11
I n t r o d u c t i o n
GROWTH AND RECESSION, BULL VS BEAR, HOW VENTURE CAPITAL CAN HELP
ECONOMY
Innovative entrepreneurship is a cornerstone in the economic growth of nations, in the most
successful instances the venture capital took on a leading role. In the Italian context as well, the
venture capital system might be considered a groundwork in the competition of the country, one of
the keys to create long-term prosperity able to generate wealth and employment. Furthermore, the
use of venture capital is one of the main vectors of innovation, it is an overall encouragement to
improve applied research and to enhance competition between companies. Future development
sceneries are various and depend on the choices that will be taken. In this study, I will investigate
the most suitable models of development through an international comparison, in which the
possible evolution of the ecosystem of innovation World Wide will be explored. Innovation is a
cornerstone of modern economic development and it is the “specific tool of entrepreneurs”. Since
the first researches carried out by Schumpeter to the theories of endogenous growth, it has been
demonstrated how companies, lands, countries rich in high technological innovation, scientific
research, investment in human capital and entrepreneurship, lay the best perspectives to the creation
of wealth and employment. To this day, the transformative power of ideas is progressively
increasing: the current production paradigm is based on knowledge, a context in which information
technology and telecommunication innovation allow us to share and modify cognitive constructs on
a scale that would have been unthinkable up to a few years ago. There was a short circuit between
two phenomena: the increase of extreme technological evolution and the presence of a particular
form of capitalism strongly enhancing innovative entrepreneurship in some areas of the world,
called Venture Capital. In the most successful examples, such as Silicon Valley, the combination is
made of reciprocal feedbacks between development in techno-scientific field, financial innovations
(venture capital system), suitable public policies (support on development of human capital,
12
foundation of research universities), opening to talents and risk-taking culture. It is all about a profound
process: as underlined by some experts, such as Sara Lacy
1
, behind new economy’s optimism and
rhetoric in the late 1990s there was a structural process that did not stop with the dot-com bubble.
For instance, keeping in mind intermediate oscillations, the level of venture capital investments
showed an annual growth composite rate of 11%, proper for inflation between 1985 and 2007. In
the United States, between 1970 and 2008, for every dollar invested in Venture Capital and in
venture backed companies, 6,36$ income were produced. Despite the new contraction of
investments due to the global financial crisis, most notably affecting the Western world, whose
effects are still uncertain, it is possible to determine how successful companies “seek innovation”,
both business products and models, increasingly employing the grid of opportunities brought about
by the Internet and the so called “net economy”. It is often the case of organizational innovations, a
rearrangement of factors of production within the same technological paradigm, no less they can
lead to notable benefits. Many information technologies – processors speed, number of transistor
per CPU, memory capacity, amount of transmittable bit per time unit – have been experiencing an
exponential growth for decades. In the next 10 years, in many production sectors it will be necessary
to get ready to the consequences and shocks of the presence of a huge capacity of processing,
memorization and transmission of information considered “real time” today and that will become a
sort of “increased reality” without realizing it. Whole markets will most probably be radically
remolded, as recently happened to the market of music production and distribution, keeping in
mind what happened to music industry, which has been utterly uprooted from its values and the
multinationals still do not know how to react, and, to this end, the same is happening to cinema
industry. Some cognitive fields, such as molecular biology or pharmacology, since forever seen as
limited areas, will turn more and more into “information technologies”, modifying its related
professions and businesses. Therefore, the global economic system is raising its level of sensitivity to
changes: innovations in the social use of technologies have an extremely fast potential of diffusion
and consequently they can lead to a quick modification of the way of living and working of millions
of people. Moreover, the alternation of technological paradigms, the accumulation of incremental
innovations and the leaps brought on by disruptive innovations led to the creation of opportunities
that may be intercepted and promoted by venture capital system. The future is unpredictable, but
1 Award-winning journalist Sarah Lacy is editor-in-chief of TechCrunch. Her columns and articles cover Silicon Valley
businesses, startups and emerging markets. She is the author of the book, Once You're Lucky, Twice You're Good: The Rebirth of
Silicon Valley and the Rise of Web 2.0 (which also goes under the name The Stories of Facebook, YouTube and MySpace). Lacy also
writes the "Valley Girl" column for BusinessWeek and serves as "Silicon Alley" correspondent for the Tech-Ticker blog.
