Venture capitalism
in the UK began in 1930, when the Macmillan committee reported on gaps within
the financial system. According to Coopey (1994) the report perceived
structural failures within the system that translated to the inability to
approach the capital market by unquoted small and medium scale businesses. Such
businesses were poorly catered for by banks and hence could not afford capital
to start up or continue with business. The solutions to these problems were
proposed to be realized through Keynesian economics. Subsequently, following
the end of the Second World War, the UK government in collaboration with the
Bank of England, Labor party and the clearing banks set up plans to handle
these problems. According to SBS (2005) they made use of the recommendations from
the Macmillan committee that saw the establishment of the Finance Corporation
for Industry (FCI) and Industrial and Commercial Finance Corporation (ICFC).
These bodies
were created following examples in the U.S. of venture capital financing for
large and SME industries. The ICFC was established for small and medium scale
businesses while FCI was set up for large scale industries (SBS, 2005). The
concept behind these efforts was the provision of a type of investment that was
to be characterized by long term and equity based investment options from
institutions or otherwise. This type of investment would involve start up
capital, growth capital or buy out capitals that could be used in areas like
information technology or bio-technology. They set up these two bodies to
provide alternative investment options, which according to the Bank of England
would preferably come from the private sector (Coopey, 1994). Ideally the FCI
and ICFC were created with the aim of investing in selected investment areas.
The interest of
this paper is in the history of venture capital in the small and medium scale
business enterprises, and the series of events that have affected it. From the
beginning, the ICFC was created in a competitive environment where the Bank of
England was calling the shots on one hand and clearing banks on the other side.
With such big forces trying to compete for the right to shape initiatives in
the investment sector, the ICFC ended up with freedom. Though the initial
intention was to define set investment areas, the ICFC was free from the
government, Bank of England and clearing banks. This was largely due to the
ability of the three forces repelling each other.
Consequently
when SMEs approached investors, banks would intervene for any case that fell outside
the ICFC’s remit of £5,000 to £200,000 (Coopey, 1994). The worst or poor cases
were sent to ICFC with the banks taking up good investment ventures.
Consequently ICFC was forced to establish their own methods of evaluation and
attracting businesses to ensure financial returns. Apparently, banks had no
intention to support SME through capital venture; for this reason they tried to
hamper the growth of ICFC and limited its market. In the end, ICFC could only
invest in unsecured firms that had no historical accounts for long term
investments. Such businesses were often found to have very low debt repayment
burdens. This was the decisive factor that drove it to develop its own
strategies to measure investment risks. After overcoming these initial hurdles,
the venture capital in SME grew rapidly into the 60s. Then the next two decades
saw a great boom in the private equity industry. This was because; the 70s and
80s saw relaxation in credit controls and the public security markets were
liberalized (SBS, 2005). This was coupled by measures by the government to
attract and make it easier for private organizations to invest in unlisted
businesses. Hence the capital venture of SME grew rapidly during this season.
The 70s, 80s and
early 90s liberalization period saw the establishment of a number of venture
capital firms which turned out to be very active. One of this was the British
Venture Capital Association (BVCA) that was established in 1983. Subsequently
the UK market also saw serious financial investment and a wide range of
finances to SMEs. SBS (2005) noted that despite this success, gaps remained in
various sectors and regions in the UK. In order to offset these gaps the
government gave out fiscal incentives in the 90s that were aimed at bringing in
more capital into the venture market. This then led to the creation of the
venture Capital Trusts in 1995, which were put in the finance Act of the UK
(SBS, 2005). This created a temporal solution to the shortage of capital to the
SME’s sector especially in the areas of information technology. Towards the end
of the 90s, more private investors joined from the retail as well as
institutions which created a new wave of venture capital firms.
The 90s
presented the SME with plenty of investment capital because there was increased
interest by the government in this sector. With policies and support from the
government, investors gained confidence in SMEs. In addition to this was an era
where SME were coming into focus internationally with the global economy
improving tremendously (Coopey, 1994). This then led to early stage investment
activities that were characterized by a wide range of funds. The market also
saw an increase in the number of venture capital firms, venture capital trusts
and angel networks.
Looking at the
effects of the behavior of the venture capital, SMEs have had varied and
diverse experiences since the 30s. Following the establishment of the first
capital venture firm for SME, businesses had now a chance to get capital with
diminished hurdles. However, from the start, SMEs had to face varied
evaluations that prevented them from receiving financial help. With the Bank of
England and clearing banks fighting to control ICFC, the SME business manager
had problems obtaining help. Those who could afford to get financial assistance
had to have good credit rating and repayment methods; if they did, they were
financed by banks rather than ICFC. On the other hand those who had poor and
unstable business backgrounds were sent to ICFC which was greatly limited. According
to Coopey, (1994) ICFC finally gained momentum, and the capital venture market
improved, managers could access financial assistance. This followed the boom of
the 60s to the 80s. From the beginning, venture capital investors were seen to
have an interest in the shares and management of businesses. The pioneer of
this was ICFC that took some interest in having equity stakes within the
businesses they invested in. This had a dual effect as firms which had given
part of their equity to ICFC enjoyed reduced debts, and shared in the success
of the firms. Consequently with time venture investors took an interest in the
management and running of businesses in the hope of securing their investments
(Coopey, 1994).
The success of
the British economy during these decades plus government support for SME made
it possible for SMEs to grow. Availability of funds meant that new sectors
could come up and establish. One of these was the Information technology sector
that flourished through VC in the 90s. However, after the implosion of the 90s,
the market saw a stop in the creation and growth of investment vehicles. In
BERR (2008), the fall in investments meant that SME managers could not access
funds, which meant that the next few years saw a fall in business.
The 90s also saw
a change in the way managers opted to invest their remaining capital where they
showed signs of a lack of interest in risk. The venture managers now opted to
invest in large and well established businesses rather than the smaller unknown
enterprises or early stage investment. Therefore those venture capital
investors that had began as early investment ventures increased their buy out
investments and raised the target for their deals. This trend increased more
during the last decade, as they placed more investments in larger established
ventures.
SME and medium
sized companies in the UK are still considered to be high risk. It is therefore
important to analyse the effectiveness of the available venture capital to the
financing of SMEs. To successfully understand the positions these businesses
are currently facing in terms of financing both the private and public capital
ventures are analyzed. This shall be considered in light of the fact that the
UK makes use of regulatory incentives in order to select, support and help the
growth of selected SMEs.
The main aim of
this research is the analysis of the effectiveness of the availability of
venture capital to small and medium sized companies in the UK. Towards the
achievement of this objective, the following specific objectives will be
fulfilled; the identification of;
- Approaches used by venture capital investors and their effect on the small and medium size company,
- Conceptual models and theoretical frameworks that is associated with the provision of venture capital to small and medium sized companies,
- Why venture capital investors intervene in managerial aspects of small and medium sized companies,
- The effectiveness to development of small and medium sized companies through the provision of venture capital,
- Approaches and means by which venture capital investors can affect effectively small and medium sized companies by means of feedback and learning effect.
1.3
Research Questions
Based on the
aims of the research, the following research questions were identified;
- How has the historical development of venture capital investment in the UK affected the development of small and medium sized companies?
- What are the current approaches in venture capital investment and how do they affect SMEs?
- What are the conceptual frameworks within the venture capital investment of the UK towards provision of capital to SMEs?
- Do venture capital investors have to intervene in management aspects of the SMEs?
- Is the availability of venture capital investment effective to the growth of SMEs?
- What approaches can the venture capital investor use to affect SMEs through learning and feedback?
1.4
Rationale for the Study
With the recent
realization that small and medium sized companies are contributing greatly to
the growth of the UK economy, the government has set out to provide incentives
to these ventures. One of the incentives identified is the access to finance by
SMEs for starting out, growth and buy out capitals. In order to understand the
effects the venture capital investor has on the development of SMEs, it is
vital to study the approaches used in investment. This will provide the
conceptual framework used by venture capital investors to identify appropriate
SMEs to invest in. Such an analysis will take into consideration, both private
and public venture capitals available currently in the UK. In the end, the
study will seek to realize the practices of venture capital investors that
affect the management, development and growth of small and medium sized
companies.
