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informal venture capital INFORMAL VENTURE CAFiTAL: INVESTORS, INVESTMENTS AND POLICY ISSUES IN FINLAND Annareetta Lumme Kera Ltd. Colin Mason University of Southampton Markka Suomi Helsinki University of Technology KLUWER ACADEMIC PUBtlSHERS Boston/Dordreclit/London A C.I.P. Catalogue record for this book is available from the Library of Congress. 333.dM ISBN 0 7923 8111-4 - - Published by Kluwer Academic Publishers, P.O. Box 17,3300 AA Dordrecht, The Netherlands. Sold and distributed in North, Central and South America by Kluwer Academic Publishers, 101 Philip Drive, Norwell, MA 02061, U.S.A. In all other countries, sold and distributed by Kluwer Academic Publishers, P.O. Box 322,3300 AH Dordrecht, The Netherlands. \ Printed on acid-free paper All Rights Reserved © 1998 Kluwer Academic Publishers, Boston No part of the material protected by this copyright notice may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording or by any information storage and retrieval system, without written permission from the copyright owner. Printed in the Netherlands CONTENTS List of Figures vii List of Tables ix Foreword xi Preface xiii 1 Entrepreneurship and Venture Capital 1 PART ONE INFORMAL VENTURE CAPITAL IN 21 FINLAND: INVESTORS AND INVESTMENTS 2 Methodology 23 3 The Characteristics of Business Angels 29 4 Deal Flow 35 5 Investment Activity 41 6 The, Modus Operandi of Business Angels 53 7 Investment Motives and Decision-Making 59 8 The Value-Added Contribution of Business Angels 69 9 Investment Performance 75 10 Future Investment Activity 85 11 The Size of the Informal Venture Capital Market in 95 Finland PART TWO POLICY ISSUES 101 12 Promoting Informal Venture Capital: Some 103 Preliminary Considerations 13 Promoting Informal Venture Capital: 1. Business 109 Introduction Services 14 Promoting Informal Venture Capital: 11. Co- 133 Investing, Syndication and Indirect Investment Models 15 Promoting Informal Venture Capital: III. Tax 147 Incentives 16 Conclusion 155 References 165 Index 175 vu LIST OF FIGURES 1.1 Sources of equity finance at different stages in the company 10 life-cycle 1.2 The small firm equity 10 1.3 Finland: provinces and major urban areas 15 3.1 Age distribution of active investors at the time of interview 30 3.2 Main source of active investors'wealth 31 3.3 Type of education of investors 31 3.4 Level of education of investors 32 4.1 Number of investment opportunities received per year 36 4.2 The investment propensity of business angels 37 4.3 How active and potential investors get information on 38 investment opportunities 4.4 Active investors' assessment of the standard of information 38 obtained from different sources 5.1 Number of investments made 42 5.2 Value of investor portfolios 42 5.3 Cumulative distribution of investment portfolios per investor 43 5.4 Cumulative distribution of number of investments per 43 investor 5.5 Size of investments: breakdown by investment 44 5.6 Size of investments: breakdown by investor 44 5.7 Distribution of investments by stage of business 45 development 5.8 Proportion of investors who have invested at particular 45 stages of enterprise development 5.9 Distribution of investments by industry sector 47 5.10 Distance of investee businesses from the investor's home or 47 workplace 5.11 Investment instruments 48 6.1 Investor's relationship with the investee business prior to the 55 investment 7.1 Motives for making an investment 61 8.1 Roles of business angels in their investee businesses 70 8.2 Frequency of contact between business angels and their 70 investee companies 9.1 Performance of exits 76 9.2 Exit routes 76 9.3 Performance of investments in current portfolio 80 9.4 Anticipated exit route for investments in current portfolio 80 10.1 Cumulative distribution of the amounts invested and 86 amounts available for investment: active investors VIU 10.2 Inforaial venture capital investments as a proportion of the 86 total investment portfolio of active investors: current and future 10.3 The preferred size of investment of active and potential 88 investors 10.4 Stage of business development investment preferences: 88 active and potential investors 10.5 Obstacles to making investments 90 11.1 Investors' taxable asset values in ascending order 97 11.2 Investors' available funds for investment purposes 97 13.1 The effect of various forms of assistance on the investment 110 activity of business angels 13.2 Representative examples of business introduction services in 113 the United Kingdom 13.3 Investor interest in the computer matching model 115 13.4 Investor interest in the investment opportunities magazine 117 model 13.5 Investor interest in the on-line data base model 118 13.6 Investor interest in investment forums 119 13.7 Alternatives for organising business introduction services 126 13.8 The organisation of the Finnish matching service 129 13.9 One of the investments arising from the Finnish Matching 131 Service 14.1 Investor interest in the fund model 139 14.2 The Sand Hill Financial Company 140 14.3 Suitability of various fund models for different investor 142 types 14.4 IM InnovationsMarknaden AB 143 14.5 Investor interest in an OTC market 143 14.6 Investor interest in the investment company model 144 15.1 Tax Incentives for Informal Venture Capit^ in the United 148 Kingdom: the Business Expansion Scheme (BES) and the Enterprise Initiative Scheme (EIS) IX LIST OF TABLES 1.1 Trends in the Finnish venture capital industry 17 1.2 Investments by Finnish venture capital funds by stage of 17 investment 2.1 Sources used to identify investors and their effectiveness 26 3.1 Employment background of active investors 33 3.2 Functional areas of expertise of business angels 33 7.1 The most important investment criteria of business angels 63 7.2 Most important reasons for rejecting investment 65 opportunities 8.1 Contribution of business angels to their investee businesses 71 8.2 The importance of the contribution made by business angels 73 to their investee businesses: a self-assessment 9.1 Methods of exit and performance of investment 78 11.1 Geographical distribution of business angels in Finland 98 12.1 Preconditions for informal venture capital activity and the 105 ways in which they might be met 14.1 The strengths and weaknesses of venture capital funds: the 134 perspective of business angels 15.1 Advantages and disadvantages of tax-related incentives 147