September 6, 2013
What can be done to improve access to finance for technology-oriented startups? This is a question many policymakers struggle with. While there is of course no silver bullet, research suggests that effective protection of minority investors is one important element to improve investments by venture capitalists, a key metric for access to finance by startups.
Entrepreneurship finance relies on equity finance. Business angels, venture capitalists and eventually an IPO provide equity. This is because startups and innovations often have a very special risk/reward profile that make them better suited for equity funding. Usually risks are skewed, meaning that there are many failures and a few spectacular successes. Only an equity investor shares fully in the upside of these successes to make up for the losses accrued on the failures.
However, assets of technology-oriented startups or other innovative firms are often intangible (think of a business concept, design idea or not-yet patented technology), making it easier for controlling stakeholders or other insiders to appropriate such assets at the expense of minority owners. Therefore, strong investor protection is needed to limit abuse.
Anglo-Saxon markets usually score better on investor protection than those in Germany or other continental European countries. This encourages investments and reduces financial constraints for startups and innovative firms.
McLean, R. David; Tianyu Zhang and Mengxin Zhao (2012). Why Does the Law Matter? Investor Protection and Its Effects on Investment, Finance, and Growth. Journal of Finance. Vol. LXVII. No. 1. Pp 313-350.
Meyer, Thomas (2012). Venture capital: investment boom requires effective stock markets. Talking Point. March 16th. DB Research.
Meyer, Thomas and Philipp Ehmer (2011). Capital markets reward R&D. E-conomics 83. DB Research.