The existing
theories that can be applied to venture capital and the SME are only applicable
in part and only a few segments of the same may be found to be relevant in the
venture capital research. The lack of comprehensive theoretical frameworks can
be explained by the fact that most theories are developed for large
organisations and not small and young enterprises (Cable and Shane, 1997). The
theoretical frameworks help in understanding the underlying factors that influence
the availability of venture capital as well as the factors that may determine
the minimisation of risks and ultimate realisation of the investors’ goals. The
most commonly applicable theories include the agency theory, the prisoner’s
dilemma theory and the resource based theory. The Agency Theory focuses on the
relationship between the investors (principles) and the business managers (the
agents). This theory delves into the disparities in interests of the two
parties and explores the occurrences of risks or losses where the interests are
in conflict with each other (Bruton, Fried and Hisrich, 2000). Some of the
practices that the business managers may view as crucial for the growth of the
business to ensure larger and higher levels of prestige in the management may
be in direct conflict with the venture capitalists’ interest of recouping their
investments in the shortest time possible. The theory also envisions a
situation where managers may award themselves hefty benefits at the expense of
the investors. This theory explores the ways in which investors can monitor
business practices and ensure that their interests are secured. Vigilant monitoring
and the influencing of management decisions have been the most acclaimed modes
(Bruton, Fried and Hisrich, 2000). The principals can also design incentive
schemes that base rewards on the attainment of targets set by the management. The
prisoner’s dilemma theory emphasises the importance of cooperation between the
investor and the managers in order to realise higher benefits (Cable and Shane,
1997). It, like the agency theory, acknowledges the existence of conflicting
interests and proposes the setting aside of these individual interest in
pursuance of a common goal that helps yield superior benefits for both parties.
The resource based view focuses on a firm’s assets and its ability to achieve
the set objectives. The superiority or inferiority of a firm’s strategic
position as viewed from the resource perspective determines willingness or
unwillingness of investors to avail venture capital for new projects or for
expansion (Erikson and Nerdrum, 2001).
The research has
multifaceted purposes and delves into the understanding of the influence of
venture capital on enterprises as well as the workings and the factors that may
influence the availability of this capital to the enterprises. The study seeks
to explore the thinking of investors with the aim of creating understanding on
how enterprises can attract larger inflows of venture capital as well as to create
the understanding of the investor interests and their actions in an attempt to
safeguard these interests in order to create the requisite information
necessary to procure cooperation between the managers and the investors.
Finally and more importantly, the research shall bring forth an appreciation of
the importance if venture capital in fuelling growth and development in the SME
sector as well as the whole economy of the UK.
Backed by the
theoretical aspects described above, the study made use of secondary data to
guide in-depth analysis into the growth of venture capital in the UK as well as
the effects recorded. The primary data collected helps give a first hand
perspective on the influence of venture capital in selected firms as an
indicator of the general effect of venture capital on enterprises across the
economy. The research borrows from the agency theory and the prisoner’s dilemma
theories to explain the actions of investors as well as those of managers as it
seeks to establish the winning formula for ensuring maximum benefits are
yielded from the provision of venture capital. This is in recognition of the
fact that the various determinants of success must be met for venture capital
to yield the desired results. Finally, the research draws conclusions detailing
the significance of venture capital on SME and gives recommendations on how
these effects can be enhanced to the benefit of both the enterprises and the
investors.
This chapter
explores related theories that relate to the topic of the study. It also gives
a glimpse into the historical perspective and subsequent development of
interest in venture capital in the UK since 1930s.
The sprout of
venture capital emerged in 1930s in the United Kingdom. The relative
conservative culture of the European coupled with the shackles of traditional
industrialization made the venture capital start really late in the UK. Venture capital is often quoted as the
filling that sealed the gap in the UK financial system. This was first
recognized in the early 1930s in the UK as published by the Macmillan committee
although its importance would not be fully embraced until 1931 during the great
depression and a decade later as UK sought to strengthen its economic position
(Van-Osnabrugge, 1998). Between 1943 and 1945, the UK government would further
commission the FCI (Finance Corporation for Industry) to finance large and long
term investments and ICFC to finance SMEs to venture into new areas of
production (Van-Osnabrugge, 1998). This step also became a beginning of
scholars in the UK taking keen interest on the use of venture capital in the
economy. The subject gathered even more interest in the 1980s as many scholars
began to study on the development of venture capital in the UK, mainly because
of macro-economic development. Fried and Hisrichchose (1988) made a review
about the main line of the operation process of venture capital firms. In order
to address the problem on how the venture capital investors take a free hand to
manage the enterprises, Tyebjee and Bumo (1883) created Tyebjee and Bumo Model in
the early of 1980s. The study of Tyebjee and Bumo has shown that that
investment decisions were mainly based on ROI and risk of capital. The key
elements were the ability of management staff, competitiveness and market
attractiveness.
In 1990s,
because the models of venture capital were imported from the U.S., the UK
gradually became aware of the strategic significance of independent innovation
for economic growth and economic independence. In academia, Murray and Robbie
(1997) made an investigation on the 10 leading venture capital in the UK. They
found that ROI is far from consistent with the expectations of venture capital
investors, and investors would adopt a more prudent action if the return on
investment declined (Zacharakis, et al., 2007). In this case, venture capital
investors in the United Kingdom hoped to establish closer relationship with
small and medium sized companies to improve the unfavorable situation. In
investors’ mind, directly or indirectly involving in the management of SME
could increase the return of venture capital. This was in line with the
perception that when the company has a good management, the rate of return is high.
Investors therefore considered the strengthening of the management of SME as
crucial. In 1999，Murray's survey also
showed that most of the investors (about 59%) were ready to intervene in the
operation of the SME management (Murray and Robbie, 1997). They generally hoped
to enhance the added investment value and generate competitive advantage
through this approach even though they were not specific on the measures to
adopt. According to Terje, et al
(2008), the selection of a good enterprise to invest is very crucial. In a
related study, Robinson (2000) confirmed through an empirical study that when
screening for enterprises to invest, venture capital investments were often
based on subjective judgments. Investors would avoid some micro-investment,
particularly when assessment cost of micro-investment nearly equal to the
assessment cost of a larger enterprise (Henrik, et al., 2008). In other words, these
studies have proved that as suppliers of venture capital, it is necessary to
get involved in the management of small and medium sized companies. Such an
approach can urge managers to strengthen management practices and protect their
investment income.
In the past
decade, the venture capital market in the UK has changed a lot. There has
appeared a large number models for the study on the provision of venture
capital to small and medium sized companies. These models play an important
role in the study of how venture capital effectively improves the operational
efficiency of SMEs (Dixon, 2000). British scholars Sweeting and Wong (2000)
chose a venture capital investment institution to make a system investigation.
The institution used ‘let go’ operation mode. So the SME has more autonomy to
decide its business. Tereza (2001) thought that there were a variety of
incentive problems in venture capital market. Based on asymmetric information,
entrepreneurs and venture capital investors had to choose an appropriate type
and financing model structure, to clear the respective rights and obligations
of both parties (Grichnik, 2006). Peirone (2002) used innovative tools that
provided by economic literature, especially the point of view of geographical
and technical knowledge and the theory of resource based companies, to
establish of a financing contract model. The model not only concerns about the
financial indicators and monetary incentives, but also deepens the links
between venture capital investors and small and medium sized companies. The
model is comprehended as a benchmark of enterprise resource (Casamatta, 2009).
About the optimal contract, Cumming(2007) proved convertible preferred stock is
the optimal form of venture capital financing in small and medium sized
companies (Cumming, 2007). When the financial instruments lack of tax
incentives, the UK venture capital investors often do not choose the
convertible preferred stock. It is a good news for small and medium enterprises
in the UK that the application of tax incentives of venture capital. In 1998,
the UK introduced two incentives. The one is providing tax relief to SME, the
mount of relief depends on the cost of R & D. The other is give tax credits
to key executives to attract and retain good managers of new companies which
received venture capital. In this context, the profit of SMEs has a great space
for improvement.
Empirical
research of Rustam and Lackaka (2007) indicates that in the venture capital
market, the leading investment targets are high-tech small and medium
enterprises in the UK. The most of the investment is in industries of
information, computer and communications, accounting for about 60% to 70%. In
recent years, the proportion of investment in emerging small and medium
enterprises, such as biological engineering, new materials, and technology of
ocean development and so on, raises rapidly. The licensed securities market
(namely, the second stock market) set up in 1980, has provided 250 enterprises
with nearly 30 billion pounds for stock trading. Theorists and practitioners
all agree that the venture capital is one of most capital to small and medium
enterprises. According to yearbook of U.S. venture capital in 1998, some small
and medium enterprises depended on the provision of venture capital being
listed companies. After listed, there was a good performance. Some stocks even
reached 283% increase (Fried, 2002). But this is rare in the mature stock
market. The demand for venture capital and support to small and medium sized
companies will lead to the expansion of venture capital. In this case, venture
capital investors how to adopt an effective method to manage small and medium
sized companies will be very important (Cumming, 2007). To determine the extent
of engagement of venture capital in financing businesses and its effectiveness
in the UK, two theoretical perspectives explaining the nature of venture
capital come into play (Myers and Majluf 1984). These theories are the pecking
order hypothesis (POH) and the financial life cycle theory. The POH (Pecking
Order Hypothesis) describes the preferred sources of financing in organizations
as internal sources, debt and equity in that order. Although the initial
intention of the hypothesis as outlined by Myers and Majluf (1984) was designed
to observe the behavior of public listed companies, analysts find their behavior
to be quite similar with all other businesses across the board. This argument
was strongly advocated for by Cosh and Hughes in their book in 1994. This
hypothesis states that when managers are faced with a decision on undertaking a
project whose projected net value is positive, they will first and foremost put
the interest of the current shareholders before other interests. In many cases,
the managers themselves may happen to be the shareholders in the SME sector.
