Added Value from Venture Investors: the Case of Healthcare Biotechnology in Scotland and Cambridge (UK)

Introduction 
 
2 
the cluster to look for respectively other opportunities and investors. This suggests that 
activities within a cluster may be more geographically bounded. Consequently, other 
locations may face the so called regional equity gap, i.e. not enough risk capital for all 
potential opportunities that appear, or a lack of sufficient opportunities to attract venture 
capital. 
To analyse this context in more details, another dimension is worth of investigation, 
that is, the demand side of venture capital. High-tech sectors looking for venture capital 
have different characteristics regarding the extent of technological opportunities, 
appropriability regime, nature and capital intensity of R&D activity, etc. Venture capital 
evolved in the US and in Israel with respect to the financing needs and development of the 
ICT industry. Since the Second World War and particularly after first discoveries in the 
70s, even biotechnology has been an area included in the priorities of universities, public 
sector agencies, governments and industry globally. Governments have promoted the 
development of research capabilities in this area as well as the formation of new 
biotechnology firms. The creation of biotech start-ups has then been both pushed by 
technological opportunities that have stemmed from biological research and pulled by 
many unmet medical needs (sometimes very huge for drugs that can achieve more than $1 
billion of revenues). However, the drug discovery and development process is very long-
term, costly, uncertain and risky. It may take 17 years and cost $800 million for one single 
drug (Burns, 2005). The drug has to pass over several approval steps required by 
regulatory bodies, and thus it may not succeed at some stage because it does not show 
adequate toxicity, safety or efficacy. Therefore, a purpose of this study is to understand 
what matters for investment decisions in this particular technological area, which shows 
opportunities and risks different from ICT. Moreover, both Cambridge and Scotland have 
got pre-eminent research in this area, but the first has been able to grow a renowned 
biotech cluster autonomously, while the second has needed a strong influence from the 
government to develop a life-science sector. Being more activity in Cambridge, the 
literature suggests that venture capital would be more available there than in Scotland. Our 
aim is thus to comprehend if and why venture investors would be more willing to invest in 
biotech companies in Cambridge than in Scotland. 
The relevance of this study hence derives from the importance of venture capital 
for economic systems and biotech firms. While the physical size of these companies may 
be small, resourcing and financing issues associated with major long-term and expensive 
R&D programs are significant (Hine and Kapeleris, 2006). Founders’ money and initial 
cash flows are generally not enough to finance further research, development and growth. 
External capital providers are thus essential, but traditional financial institutions such as 
banks are not willing to supply them with loans. First of all, high-tech start-ups tend to lack 
tangible assets (especially in biotechnology), which are extremely important, since they are 
required as collaterals, to get debt. Being mostly intangible and knowledge-based, assets 
are not easily tradable if the company fails. The higher the asset specificity, the higher the 
Introduction 
 
3 
transaction costs. These are also affected by the high uncertainty of high-tech projects in 
technology development, market, legislation, and so on. Other issues concern ex-ante and 
ex-post information asymmetries. Entrepreneurs have more information quantity and 
quality about the potential of their technologies than the financing institution. Every actor 
is affected by bounded rationality in knowing future states and how achieving them, and 
can act opportunistically. These cause problems of adverse selection and moral hazard. 
Entrepreneurs may not reveal the real quality of a project and/or investors may not 
understand it, thus the best opportunities may not get funded. Once entrepreneurs get 
funds, it may happen that they may pursue their own objectives instead of shareholders’ 
ones. 
The economic literature has thus mainly described venture capital as that particular 
form of financial intermediation able to overcome these problems, enabling high-tech 
companies to get funded. Venture capitalists have followed economies of scale and 
learning curves in the use of information that allow them to alleviate adverse selection 
(Chan, 1983; Sahlman, 1990; Tykvova, 2000). They actually undertake a rigorous 
screening process to evaluate ventures’ potential and/or syndicate to have a second opinion 
(Fried and Hisrich, 1994; Amit et al., 2002). To prevail over moral hazard and reduce 
transaction costs, venture capitalists normally: invest through preferential shares, which 
give them seniority in case of liquidation; provide capital in subsequent funding stages 
with respect to the achievement of particular milestones; syndicate with other investors to 
share risks and diversify their portfolio; get veto power over important decisions and settle 
a fraction of managers’ compensation in form of stock options to realign incentives; and 
become members of companies’ boards of directors to directly monitor them (Bertoni and 
Colombo, 2005). 
However, the particular form of financial intermediation does not concern only the 
resolution of adverse selection and moral hazard problems and the reduction of transaction 
costs. Venture capital is mainly renowned for the added-value function performed in 
support of high-tech start-ups. Out of the cases where those companies are founded by 
serial entrepreneurs, in fact, small and young high-tech firms generally suffer from 
weaknesses in commercial resources and managerial capabilities. Therefore, they need 
access to complementary knowledge possessed by third parties. In this sense, venture 
investors as intermediaries have become repositories of knowledge and experience that 
allow high-tech start-ups to fill their competence and resource gaps (Sahlman, 1990; Zook, 
2004; Sorheim et al., 2007). Regarding biotech, certainly the financing side is very 
relevant, but the added-value support has a primary role too. Biotech companies are 
generally founded by researchers without any experience on business. So, venture 
investors can help in matters such as management, headhunting, marketing, etc. They also 
have contacts with pharmaceutical companies, other biotech firms, research centres and the 
like, that can be very valuable for funded companies. 
Introduction 
 
