«Financing innovative entrepreneurship Mahmoud Alinejad, Antonio Balaguer and Luke Hendrickson December 2015 Abstract Surveys in Australia and across ...»
RESEARCH PAPER 8/2015
Mahmoud Alinejad, Antonio Balaguer and
Surveys in Australia and across the OECD suggest that obtaining adequate access to capital is one of
the biggest hurdles to growing innovative firms. This paper investigates the likelihood of firms of
different age, size and innovation intensity to seek debt or equity finance. Our analysis shows a
majority of Australian firms do not tend to seek debt or equity finance in any given year, and that most young SMEs obtain the debt finance they seek. Young innovative firms, particularly the new-to-market innovators, are significantly more likely to seek debt and equity finance than non-innovators. Young innovative SMEs are also significantly more likely to get the equity finance they seek suggesting that there is not an issue with equity finance for young innovative SMEs in Australia. Additional venture capital financing data suggests that fewer high-growth potential, innovative firms are now receiving venture capital despite resurgence in demand. Australia’s venture capital early-stage investments are also very low when compared with OECD countries. This specific equity financing gap may present significant challenges for the diversification and growth of innovative, disruptive firms in Australia JEL Codes: G24, L26, M13, O16 Keywords: innovation, entrepreneurship, start-up, capital market, debt finance; equity finance;
venture capital, high-potential firm
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Acknowledgements We thank the following colleagues for their comments on the paper: Laurie Hammond, Paul Steffens, Martin Jones, Rhys Hunt, Veronica Heard, Martin Russel, David Thomson, Arthur Lau and Will Hartigan. We also thank Diane Braskic and her team in the Australian Bureau of Statistics for providing the data.
Key points This paper uses Australian Bureau of Statistics (ABS) data to investigate the likelihood of firms of different ages, sizes and innovation status to seek and obtain external (debt and/or equity) finance.
The proportion of young innovative Australian SMEs (less than five years old) that seek external finance is around 25 per cent in any given year.
Innovation-active SMEs of any age and any degree of innovation novelty are more likely to seek and successfully obtain debt or equity financing than non-innovation active firms.
The data suggests that debt finance is not an issue in Australia with success rates in obtaining debt finance at around 90 per cent in 2012–13.
Equity finance success rates are considerably lower than debt finance at around 50 per cent. Approximately 4,500 young SMEs seeking equity finance in 2012–13 were unsuccessful.
Venture capital investment in Australia has declined to 0.017 per cent of GDP ranking it low compared to many competitor countries. Unlike many OECD countries, such as the US and Israel, it has not bounced back to pre-global financial crisis levels.
The success rate of firms applying for venture capital investment has fallen from 3 per cent in 2005-06 to just over 1 per cent in 2013–14.
Australia’s early-stage venture capital investments are relatively low. At 0.007 per cent of GDP, it is half the OECD median (0.015 per cent GDP). Surprisingly, mature firms (5+ years) receive a large share of seed and start-up capital.
The data currently available is insufficient to conclude that there is no systemic issue with equity finance in Australia. We suggest new questions be developed for the ABS Business Characteristics Survey to address major information gaps in debt and equity financing of young firms.
Financing innovative entrepreneurship 2
Innovative entrepreneurs can be an important driver of economic growth through the development of new business models, application of new 1 technologies, and creation of new jobs. Access to finance is often necessary for the creation, survival and growth of innovative new ventures. Efficient functioning of capital markets is crucial for entrepreneurs’ access to finance and hence the rates of firm formation.2 While debt financing by financial institutions plays the most significant role in small firm formation after personal savings,3 equity finance is also an important source of finance particularly for technology- or knowledge-intensive firms. Muller & Zimmermann’s (2009) study of 6,000 German SMEs showed that companies with high R&D intensities, such as high-tech firms, need more equity capital and are more dependent on a functioning market for external equity.
As a specialised form of private equity finance, venture capital can stimulate innovation, spur entrepreneurship, and enhance productivity growth.4 The venture capital sector is an important component of national innovation systems, playing an important role in driving innovation and supporting skills development by providing finance and other support to turn novel ideas into innovative outputs.5 Australia performs relatively well against other OECD countries in terms of financial market asset and liquidity measures. 6 Although the absolute size of the Australian stock market is small by some international comparisons, its relatively high liquidity provides opportunities for entrepreneurs and innovators to finance their business activities.7 The stock market capitalisation of listed companies as a percentage of GDP (representing the size of the capital market) was around 84 per cent in Australia in 2012.