Accordingly, the managers will always prefer to preserve the benefits of
increased market value of the companies for the current shareholders. The
investors who think in a similar fashion may interpret a company’s request for
equity financing as a sign that the company is overvalued and they hence may
want to acquire a relatively high shareholding at low amounts (Armour, 2002).
According to Armour (2002), these implications on equity form the basis for
most SMEs to consider equity financing as the option of last resort. The use of
accumulated liquidity in financing new ventures and projects becomes the most
preferable mode of financing. In the cases where the firm is forced to look
outside for financing, the most preferable mode according to the hypothesis is
debt financing. There is also a common problem with securing financing for
small SMEs i.e. credit rationing. In their 1984 publication, Myers and Majluf
explained that this credit rationing is caused by information parity between
the lenders and the firms where the lenders have insufficient information to
assess the riskiness of the ventures in order to take appropriate decisions.
This is further reinforced by the fact that most venture capitalists may be
newly formed past without a known credit history who have equally chosen to
enter a market segment with no known trends at the market level. This leaves
them as the only parties that can understand the risks involved. The result of
this parity may be an increase of interest rates that may discourage the SMEs
from borrowing. Banks may opt to increase their interest rates in a bid cover
the perceived increase in risk. As Aghion and Bolton (1992) records, this step
would result in the businesses that perceive their riskiness as equally high
being the only ones taking the loans leading to a situation where the banks’
loan portfolio bears an abnormally high risk.
In order to
avoid such eventualities, the banks may opt to simply refuse giving loans for
ventures whose riskiness cannot be ascertained. The alternative measure for
risk mitigation may be the demand by banks for borrowers to provide collateral
to shield the bank from losing their funds. This step cuts out businesses with
superior ideas and potential but with insufficient assets to guarantee their
loans. Moreover, demand for collateral tends to erode the concept of limited
liability for small firms when the directors have no option but to attach their
personal belongings to the loan facility.
The Financial
Life Cycle theory is based on the business life cycle theory. Businesses
generally progress from inception, survival (growth and expansion), and finally
to the maturity stage (ACOST, 1990). At inception, the business is largely
entrepreneurial with a largely unstructured management where the business
owners are directly involved in the daily operations of the business. This
stage differs from maturity stage where the management is highly professional
with a well established organizational culture. The transitions from one stage
to another would usually be a product of an evolutionary or revolutionary
process with the defining moments being point of crises within the
organizations that trigger certain changes in their operational or management
styles (ACOST, 1990; Greiner, 1972; Scott and Bruce, 1987). According to Berger
and Udell (1998), the relationship between this life cycle and financing
characteristics is purely based on corresponding information characteristics
accompanying the life cycle in business development. They further stated that
since small business start with little public information that is verifiable
enough to ascertain their business quality, financial intermediaries dealing
with them should act as information centers that can reliably convey such
information to interested parties (Greiner, 1972). These financial intermediaries
are also concerned with the process of screening businesses information and
processes, monitoring the manner in which they operate as well as designing
contracts that are aimed at impacting on the business operations with the aim
of minimizing the risks to the lenders or investors. These intermediaries are
instrumental in matching the needs of the businesses to the objectives of the
firm or person providing the finances (Aghion and Bolton, 1992). While
determining measures commensurate with the expectations of the financiers, the
intermediaries take into account the need for venture capital providers to have
an influence over the strategy and operations of the firm. In his finding,
Armour (2002) records that investors can control managers’ actions by injecting
finances in stages with each level being linked to achievement of agreed
objectives. This would help ensure the managers are focused on the matter at
hand. The venture capital providers may also opt to take up preference shares.
This would keep the original owners in management wary of the fact that they
stood to lose more if they were to let the venture fail. The UK has, through
various government agencies established such financial intermediaries to help
entrepreneurs in need of venture capital access the financing they need in
order to implement their business plans (Aghion and Bolton, 1992). The end
result has been an increasing supply of venture capital in the UK as evidenced
by the rapid growth of venture SMEs between 2000 and 2008 (TSO, 2009).The
investors can also require that the managers sign contracts requiring them to
have no engagement with competing interest even after their departure from the
ventures in question. This will ensure the managers do not use the firm’s
strategic technical know how to jeopardize their chances of excelling in the
market.
Venture capital
is considered to bear more risky than other forms of financing. The investors
give finances and in return are allocated equity in the businesses in form of
shares. This form of financing is considered subordinate to other forms of
financing such as debt. It therefore means that investors undertaking this form
of financing demand higher returns to cover for this risk. This is because
ordinary shareholders are the ones considered last after creditors and other
stakeholders in case a business get liquidated. As businesses growth, their
growth assumes a moderate rate that may not be able to sustain the expected
returns if they were to choose to obtain finance solely from venture
capitalists. Other forms of financing such as debt have lower expected rates of
return hence businesses opt to structure their capital with a realizable
mixture of equity and debt. Study into the investor behavior in the UK reveals
that the investors usually did not intend to invest to high-risk areas. So they
were willing to choose a better debt way, such as ‘stop-loss mechanism’. The
participation of venture capital usually is carried out by the support and
promotion of national plans (Allen, 2008). At the same time, Wong (2008) also
believes that, although Venture capital investment grows naturally in its rich
market economy in the UK, the specific model of development is to learn the
experience of the United States. So the government maintains a high level of
participation in the provision of venture capital to small and medium sized
companies (Wong, 2008). The broad Participation of government in the field of
venture capital constitutes the basic characteristics of venture capital model
in the UK. In addition, other scholars research the question from other
Perspective. Zacharakis and McMullen (2007) analyzed the economic system
influenced the venture capital investors when making a decision to provision
venture capital to small and medium sized companies (Zacharakis, et al., 2007).
Based on the view of investee companies, Terje and Dystein (2008) researched
the expectations of small and medium sized companies and perceptions of value
added activities (Terje, 2008). The results showed that there was a significant
gap between the expectations and perception of entrepreneurs. In short, the
provision of venture capital in the UK to small and medium sized companies has
become a new focus. This is because the UK has a significant international
economic position. However, few scholars to explore how effective is the
provision of venture capital in the UK to small and medium sized companies. The
research will analyze the issue from the perspective of process of venture
capital investment.
Within the UK,
Cambridge receives the highest proportion of venture capital (over 10%) in the
most attractive high-growth start-ups. This region sits in the of UK’s
knowledge economy, otherwise called ‘the Golden Triangle’. The state support
for venture capital in the UK is generally very low and stood at a feeble £ 0.2
m out of a possible £ 2 m that is required to see effective funding of
start-ups in the economy. To fill this gap, UK has in the past turned to
private equity investment to fill the funding gap to ensure adequate investment
in funding the high-growth start-ups. Such investors included the Catapult
Ventures Managers Ltd who was running the East Midlands Regional Venture
Capital Fund. This fund was worth £ 30m which was to be used for funding over a
period of six years and would provide venture capital for young and developing
businesses with a high potential for growth (Hughes, et al, 2003). It limited
initial investment £ 250k with the option of investing a similar amount after
assessing progress for the next six months. Accordingly, they supported
start-ups, management of buy-in buy-out transactions, early stage, and were
also involved in the development of capital opportunities. Quester Capital
Management Ltd also managed a £ 7.9m Lachesis fund aimed at financing start-up
and early-stage technologies for higher education institutions. It is aimed at
encouraging investment in technologies discovered through research conducted by
the higher education institutions (Hughes, et al, 2003). Another fund, known as
Connect Midlands would fund up to £ 3.5m (Hughes, et al, 2003). This funding
would be directed to revamp young and developing businesses to prepare them for
introduction to potential investors. Significant interest has also been
developed by organizations such as GINEM (Growth Investment Network East
Midlands) to help investors identify high-growth potential areas of investments
and suitable young businesses to engage in exploiting these opportunities
(Hughes, et al, 2003). Numerous other funds have been established by private
firms and non profit organizations have been established to further encourage
venture capital funding to stimulate growth of high-growth organizations
especially in innovation and knowledge based industries.
