The institutionalisation of venture capital

The institutionalisation of venture capital

Technovation 25 (2005) 599–608 www.elsevier.com/locate/technovation The institutionalisation of venture capital Barbara Cornelius*,1 School of Accoun...

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Technovation 25 (2005) 599–608 www.elsevier.com/locate/technovation

The institutionalisation of venture capital Barbara Cornelius*,1 School of Accounting and Finance, Faculty of Commerce, University of Wollongong, 2522 Northfields Avenue, Wollongong, NSW, Australia

Abstract Venture capital has changed under the influence of a new generation of industry participants. Competition for ever increasing pools of capital, combined with an increasingly homogenized experiential background for venture capitalists world-wide, has resulted in increased risk aversion and a preference for later stage investments than were the standard when the industry first achieved prominence. Thus, government efforts to encourage economic growth through venture capital initiatives will fail unless these programs are carefully targeted toward those able to actively support portfolio companies through skills honed in the workplace. q 2004 Elsevier Ltd. All rights reserved. Keywords: Venture capital; Institutional theory; Private equity

1. Introduction The first use of the term ‘venture capital’ is reputed to have occurred in 1946 in a discussion between J.H. Whitney and Benno Schmidt. Whitney, who had inherited US$ 179 million, had founded an investment development fund whose purpose was to supply capital to those who had difficulty obtaining it from more traditional sources. When Whitney asked Schmidt how this fund could be separated, in the minds of the public, from investment banks, Schmidt suggested the term ‘venture capital’ (Gallese, 1990: p. 33). Whitney’s original impulse to differentiate his fund’s practices from investment bankers worked, at least for a period. Venture capital became synonymous with risky, potentially high return technological investments. Beginning in the early 1980s, those writing about venture capital as well as venture capitalists themselves began to differentiate between ‘traditional’ or ‘classical’ venture capital and venture capital as practiced ‘today’. The industry was said to be “in the process of becoming more structured and rational, more mature and more efficient” (Brophy, 1981: p. 26). Traditional venture capital was still associated with speculation or risk taking with an emphasis on new ventures, often technological ones. It was ‘private’ money, 1

Visiting Professor, Umea˚ Universitet, SE901 87. * Tel.: þ61-2-4221-4004; fax: þ 61-2-4221-4297. E-mail address: [email protected] (B. Cornelius). 0166-4972/$ - see front matter q 2004 Elsevier Ltd. All rights reserved. doi:10.1016/j.technovation.2003.12.001

professionally managed, always growth oriented and always providing management assistance. While venture capitalists did not necessarily take voting control or provide equity, they were always interested in taking rewards through capital gains (Dauten and Welshans, 1951: p. 278). However, a ‘new breed’ of venture capitalist was coming into the industry with the result that investments were being made in later stages of enterprise development (Dizzard, 1982: p. 117; Kotkin, 1984: p. 66). One explanation for this shift in investment emphasis in the venture capital industry was that it had become a “victim of its own successes” (Kotkin, 1984: p. 66). Briefly, investors, seeing the high returns in the industry, wanted some of the action. Money flooded into the hands of venture capitalists who sought assistance in placing this capital under management. They turned to the business schools for apprentices. These new market entrants applied the principles learned in tertiary institutions to their investments, trading off higher returns for lower risks. In addition, the large sums of money under management required monitoring and, with few trained and experienced personnel to participate on the boards of young and struggling companies, investors found it easier to place larger trenches of funds in later stage investments. The transformation in venture capital investing was hurried by the expectations of the fiduciaries of investor groups such as pension funds. Large fund managers were not used to taking high risks and limited the sorts of investments that could be made with their capital (Bygrave and Timmons, 1992).

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Research examining this shift in the focus of venture capital has provided explanations ranging from those already mentioned, such as higher levels of capital (Kotkin, 1984) and the influence of pension funds (Bygrave and Timmons, 1992) to economic cycles affecting venture capital exits through IPOs (Gompers, 1998). However, little research has targeted the changing venture capitalist. It is proposed, herein, to develop an explanation for the changing industry focus based on two tenets of institutional theory, mimetic and normative isomorphism. It is hypothesized that the industry has changed because the practitioners have changed. The experience and training that current venture capitalists bring to their activities are considerably different than those of even one generation ago. The explanations for these differences lie in the nature of the industry itself. Those who would value a resurgence of traditional venture capital may find a solution in the application of yet another tenet of institutional theory, coercive isomorphism. This paper is organised as follows. The next section covers the methodological perspective adopted, explaining the relevance of institutional theory in the venture capital milieu and developing and describing the hypotheses to be tested. The approach to the collection of data to test the hypotheses is outlined and an analysis of that data, undertaken using descriptive statistics and non-parametric tests of significance, is explained in Section 3. This is followed by a discussion of the findings from the analysis as they apply in each region examined. Finally, the implications of this research as it may impact on government initiatives for furthering a healthy venture capital industry are described.