13
many of these trends are rather tough and we may observe them closely in their “real time”
evolution. Development processes may be addressed in a pro-active way, a challenge that we can
and should face. The purpose of this study is to encourage the debate on the strategic role of the
venture capital to the competition in the western financial economy in the long-term. As is common
knowledge, the venture capital is the financing of early-stage companies active in rapidly growing
sectors. It is a kind of investment with a long-term perspective, basically not much liquid and with a
remarkable level of risk, which has the goal of getting comparatively higher returns than other forms
of capital investment. Venture is traditionally structured in investment ranges of increasing amount,
usually tied to specialized partners: funds initially connected to angel investing dedicated to bootstrapping
2
(50-200k €), funds dedicated to seed-early stage (200k-2M €), and those dedicated to first round (2M–5M
€), growth capital (5M-50M €). In the Italian case, the bootstrapping and early stage range appears to be
inadequate, the first stage of venture capital and crucial basis for the launch of innovative projects.
In the study “The Global Venture Capital and Private Equity Attractiveness Index 2009-10” by
IESE Business School in collaboration with Ernst Young, Italy ranks 21
st
in the global index for
attractiveness of its economic system towards such investments. According to that study, the main
threat for the venture capital market in the next few years consists in the limited VC role in supporting
R&D activity and early stage financing in innovative ventures. This factor is connected to the usual
weaknesses of the Italian area: extreme taxation, notable weight of mature industries exposed to
international competition, deficient organization of the labor market, low level of investments and
small Internet and new technologies penetration. Their impact goes beyond specialized or directly
involved subjects: the tie between venture capital and economic development is clear and has been
detected by diverse sources. A higher incidence of investments in innovative industries in their early
stages is connected to an increase in the economic growth, employment and the main indicators of
innovation. For instance, venture backed companies in the United States account for 21% of US
GDP and 11% of private sector jobs come from venture backed companies. Furthermore, venture
backed companies are more performative and get higher results than other companies both in terms
of income and job creation. This is true especially to funds operating in the first quartile, with a
2 Bootstrap is a common way to finance commercially innovative projects through personal savings without external help.
It is intended as a frugal possibility that the company could start just with the money owned. Determination and discipline
are crucial in a bootstrap. Not everyone has the courage to put it into practice, since the risk is on the individual foremost.
However, it can transform a concept of business. S. Gail's Tom, professor and executive at the University of Houston’s
Center for Entrepreneurship and Innovation, claims that between 75% and 85% of the startups use some forms of
automatic start to help financing themselves.
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“hands on” approach, supporting entrepreneurs in the development of the business and financial
and commercial networking, approach which will be investigated in the following pages. According
to a recent study of the Ewing Marion Kauffman Foundation, high growth industries – top 1% of
United States companies - created on average 40% new workplaces. This is a kind of conclusion
that highlights the central role of innovative entrepreneurship and of the creation of new companies
in high growth sectors. In the European case the figures are more restrained but the potential for
development is higher. Between 5 and 6 billion Euros annual investments are reached and,
according to EVCA (European Private Equity and Venture Capital Association), in 2004, the total
of people employed in European venture backed companies was 1 million units. This led to a
cumulative growth of employment of 30,5% between 1997 and 2004, which is to say an annual
growth of 2,4%, notably higher than other companies with a 0,7%. The European context,
according to EVCA’s white paper of March 2010, is ready for a new development phase, with
specific reference to the necessity of an increase in private investment in the area of venture capital,
most notably by (companies) operating on an international scale. This must take place in a situation
of improvement of the tax policies for startups, of higher market integration with a long-term
strategic view able to make Europe attractive to global investors. The new competition environment
will be much different from the past years, being it shocked by the global financial crisis, the deep
shift of the trend of some financial sectors, new ways of public control in many countries and the
modification of global power balance in which Asian countries have much more power. In this new
scenery, venture capital operators will experiment a process of adaptation that will make them
survive, keeping the innovation driving force alive with different characteristics in respect from the
past. As a reference scheme, it is possible to set the models of development of venture capital in
terms of evolution and change undergone in the last years, which will be explored in this study in a
very present way and in an international context. The models considered here are not available on
other manuals, since they are the result of an exhaustive research on investment methodologies
explored starting from real everyday situations, such as news on financial or venture capital
publications, like TechCrunch and Cruchbase just to mention a few, or such as interviews, videos
and encounters I personally had with influential exponents in this sector, or taking part to specific
events in the Silicon Valley or in the state of New York. We can briefly summarize the analysis in
three central ideal models, structured at their core in a mass of different strategies, very different
from each other themselves.