Venture capital
is mainly directed towards the establishment of SMEs and the availing of these
funding has stimulated the growth of SMEs in the UK to an extent that recent
figures show that SMEs form the one of the largest contributors to the gross
domestic product (GDP) in the UK. The rapid emergence and growth in SMEs in the
UK has been a proof of the influence of the changing attitudes towards venture
capital funding. SMEs employ about 59% of the total workforce in the private
sector. The SME sector has also grown significantly with over a million new
businesses started in the period between the year 2000 and 2008, (TSO, 2009).
SMEs have also been acknowledged widely as the drivers of the economic growth.
As the new businesses enter the market, they displace the older businesses that
have been found wanting in terms of efficiency. They are also instrumental in
the advancement of innovation in products, services and business processes. An
economy that provides for adequate venture capital stimulates its growth in
terms of total GDP as well as the development of new products and services in
the economy leading to a rise in the level of satisfaction in the population.
The UK has been a beneficiary of this increased attention to venture capital
funding and has had economic growth driven by it with employment levels rising
by 13% between 2000 and 2008 in the SME sector alone (TSO, 2009). This support
in funding also applies in funding growth of the newly established businesses
hence giving them the strength needed to explore further avenues of growth
including engagement in exports and exploration of international expansion
opportunities which would further enhance the growth of the economy of the home
country. The financial recession that hit the world economy in 2007-2008 later
worked against the progress achieved in the UK as a result of the willingness
by UK investors to engage in Venture capital. It was estimated the over 27% of
businesses seeking venture capital in the UK market failed to secure the
financing from all sources approached while a whooping 44% failed to raise the
funds from their preferred source of investment. Given the trends followed
under previous recessions across the world, it is expected that this lack of
financing is likely to persist for a couple of years.
Although there has
been significant growth in the SME sector presumably fuelled by the increased
attention to venture capital funding, it would be observed that the performance
still remains below the levels commensurate with the market potential.
Researchers have now turned their attention to this aspect and have identified
a number of impediments that render the effectiveness of venture capital in the
UK scores lower than would be expected. Firstly, many owners of the SMEs
generally avoid financing through equity since this would lead to them ceding
part of the ownership of their businesses. Many business owners are still
attached to the concept of maintaining ownership and this forces them to turn
to other modes of financing such as debt to finance growth or venture into new
interest areas. According to a report by TSO (2009), Over 35% of SMEs in a 2008
survey stated that their reluctance to cede ownership of their companies was
the main reason for avoiding equity financing. Out of the over 20% of SMEs in
the UK that considered equity as a source of finance, only about 1% actually
took it up, (TSO, 2009). The aversion from Venture Capital financing by many
SMEs may also be due to the availability of cheap sources of debt with the UK.
This engagement is undertaken in oblivion of the fact that business
circumstances could change and where such changes affect the business
performance negatively, long term debts could prove detrimental to the welfare
of the business. Researchers also identified investment readiness as another determining
factor when investors are considering investing equity into a business.
Investment readiness can be described as the level of operational and
management sophistication within a SME that would make the potential investors
have the interest to invest in it with the confidence that their investments
would remain secure, especially given that venture capital offers the investor
no guarantees as relates to returns from their investment. For an investor to
engage, the business needs to present itself as one that the investor can
prudently decide to invest in. Many high-growth start-ups run haphazardly and
are not considered as ready for investment.
Venture capital has not been a preserve of the UK for a long time. Even
tough the popularity of this mode of financing has grown significantly in
recent time; there has been insufficient creation of data relating to returns
expected from such ventures. The insufficient track record denies many
potential investors and businesses the much needed track record that would
support their intentions to engage venture capital financing. There is also the
problem associated with the cost of restructuring the company and due diligence
when equity financing is concerned. Some of the costs can be as high as 10% of
the financing deal (Cannon-Brookes, 1993). To many SMEs, this is a cost they
can easily avoid by engaging other forms of financing. Research has also shown
a worrying trend among the managers of Venture Capital funds that are privately
run. They tend to concentrate on areas that are considered less risky and even
where they choose to engage, they insist on being directly in control of the
management by ensuring they obtain a majority share in the business. These
aspects discourage SME owners from utilizing these funds hence their
availability makes little impact as far as exploiting them is concerned. With
the emergence of these factors that may negatively impact on the effectiveness
of providing venture capital in the UK, further research is recommended to
establish the current position as relates to the subject stated above. Scholars
have also noted with keen interest the open preference for financing older
firms seeking to venture into new project to financing new firms that are
formed to enter into novel areas of business (Cosh and Hughes, 1994). This
preference as observed by Cannon-Brookes (1993) is linked to the proven
assumption that new business and small firms tended to die out more than the
already established relatively bigger firms. This further limits the ability of
these firms to secure financing despite the efforts already made by the
government to encourage the availability of venture capital in the market.
The research
methodology details the processes involved in the collection of information as
well as the research philosophies that governed the entire research process (Chia,
2002). This gives the users of the information an ample opportunity to
appreciate the perspectives taken into consideration when drawing conclusions
and recommendations detailed. Focus on research methodology ensures the
conducting of a comprehensive and balanced process as well as guaranteeing the
integrity and reliability of the findings, analysis and recommendations (Chia,
2002).
Understanding
research philosophies enables a researcher to appreciate the various
perceptions, beliefs and assumptions in the researching field (James and
Vinnicombe, 2002). The appreciation of these perceptions help understand the researcher
biases and helps them draw balanced conclusions with due regard to these
biases. The knowledge of research philosophies and paradigms of thought
governing the field enables the researcher to match the philosophies to the
research based on the nature of information sought and the overall research
aims (Chia, 2002). The coherence is instrumental in ensuring accurate results
and reliable recommendations. This brings to the fore the aspects of ontology
and epistemology. Ontology seeks to integrate the researcher’s own views on the
reality with an aim to distinguish between prevailing realities and the
researcher’s interpretation of these realities (James and Vinnicombe, 2002).
This helps understand researcher biases and hence reduce its influence on the
findings of a research. It seeks to distinguish subjective interpretations from
objective ones in a research process. The consideration of ontological
perspectives was useful in testing research design in order to ensure balanced
surveys that would produce the required answers. Epistemology on the other hand
informs the researcher on the importance of embracing the correct procedure in
collection of the information sought. It also enables the researcher to focus
on the integrity of the sources to be considered for data collection through
its emphasis on ensuring the correct definition of knowledge in possession of a
given source (Saunders, Lewis and Thornhill, 2007). Epistemology also enables
the researcher to focus their attention on attainable objectives by
establishing what information is collectable and which one is not. This
distinction is crucial to ensure the success of a research process and the
accurate matching of research process to the level of resources at the
researcher’s disposal. The epistemological perspective also recognises the
influence of the researcher’s ontological views in determining the research
process and is useful in keeping the researcher biases in check (Saunders,
Lewis and Thornhill, 2007). The common research philosophies include the
positivist view, the interpretivist/ constructionist view, and the realist
view. The positivist views focuses on the measuring of observable social
realities in order to test a defined hypothesis generated from analysis of
previous studies. This philosophy emphasises the value of observable variables
as well as the existence of an objective and external social world. Positivist
philosophy mainly involves quantitative methods that provide statistical
analysis on information gathered preferably through written surveys and
questionnaires as well as secondary data sources (Chia, 2002). Interpretivist
view recognises the influence of one’s experiences and attitudes on their
interpretation of the goings on around them. This philosophy explains the
constantly changing views and interpretations of various phenomena and explains
the reason for constant research in order to update the available knowledge
sources with the prevailing changing attitudes (Chia, 2002). This philosophical
dispensation therefore advocates for analysis of not only the phenomena but
also the environmental factors that may influence the views adopted by the
respondents in a survey. This view acknowledges the existence of multiple
philosophies since realities are a function of people’s different experiences.
This philosophy also warns against the formation of researcher’s perspectives
that may influence the nature and content of their interpretation hence denying
the study the objectivity expected (James and Vinnicombe, 2002). The realist paradigm
adopts aspects of both positivist and interpretivist paradigms. It acknowledges
the influence of social conditioning on people’s perspectives and
interpretations while upholding the view that real structures exist
irrespective of people’s perceptions (James and Vinnicombe, 2002). Unlike the
positivist view, realist view acknowledges the existence of realities that are
yet to be scientifically proven. Realist views acknowledge the variations in
cause-effect relationships based on the fact that various circumstances may
influence the outcome and the extent of it. It therefore focuses on explanation
rather than prediction.
Research
strategy determines to a large extent the reliability and accuracy of findings
recorded (Eriksson and Kovalainen, 2008). It is therefore crucial that the
right strategy be adopted for a study in order to guarantee the integrity of
the findings. The strategy adopted is mainly dependent on the nature of
research and the type of information that the researcher seeks to find (James
and Vinnicombe, 2002). Whether the research recommendations are dependent on
qualitative analysis or quantitative analysis is crucial in determining the
strategy to be adopted. Research strategy also entails the focusing on the appropriate
modes of data collection applicable to the study. It is important to accurately
determine the sources for the information sought in order to save on research
time and to ensure the information bears the requisite level of intelligence.