2. Methodology The conditions that have faced venture capitalists over time, in a relatively inefficient market where venture capitalists have more information than have their subscribers (Chan, 1983) suggest that the new breed of venture capitalists have sought legitimacy through mimetic isomorphism as suggested in institutional theory. That is, investors do not place their trust in venture capitalists blindly. Venture fund performance differs one from another due, at least in part, to their heterogeneity (Naqi, 2002) but information about these differences is not readily available to potential fund subscribers. Thus, as rational market players, subscribers will seek information about the quality of agents (venture capitalists) who will be acting for them. Therefore, competition for the investor’s dollar forces venture capitalists to demonstrate their future proficiency in the portfolio company selection process. Investors, because they cannot assume that past performance will be indicative of future performance,

have come to rely on various institutional norms that provide industry players with the legitimacy they seek to portray (Wells, 2001). Those who most successfully convince the investing public of their leadership and reputation receive the greatest proportion of the resources (capital) available. Institutional theory explains how this eventually leads to homogeneity in the organizational culture. DiMaggio and Powell (1983: p. 152) describe the process by which organisations conform. Newcomers, those with the least experience in the field, mimic those who have been operating for a longer period. That copying or “mimetic isomorphism” is greatest where there is the greatest uncertainty. Thus, by copying existing funds, new funds increase their chances for survival (DiMaggio and Powell, 1983: p. 155). Norms (normative isomorphism) are then created within the industry that confer professional status on those adopting appropriate behaviours (Wells, 2001). Governments, too, play a role in the development of institutional legitimacy. Because governments impose rules and regulations to control industry behaviour (asserting coercive isomorphism) and to achieve given ends, those companies who receive the benefits of government initiatives are seen as having greater legitimacy than those who do not receive those benefits. Thus, the certification hypothesis, described by Lerner (1998), also indicates to potential investors which funds are worthy of their support and as a consequence, influences the behaviour of venture capitalists. If the institutional theory of mimetic isomorphism holds in the venture capital arena, then we should be able to see an increasing similarity between venture capitalists over time. As their business skills are employed by venture capitalists in daily operations to add value to their portfolio companies, these ought to be analogous across international boundaries. Thus, it is proposed that business experience be used as a proxy for similarity when testing for homogeneity among venture capitalists. By examining a group of venture capitalists at one period (T1) and then examining those operating in the same region at a later period ðT 1 þ T 2 Þ it should be possible to determine if they show an increasing homogeneity over time. Although cultural differences compound heterogeneity, it is intended to compare venture capitalists for homogeneity across regions as well. The first hypothesis, therefore, is: H1. Venture capitalists at time T1 have more diverse experiential backgrounds than do venture capitalists at time T 1 þ T 2 . Another aspect of institutional theory holds that ‘like’ training leads to standardization or ‘normative isomorphism’. An earlier paper by the author, in concert with Scandinavian colleagues (Isaksson et al., 1999),

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demonstrated that there is, indeed a similarity in practices among venture capitalists in Sweden in terms of the covenants selected for inclusion in venture capital contracts. The training received by those venture capitalists, however, and of those in other parts of the world, has not to this author’s knowledge been previously examined. If normative isomorphism is, indeed responsible for, or at least a contributor to, the similarity in venture capitalists’ investment and contracting choices, then that proposition, too, should be testable. Hypothesis 2, then, is intended to test the degree of homogeneity in venture capitalists’ training. Again, training may vary over time or across regions but if institutional theory holds, there will be greater heterogeneity in the educational backgrounds of venture capitalists the earlier we examine players in the industry. The second hypothesis, therefore, is: H2. Venture capitalists at time T1 have more diverse educational backgrounds than do venture capitalists at time T 1 þ T 2 . The influence of coercive isomorphism or the influence of rules and regulations upon venture capitalists cannot be tested by examining the characteristics of the venture capitalists themselves as much as it can be tested by examining the conformity of their strategies with the stated ends of government policies. Through their initiatives, governments have a strong influence over the “financial instruments that will be designed and used, and also which type of investor (e.g. banks, pension funds, individuals) will provide the funding” (OECD, 1996: p. 34). That is, governments regulate industry in order to achieve targeted ends (NUTEK, 1994). Because venture capital is believed to encourage entrepreneurial development and further economic growth, governments provide direct and indirect incentives to the industry (McKeon and Ryan, 1989). What is it that governments believe they are supporting? For several decades, OECD countries have, with few exceptions, been attempting to increase the supply of capital to SMEs (OECD, 1986). The literature has consistently defined venture capital as that provided “to finance growth oriented small and medium sized enterprises (SMEs)” (Coutarelli, 1977), or as capital committed “for the formation and setting up of small firms” (OECD, 1985). It is “financing extended to an emerging growth company” (Brophy, 1981), that provided to “unlisted potentially high growth businesses” (Cornelius and Cooper, 1994) or to “investments in privately held, high growth companies” (BIE, 1987). That is, venture capitalists as perceived by policy makers have goals similar to their own. Thus, the success of government initiatives or the measure of coercive isomorphism on venture capitalists can be measured by the extent to which