We can summarize it as follows:
a-The European continental model: it is a top-down scheme, where usually the countries identify
15
and address the sector to finance. In many European countries, the governments directly intervened
to encourage the setting-up of entrepreneurial initiatives, with variable effectiveness. In terms of
dimension, the main example is France, which in the second trimester of 2010 generated 21%
investments of whole Europe (in extra-continental Europe the record belongs to the United
Kingdom with 32%), invested 221 million Euros and created 74 deals. One of the main vectors is
CDC Enterprises, a sovereign fund of funds specialized in private equity operations. The
continental model will be explored starting from the Italian context and cultural situation, from
which my study starts to move then to the most successful models.
b- Hybrid model: a strategy based on structures of venture capital financed through public-private
coinvestment, such as Israel with Yozma Group, and a unique methodology of investment. The
story of the Israeli model is frequently mentioned in the literature, considered the noteworthy
impact of public policies: through Yozma Venture Fund, they passed from one VC fund in 1992 to
10 funds and 122 listed companies in a few years time. In this case, we witnessed the convergence of
several factors: cultural, geopolitical and related to effective government regulation.
c- The Silicon Valley model: an ecosystem of private subjects, funds and universities in the USA,
which employs liquidity collected through pension funds, university endowments and individuals.
The major investors and a large amount of venture backed companies polarized within a territorially
delimited area, through the activation of relevant network effects. Among the fundamental element
of this network there are research universities, such as the Stanford University, almost completely
devoted to Venture backed, generating a constant flow of human capital and ideas potentially
transferrable to the market. This model of development had an initial input from military research,
but with the passing of time broke away from public spending and since a few decades stands on
private investments. Therefore, we will analyze the geographical areas in the world in which the
venture capital is more widespread and involved in social fabric, in terms of dimension of capitals,
subjects connected to such processes and complexity of investment methodology. Later on, I will
draw up a comparison of the evaluation of investments and the different procedure of growth of
the start-ups, and their transfer of technology from universities to the market. The present analysis
is structured following a scale through a bottom-up approach with two conclusive models of operative
proposals in order not to lose the future in our country. This study aims at demonstrating that
Venture Capital is not intended the same everywhere in the world, but there is empiric evidence, a
multiple different idea and implementation of stakeholders in the venture financial world about how
to build a sustainable business, how to approach and rate a determined “deal” and its potentialities,
how to create innovation and how to encourage young fervent rich in new ideas brains upon which
16
we should bet on as a sustainable growth supporting the transfer of such wealth from university
brains to the market day by day.
17
F i r s t P a r t
VENTURE CAPITAL FOR THE “START UPS”
Abstract : In the early chapters has been shown that firms, regions, states, where most
technological innovation, scientific research, investment in human capital, and entrepreneurship,
have the best prospects for creating wealth and jobs.
The acceleration of technological change has led to the exasperation of a particular form of
capitalism that strongly encourages innovative entrepreneurship: Venture Capital.
Have been analyzed its rule, adopted business models and success stories in recent years from the
dot-com bubble of 2000. Particularly in the funds operating in the first quartile, acting with a "hands
on", supporting entrepreneurs in business development and networking in the commercial and
financial.
This is the financing of young firms operating in high growth sectors, with a form of investment
which has a long-term, illiquid and tends to a significant level of risk, which aims to achieve returns
comparatively higher than other forms of funds.
Starting to angel investing dedicated to boostrapping (50-200k €), dedicated funds for early -stage
seed (€ 200k -2M), those dedicated to firsth round (2M-5M €), growth capital (5M -50M €).