4 
Scholars then highlight that venture capital has a significant impact on the 
performances of investee companies. Pressure from venture investors obliges start-ups to 
grow convincingly (Zook, 2004). Venture capitalists are considered providers of added-
value services that allow venture-backed companies to have better results than their non-
venture-backed counterparts. Contribution from investors may entail relationships with 
suppliers, potential partners, lawyers, consultancies, etc., recruiting of experienced people 
like managers, marketing personnel, etc., strategic planning, fund raising, cash-flow 
management, and the like (Sapienza, 1992; Hellmann and Puri 2002). Investors 
involvement may imply higher growth in terms of commercial (e.g. turnover) and 
innovation (e.g. patent applications) capabilities (Engel and Keilbach, 2002; Bertoni and 
Colombo, 2005). The importance of these aspects encourage start-ups to look beyond the 
simple financial intermediation, for instance accepting lower valuations to have renowned 
venture backers, and the venture-backed status may also function as certification of quality 
within the business community (Hsu, 2004a; Zook, 2004; Megginson and Weiss, 1991). 
Most empirical works concerning venture capital rely on data provided by 
organisations such as the EVCA, national associations like the British Venture Capital 
Association (BVCA), the US national venture capital association, etc. Members of these 
associations are typically organised as limited partnerships, i.e. venture capital firms create 
one or more funds of a specified size, duration and investment focus; the fund is 
constructed as a separate legal entity, with the venture capital firm being the managing (or 
general) partner and the institutional investors in the fund (e.g. banks, insurance companies 
and pension funds) being the limited partners. This is a modus operandi created in the US 
to regulate the activity of financial intermediaries, and it is now dominant in the UK and 
Israel. Nevertheless, studies that only report venture capital investments made by this 
category may underestimate the real dimension of the venture capital market. This 
omission can be illustrated for the case of Scotland, where Don and Harrison (2006) 
reported £170 million of venture capital investments in 2004 compared to £96 million 
invested by BVCA members in early and expansion stages. Mason and Harrison (2000) 
state that business angels make eight times as many investments in early-stage companies 
as venture capitalists in the UK. As a result, many investments from organisations like 
Scottish Enterprise6, business angels networks or individuals are unreported by most 
studies. In the present dissertation, thus, we use the expression ‘venture investors’ to 
include venture capitalists that adopt the limited partnership as well as other types of early-
stage investors. 
Furthermore, there is some evidence that venture capitalists currently behave much 
more like traditional financial institutions and focus much more on later stages and 
financial engineering (Etzkowitz, 2005; Mason and Harrison, 2002). This is mainly due to 
the growth of successful venture funds that consequently look more for lower risk 
businesses. Since many have moved later, the literature suggests that among different 
                                                