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they are involved in the formation or setting up of unlisted, emerging, growth oriented SMEs. Which leads to the third hypothesis, which is: H3. A high proportion of venture capital investments are made in the early stages of new venture development.

3. Data collection Hypotheses 1 and 2, involving the increasing influence of mimetic and normative isomorphism over time, were examined through a longitudinal study. A generational change occurs, according to researchers, about every 17 years (Anthes and Lee, 2001). As a consequence, data were collected on the characteristics of venture capitalists from the current period (2002) and from the mid-1980s. Annual reports from Australia and the US were used to gather past data while current data were gathered from venture capital web sites linked with regional Venture Capital Associations1. Data on 160 venture capitalists working in 38 venture funds from both Australia and the US were collected to determine the experience and education of industry players in the mid-1980s. The second generation of venture capitalists to be examined included another 192 industry players working in 27 funds operating in 2002. The homogeneity or heterogeneity of experiential and educational backgrounds was further examined by including broader cross sectional data including information collected from funds operating in Europe and Hong Kong in 2002. In all, data on 86 separate venture capital funds from four regions, Australia, Asia (Hong Kong), the US and Europe and involving 521 (Australia, 192; Hong Kong, 69; US, 178; Europe, 82) industry specialists made up the database. Hypothesis 3 was examined using two methods for assessing current investment preferences of venture capitalists. That assessment is based upon the strategies of only those funds randomly selected and making up the 2002 portion of the collected data as well as on existent published references to investment stage preferences in venture capital in various regions. Those 59 funds were also assessed on a variety of determinants of their investment strategies. Most made explicit statements about their investment philosophies but even where these were absent, average amounts of capital invested per portfolio company in each round, plus statements about the worth of portfolio companies at the time of investment, made fund stage preferences clear. 1 Given the vast number of potential investors to be found on the internet, the linkage with venture capital associations assured that those studied would be defined, at least by their peers, as venture capitalists. The funds examined were picked randomly from these web pages.

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Spreadsheets providing information on the company, its officers and their qualifications as well as their background experience were put together in separate matrices depending upon the year and the origin of the company. No significant differences in the backgrounds and qualifications of venture capitalists were observed between larger and smaller funds. Qualifications obtained were first classified as undergraduate or postgraduate with information upon the type of degree also collected. It was apparent that a difference occurred over time in the number of industry participants who were certified or chartered public accountants, thus this information was also included in the matrices used for comparative purposes. Experience, as a category, required a large degree of subjective judgment based upon information provided. For example, information on the background of a venture capitalist could range from a list of directorships to specific named companies founded by the individual. All publicly provided information on venture capitalists’ experience was divided into one of five categories. These categories included financial management and consulting; industry experience; business law; government employment and ‘other’. Thus, a research physicist would be categorised as having ‘other’ experience as would a trial judge or medical doctor. The first category, ‘financial management and consulting’ was combined as experience in these areas has less to do with creating wealth than with controlling it. ‘Industry experience’ was also a broad category, including as it did everything from managing a restaurant to being a managing director of a major listed company. Those employed in industry to manage the finances of a firm were categorised as having industry experience. The latter category, industry experience, appears to be vital to a venture capitalist if he or she is to add value to a portfolio company. That is, actual experience rather than theoretical, knowledge is assumed to provide greater aid in the development of portfolio companies. Those in the areas of business law or government employment were less difficult to categorise as people either were or were not employed in these areas. An analysis of industry players, using descriptive statistics, was undertaken using SPSS for windows. First simple frequencies were employed to determine the percentages of individuals falling into various categories. It was apparent that changes had occurred; Chi-squared tests were then run to determine the significance, if any, of these changes (Table 1). The educational qualifications of venture capitalists were also summarised. Both MBAs and specified business degrees were counted together in the category of ‘business degrees’ while MBAs were also considered independently of other qualifications. The other broad areas that were often listed in annual reports and on internet sites included legal training and engineering (including but not limited to IT areas). Information about accountancy certification, at times provided without