It was possible to see how successful organizations have to hunt for innovations, which are
products or business models, using the grid in ascending order of the opportunities offered by the
Internet and new technologies from the so-called " New Economy ", through the activation of
relevant network effects, has focused a significant amount of investors and venture backed
companies. Among the key nodes of the network, the Spin Off: The real engine of the brain, the
universities, these research-oriented, such as Stanford, Columbia and MIT in the U.S. or Jerusalem
or Tel Aviv University, which, almost entirely devoted to Venture-backed securities, generating a
steady stream of ideas and potentially transferable human capital on the market.
See inc. such as Apple, Microsoft, Google, the world's best earnings per share
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Chapter 1: VENTURE BACKED START-UPS, STARTING NEW ICT WORLD
1.1 High-Tech Impact: Starting from Internet
Going through mainstream media, you have probably read about the so called dot-com
3
revolution.
This study starts chiefly from it. The irrational euphoria of markets and economic bubbles is usually
ascribed to ICT high-tech applications projected on the Web by students at the most prestigious
Universities. More or less newly created companies set up by young men, such as Google, Skype,
Apple, Microsoft YouTube, EBay, Facebook, Twitter Wikipedia, Amazon, Tivo etc. just to mention
a few, are now industrial giants ruling over customer markets and business in the Western world.
Leaving this superficial analysis out, there are interesting aspects which would be useful to
understand in order to realize what is exactly going on worldwide. To this day, these ITC giants
represent just a small part of the global economic impact that innovative high-tech companies
exercise. These days, it is really hard to remember the time when Internet and ICT were not already
part of our life, 15 years ago high-tech companies were only 18.000 worldwide, today they are more
than 80 million, determining the most amazing migration in the human history. In the last 25 years,
since the creation of the first high-tech application Symbolics.com in March 1985, Internet and the
information technology have revolutionized industries, economies and societies all around the
world. In a more widely accepted sense, the new economy has generated a variety of high-innovation
companies never seen before in human history, giving birth to new business models, encouraging
the creation of new products and services, wholly changing the approach to customer and
companies markets and even transforming people's life, their ways of interacting, building up
communities, socializing and behaving. However, while high-tech companies have their next-
generation products and services used and consumed, something of higher visibility happens:
3 Dot-com term is used to define those companies grown out of the remarkable surplus of funds generated by venture
capital and the optimism of the stock market at the end of the 20th century. They based their business on web services.
They were excessively confident in the potentiality of Internet and thought they could easily expand, and later realized that
they had to deal with the lack of innovative ideas, experience and management skills.
19
capital, ideas, people movements take place and that market becomes the leading sector in national
economy in the most important countries of the world, in terms of wealth indicated by GDP, up to
become an essential basis to enhance long-term innovation and competitive advantage of economic
growth of every developed or developing country. For instance, in September 2009 an Internet and
high-tech applications use of 2,7 billion users on a world population of 6,7 billion people (40,6%)
was estimated, with an increase in the use equal to 280% from 2000 to 2009. ITIF
4
foundation
estimated that annual benefits in terms of global wealth generated by online web applications is
around $1,5 trillion, much higher than economic profits of medicine, investments in renewable
resources and governance investments in R&D all put together. Should e-commerce continue
growing at even half the speed it has grown from 2005 to 2010, in 2020 the global economic profit
would be $3,8 trillion, which is to say, more than the annual GDP of Germany, one of the five
countries in the world with the highest GDP. Internet is transforming economies worldwide, from
Western countries such as Europe with 85% growth from 2004 to 2009, to Southeast Asia such as
Korea, with 32% internet users regularly posting articles on their personal blogs. The economic
benefits of such euphoria reflect both on whole ICT industry and the high-tech market in general,
since they are closely interconnected, with a significant impact on consumers, workers and business
models, improving the creation of efficient markets, extending the access of users to available
information, reducing informative asymmetries and goods price determined by global competition.
