Financing sources and complementary assets - Video 1
Transcript
Human capital is a key pillar of entrepreneurial success but other resources also play a role. A second major driver of entrepreneurial success is financial capital. We can even say that access to finance is an essential condition for entrepreneurial activity as virtually every startup needs some financial resources. Of course, there are steps that can be taken without external funding, like having a great idea, or creating a positive and inspiring working environment, and the entrepreneur should try to exhaust them. However, many steps, even in the very early stage do require financial capital. Thus, let’s first list possible sources of funding for a startup.
First, entrepreneurs own capital, money the entrepreneurs own and are willing to invest in their startups. Second, family and friends who are able and willing to provide money to the entrepreneurs. These are two informal sources of financial capital. There are two other formal sources as well. First, debt financing similarly to a car loan or an apartment mortgage, startup can get funding by means of a loan from financial institutions like banks. And second, equity financing, which comes from professional or institutional investors who are specialized in investing in startups. These four represent basically the whole financing universe for startups. Let’s analyze them individually.
The informal ones, entrepreneurs own capital and capital provided by family and friends are common initial sources of financing. They can be relatively easy to get, compared to the formal ones and entrepreneurs also get more flexible deals, as they have different repayment schemes on their disposal, not just the formal ones. However, there is a limit to the informal capital: its availability particularly in high volumes. Larger investments are usually out of reach of both entrepreneurs and individuals close to them. That is why the formal sources are crucial. The formal investors are able to provide by far larger amounts of capital. There are differences among formal sources of capital too. Firstly, there are banks and other lending institutions, which provide debt capital. In return to the received capital, startups are supposed to pay back the loan in predefined installments, as well as an interest rate on top of that. It should be remarked that the lending institutions do not own the startup, that is they have no control over how the startup is run. Once the loan is paid back the relationship with the lender ends, that is especially important as the business becomes more valuable.
On the other hand, there are some issues with debt financing, which stem from the very nature of startups. Namely, startups, and particularly, the most innovative ones, have the following features: They lack hard tangible assets that could be used as collateral that is guarantee to the lenders. When they do possess the assets, they are typically intangible. For instance, human capital of entrepreneurs cannot even be measured. These cannot be used as a collateral as well. Finally, by definition, they have a short track record, as they are newly created companies. All of these make access to debt extremely difficult. The lack of tangible assets, collateral and track make it challenging for lending institutions to assess the value and potential of startups. Therefore, in reality, startups rarely manage to get a loan. Exactly that is the reason for emergence of the other formal source of capital, the institutional investors, who provide equity financing and focus on startups only. They are specialized firms called Venture Capital firms comprising experts who are better able to assess the value of startups, despite the lack of tangible assets and hence are more prone to invest in them.
Equity investors get shares of ownership into the startup, a fact that may have both pros and cons. A first advantage is that no payback of money is needed. Instead, a portion of the startups equity is shared with the venture capital firm. As the venture capital firm owns a part of the startup, their investors will usually try to help the startup succeed. So, venture capital investors do not only provide their financial capital, they also share their human and social capital. On a more critical note, as the venture capital firm has ownership rights over the startup, its shares the returns and risks of the venture with the entrepreneur. As a consequence, it will generally try to strongly influence the decisions, which results in a partial loss of control of the startup for entrepreneurs.
Overall, all four types of financing might be necessary during the startup development. Hence, being aware of how they work and understanding the right funding model is vital. As we have seen, there are no doubts that financial capital, on the one side, and human capital, on the other, are essential for the startup and its core operations. Nevertheless, core operations alone are not sufficient to deliver the whole potential value of the startup. The so-called complementary assets are as necessary. In particular, the complementary assets are the ones that are not strictly related to the startup’s key knowledge, yet they are still instrumental for delivering the value the startup is creating. In order to commercialize an invention, the innovative entrepreneur typically requires that the know-how in question is utilized in conjunction with other capabilities or assets. Services such as marketing, competitive manufacturing, distribution channels and after-sales support are almost always needed. A good example of the importance of complementary assets is the story of Robert William Kearns, an American inventor who developed windshield wiper system using most cars from 1969 till today. He obviously needed cars to deliver the value of this invention, but as he was not able to make the cars himself, he had to find a way with the companies that did, which was a challenging process. According to his story, an interesting movie called “Flash of Genius” was recently made.