Table 1 Sampled venture capitalist experience/backgrounds

Financial Industry Other

US 1987

US 2002

Australia 1987

Australia 2002

Hong Kong 2002

Europe 2002

54% 36% 10%

40% 54% 6%

32% 49% 19%

64% 23% 13%

55% 34% 11%

56% 31% 13%

Table 2 Qualifications of sampled venture capitalists US US 1987 2002

Australia Australia Hong Kong Europe 1987 2002 2002 2002

MBAs 41% 48.5% 18% Business 64% 64% 48.5% Accountancy 8% 4% 16% Law 9.5% 6% 7.5% Engineering 16% 30% 12% Higher 33% 23% 16% degrees

37% 68% 29% 16% 9% 8%

32% 68% 20% 0.5% 15% 25%

33% 69.5% 30% 2% 17% 34%

information about educational training, was included in a separate category. Other qualifications were so broadly spread that they were not specifically included in the summary tables or the analysis. However, the number of postgraduate qualifications in any discipline, apart from MBAs, has also been included in the summary tables (Table 2).

4. Analysis Chi-square tests were run to determine whether there were significant as well as apparent differences in experiential and educational variables over time and between regions. The calculated r value, in all cases, was extraordinarily small indicating that the changes in the experience levels were invariably significant. First, the two countries where information was available on venture capital funds from both 1987 and 2002 were compared. It was expected, as indicated in Hypothesis 1, that there would be a significant difference between the experience of venture capitalists from one period to the next and that those in the earlier periods would have significantly more diverse backgrounds. Less anticipated but also significant was the difference in the background experience of venture capitalists from one region to the next. Hypothesis 1 was partially supported; venture capitalists from the earlier periods in Australia had more diverse experiential backgrounds than do their current counterparts. Venture capitalists from the US, however, appear to have had more diverse backgrounds a generation ago than they have today. Those venture capitalists from Hong Kong and

B. Cornelius / Technovation 25 (2005) 599–608 Table 3 Changes in venture capital experience/background over time 1987/2002

USA Australia

Pearson x 2 Pearson x 2

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Table 4 Changes in venture capital experience/background over regions

Value

df

Asym. Sig. (2-sided)

12.26 44.053

2 2

0.002 0.000

the European Union most closely resemble venture capitalists in Australia today (and the US a generation ago) (Tables 3 and 4). Variations in educational levels were also examined using Chi-square tests. These were run based on the number of people in each time period/region that had particular qualifications. Again, the Chi-square tables represent a bivariate analysis of the same generational spread in both the US and Australia. The test was run first to determine any significant variation over time in the numbers of MBAs, business degrees and higher degrees and, secondly, on these degrees plus qualifications in accountancy, law and engineering. Hypothesis 2, stating that earlier generations of venture capitalists had more diverse educational backgrounds than the current generation, appears to be supported in both regions. There are fewer higher degrees outside of business in both Australia and the US. There has been an increase in business qualifications in both countries, although this change is smaller in the US than in Australia and appears to be offset by an increase in engineering qualifications among current venture capitalists. Venture capitalists from Hong Kong and Europe closely resemble those in Australia in terms of their business qualifications (Table 5). Current investment preferences of venture capitalists, in all regions, have been studied extensively. If there is a correlation between these preferences and the policies initiated by governments to promote new enterprise growth and development Hypothesis 3 will be supported. Asian venture capitalists, in the early 1990s as the industry really began to take off, made some investments in early stage ventures but the majority of private equity was and continues to be invested in the high growth technology and life science sectors; management buy-outs predominate2 (Naqi, 2002). Despite this accord among researchers, the Asian Venture Capital Journal (AVCJ) states that only 14% of total investments are made at these later stages (AVCJ, 1999). According to the AVCJ (1999), 39% of venture capital is invested in seed and start-up financing in Hong Kong. Again, this is contradicted by recent reports that suggest that venture capitalists in China, including Hong Kong, are becoming 2 The statistics given in Table 1, based on information from the Asian Venture Capital Journal, contradict this common assertion among researchers. This may be a result of one group looking at the total number of investments while the other is examining capital contributed.