6
 Scotland’s economic development agency. 
Introduction 
 
5 
venture investors, who normally invest in subsequent phases, there is an equity gap that 
constrains the development of companies at some stage. This implies that, in relative 
terms, other early-stage investors have perhaps acquired more importance than venture 
capitalists covering that gap. Following these statements, we thus exclude venture 
capitalists who focus on later stages and financial engineering, but we comprehensively 
consider all those early-stage investors whose objective is to have a company-building 
experience. 
This study has therefore analysed the non-monetary function of venture capital 
within the UK, with specific regard to Cambridge and Scotland, for the case of 
biotechnologies affecting the healthcare sector. Given the high interest of many 
governments towards venture capital and biotechnologies, the analysis of peculiarities of 
two regions at different stage of development (Cambridge and Scotland) within one of the 
most advanced countries (the UK) may be extremely interesting to understand how policies 
might promote a well-functioning venture capital sector for biotech companies. 
The methodology of this study has concerned the use of a qualitative approach, 
mainly because, given the complexity of the phenomenon to describe and according to the 
time horizon of the survey, a quantitative investigation would not have allowed to collect 
an appropriate amount of data and to reach an adequate depth of analysis. Therefore, we 
conducted twenty interviews based on a semi-structured questionnaire that touched the two 
issues relative to our analysis of venture capital (added value and regional dynamics). The 
questionnaire was written up in two versions in order to consider perspectives of both 
biotech companies and venture investors. Moreover, we interviewed people working in 
governmental agencies, incubators, consultancies, etc. This has allowed to investigate the 
specific non-monetary intermediation between venture capital and biotech firms as well as 
external insights of that relation. Interviews have been examined using a method called 
grounded theory, which consists in a careful reading of transcriptions, a successive coding 
of the text into categories and relations between categories, and finally selection of the 
main idea to which tying all the categories and on which developing the discussion. In 
order to follow this method, the software package NVivo has been used. 
The innovative contribution of this study is associated the importance of 
experienced business people. They influence investment decisions, dimension of venture 
capital sectors in different regions, perception/realisation of added-value services and 
public policies. 
Interviewees highlight that risks of technological opportunities do not depend only 
on the technology, but also on the kind of people involved. In other words, serial 
entrepreneurs are more likely to receive venture capital than scientists without any 
experience on business. Those entrepreneurs actually have greater ability in adopting high-
quality business models and pursuing successful strategies than researchers. 
Introduction 
 
6 
More people have worked for pharmaceutical companies, have founded one or 
more enterprises and are in contact with investors in Cambridge than in Scotland. 
Closeness to London as well as the fact to have started doing biotech forty years ago have 
helped the virtuous cycle between venture capital investments and formation of biotech 
companies. Hence, venture investors perceive different risks associated to distinct 
locations. Moreover, network of contacts appears more regionally bounded in successful 
regions (Cambridge) since added-value activities are more efficient in proximity to those 
contacts. 
Since venture investors tend to prefer opportunities coming up with experienced 
business people, venture investors appear to focus more on investment protection rather 
than support for achieving success. Nevertheless, interviewees argue that venture investors 
actually offer added-value services. These regard more importantly contacts with potential 
customers, suppliers and partners, further investors or other skilled people rather than a 
direct involvement on activities of the funded companies. 
Finally, although how co-evolution of venture capital and biotech companies 
begins and how it achieves critical mass still remains unsolved questions, this study 
evidences that technology and money are necessary but not sufficient. Skilled people are 
particularly important behind the formation of biotech companies, the development of 
venture capital and the economic growth of countries and regions. 
Beginning with a literature review (chapter 2) on the role of venture investors in 
relation to high-tech start-ups, and on regional dynamics of venture capital to perform this 
role, we shall then discuss the situation of both venture capital industry (chapter 3) and 
biotechnology (chapter 4). After showing the leading position of the US in both cases, we 
enter in some detail the European context, where the UK has a leading standing, to 
subsequently describe the specific environments in Cambridge and Scotland. Hence, we 
discuss specific issues regarding: biotechnology and the healthcare sector; biotech 
companies and innovation systems; and venture capital, as part of innovation systems, in 
relation to biotech companies that operate in the healthcare sector (chapter 5). After 
describing the methodology of our empirical study (chapter 6), we present and discuss the 
empirical evidence gathered by interviewing investors, biotechnology companies and other 
key players (chapter 7), and we conclude with the interpretation of our findings (chapter 8).