Furthermore, Internet and high-tech applications do something never done before: they allow
everybody supplied with a brain, expertise and a personal computer to create a service or a product
dedicated to that market, at ridiculous prices and offering job opportunities basically to everyone,
especially in the interests of the youngest classes all over the world, which had the last few years
characterized by crisis and recessions and relative insecurity. Therefore, new worlds with ever-
evolving business model open up, maintaining a high quality of output, guaranteed by the final
choice of the global consumer. We can affirm thereby that the new economy brings real benefits to the
labour market, boosting salaries and encouraging a more efficient progress. The new economy
stimulates the growth of countries in a situation of economic stagnation: it makes companies be
more competitive and efficient yet more productive; it allows consumers to spare or even earn
money and the wealth of most countries in terms of the GDP produced has increased in the new
4 (ITIF) The Information Technology and Innovation Foundation is a Washington, DC-based think tank at the cutting
edge of designing innovation policies and exploring how advances in technology will create new economic opportunities
to improve the quality of life. Non-profit, and non-partisan, we offer pragmatic ideas that break free of economic
philosophies born in eras long before the first punch card computer and well before the rise of modern China and
pervasive globalization. ITIF, founded in 2006, is dedicated to conceiving and promoting the new ways of thinking about
technology-driven productivity, competitiveness, and globalization that the 21st century demands.
20
economy. It also supports the efficiency and allocation of poor resources available allowing a matching
between markets with endless varieties of products, skills and services, whether they are personal
services on EBay or professional skills on Monster, or solutions and challenges for innovation on
InnoCentive, or mass customization commercial business models, such as Dell, with its custom-
made Personal Computers directly ordered online, or the customization of Nike; it also offered a
series of new-generation software services such as the cloud computing based or services of
handling the relationship to the costumers offered by Salesforce. The new economy also offers small
and medium-sized enterprises worldwide the opportunity to access international markets. Access to
information, online entry of data, increase of information on health and health services,
opportunities of online-education, facilitation of social interactions, wider choices of entertainment,
promotion of sustainable energy are daily carried out by high-tech start-ups. The global diffusion of
Internet is the primordial cause of this unprecedented expansion. It occurred at an amazing speed
and every developed or developing country on earth have adopted the Internet.
1.2 Dot-Com Bubble and Market Valuation
The high-tech bubble of the early 2000 might have induced someone to believe that Internet and
ICT were just a temporary trend of the late 1990s, but it is all wrong, since companies grown out of
the web and high-tech sector managed to maintain higher survival rates than start-ups in other
sectors, despite the crisis, in the same period and without a doubt higher than high-tech companies
themselves in the past. To give some examples: despite the clamorous fail of start-ups set up in the
USA such as Webvan which at the time of its foundation did not succeed in achieving the estimated
success in its business plan, it seems now to start yielding results, even though it has been another
start-up to put them into practice, recreating and remoulding the service with a more sustainable
model of business. Webvan failed but US Giant offers a “Peapod” service of food home delivery
developed in 1989, reaching a billionaire turnover and setting home delivery as a standard, which is
now applied by most of the companies. Up to that time, home delivery was an unthinkable service
to offer. A further example: researchers at Start Home designed a simple pc application able to let
people monitor their home electronic devices straight on their laptop or smartphones, such as
regulate their heating, turn on lights and programme a recording on TV just through their
smartphone at a distance. This company has now has an inexpressible bulk of users in the Unites
21
States, who, just paying a subscription charge of 12$ per year, have unlimited access to the service.
In short, despite the explosion of the high-tech bubble in the early 2000, Internet sector had later
more than fulfilled its initial promise of transforming both the economy and society, and there seem
not to be an end. And as the years go by, this is hardly possible to happen. Since the first listed
companies were set up 25 years ago, Internet may be described as a global technology (GPT), whose
importance to the society should be seen in the same way as the introduction of low-cost steel,
electricity, telephone and internal or engine combustion. Future trends on Internet and high-tech
applications may include the use of current technological standards more and more, people as users
and companies will be in line in the use of online high-tech business such as: e-commerce, internet
mobile as well as the growth of services based on geo-localization, and new applications based on
new portable devices like tablet, ipad, smartphones, iPhone designed by Apple computers, making
the world more and more informed, smarter in its choices and always interconnected. Considered
that the telegraph represented a global communication network for short written messages, and the
telephone for voice communication, Internet now represents a unified global network for vocal data
and video communication, that will be governing ICT in the next decades. Moreover, Internet
provides a crucial new digital platform through facilities that the global commerce may exploit.