USA and Australia in 1987 All regions in 2002

Pearson x 2 Pearson x 2

Value

df

Asym. Sig. (2-sided)

17.088 54.965

2 6

0.000 0.000

Table 5 Qualifications 1987/2002

USA 3 degrees USA 6 degrees Australia 3 degrees Australia 6 degrees p

Pearson x 2 Pearson x 2 Pearson x 2 Pearson x 2

Value

df

Asym. Sig. (2-sided)

25.896 32.353 45.216 10.992

2 5 2 5

0.000 0.000 0.000 0.052p

This latter is significant at 5% only.

increasingly “reluctant to get involved in start-ups” (Slater, 1998). Hong Kong’s investments in the expansion stages, again according to the AVCJ (1999) is said to make up 47% of the total. The European industry, essentially beginning in the mid-1980s, has never focused on early stage investments and had been primarily known for late stage and nontechnological investments (Rausch, 1999). A study by Manigart et al. (2002) randomly sampled venture capitalists from four European countries and the US. They felt that their results were “representative of the countries studied” (p. 300) despite the data on investment stages being different from that put out by the European Venture Capital Association (based upon 28 countries). The stage distribution of investments, in the Manigart study suggests that only 17% of investments in the European countries sampled3 were in early stage companies. The EVCA reports 33.6% of investments at this stage (EVCA, 2002). At the other extreme, 50% of the European countries in the Manigart sample were involved in acquisitions, buy-outs and other late stage investments, compared to 45% in the EVCA study. Finally, the Manigart study equated European and American investments in expansion and development capital (33% and 31%, respectively) while the EVCA study suggested a much higher proportion of investments were made at this level (65.6%). The Manigart study, having focused on major players within the European Union, will be used for comparison purposes as shown in Table 6. Still relying on the Manigart study, 46% of US investments are in early stage companies, 31% in expansion and development 3 17% in the UK, 12% in France, 21% in the Netherlands, 18% in Belgium (Manigart et al., 2002: p. 299).

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Table 6 Current investment preferences of venture funds as a percentage of the total Early stage investments

US Hong Kong Australia Europe

Expansion stage investments

Acquisition, buy-out and other investment stages

Literature

Sample

Literature

Sample

Literature

Sample

46 39

41 20

31 47

47 20

23 14

12 60

30.2 17

20 21

52.5 33

20 36

17.3 50

60 43

capital and only 23% in acquisitions, buy-outs and other late stage investments. Australia, according to the Australian Venture Capital Journal (Anon., 2001a: p. 8), has had an upsurge in early stage investments of 28% at the seed level and 50.7% at the start-up level. This translates into 30.2% of invested capital being placed with early stage portfolio companies. Also providing a strong contrast to the European environment and appearing similar to its Asian neighbour Hong Kong, Australia claims only 17.4% of investments in the later, acquisition, buy-out and other category. The largest proportion of capital invested in Australia is said to be placed in expansion stage developments, 52.5%. However, before assuming that Australia and Hong Kong are investing on a par with the US, a reminder, definitions of stages change from country to country. In Australia “investment in small listed companies [is considered] as expansion phase investment” (PDF Registration Board, 1997– 1998: p. 7). While no similar corrosion of terms has been identified in Hong Kong, the numbers involved would suggest that these definitions should be investigated more closely4. Table 6 provides a summary of the investment stage preferences for each country as suggested in the literature reviewed and contrasted with the investment preferences of the 59 randomly sampled funds from the regions used in this study and active in 2002. The venture capital funds used in this study stated investment preferences which do not correlate highly with the stage preferences given in the literature reviewed5. The majority of the venture funds in every country except the US gave mergers and acquisitions or buy-outs as their preferred 4

The average fund size in Hong Kong is US$ 100 million (Naqi, 2002). The average number of professionals per fund is 5.7 (Cornelius and Naqi, 2002). Given 39% of investment dollars are said to be made in early stage funds, each professional is managing over US$ 16 million in such investments. Early stage investments generally absorb less than US$ 1 million in the first round. Time factors alone would indicate that each professional in Hong Kong could not be managing this load and later stage investments as well. 5 Arguably, a lag between research and publication could account for some of the difference between the sample of venture capitalists used in this study and the reported investment preferences of venture capitalists in the previous studies. If this is the case, however, it only reinforces the view that preferences are now severely skewed to later investment stages.

