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...important market and product characteristics. Factors affecting the required rate of return were more important for the early-stage firms than for late-stage firms. Discounted cashflow analysis is the most frequently used valuation method. Private venture capital firms invest more during late development stages, while public venture capital firms invest more during the early stages. The results can be used by firms seeking venture capital, venture capital firms, consultants, and support agencies that provide capital-acquisition assistance. By gaining insight into decision criteria and processes, firms can develop better and more targeted materials to attract capital. Venture capital firms can use the information from this study to better understand their decision processes, individually and relative to competitors. Consultants and support agencies can use the information to provide better advice to both firms and venture capital firms. Information is this study could easily be built into training programs for both new and existing businesses. Finally, the results can also be incorporated directly into university courses that include material related to venture capital.
Introduction
Venture capital (VC) is important to many Spanish SMEs that are rapidly growing or that are developing high-risk products. Traditional financing sources are commonly unavailable as financial institutions are reluctant to provide risk capital and personal equity is often consumed during the early stages of company operations (Van Auken 2001). Venture capital can fund product development, marketing, expansion, turnaround, employee buyout, and acquisition. Venture capital investment can position the firm to obtain additional capital through the venture capitalist's experience, expanded network of contacts, enhanced market creditability, and stronger financial position (Ruhnka and Young 1997). Gupta and Sapienza (1994) suggest that venture capitalists add value to firm by bringing investors and entrepreneurs together in an efficient manner, making better investment decisions than limited partners would make, and providing nonfinancial assistance that in turn promotes survival. Zacharakis and Meyer (2000) pointed out that VC-backed ventures have higher survival rates than non VC-backed ventures.
Understanding the nature and process of VC investment decisions can improve the likelihood that a firm will be successful in raising funds. Stage of development, risk of the venture, background of the owners, geographic location, and exit opportunities affect the venture capitalists' assessment of risk and return potential (Van Auken 2001). Understanding these issues will enable companies to develop better proposals and negotiate more effectively with venture capitalists (Timmons and Spinelli 2004).
The creation of an active VC market that facilitates the financing of early-stage and high technology ventures has been a high priority for economic politics (Da Rin, Nicodano, and Sembenelli 2005). Early-stage companies that attract VC investment can take advantage of the VC's experience, knowledge, understanding of the entrepreneurial process, and network of relationships (Repullo and Suarez 2004; Lindsey 2003; Lerner 1995). Late-stage companies that attract VC capital have less opportunity to take advantage of these VC contributions (Michelacci and Suarez 2004).
The tendency of the VC in Europe in comparison with Asia countries and the United States is to invest in more in late-stage projects (Allen and Song 2003). This takes place in a higher intensity in Spain, where the investments in early stages only represented 4.2 percent of the invested volume and 21.9 percent of the number of operations in 2003 (ASCRI 2004). Spanish SMEs have traditionally experienced problems accessing medium and long-term financing. Public VC funds were established to provide funding for SMEs, particularly start-ups who could potentially contribute high added value. Regional governments are especially interested in establishing regional VC funds to promote regional economic development.
This paper fills a gap in VC research by examining VC investing in Spain. Specifically, the study examined the relationship between the stage of development and investment decisions of 51 Spanish VC firms. Little research has been completed on Spanish VC, especially on VC investing in relation to stage of firm development. Venture capital investing in Spain has increased fourfold since 1997, and much of this growth has been achieved through international capital inflows. In 1999-2000, the Spanish government developed economic initiatives to spur VC investing (Tejado 2003). Gaining insight into the decision criteria and processes of Spanish VC decisions can assist further development of government policy that facilitates VC investing. A better understanding of VC investing can help Spanish firms to develop better and more targeted materials to attract capital. Venture capital firms can use the information from this study to better understand their decision processes, both in isolation as well as in relation to their competitors.
The next section of the paper provides an overview of VC investing. Section 3 presents a description of the data and methods used in data analysis. Section 4 explains the results of the analysis, and the final section provides summary results and conclusions.
Venture Capital Investments
Stage of Development
Lam (1991) recognized the importance of analyzing investments according to the stage of development by stating that VC investments relative to the stage of development provide important information on company value. Venture capital investment of capital is similar to buying an option to participate in the subsequent stages of company development. The company's stage of development directly impacts the VC's investment analysis, especially as related to the risk assessment and return potential (Carter and Van Auken 1994). Venture capitalists would require higher expected rates of return for early-stage investments as compared to late-stage investments due to the greater risk exposure.
Venture capitalists typically specialize by stage of development and geographical location. Specializing by stage of development allows them to balance investment risk, portfolio diversification, and return potential. Investing in specific geographical locations permits greater opportunity to influence and advise firms in which they invest (Cano and Cazorla 1998; Carter and Van Auken 1994; Barry 1994; Norton and Tenen-baum 1993). Gupta and Sapienza (1992) show that VC firms that specialized in the early stage of development prefer less diversification and close geographic proximity to the firms in which they invest than VC firms that invest in late stages. Larger VC firms often invest in multiple stages of development and a larger geographic area to manage risk exposure through diversification (Cano and Cazorla 1998).
Information
The flow of information between the venture capitalist and the entrepreneur is one of the more important elements affecting negotiations and investment. Several alternative approaches, including information asymmetry, signaling, and agency theory, have been used to understand the role of information in consummating the investment decision. Information asymmetry has been cited as one of the more important factors in the acquisition of capital by small firms (Landstrom 1992). Expecting the exchange of all knowledge about a venture is unrealistic, particularly in view of the specific knowledge embedded in the skills and capabilities of the founders. Asymmetrical information is greater in the early stages of development than in later stages because of the difficulty of assessing performance in earlier stages (Sahlman 1990). Information asymmetry is potentially an even greater problem for firms involved in technological innovation than other firms because of the uncertainty of market forecasts and long product development lead times (Van Auken 2001).
Even with a superior business concept and a competent team, new ventures are likely to be underfunded unless they can effectively communicate the appropriate information to potential investors (Busenitz, Fiet, and Moesel, 2005). Problems associated with information asymmetry can, however, be mitigated through interactions between the venture capitalist and the entrepreneur (Sapienza and Gupta 1994). The venture capitalists' due diligence of the...
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