General use technologies, such as Internet, had historically appeared at a speed of one every half
century, and now represent a system of new technologies able to change basically everything, from
what and how the economies produce to the way production is managed, from localization of the
productive activities to the essential skills and facilities to start and support it. A technology usually
starts in relatively raw form for a single use and to serve few people, over time the level of
sophistication improves since it spreads to whole economy, generating effects in form of
technological complementarity and externalities. To this point, its evolution requires decades or
even centuries of diffusion. Furthermore, the new technology may undergo fast price decreases and
on-going improvements and services, permeating the social fabric and becoming integral part of
industries, products and corporate functions, to allow a further innovation in products, practices,
business models and corporate structures. These are dot-com's areas of expertise. Internet falls into
the line in favour of a new technology of transformation which will be later called human discovery.
As documented by the present study, the influence of Internet has been much more enduring and
high-performing than we should have expected after the explosion of the dot-com bubble in March
2000. In the late 1990s, the new economy was highly praised by the mass media. Many leading figures
spoke about it: Kevin Kelly, Executive Editor at Wired, said: "The network economy will open
opportunities on such a scale never seen before on earth". Futurists as Peter Schwartz and Peter
22
Leyden wrote: "We are witnessing the beginning of a global economic boom which occurs every
100-150 years". Also company managers spoke about the new economy. Jack Welch, CEO of General
Electric, declared in a press release: "In the next decade, Internet will change the world more than
any other instrument has done in a century". Every society which would have not used Internet
would have been sentenced to extinction, according to popular wisdom. Nevertheless, when a
transformation is an historic turning-point, the reality is intended to disappoint. The extraordinary
financial profits of the first high-tech start-ups were combined with the lack of a reasoned economic
assessment of the stock markets. The dot-com bubble was most notably marked by the NASDAQ
Stock Market crash, which in 2002 caused the loss of 60% of its 5,048.62 peak on 10
th
March 2000,
and the mass of new economy irrational euphoria rapidly turned into despair. It became the standard to
consider the new economy just as a flash in the pan blew up by the mass media. Stephen Roach, senior
executive with Morgan Stanley investment bank, once leader and supporter of the new economy world,
is now considered to have led to the irrational bubble through his excessive valuation of companies
on the stock market, and in case of bankruptcy, internet companies became just an expedient to sell
books, incriminating their potential. In 2003 Nicholas Carr at ADT Press Magazine of Harvard
Business School wrote: "As far as information technologies are concerned, they foster the evolution
of the sector, both as for transformations about to occur and as for transformations already
occurred or in the wind". Actually, those overconfident perspectives were uncertain and it was clear
that most of the innovations and evolution achieved were just at the beginning. Therefore, it
became clear that a temporary interruption in the course of an economic revolution is actually the
standard. According to scholar Carlota Perez
5
, considered that technology revolutions arrive with
regularity through the financial capital, technological revolutions start with what she defines
"installation period", when new technologies explode in a mature economy and move forward as a
bulldozer soaking deep into the socio-economic fabric by articulating new industrial networks. At
the beginning of the installation period, the revolution is just a great promise. At the end, the
conceptual framework achieved will have a remarkable power, ready to serve the diffusion of
5 Carlota Perez. Venezuelan. Researcher, lecturer and international consultant, specialized in the social and economic
impact of technical change and in the historically changing conditions for growth, development and competitiveness. She
is Professor of Technology and Development at the Technological University of Tallinn, Estonia, Visiting Scholar at the
Faculty of Economics, Cambridge University, U.K. and Honorary Research Fellow at SPRU, Science and Technology
Policy Research, University of Sussex, U.K. Her articles from the early 1980s and her book Technological Revolutions and
Financial Capital: The Dynamics of Bubbles and Golden Ages [Elgar 2002] have contributed to the present understanding
of the relationship between technical and institutional change, between finance and technological diffusion and between
technology and economic development. Some of her papers and books are used as study material in post-graduate courses
in universities in many countries. As consultant and lecturer she has worked for various public and private organizations,
for major corporations and governments in Latin America, North America and Europe as well as for the EU, the OECD,
the UN and several multilateral agencies.
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