investment strategy. Those listing expansion stage investments as a preferred strategy were expecting to invest between US$ 2 and 15 million or more in the first or second round of funding for a portfolio company. By contrast, US firms giving this preference stated that they would invest from US$ 1 to , 5 million. What is notable is that the anecdotal evidence suggesting a move away from early stage investments and toward later stage strategies, as suggested by researchers already mentioned (Slater, 1998; Rausch, 1999; Naqi, 2002;) is more evident in the randomly sampled funds used in this study than in the reports prepared by national venture capital associations such as the European Venture Capital Association, or the Asian or Australian Venture Capital Journals. Hypothesis 3, proposing a high proportion of early stage investments, arose from the current efforts of governments to support early stage ventures and economic growth through initiatives promoting venture capital. It would appear, from this analysis, that coercive isomorphism is not affecting the strategies used by venture capitalists in making their investment decisions. That is, Hypothesis 3 is not supported in the literature as the greatest proportion of investments, outside the US, are made in expansion stages of venture development. Hypothesis 3 also fails to be supported in the sample data where, again outside the US, the greatest proportion of venture capital investments are made in acquisition, buy-out and other late stage ventures.

5. Discussion 5.1. The Australian case Simply in terms of frequency, there are far more individuals in the current crop of venture capitalists with business degrees than there were a generation ago. Australian venture capitalists today are more likely to have an MBA and less likely to have an engineering or science degree than they were in the mid-1980s. It is also apparent that there are far more certified or chartered accountants operating in the industry than there were in the past. Along with this latter qualification, there has been

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a significant increase in the number of venture capitalists who list their experience as financial management or consulting rather than providing evidence of specific industry experience. In fact, the level of industry experience mentioned has been more than halved in the Australian sample. Both Hypotheses 1 and 2 are supported by the data in Australia. Given the training and experience of Australian venture capitalists, it is not surprising that their preference is for later stage investments. Whether these investments are in the expansion stages, as claimed in the literature, or in the merger and acquisition or buy-out stages as demonstrated in the sample data, the emphasis is clearly not on early stage (seed and start-up) investments. This has occurred despite the attempt to promote early stage venture capital investments in Australia that began 20 years ago with the Management Investment Company (MIC) Act of 1983. This Act, according to its authors, was intended to create funds that would cater to the requirements of businesses needing seed capital (BIE, 1987). The scale of these MICs, with relatively low levels of capital under management6, meant that investors could not directly finance projects needing AU$3 –5 million dollars in the later stages (some of these funds had less than AU$5 million to invest (DITAC, 1988)). The MIC program, however, ended in 1991. The MIC program was followed by Pooled Development Funds (PDF) in 1992. This program too, was designed to ‘encourage the provision of patient equity to small or medium-sized Australian companies’ (PDF Act, 1992: p. 2044). However, the scale of the funds was much larger and investors preferred later stage investments including but not limited to those in newly issued ordinary shares. These investments were allowed, provided the total value of the company did not exceed AU$30 million. Yet another initiative, to try to re-orient venture capitalists in Australia toward early stage seed and start-up portfolio companies, was the creation and support for Innovation Investment Funds (IIFs). Australian policy makers hope that this will encourage traditional venture capital by increasing the upside potential for investors, and by “develop[ing] fund managers with experience in the early stage venture capital industry…[thereby creating] a self-sustaining Australian early stage, technology-based venture capital market” (IIF Program, 1997). The funds were expected to have a 10 year life, and to invest in small (annual revenue below AU$4 million) firms. They were to have sufficient money (AU$30– 50 million) to continue to operate over the life of the fund. Given 6

A AU$20 million maximum of tax concessional capital could be raised by MICs in any given year (McKeon and Ryan, 1989: p. 384). Only venture capital companies that were licensed by the MICLB could raise tax concessional capital, and this only within prescribed amounts. Investors in MIC’s received a 100% tax concession on their investment with claw back provisions if the capital was withdrawn prior to 4 full years. Thus, the maximum size of MICs was AU$40 million.