Data collection is always the thrust of any research process and its collection
should bear the greatest level of emphasis when strategising on how the
research is to be carried out (James and Vinnicombe, 2002). Considering the
nature of information sought in this study, the research focussed on both the
secondary and primary data collection methods. The secondary data gives insight
into related research topics and provides crucial information that would cost
the researcher an enormous amount of time and resources to gather through
primary means (Saunders, Lewis and Thornhill, 2007). These secondary data were
collected from reliable sources such as bureau of statistics, industry reports,
economic journals and other reliable sources believed to ensure integrity of
information published by them. These data were specifically useful in
understanding theoretical aspects relating to the subject matter as well as the
provision of figures that give definite indications on the trends in the SME
sector in relation to similar statistics in the establishment of institutions
charged with the responsibility of helping to avail venture capital to SME in
the UK. Primary data collection methods were used in order to collect current
trends as well as to capture any changes in prevailing attitudes and
philosophies in the economy. The main data collected through primary sources
was qualitative as it mainly reflected on the views of the respondents
regarding the subject matter.
This study shall
assume the Realist perspective. This is due to the fact that it concentrates on
the existence of real structures while acknowledging the subjective
interpretations of the same. Investment is a function of the study of the real
risks and market structures as well as the investor attitudes as shaped by their
various experiences. Similarly, the interpretation of the effects of venture
capital on business contains both real and perceived effects based on the
perspectives of the person observing. The study shall seek to establish the
cause-effect relationship between the growth of venture capital in the UK as
well as the perceptions of the business managers and investors on the same
effects. The real segments will entail quantitative analysis based on observed
trends while the interpretivist aspect will involve the gathering of
perspectives in relation to the perceived effects of venture capital in the SME
sector.
The primary data
shall be collected mainly through written questionnaires. The use of written
questionnaires gives the respondent ample opportunities to reflect on the
questions asked before responding with answers that are largely reflective of
their perceptions and attitudes (Chia, 2002). The questionnaires also offer the
advantage of providing data in printed form whose permanence ensures that the
data provided is not prone to loss or misinterpretation. The questionnaires
were designed and taken through a series of experimental testing procedures to
ensure that the questions asked were likely to attract the kind of information
needed in the respondents’ answers. This was meant to minimise the effect of
misinterpretation of questions by respondents as is common in the case of
written questionnaires. The fact that the respondents attend to the
questionnaires without the researcher’s guidance leaves them exposed to
misinterpretations due to the absence of ample and timely interpretations of
the questions asked. This misinterpretation could be two-way: where the
respondent fails to understand the question and provides the answer according
to their faulty interpretation, the researcher, who uses this information
assuming the question was correctly understood, is likely to draw faulty
conclusions in the study. This fact underscores the importance of ensuring the
questions are clear and easy to understand. The questionnaires were
administered through email. This mode of administration proved less costly and
convenient as it allowed for direct communication with the respondents hence
making it easier to monitor the levels of response and ease of follow up. Once
the addresses of the respondents were obtained, the only resource required was
the internet which was readily available, making the research less costly.
The population
of a research refers to the total elements to be considered in a study
(Saunders, Lewis and Thornhill, 2007). It implies the totality of the subjects
on which the findings of the study can be assumed to be applicable to. It is
the broad composition of the subjects that the researcher intends to base his
findings and recommendations on. The population of this study is the Small and
Medium Enterprises (SME) in the United Kingdom and venture capitalists in the
United Kingdom. The SME were instrumental in determining the effects of venture
capital on small businesses while the venture capitalists were instrumental in
understanding investor perceptions as well as the factors that affect the
availability of venture capital to the SME sector. These populations were
viewed to be essential to bring an understanding on the subject matter of the
research.
Numerically, the
UK contains thousands of SME and venture capitalists. In the scope and resources available for this
study, it would be impossible to conduct a survey across the entire population.
It was therefore necessary to come up with a sample for the study. A Sample can
be described as a representative portion of the whole (Saunders, Lewis and
Thornhill, 2007). Samples are believed to bear similar characteristics as the
whole and are therefore expected to provide realistic interpretations that are
largely reflective of the population. The determination of the sample size
needs to take into consideration the time and resources available for the
researcher to conclude a study (Saunders, Lewis and Thornhill, 2007). Where
time and resources are adequate, it is advisable to include larger sample sizes
in order to increase the level of integrity in the findings made. Use of
samples can be highly restrictive in a study such as this one. This is because
a significant part of the study reflects personal perceptions of the
respondents. Perceptions based on unique experiences of individuals may not be
an accurate reflection on the whole population. However, given the
circumstances of the study, the use of samples is an unavoidable necessity,
while acknowledging the uniqueness of the responses, it is expected that the
findings detailed fall within the acceptable margin of error. The sample size was determined to include 300
small and medium enterprises where three respondents per firm were to be
engaged. This sample size was believed to be adequate in reflecting the
realities of the whole economy irrespective of the existence of varying schools
of thought. For venture capitalists, 20 venture capital providers and 20
financial institutions and intermediaries were picked. This sample size was
considered adequate in determining the investor perceptions in the economy. The
sampling process also involves the determination of which individuals to survey
once the sample size has been determined (Chia, 2002). The most common sampling
method is known as random sampling where the researcher randomly chooses them
from the population the number of respondents predetermined for sampling. This
sampling method is suitable where a high level of homogeneity is predicted in
the population (Saunders, Lewis and Thornhill, 2007). Another common sampling
method is judgmental sampling. This method is appropriate for populations with
little or no homogeneity (Saunders, Lewis and Thornhill, 2007). It involves the
deliberate determination of respondents based on the researcher’s perception of
the sample’s suitability in reflecting the views of the total population. This
sampling method is prone to researcher biases and care must be taken to ensure
certain views are not excluded hence giving a biased points of view. This
research combined the application of random sampling and judgemental sampling. Judgmental
elements were applied to determine the broad characteristics of SME that may
have differing opinions based on the geographical locations, nature of
business, and other factors. To ensure a balanced view, the numbers allocated
to these sections were a function of their proportion to the total. Once
potential differing perceptions were catered for, and the numbers per group
determined, random sampling was done to determine the individual firms to be
considered. An element of judgmental sampling also featured in determining the
specific respondents within the firms where most respondents were middle level
and senior managers based on the researcher’s view that they would be best
placed to give meaningful insight into the subject matter. Random sampling was
conducted on the investors segment as well.
Raw data is
often bulky and difficult to understand. The essence of data analysis is to
arrange the data into formats that can be easily understood and the
interpretation of the figures involved in a manner that is palatable and usable
by an average reader (Eriksson and Kovalainen, 2008). Data analysis is an
integral part of any research. It bears an equal weight in terms of importance
as other sections of research. This is because it determines the usability of
any research findings. Data analysis may be done quantitatively or
qualitatively. Quantitative analysis focuses on figures and statistics
(Eriksson and Kovalainen, 2008). It gives real variables and is instrumental in
establishing cause-effect relationships between the variables in question.
These variables hold over long periods of time and can be used to make reliable
predictions over the effects to be generated by certain actions provided other
factors are held constant. On the other hand, qualitative analysis focuses on
generating explanations, perceptions, and interpretations (Eriksson and
Kovalainen, 2008). These are mainly influenced by the respondents’ experiences
and are a function of the social conditioning they may have been through over a
period of time. These perceptions are prone to changes and render studies
obsolete within short periods of time in a rapidly changing economic
environment. Data analysis also entails the use of excellent presentation
skills to enable quick understanding by the consumers of the data. The data
analysis in this study was both qualitative and quantitative. Quantitative
analysis was used to establish the relationship between enhanced provision of
venture capital in the UK and the changes observed in that sector with an aim to
establish whether the effect was positive or negative. This was done by
comparing changes in the movement of venture capital to changes in the
performance of the SME in the economy. This was mainly obtained from secondary
data. Qualitative analysis delved into perceptions and interpretations of the
respondents. The responses were coded to ensure grouping of results to
establish similarity of results and proportions involved in the various
responses. These were numerically numbered to establish the level of dominance
of opposing views and the responses presented in visual charts to help create
understanding.
The application
of related theories relating to venture capital was done to clarify and create
understanding on the meaning of the analysis done. The interpretation models
were also useful in ensuring reliable and meaningful conclusions.
This study
encountered a number of limitations some of which were overcome. The choice of
administering the questionnaires was non-personalised and involved little
contact with the respondent making it difficult to procure their cooperation.