So, the same startup does not need to be in control of all assets, and typically it is not. In return, that means that startups should be partnering with other startups or even established companies, who are specialized in providing the complementary assets. In that process, it is essential for entrepreneurs to understand what is the competitive advantage of their own startup, and how they can maintain it even when they collaborate with the other firms. In case that is not possible a startup should also try to own the necessary complementary assets and by that protect its competitive advantage against the other firms. As a minimum, entrepreneurs should be aware of the existence of complementary assets, who controls them, and how they can reach them without jeopardizing their own activities.
The final factor for entrepreneurial success is the so-called social capital of entrepreneurs. Social capital stands for the extent to which the entrepreneurs are effectively connected to their social environment, which in turn should enable them to more easily access the other resources. Social capital can help them find the right co-founders, that is, the right human capital. It can also be essential for reaching external finance. Personally knowing investors improve the trust and facilitates easier access to funding.
Finally, strong social capital is valuable for finding strategic partners that can provide the necessary complementary assets, without hurting startup’s core operations. To summarize, the four fundamental factor for entrepreneurial success are: human capital, financial capital, complementary assets, and finally social capital.
Retrieved from: https://www.youtube.com/watch?v=6arog4QKWDU
Complementary assets - Video 2
Transcript
A: Hello! I’m Gary Dushnitsky.
B: And I am Elisa Alvarez garrido.
A: And we would like to share with you so far key findings in the study published in the strategic management journals titled “Entrepreneur Ventures Innovation Rate Sensitive to Investors Complementary Assets”. What we do in that study is we seek to explore what is the role of different investors, and how it affects deep science innovation in different domains. Specifically we are looking at the biotechnology sector where biotechnology startups or entrepreneur adventures have been an important source of deep science-based innovation.
In the past, independent venture capitalists have been instrumental in funding those startups, but for various reasons they have slowly reduced their capital allocated. At the same time, many corporated investors tend to bank and fund those entrepreneurial ventures which led us to ask the following question, to what extent are the technologies startups innovation rate sensitive to different investors and the different asset profile that are associated with them? Elisa will show it as some of the basic design that we took to that end.
B: So, we wanted to see what Is the effect of corporate VCs but also what are the mechanisms behind it. So we have over 500 biotech startups all of which are funded by venture capital firms and about a third are also from the fight syndicate of course that also includes corporate VCs and this gives us a clean effect of what is the corporate VC effect.
We compare our startups that have similar age and also similar investment amount and we are very careful with how much of this is selection versus how much of it is nurturing. We find that selection is indeed one of the mechanics, so corporate VCs do select startups that are more innovative. However above and beyond that there is also a nurturing effect, and we find that startups with a corporate VC index indicate but then three times as much and publish twice as much as those that only have a VC (2:40).
A: And so this was where we were very curious as to why do we observe these patterns, and we wanted to get further at what is driving these results, and to that end we focused on the mechanisms. Specifically we studied the asset profile of the different investors. And so, when you think about it you have independent and corporate the venture funds, both of them share the same number of, not the same number but a similar number of these tend to be relatively small groups. What they differ is on a number of dimensions. Importantly, the independent venture capitalists receive most of the money from limited partners and most of the relationship there is a financial nature. Corporate venture capital on the other hand, they tend to be associated with large corporation, often time large pharmaceutical firms that in addition for fundings provide access and support of different type, and in fact, when we look at that, we see that they bring together complementary assets in terms of laboratory infrastructure, are in the talent pool, access to regulatory know how, and so on and so forth. In table one of the paper we explicitly talk about and compare these two investors rooms. What is more interesting is that this heterogeneity or diversity in their investment, in their resource profile seem to be associated with the innovation rate of the biotechnology startup. Elisa can you share with us why is that the case?
B: Yeah, we thought about this along the value chain of the innovation. So most biotech startups are involved in the discovery and in the development stage. In the discovery stage, it is very important to have access to the corporate VCs research labs. The proximity increases the frequency under the high bandwidth conversations and what we find is consistent with that proximity having an effect. On the development stage, it matters the regulatory process of the FDA becomes really important, especially for those biotech startups that need to go through the human drug FDA approval process. What we find is again consistent with this, in those cases it is more relevant to have the corporate VC behind. So, in sum what we find this in a sector what deep science innovation is very important that the complementary assets of the corporate VCs have an effect on the innovation grades of startups. Thank you for listening! I am Elisa Alvarez Garrido.
A: I am Gary Dushnitsky, and thank you for giving us the opportunity to share our findings with you.
Retrieved from: https://www.youtube.com/watch?v=OAfT9Gb-4Qs
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