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the limited level of early stage investment in Australia, however, Hypothesis 3 is not supported. 5.2. The American case The early sample from the US, randomly selected from Silver’s guide to practitioners published in 1987 (Silver, 1987), suggested some contrasts with the data from the same period in Australia. There were, for example, fewer first qualifications in commerce7 but a similar number of MBAs. What stood out, however, was the disproportionately smaller proportion of qualified accountants with careers in venture capital. The change that has occurred in the sample of venture capitalists from the US is the reverse from that in Australia. Where Australia appears to be moving away from industry experience and qualifications other than business ones, the US is moving toward greater levels of experience in industry and a higher proportion of degrees outside of business, particularly in engineering. This is clearly due, at least in part, to the greater American emphasis on investments in IT. It may also be a move back toward the skills, qualifications and experience of venture capitalists as they were originally configured. The increasing heterogeneity among American venture capitalists over the last generation negates the first hypothesis and fails to lend a great deal of support to the second one. The US has had a very successful venture capital market with relatively limited supports put in place by the Government. The US Small Business Investment Companies Act of 1958 increased the number of participants in the industry but at some expense to investment strategies previously employed. That is, the leverage offered by the Government encouraged fund managers to put a greater emphasis on debt strategies rather than equity strategies when distributing their own capital to portfolio companies. Many of the SBICs dropped out of the program during periods of rationalization that were largely driven by tax changes. The major impact that US legislators appear to have had on venture capital comes from two areas that have been difficult for researchers to separate. That is, the Employee Retirement Income Security Act (ERISA) enhanced capital availability for small firm growth through encouraging the participation of pension funds. However, alterations in taxation during this same period clouded any assessment of the impact of this legislation as some of the increased funding may have been due to decreased capital gains on such investments. Nonetheless, it is apparent from the data that US venture funds do invest in early stage portfolio companies supporting Hypothesis 3. 7 This may be a result of the way degrees are listed. That is, a Bachelor of Arts or Science in the US may represent a Bachelor of Economics or Accountancy but, it is not specified as such. The number of commerce undergraduate degrees may be under-represented in the data.

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5.3. The European case The business qualifications of the Europeans are similar to those of the Australian’s whose industry began at about the same time. Business qualifications and financial experience are the predominant characteristics of all but the American venture capitalists in 2002. The homogeneity among these industry players, especially in regard to accounting qualifications, contrasts strongly to any generation American practitioners. Thus, the European data tend to support Hypotheses 1 and 2 on a cross sectional basis. Policy makers in Europe are trying to increase SME access to venture capital (Bottazzi and Da Rin, 2002). It is difficult though, given the fact that policies vary from country to country, to generalize on the extent of pressure that arises from coercive isomorphism in the region. The European Commission, since the Edinburgh summit, has charged the European Investment Bank (EIB) with the task of managing a European Investment Fund (EIF) tasked with the support of SMEs both through loan guarantees and capital for infrastructure (Anon., 1993). Given the low level of early stage investments, using either the sample data or the literature review, Hypothesis 3 is not supported in Europe. 5.4. The Asian case Venture capitalists in Hong Kong have established a profile very similar to that of the Europeans. The predominant experiential background of practitioners is in the financial market. It is interesting to note that the venture capitalists in Hong Kong, as those in Europe, have a greater proportion of higher degrees, matching or exceeding those in the US and far exceeding those in Australia. However, the educational background of these industry participants is, largely, in the business disciplines. Thus, both in experience and education, the training of venture capitalists in Hong Kong tends to support the hypothesis of increasing homogeneity suggested in Hypotheses 1 and 2. The Chinese Government attempted to kick start venture capital in the mid-1980s with the state-owned and funded China Venture Investment Corporation. This was intended to invest in early stage new high technology ventures which would have a socially responsible impact in China (Lau, 1999). The China Venture Investment Corporation folded after having little, if any, impact on SMEs. In 1992, an Industrial Technology Centre was created in Hong Kong to provide funds for start-up hi-tech ventures, as well as support facilities and low-rent space for hi-tech firms. Additionally, a recent report from the Government of Hong Kong recommends the establishment of four programs to assist small firm development. These include two funds which provide capital or capital guarantees (a loan guarantee fund and a development

fund) and two which assist in the training of SME owner/ operators (a marketing/export scheme and a training scheme) (Anon., 2001b). Despite these initiatives, early stage investments are avoided by Hong Kong based venture capitalists. Thus, once more, Hypothesis 3 is rejected.