It was therefore necessary that follow-ups be made using phone calls. In some
of the cases, some of the respondents were not accessible by phone and it
necessitated a change of respondent to ensure that the sample sizes were not
significantly reduced. The use of email also came as a source of a hitch. Many
respondents always prefer anonymity when answering questionnaires. The use of
email for administering questionnaires violated this expectation. Once the
questionnaires are sent back to the researcher, it implies that the researcher
has the identity of the respondent hence compromising the principle of
anonymity. The researcher had to make a commitment in writing that the identity
of the respondents shall remain confidential and that under no circumstances
would the identity of the respondents be revealed. The researcher also
expressed acceptance for questionnaires to be sent back through fax for those
who were not at ease with using their emails. This would substantially help
protect the identity of the respondent.
The study also faced the problem of poor response from some quarters.
This may have been attributed to the fact that a significant proportion of the
respondents were senior level managers whose schedules were highly
unpredictable due to the highly dynamic economic environment. This presumably
reduced the amount of time at their disposal that would enable them answer the
questionnaires. Fortunately for this study, enough time had been allocated for
data collection and with subsequent promptings; these respondents were able to
attend to the questionnaires in good time. The problem of loss of
questionnaires was also experienced. These may have been lost by erroneous
deletion from the respondents’ inboxes or where there was an error in the email
addresses of the targeted respondents. This was overcome by making
confirmations via telephone to establish that the respondents were in
possession of the questionnaires. Where lost for any reason, arrangements were
made to quickly give out copies. Some of the limitations that were not overcome
included the unwillingness of some respondents to submit some information and
the inadequacy of secondary data. Some respondents considered certain questions
to be sensitive and were of the view that releasing such information was
tantamount to compromising the privacy of the enterprises. This right to
silence was respected. However, since such cases were isolated, it is the
considered view of this study that the findings can be considered reliable. Secondary
data covering various growth levels in the SME sectors in recent years were not
readily available. In the face of rapidly changing economic environments, this
precipitated a great limitation for the study. This study had to rely on
information from sources that may not be reflective of recent happenings.
This section
details the findings of the study and seeks to interpret them in the context of
research aims and objectives. These results are mainly the reflections of the
900 (three respondents from each enterprise) respondents from the SME sector
and the 80 (two respondents from each investment organisation) from the venture
capitalist sector. To ensure ease of reference, tables and charts have been
used to show the numerical aspects of the findings. The coding used to help in
the data analysis has also been briefly explained. The coding was based on the
level of similarity between the variables based on defined keywords identified
in the responses. A brief overview of the results is as illustrated below:
This study
broadly finds that the rise in venture capital provision often coincided with a
simultaneous rise in the development and performance of small and medium
enterprises in the UK. On the question on whether venture capital contributes
to growth and development of SME, more than 93% of respondents answered to the
affirmative. This is reflective of strong sentiments in support of venture
capital as a source of financing of small and medium enterprises. However,
opinions were varied when the same question rephrased to establish how many
managers would favour venture capital over other forms of financing such as
debt and retained earnings. In relation to these, the preference for venture
capital was a feeble 20% indicating that other forms of financing tend to be
more popular than venture capital whenever a firm is in a position to make that
choice. On the question on the factors influencing investors’ decisions to
invest in a business, the leading factor was the level of information available
and the level of understanding the investors have on the operations of the
business. Lack of relevant information tends to heighten the level of risk
involved hence discouraging investors from engaging in such ventures. The
results from primary data have therefore been categorised into two sections:
that dealing with SME and that dealing with the venture capitalists. The
results from secondary data have also been displayed in tabular forms. These
are figures that have been collected from various reliable sources to help
determine the usefulness of venture capital in enhancing growth and performance
of the small and medium enterprises in the UK. The results are as detailed
below:
The focal point
of the survey was to establish the feelings that the respondents had about
venture capital financing. When asked on whether the use of venture capital
contributes to growth in the SME sector, over 93% responded to the affirmative
stating that indeed venture capital was instrumental in steering growth in new
ventures.
YES
|
NO
|
|
837
|
63
|
|
%AGE
|
93%
|
7%
|
Source: Own
Design
This
reflected a sense of broad consensus on the fact that venture capital
contributes positively to the establishment and growth of SMEs in the economy.
Subsequent enquiries on the level of importance that the SME operators placed
on venture capital revealed that the majority (87%) rated the relative
importance between important and extremely important. This response was assumed
to have been as a result of the experiences of most of the managers who had
intimated that their organisations had at the onset been started off through
venture investment by the owners (some of which continued to play active roles
in the management). Given their acknowledgement of the fact that their
organisations would probable be non-existent without the input of venture
capital, the responses were therefore not surprising. The overwhelming
endorsement of venture capital was clearly in order (from their perspective). The
main reasons cited by the respondents in giving their responses included the
fact that venture capital investors were willing to assume risks not acceptable
by other financiers hence being the missing link required in ensuring the
market potential is explored accordingly through the undertaking of risky
ventures. It was also said that venture capital always acted as a catalyst in
any economy by enabling the creation of new industries through technological
innovations that other market players may find risky to undertake. Venture
capital therefore featured as a crucial medium through which the economy could
be set on an entirely new path. Many of the respondents were keen to draw
comparisons using the USA as the model for near-actualization of venture capitalists
citing it as one of the reasons why their economy has become the strongest in the
world. They also noted the level of development of new technologies and the
economy as a whole due to the renewed interest in venture capital in the UK. However,
despite the overwhelming endorsement of venture capital, many of the
respondents expressed a noticeable level of reluctance to engaging the use of
venture capital in further financing the long term projects of the businesses.
When asked to rank the various modes of financing available to the firms namely
savings, debt and venture capital, a clear majority seemed to favour savings
over the other two methods with venture capital receiving a feeble 20% approval
in relation to the other modes savings at 56% and debt equity at 24%. This is
as illustrated below:
Source: Own design
The main reason
why many managers preferred the use of savings within the organisation was
because it was readily at their disposal and they would need no consultation
with any other parties to put into effect such schemes. Where the savings are
adequate to undertake the ear-marked projects, the managers, with the authority
and finality desirous of them make the final decisions. This is mainly due to
the fact that in many cases, only the managers may fully understand the risks
and rewards associated with various projects and may not want to engage in the
tiresome exercise of convincing other stakeholders of their wisdom. The
preference for debt equity is mainly due to the fact that it is requires lower
rates of return and therefore cheaper for the firm. The respondents also made
the observation that debt financing often does not result in the levels of
ownership changes that can potentially alter the manner in which the firms are
run.
When queried on
whether the investors trust the managers’ assessment of risks involved in
various projects, the managers largely answered negatively. In their opinion,
the investors were mainly not privy to the operations of the ventures that were
intended to be undertaken and felt vulnerable due to the fact that, in their
opinion, the managers were not necessarily motivated by their investment
interests. This, according to the managers often leads to a devaluation of the
stocks where the investors are of the opinion that equity would not be on offer
if the projects were of low risk. The end result is a situation where the
venture capitalists tend to acquire stake in the organisations at relatively
lower prices. This discourages managers from engaging in equity financing.
Besides, equity financing could bring with it major changes in shareholding,
which according to many of the respondents, could lead to management overhauls.
When asked on
whether the level of agreement between the managers and the investors, 85% of
the respondents cited various instances of conflicts of interests that have
potentially led to deteriorating relationships between the two stakeholders.
When asked whether these conflicts could be amicably resolved, 90% of the 85%
responded in the affirmative. The major areas of conflict were the
prioritisation of expansion projects as opposed to paying regular dividends,
and the investor’s bid to limit the benefits that the managers felt they
rightly deserved after working very hard to realise the organisational goals. According
to the respondents, these conflicting interests have had a bearing on the
compensation schemes that the business owners make available to them. Some of
these schemes formed the most popular answer to the question: which investor
action motivates the managers most to realise the investor’s goals. The most
frequent answer was the offering of compensation perks that rewarded the
achievement of certain objectives. In so doing, the managers contended that it
was possible to realise both their personal goals as well as realise the
interests of the investors. When asked to share their opinion on the assertion
that the government has been instrumental in ensuring the availability of
venture capital in the market, the responses were as follows:
Strongly
Agree
|
Partly
Agree
|
Partly
Disagree
|
Strongly
Disagree
|
|
315
|
405
|
135
|
45
|
|
%age
|
35%
|
45%
|
15%
|
5%
|
Source: Own
design
Source: Own Design
Many respondents
were of the opinion that although the government has been very instrumental in
ensuring the growth of venture capital in the economy, a lot could still be
done. The managers proposed the provision of technical know-how to accompany
the venture capital in order to improve the firms’ capability to make superior
returns. The respondents were also of the opinion that the government could
help in research and development programs that would pioneer into targeted
areas with the aim of creating awareness among the potential investors. In
their opinion, the awareness would be useful in reducing the risk on the part
of investors hence encouraging them to invest without demanding undervalued
stocks as a way of cushioning themselves against risk.
