are affected by the criteria through which financial markets allocate resources (Dosi 1990; Aoki and Dosi 1992). • Banks and financial markets play the essential role of ‘‘bridges’’ or ‘‘facilitators’’ of the innovative efforts carried out by entrepreneurs (Schumpeter 1911) 2015 – Samuele Murtinu Financing gap FINANCING PROBLEMS • Informational opacity of new firms involved in R&D (patents vs. secrets) • Highly uncertain returns and costly monitoring • Technology-intensive nature of NTBFs’ activity: complexity • Lack of a consolidated track record • High % of firm-specific and/or intangible assets low collateral HIGH DEFAULT PROBABILITY • Asymmetric information - moral hazard and adverse selection (Akerlof 1970) – and transaction costs (M&M hp are violated) • Difficult access to financial markets: wedge between the cost of internal and external funds • Financial constraints 2015 – Samuele Murtinu Financial constraints: definition A firm’s investment is constrained by the availability of finance if and only if • There are investment opportunities (Tobin’s Q) • Such investment opportunities are more profitable (or strategically profitable) than alternative uses of capital 2015 – Samuele Murtinu 5 Financial constraints: definition Wedge between internal and external cost of capital • Information asymmetry (Akerlof, 1970) • Asset intangibility • Track record • Investment specificity • Cash flow stability • Market demand • Capital structure (Modigliani and Miller, 1958) 2015 – Samuele Murtinu 6 Varieties of capitalism Financial systems are classified within different varieties of capitalism: • Germany, Japan and Scandinavian countries are bank-based systems • UK and US are market-based systems Countries also differ in terms of • Tax and bankruptcy codes • Ownership dispersion 2015 – Samuele Murtinu 7 The role of banks R&D funding-gap: internal cash flow as primary source to invest in R&D projects (Hall & Lerner, 2009): • Asymmetric information • Lack of collateral assets/low ratio of tangibility • Credit risk assessed through financial ratios and historical data (tendency to invest in government bonds) • Banks are not able to separate good projects from 'lemons' in industries characterized by skewed returns • High pro-ciclicality of R&D investments • Discontinuity of R&D investments • Banks invest in traditional industries: food, beverage, healthcare, utilities 2015 – Samuele Murtinu The role of banks • IF: internal finance (=CF) • `lenders are only concerned with the bottom part of the tail of the distribution of returns' (Stiglitz, 1985: p. 146): – Credit rationing (Stiglitz and Weiss, 1981) – Higher interest rate 2015 – Samuele Murtinu (Indirect) Costs of bankruptcy Loss of customers • Hw/sw no support/upgrade • Airline tickets failure to honor frequent flier schemes • Manufacturers of durable goods warranties/replacement parts Loss of suppliers • Inventory Loss of employees • Lack of job security/Hiring-away • Difficulty to hire new employees • Important for firms whose value largely depends on human resources 2015 – Samuele Murtinu Indirect costs of bankruptcy Loss of receivables • Difficulty in collecting owed money Fire sales of assets • Firms forced to sell assets quickly to raise cash (i.e., acceptance of a lower price; airlines: -15/40% in the selling price of aircrafts) • Subsidiaries 2015 – Samuele Murtinu Agency costs NTBFs are usually owner-managed In any case, managers are hired and retained with the approval of the owners LEVERAGE conflict of interest: when the risk of financial distress is high, managers may choose investment decisions that benefit shareholders but harm creditors: • Over-investment Agency costs are smaller for short-term debt (less time for moral hazards). The firm is obligated to repay its debt more frequently 2015 – Samuele Murtinu Agency costs OVERINVESTMENT V = 400 D = 390 E = 10 Timing: close to debt obligations Investment A PV = 10 Investment B PV = 90%(-30)+10%(200) = -7 Baseline situation: V = 400 Payoff (debt holders) = 390 Payoff (shareholders) = 10 2015 – Samuele Murtinu Agency costs Investment A: V = 400 + 10 = 410 Payoff (debt holders) = 390 Payoff (shareholders) = 20 Investment B: V = 400 -30 = 370 (prob. 90%) OR V = 400 + 200 = 600 (prob. 10%) Expected V = 370*0.9 + 600*0.1 = 393 Payoff (debt holders) = 370 (prob. 90%) OR 390 (prob. 10%) Expected payoff (debt holders) = 370*0.9 + 390*0.1 = 372 Payoff (shareholders) = 0 (prob. 90%) OR 210 (prob. 10%) Expected payoff (shareholders) = 210*0.1 = 21 2015 – Samuele Murtinu Agency costs Investment A is the best one for the firm because: - It allows to pay debt-holders - It increases shareholders’ wealth (10 20) Investment B INSTEAD: - With a very high likelihood (90%) leads the firm to bankruptcy - With a very high likelihood (90%) the firm does not pay the debt HOWEVER… Shareholders will choose the investment B (their payoff is higher) 2015 – Samuele Murtinu The role of business environment Obstacles to growth are a function of • Development of financial and credit markets • Efficiency of legal systems • Shareholder and creditor rights • Regulatory burdens • Corporate taxes • Bankruptcy processes • Perception of corruption • IPR protection • Provision of infrastructures • Crime • Political stability 2015 – Samuele Murtinu The role of firm-specific characteristics Obstacles to growth are a function of • Size: power of banks decreases with borrower size (Petersen & Rajan, 1995) • Age • Ownership • Networks 2015 – Samuele Murtinu Pecking-order theory Entrepreneurs prefer (in order): • Internal finance • Debt • Equity (does not require collateral, and does not increase the likelihood of financial distress) Sometimes, firms are not able to grasp business opportunities because of a lack of external finance 2015 – Samuele Murtinu Pecking-order theory Reasons: • max(π) is ONE of the GOALS • Financial markets are not EFFICIENT (Modigliani and Miller, 1958), as assumed by traditional neoclassical models - No full information (entrepreneur vs. investor) - Information are costly Adverse selection (Akerlof, 1970) second-hand cars VG = value of a “good quality” car VB = value of a “bad quality” car Customers cannot evaluate which are the good cars Dealers are not able to signal the quality of their cars 2015 – Samuele Murtinu Pecking-order theory If we assume that in the market: • 50% good cars • 50% bad cars Customers’ willigness to pay = (VG + VB)/2 Result: dealers “put on the market” BAD CARS ONLY! In the long run: customers expect that there are only bad cars in the market and will pay VB Conclusion: GOOD FIRMS SELF-SELECT OUT from the financial market MARKET FAILURE! 2015 – Samuele Murtinu Pecking-order theory Why DEBT before EQUITY? First possible reason: DILUTION Example: n = 500 million p = $16 Equity market value = n*p = $8 billion Necessity to invest $1 billion through new equity issuance nnew = $1 billion/p = $1 billion / $16 = 62.5 million p before = $16 p after = $9 billion/562.5 million = $16 2015 – Samuele Murtinu Pecking-order theory Second possible reason: firm is underpriced The use of DEBT varies greatly among industries Firms in high-growth industries (e.g., biotech) use little debt, while airlines, automakers, utilities and financial firms have high leverage ratios Firms in high-growth industries do not have any taxable income. Their value comes from their potential to produce high profits in the future (e.g., drugs with tremendous potential). 2015 – Samuele Murtinu Pecking-order theory When the marginal cost of debt financing becomes sufficiently high, new equity financing becomes the least-cost marginal source of finance 2015 – Samuele Murtinu The role of private venture capital (VC) • Positive impact of VC on NTBFs’ performance: innovation, growth, TFP, and likelihood of going public • Context-specific screening • Monitoring and value-added (financial, marketing, human resources, and operations management) HOWEVER • Focus on a limited set of industries • Backing of a very small fraction of ‘potentially investable’ NTBFs: – Kaplan & Lerner (2014): 1,200 firms out of 600,000 firms (with employees) in the period 2009-2013 (0.2%) FINANCING GAP MARKET FAILURE 2015 – Samuele Murtinu The role of private venture capital (VC) The GP is typically a limited liability company, participated only by the fund promoters, and is an unlimited shareholder of the fund. For sake of credibility, it also provides a (small) fraction of the VC fund Investors are limited shareholders of the fund, with priority in case of liquidation 2015 – Samuele Murtinu 25 Statistics on VC fundraising 2015 – Samuele Murtinu 26 Screening What VCs consider: • Quality of the business plan and coherence with investment policies • Founders’ human capital • Expected growth of the business • Innovation (and means to protect it) • Synergies with other portfolio investments • Way-out perspectives (4-7 years) RATE OF RETURN • Market conditions and timing are important • Specialization vs. diversification 2015 – Samuele Murtinu 27 The deal structuring The main issues to be discussed between the VC and the entrepreneur are related to: • Price to be paid for the shares, in excess of the par value; if the price is ‘low’ the entrepreneur is selling his project at a discount, while if the price is ‘high’ the VC profitability will be lower (target IRR) • Stage financing, according to the achievement of the business plan milestones • Composition of the board • Options held by the VC (e.g. ‘tag-along’ or ‘drag-along’ clauses, supermajority, take-over clauses, pre-emption and veto rights) • Way-out perspectives 2015 – Samuele Murtinu 28 VC investments as % of GDP (country of portfolio companies) 2015 – Samuele Murtinu 29 VC investments as % of GDP (country of VC funds) 2015 – Samuele Murtinu 30 Europe vs. US VC investments • USA (19.1 billion € in 2011; 0.13% of GDP) • EU (3.9 billion € in 2011; 0.03% of GDP) 2015 – Samuele Murtinu 31 Exit The exit may occur in one of the following ways: • IPO: the company is taken public with an Initial Public Offering, and access the Stock Exchange; the VC stake is part of the IPO • Trade sale: the VC stake is sold with a private offer, to a bidding company, or to another fund, or the entrepreneur buys back the shares • Write-off: in case of failure and poor performance, the venture is left to its own destiny and the investment is written-off 2015 – Samuele Murtinu 32