Although lower than its heights in 2009 and 2010, this was still relatively high, 1 Hendrickson et al. (2015); OECD (2015b) 2 Kerr & Nanda (2009); Allman et al.(2011) 3 The World Bank (2008) 4 Popov & Roosenboom ( 2009); Davis et al. (2008); Gompers et al. (2005); Gilson (2003);
Gompers & Lerner (2001); Gompers & Lerner (1999) 5 Treasury (2012) 6 The World Bank (2014) 7 In total, 49 companies listed on the Australian Securities Exchange in 2013, a slight increase on the 46 listings of 2012, but substantially less than the 104 new listings completed in 2011 and the 96 new listings in 2010 (partly a reflection of the reduced contribution of small cap listings). There was a shift towards larger IPOs in 2013 compared to 2012, with 96 per cent of all funds raised completed by companies with a market capitalisation of more than $100 million, with the total amount raised from new listings in 2013 just over $8.5 billion (significantly higher than the $2.3 billion average of the past five years). While resource stocks have dominated the statistics in recent years, this was not the case in 2013 (a possible combination of falling commodity prices and reduced investor sentiment).
In a recent inquiry into firm creation in Australia, the Productivity Commission reviewed access to finance for new firms.8 The draft report showed that many new firms do not require external financing; that innovation-active firms are more likely to identify access to finance as a barrier to innovation; and that personal finance is the dominant source of finance for micro and small startup firms. Drawing on a limited body of conflicting evidence the Productivity Commission concluded that equity finance was not an issue for Australian entrepreneurship.
The Treasury’s recent financial inquiry found that new small to medium-sized enterprises (SMEs) have more difficulty accessing bank loans as banks’ business models and expertise are more suited to providing debt finance to established firms, with venture capital more suited to start-up firms in emerging industries.9 Often the business concepts and technologies of innovative start-ups that are not yet generating revenue and that have predominantly intangible assets are judged by financial institutions as unviable investments.10 Firm external funding as a share of GDP shows a current downward trend. 11 The vast majority of young SMEs do not seek external finance instead drawing on personal savings, personal credit cards, family and friends, and personally secured bank loans.12 This paper describes new data on debt and equity financing of young small to medium-sized enterprises (SMEs) in Australia. A particular focus is placed on young innovation-active SMEs and the state of venture capital, using the Business Characteristics Survey (BCS) and Venture Capital and Later Stage Private Equity (VC & LSPE) survey from the ABS (See Appendix A).
8 Productivity Commission (2015) 9 The Treasury (2014)
Innovative entrepreneurial firms are not synonymous either with small and medium enterprises (SMEs) or with early stage firms alone. The OECD
locates innovative entrepreneurial firms at the intersection of three areas:
(1) innovative firms; (2) young and high-growth firms and (3) SMEs.
Source: OECD and World Bank Group (2013) Innovation Policy Platform https://www.innovationpolicyplatform.org/content/innovative-entrepreneurship
The term ‘start-up’ has many definitions due to the variety of usages in government, industry and academia. In this paper we identify ‘start-ups’ as newly created firms (New firms; less than one year of age) that move from the idea stage to seeking finance in order to lay down the basic structure of the firm and start operations.
A ‘young firm’ is a broader definition encompassing new firms and is defined as firms less than 6 years (0–5 years) of age. In some cases in this paper, due to ABS confidentiality restrictions, we have had to use a definition of young firms as less than 5 years of age. See Table 1.1.
We use the term ‘innovative-active firm’ as used by the Australian Bureau of Statistics (ABS) to refer to firms that undertake to develop or introduce new or significantly improved goods, services, processes or methods in a 12 month reference period irrespective of whether the innovation is introduced, still in development or abandoned. All classes of innovation novelty are included in our definition unless noted otherwise. This definition is different from that adopted in the Productivity Commission’s Business set-up, transfers and closure report, where innovative firms are those delivering products, services marketing or organisational processes that are new to Australia or new to the world.
A New to Market innovator is one that has introduced an innovation that is either new to the world, new to Australia or new to the industry. A New to Firm innovator is one that has introduced an innovation that new to that firm only.
Table 1.1: Defining firms by age and size
Notes: The young firm age definition may vary from the above to support data confidentialisation by the ABS. See Methodology.
Source: ABS (2001) Small Business in Australian, cat. no. 1321.0
Debt financing Debt financing refers to funds borrowed by a firm for working capital or capital expenditures by selling bonds, bills, or notes to individual and/or institutional investors. The individuals or institutions lending the money thus become creditors of the firm and often receive a security that the principal and interest on the debt will be repaid. Security involves a form of collateral as an assurance the loan will be repaid, to be forfeited to satisfy payment of the debt if the debtor defaults on the loan.
Equity financing Equity financing refers to the sale of an ownership interest (e.g. shares in an enterprise) to raise funds for business purposes. Equity financing spans a wide range of activities in scale and scope, from a few thousand dollars raised by an entrepreneur from friends and family, to initial public offerings (IPOs) running into the billions by companies like Google and Facebook.