Investors on the other hand were subjected to
questions aimed at understanding their preferences and decision making
procedures they would normally take themselves through when taking investment
decisions. When asked why they had chosen to invest in the various ventures
that they had invested in, the respondents provided a variety of responses with
most of them citing the fact that they were optimistic that the ventures in
question had the potential for abnormal growth and would therefore lead to
abnormal profits for the investor. Over 95% percent of the investors surveyed
cited profit maximisation and wealth creation as the most important motivation
that had led them to make the various investment decisions that they had made.
This motivation seemed to override any other underlying motives for making
investment decisions. When asked on whether they would prefer already
established enterprises or invest in new ventures, the investors were
favourable towards the already established ventures with about 63% in favour of
the segment. The reasons cited for this preference was the fact that the
existing ventures tended to pose lower risk of losing the investment since the
decisions are made after evaluating their performance trends and gaining a
certain measure of confidence in their management and operational performance.
This reasoning is in line with the dominating motivation of wealth
maximisation. Those who opted to invest in new start-ups were equally in
pursuit of profit maximisation and wealth creation. In their opinion, the high
risks associated with the new ventures could easily translate into high rewards
the moment the ventures yield the desired results. Some of the respondents
cited various entrepreneurs that had managed to raise world class organisations
by simply effecting certain innovations that had not been given serious thought
in the past. Moreover, start-up ventures tend to be undervalued hence the
investors tend to acquire disproportionate stakes in the ventures and are bound
to be the biggest gainers in the event that the ventures succeed. When queried
on why prefer equity to giving loans through bonds, the principle of profit
maximisation came to the fore again. In the opinion of most of the respondents,
venture capital yields much higher rewards in the long run than debt capital.
Although debt capital is secured and therefore not easily lost, respondents
argued that equity financing gives the investor a permanent stake in the
business where they stand to benefit from it for as long as it is in operation.
The focus then shifted to how these investors ensure their investments are not
reckless and that they are not lost arbitrarily. When asked on how the decision
to invest in the various ventures was arrived at, most of the respondents
revealed a remarkable ability to make various analyses that ensure the risk
assumed is as low as practically possible. The dominating factor was the extent
to which the investors were versed with the operations of a venture. This was
helpful in ascertaining the level of returns that would expect from engaging in
such ventures. Most investors cited their background knowledge into various
fields as the main reasons for their respective investment decisions. The
second most important factor was the strategic positioning of the venture in
serving various needs in the market. A firm with a unique strategic position
would tend to perform better than those that were not equally placed. Thirdly,
the respondents cited the level of commitment of the managing team in the
project. Where the founding managers had invested substantial amounts into the
ventures, respondents argued that it was a reflection of their confidence that
the venture is likely to yield results. Where the pioneering team has little or
no stake, it would be translated as a statement that the venture was too risky.
The investors would therefore avoid investing in it. When asked on whether they
believed in offering more than just the finances, various differences emerged.
There are those who were willing to invest substantial finances and nothing
else, those who would invest finances and offer a little expertise, those who would
offer little finances with a lot of expertise, and those who would offer
substantial finances together with substantial levels of expertise. The
rationale for the extents to which these investors were willing to go was,
according to them, wealth maximisation- again. Those with expertise at their
disposal preferred to help enable the organisations thrive. Those who didn’t
have the expertise, or the time to spare, equally chose to engage themselves
productively elsewhere in order to ensure wealth maximisation in their diverse
investment portfolio.
When asked on
whether they had complete trust in the management teams of the firms in which
they had invested, most of the investors had reservations. Most of them took
cognisance of the fact that the managers may have their own interests to pursue
that may not necessarily be in line with their own. They therefore expressed
reservations and expressed a certain willingness to go out of their way to
monitor certain management activities with an aim to safeguard their interests.
The main ways in which most investors (89%) proposed to safeguard their
interests was by offering incentives to management teams upon achievement of
certain standards. In their opinion, this measure would ensure the managers
remain free to exercise their expertise without being held back by unnecessary
investor actions hence enabling them to realise the targets set with relative
ease.
Asked about the
global market environment and its influence in their investment decisions, the
majority (65%) answered that it could affect their investment decisions. Most
were of the opinion that the increased globalisation has presented enormous
opportunities overseas and given that the ventures in emerging markets
generally had higher chances for superior performance, they would readily
invest in such markets. This of course means that the resources would be
diverted from the local economy and the investors were of the opinion that it
was the government’s duty to ensure that the domestic market remained attractive
for investors in order to sustain domestic economic growth.
Chapter
5: Discussion of the results
This section
addresses the main points as collected from the results in a bid to link them
to fit the research objectives. The results have also been linked to various
theories of relevance to the study. This section has also sought to incorporate
some information that have been collected while reviewing secondary data
sources, although the section mainly addresses itself to the findings of the
primary research as outlined above. This section links the results to the
pecking order hypothesis which largely explains the preference for the various
financing models hence is of relevance to the research topic. It also uses the
results to explain the agency theory which is the theory that mainly explains
the manner in which managers and investors interact with each other. Finally,
this section shall seek to interlink the different components of the results
with some of the recent findings as recorded in the secondary data reviewed.
From the results
above, it is clear that the availability of venture capital is crucial in
ensuring establishment and growth of SMEs in the economy. However, the ability
of the funds availed to fuel SME growth can potentially be hampered by the fact
that many managers of the SMEs do not generally prefer use of venture capital
in financing their long term projects due to various factors that may include
the avoidance of ceding ownership and control. The effectiveness of these funds
is further inhibited by the information asymmetry that exists between the
project managers and the would-be investors. This implies that the business
managers tend to have information that is not known to the investors concerning
the risk of the projects to be undertaken and are therefore better placed to
predict the likely results and returns due to the investors (Pierrakis, 2010).
Since the investors are aware of this asymmetry, they tend to assume that the
willingness of managers to sell equity translates to existence of poor
prospects hence leading to undervalued shares. Business managers, in cognisance
of the workings of this asymmetry tend to avoid the venture capital option in
order to avoid eroding the value of the organisation’s stocks. Some of the
responses by the managers on the importance of venture capital emphasised on
some phenomena that have been echoed by various recent studies. The
latest available estimate of enterprises in the UK places the number at 4.8
million businesses 97% of which are small and medium enterprises (Jones and
Wells, 2010). Most of these SMEs were initially funded using venture capital,
hence underscoring the importance of venture capital to the UK economy. The
SMEs have contributed tremendously to economic growth and development in the
UK. The SMEs have been lauded for their ability to provide employment
opportunities to various persons. In the economy where unemployment concerns
have been raised, SMEs go beyond the already established work parameters to
create jobs which eventually lead to a reduction in the unemployment levels. These
SMEs have also been known to provide better levels of job satisfaction than
their more established counterparts (Jones and Wells, 2010). The closeness
between the managers and the lower level employees often replicates a family
scenario where all members feel highly valued and are in turn willing to go the
extra mile to ensure the company performs well.
The responses by
business managers confirmed the pecking order hypothesis which outlines the
order of preference of financing methods available to the organisations. In
this order, equity financing comes last after savings/ cash reserves, and debt
financing. This low preference for venture capital has seen its use drop from
7% in 2004 to only 2% in 2009 (ACCA, 2009). This poor use of venture capital
may also have been as a result of poor publicity of the various schemes that
the government had effected to help in the provision of venture capital to SMEs
with only about 20% being aware of such schemes and programs aimed at enabling
them attract more venture capital (ACCA, 2009).
Focus was also
drawn to the concept of the agency theory which recognises the conflicting
interests among various stakeholders in the organisation where the business
owners remain weary of the managers and their commitment to maximise
shareholder value through their actions. The acknowledgement of the existence
of various degrees of conflict among the stakeholders provided the needed proof
that the agency theory remains relevant to date and can be used to ensure
better understanding is fostered in the various organisations. The thrust of
the agency theory is the management of the resultant conflicts of interests
through incurring various degrees of agency costs through expenses such as
performance incentives. The results in this study highlighted the fact that
investors tend to act in accordance with the recommendations of the agency
theory where their preferred tool of control happened to be the offering of
performance-based incentives to managers to achieve the given targets.
There was a
general consensus that the government has taken impressive measures to ensure
the availability of venture capital to SMEs in the UK. This has been through the
establishment of various funds in different regions within the UK together with
various training programs designed to prepare small enterprises to attract
venture capital in order to advance their goals. However, reports show that
many SME operators remain largely ignorant of these opportunities with only
about 20% of them being fully aware (ACCA, 2009). This significantly reduces
the effectiveness of the venture capital availed to fund the SMEs.