6. Conclusions and implications Venture capitalists are and have always been as riskaverse as any rational investor (Wells, 1974: p. 161). However, the strategies employed by venture capitalists to minimise risk have varied over time and space. Traditional venture capitalists were often individuals who had retired from successful business ventures. Hence they brought a repertoire of business skills and contacts as well as money to the endeavour. Entrepreneurs came to value these contributions as much if not more than the financial assistance provided (Sweeting, 1991: p. 6). Venture capitalists used their specialised knowledge to inform their due diligence, and their expertise in particular areas to assist their portfolio companies, thus directly reducing the risk of their investments. The success of the early venture capitalists, who managed the risks of their portfolio companies with their own expertise in business development, created phenomenal economic growth. This attracted more money to venture capital which, in turn, attracted new players to the industry. By the early 1980s a shift had occurred in the levels of experience held by venture capital managers. Those with 15– 20 years of experience were superseded by those with only 2 – 3 years (Dizzard, 1982: p. 106). The majority of the new generation of venture capitalists were said, in the 1980s to have a business school background (Dizzard, 1982: p. 106). The need to draw on a less experienced, albeit a well-trained, new generation of venture capitalists resulted in a gradual shift of emphasis in venture capital (Ham, 1984: p. 22). Those with business school backgrounds approached investments more conservatively than did their predecessors. Their training re-enforced their conservatism and altered investment strategies moving them away from early stage investments. Given the need to decrease uncertainty and to control risk, the newer venture capitalists employed investment strategies that included a predominance of late stage companies in their portfolios. A second risk reduction strategy, diversification, was also employed as the new generation of venture capitalists invested in an increasing variety of industries (Sexton and Kasarda, 1992). The norms in the industry changed. Hence, the change in venture capital trends that started in the early 1980s in the US spread throughout the world as new industry participants sought legitimacy by adopting the strategies of those already recognised as leaders in the industry.

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The industry now appears, worldwide, to be governed by qualified MBAs who make relatively (compared to the past) conservative investments in diverse industries. The “new” players are financial managers who have great skill in conserving wealth. They do not come to venture capital with industry experience to draw upon in assisting a portfolio company to overcome the pitfalls associated with growth. Apart from the US, the emphasis has not been on early stage investments. Where the Europeans have openly placed their greatest faith in buy-outs, turn-arounds and other late stage investments; venture capitalists in Hong Kong and Australia have, ostensibly, concentrated on expansion stage developments. However, ‘expansion stage’ as defined in these countries, appears to include many of the later stage investments preferred in Europe. Significant changes have occurred in the venture capital industry. New entrants have become established players. Venture capitalists want to maintain their reputation and do so through standardised choices. They depend upon their reputational capital for their very survival. The profile of the industry has, as a consequence of these institutional factors, changed significantly. The basis for venture capital decision-making continues to be profit maximization but the approach to that end has changed along with changes in the skills and training, the background of practitioners. As venture capitalists became more homogenous they sought to minimize their risk taking through diversification and later stage investments. It has been shown that the training of venture capitalists has changed over the past 15 years. At the same time, it can be demonstrated that the strategies employed by venture capitalists have also changed in parallel with their training. If government’s are to promote economic development through venture capital initiatives, there should be a reconsideration of which players should be supported, that is, there should be a re-evaluation of what it means to be a venture capitalist. Government efforts to promote the industry need to change. Rather than focusing on initiatives that increase the capital available to all players in the industry, there should be some consideration given to the types of players most likely to adopt strategies that will begin to close the finance gap. If governments are going to create economic growth through legislative initiatives, they will need to use policies that target appropriately trained and experienced investors. Having skills in accounting or experience in funds management is insufficient justification for appropriating funds from government programs intended to support early stage growth firms.

7. Further research The institutional approach, used in this research to explain the historical changes in venture capitalist’s activities, would be strengthened if the examination took

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in earlier generations of industry players. Additionally, an analysis of the training undertaken, at what schools and with what emphasis, as well as an indication of where venture capitalists were apprenticed, would better test the mimetic and normative isomorphic institutional assertions than the generalised degree and experience data collected for this paper has done. It is likely that funds managed by venture capitalists entering this industry at a later stage in their careers are better able to leverage their investments with management support. This proposition has not been tested as data on the age of venture capitalists and specific data on other work experience were not available when the research began. While no difference in the training of venture capitalists from funds of different sizes was apparent in the data, size, as measured by capital under management, and the number of employees per fund, has an impact on investment strategies and should be examined in more detail from the institutional perspective.

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Dr Barbara Cornelius holds a BA (Cum Laude) from Georgia State University, US; and an MEc (Finance) and PhD from the University of New England in Armidale, NSW, Australia. She is currently employed by the University of Wollongong, in Wollongong, NSW, Australia. Prior to becoming an academic, Barbara worked for an American venture capital firm providing an assessment of and advice on investment opportunities. Her publications have been in the fields of venture capital, small business finance and entrepreneurship and she has presented seminars and lectures on venture capital in Europe, Asia and Australia.Barbara was a founding member of the Small Enterprise Association of Australia and New Zealand and has also been active in local and regional initiatives to promote small firm access to capital for growth and development. She is a Board member of a small business incubator in the Sutherland Shire, Sydney, Australia.