The results also
ably demonstrated the different kinds of investors in the market. Investors are
normally classified based on the level and type of input they make into the
firms. The capital-oriented investor tends to invest heavily in financial
resources and in little or no non-financial input; the knowledge-oriented
investor invests very little financially but heavily in technical know-how; a
micro investor brings in low inputs in both finances and technical knowledge;
while a business angel is the investor that inputs high levels of technical
know-how and finances in an organisation (Warma, 2010).
The results also
shed the philosophy that guides the choice of firms in which to invest. The investors’
main motivation when making investment decisions is the minimisation of risks,
profit maximisation and wealth creation. As a general rule, investors tend to
prefer to invest in business where they are well versed with the operations of
the venture or project. The due care taken by investors in evaluating the risks
involved in any venture is often indicative of the assertion that investors are
always rational in their thinking- even though experiences may prove this
assertion to be wrong. Equity distinguishes itself as a source of superior
benefits in the case that the business venture performs up to expectations. On
the other hand, debt equity yields constant results and the debt holder does
not stand to gain any additional benefits from the remarkable performance of
the ventures. However, the debt holder is often protected by law and rarely
loses their investment in case of failure of the venture. Another parameter
normally emphasised by investors is the level of commitment into the business
shown by the founding entrepreneurs. This commitment is often in terms of
capital invested into their ventures. A heavy investment is indicative of the
managers’ commitment to the success of the venture as well as a statement of
confidence since it is assumed that such heavy investment would never arise
where the entrepreneur has serious doubts of the project he seeks to run. The
investors therefore ensure that they are reasonably covered before they engage
in the ventures.
The results also
revealed a worrying trend that shows that investors have in recent times made
preference for ventures that are already ongoing and stable. The preference for
large stable enterprises is a probable indication that investors are becoming
more and more risk averse, avoiding unnecessary risks at every opportunity. The
general market trends observed through various secondary data also concur with
the findings of this research where the more and more investors are avoiding
risky start-up ventures in favour of already running and stable enterprises. Although
this move by investors is very understandable, there is a risk of slowing down
the gains already made in stimulating economic development through start-ups
that mainly thrive on innovation. Other environmental factors have also
adversely affected the effectiveness of venture capital for the SMEs. For
instance, the economic downturn in 2008 caused significant drop in disposable
income for many potential investors hence limiting the amount of finances
available to be used as venture capital in the market.
The results also
brought into focus the investors’ views on the influence of the global and domestic
environments on their decision making processes. The rapid globalisation has
made it possible for information and capital to travel across borders with
relative ease. Given the fact that the UK is a developed market, and that most
parts of the world are still emerging markets, the UK investors are faced with
the choice of investing locally in the UK or in the emerging markets where the
potential for growth is enormous. The main aim of any investor is to create
wealth and maximise profits. The rapid globalisation therefore becomes an
impediment as the UK investors may be tempted to divert their finances to high
growth regions, leaving the SMEs in their backyard under-funded and therefore
unable to make significant improvements.
This finding is
further enhanced by the observation that many SMEs once started do not expand
significantly. They remain small for long periods of time and may eventually
close down having never made any significant improvements (Jones and Wells,
2010). This phenomenon comes into being due to the fact that the founding
entrepreneurs tend to avoid venture capital investors who may be willing invest
in their ventures due to their reluctance to cede some level of ownership to
the new investors. Even where such an entrepreneur may be interested in
involving an investor, research shows that very few small business owners know
how or where to access the venture capital from (Jones and Wells, 2010). Other
sources of finances tend to be quite restricted. The use of retained earnings
becomes untenable due to the fact that the small businesses operate in small
scale and very unlikely to accumulate the kinds of savings that could be used
to roll out an effective expansion programme. On the other hand, the poor
financial base makes it impossible for the businesses to secure loans from the
financial institutions. These factors lead to the stagnation of development of
such ventures which remain perpetually small over long spells.
On the whole,
the results, and other reviews leave no doubt about the UK government’s
commitment to ensure that the SMEs are funded. However, it has sought to
largely play the role of a facilitator where the main drivers of the
investments are supposed to be the non-state investors. This implies that the
market for venture capital is largely dependent on the forces or supply and
demand where capital is mainly availed to investment opportunities that offer
the highest and most reliable returns. This fundamental philosophy dominating
the UK market renders the venture capital largely unavailable to the small and
medium ventures (Pierrakis, 2010). The fact is further complicated by the fact
that many entrepreneurs running the SMEs have been found to be less than
enthusiastic about enlisting the services of venture capital to spur their
growth and development. This coupled with the ignorance about the mechanisms
that government has put in place to help the SMEs grow has been the reason for
diminished effect of venture capital on the growth of SMEs in the market.
This chapter gives
a summary the information contained in the whole study and also focuses on
making recommendations on how venture capital in the UK can be made more
effective for the SMEs. The sections also makes recommendations for future
research to build the body of knowledge available regarding the topic.
The private
sector is a major player in the UK economy and the SMEs form an influential
part of this sector. Since the renewed focus on venture capital in the UK after
the World War II, the growth of SMEs in the UK has been remarkable. The SMEs
have grown to become a driver of growth and development in the UK especially in
areas that were previously avoided by entrepreneurs due to perceptions of high
risk. The UK government has subsequently taken various measures that are aimed
at ensuring the availability of venture capital to the SMEs operating in the
UK. However, in the face of changing investor and manager preferences, it is
important to evaluate the effectiveness of the venture capital availed in
enhancing the growth and development of the SMEs in the economy. Various
theories that relate to manager and investor behaviour have also been explored.
The pecking order hypothesis has been used to explain the preferences for the
various methods of raising finances for financing long term projects in the
organisations. This theory places the use of venture capital last after
retained earnings/ savings and debt financing. The interaction between business
owners and the managers has also been focused on using the agency theory. This
theory acknowledges the differences in the interests of the investors and the
managers and is instrumental in ensuring these interests are harmonised in a
manner that does not yield discord. The research was conducted on a sizeable
sample to ensure the views captured were reflective of a significant proportion
of the population. The results were able to show that although the government
remains committed to ensuring venture capital is available to the
entrepreneurs, the level of uptake of these finances have remained below
average. This is due to the fact that the firms tend to avoid equity finance
because it is considered to be more expensive than other forms of financing.
Moreover, equity financing involves ceding a significant amount of ownership,
an eventuality that many entrepreneurs tend to avoid. From the investors’ perspective, the venture
capital in their possession is an asset that must be used prudently, avoiding
unnecessary risks and investing them in areas where it is likely to maximise
profits and create wealth. These basic requirements that the guiding principles
that guide investors in their investment decisions. The effectiveness of the
venture capital to SMEs is therefore a culmination of various factors that need
to meet at a certain confluence before the venture capital availed through
proactive government policies can have the desired effects on SMEs in the
economy.
To ensure that
the venture capital has the desired effect on the businesses, the government
needs to focus on the key factors that lead to its poor performance with the
aim of improving its effectiveness. The avoidance of start-up ventures by
investors is usually as a result of lack of knowledge on the operations of the
different ventures. The government needs to ensure adequate research and
knowledge is available to investors regarding the operations of the various
SMEs that they may be interested in. The government should also be able to
legislate on the requirements for disclosure of information that investors may
find necessary to determine the risk involved in undertaking any of the
investments. The government should also mount awareness campaigns to sensitise
various entrepreneurs on the opportunities available for them to expand their
businesses. This would be instrumental in ensuring the participation of the
over 80% of entrepreneurs who have been found to be ignorant of the
opportunities that they could use to expand their businesses. The cost of
equity is often too high for many entrepreneurs who are usually forced to
forfeit plans of expansion due to lack of financing. The government can lower
the cost of capital for such ventures on the part of the entrepreneur through
making certain tax exemptions. These exemptions would have a two-fold effect:
firstly, the entrepreneurs would be more willing to take up venture capital for
investment, and secondly, the investors would remain willing to invest since
their rates of returns remain high. The government should also spearhead
research and development efforts into areas that would normally result in the
proliferation of various inventions. Such research findings would act as a
motivating factor for the businesses whose cost of operation would have been
reduced drastically. This intervention would encourage entrepreneurs to access
various forms of financing (including venture equity) with the confidence that
the ventures would succeed. Finally, the government should be keen to protect
SMEs from the harmful effects of financial meltdowns. This is in cognisance of
the fact that SMEs are very instrumental in pulling countries out of economic
recession through innovation of new low cost and suitable products, as well as
through the provision of the much needed employment opportunities that are
normally sought after during meltdowns.
Scholars should
consider conducting further research on the relative effectiveness of venture
capital in starting and growing SMEs in the UK as compared to the USA, Germany
and two emerging markets. This would enable meaningful comparisons as well as
demonstrate the influence of various market factors in determining the
effectiveness of venture capital.
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