Financing of Innovation Part 1fp7-nip.org.by/pdf/2015/6-Dobrinsky_Financing_of... · Financing...
Transcript of Financing of Innovation Part 1fp7-nip.org.by/pdf/2015/6-Dobrinsky_Financing_of... · Financing...
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Financing of Innovation Part 1
Presentation by Rumen Dobrinsky
European Alliance for Innovation
Training in the field of Innovation
Minsk 26-28 May 2015
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Introduction: Why finance is key to innovation?
Module 1. The Nature and Financing of Innovative Enterprises
Module 2. Private Early-Stage Financing of Innovative
Enterprises. Business Angel Financing
Module 3. Private Early-Stage Financing of Innovative
Enterprises. Venture Capital Financing
Module 4. Public Policy Initiatives to Address the Early-Stage
Financing Needs of Innovative Firms
Module 5. The Experiences of Different Countries in the
Financing of Innovative Enterprises
Module 6. Interactive Discussion on the Topic
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Structure of the presentation
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Why finance is key to
innovation?
The broader picture
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What is innovation?
• Introduction to the market of:
– New products or services
– New business models that enhance the value of existing products or services
• Disrupts existing market processes
– Incremental (small-scale improvements)
– Radical – new ways of doing business
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• Innovation is a complex phenomenon, requiring a combination of different types of knowledge and skills
• Involves the interactions of many “actors” (stakeholders): academic and R&D institutions, firms, public bodies, financiers, users, etc.
• Innovation is a process with highly uncertain outcomes: therefore there is a need to commit resources to reduce uncertainty
Innovation in the modern economy
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Innovation and Finance
• Innovation is about making money:
• “Whereas R&D focuses on transforming money into knowledge
Innovation is about transforming
knowledge into money“
Esko Aho, Former Prime Minister of Finland
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The innovation-finance cycle
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How is innovation related to finance?
• Innovation performance and financial flows are closely interrelated and correlated
• Finance (relevant and adequate financial support) is a key factor driving innovation at all levels
• What follows illustrates these links and interrelations at the macro level
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Measuring innovation performance (EU)
• The Innovation Union Scoreboard provides a comparative assessment of the innovation performance of the EU28 Member States
• IUS uses 25 indicators grouped in 3 categories: • Enablers capture the main drivers of innovation
performance external to the firm • Firm activities capture the innovation efforts at firm level • Outputs capture the effects of firms’ innovation activities
• Average performance is measured by a composite indicator, the Summary Innovation Index (SII)
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Measuring innovation performance (EU)
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11 Source: European Commission
Performance groups by SII
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13 Source: European Commission
Regional innovation performance by SII
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Name Editing Institution
Preparing Institution
First Ed.
Last Ed.
Frequency Standard structure
Target countries
Number of indicators
thereof based on innovation surveys
Selection criteria
Composite Indicator
Innovation Union Scoreboard
European Commission
MERIT 2001 2014 Annual Yes EU Member States
25 6 Reasoning, Correlation analysis
Yes
Innovation Union Competitiveness Report
European Commission
European Commission
2011 2013 Biennial unknown EU Member States
51 None No
OECD Science, Technology and Industry Scoreboard
OECD OECD 1991 2013 Biennial No OECD countries
~180 34 Reasoning No
OECD Science, Technology and Industry Outlook
OECD OECD 1998 2012 Biennial No OECD countries
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(country fiches)
None Not available
No
Global Innovation Index
INSEAD, WIPO
INSEAD 2007 2014 Annual Yes World 84 None Yes
Innovationsindikator Telekom Stiftung, BDI
Fraunhofer ISI, ZEW, MERIT
2005 2014 Annual Yes Germany and selected countries
38 None Model, Regression analysis
Yes
Global Competitiveness Report
World Economic Forum
Centre for Global Competiti-veness and Performance
1979 2013-2014
Annual Yes World 116 None Yes
Knowledge Assessment
World Bank
World Bank 2001 2012 Regularly updated
Yes World 148 None Yes
Diferent innovation scoreboards
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Global Innovation Index 2014 (WIPO)
Source: WIPO
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Total R&D expenditure as % of GDP (2013)
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R&D expenditure and innovation performance
Source: European Commission (2013-2014)
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R&D expenditure and innovation performance, 2013
Source: WIPO; UNESCO; OECD
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Private equity investment - innovation performance
Source: EVCA, European Commission (2013-2014)
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SME access to finance and innovation performance
Source: European Commission (2013-2014)
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Financing instrument
Key features in financing Remarks
Grant, subsidy Seed funding for innovative start-ups and SMEs at the seed and early stage
Complements market failures, financing at seed and initial stage
Business angel Financing source at early riskier stage and provides financing, advice and mentoring on business management.
Financing at start-up and early stage
Venture capital Invests at later, less risky growth stage. Referred to as patient capital owing to the lengthy time span (10-12 years) for investing, maturing and finally exiting.
Financing at later expansion stage
Corporate venturing
Used by large firms to invest in innovative start-ups with a view to improving corporate competitiveness with either strategic or financial objectives.
Strategic motive
Crowd funding A collective funding tool via the Internet which makes it easier for small businesses to raise capital at the seed and early stages.
Still developing; potential for fraud
Bank loans Needs collateral or guarantees in exchange for loans. Obligation to repay as debt
Tax incentives A broad range of tax incentives for R&D and entrepreneurial investments in most countries.
Indirect, non-discriminatory
Innovation: the main financing instruments
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1. The Nature and
Financing of Innovative
Enterprises
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• The nature and characteristics of
innovative enterprises
• The financing needs of innovative
enterprises
• The financing options for innovative
enterprises
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Issues covered in the module
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What are innovative enterprises?
• Innovation takes central stage in their activity
– Tend to be new or younger and small (startup, SME)
– Can grow substantially
– Account for over half of all innovations and almost all radical innovations
• Innovation opportunities:
– Market applications for new inventions or technological discoveries
– New applications for existing technologies
– Imitation (replication of business practices/ introducing products new to the local market)
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Some key factors driving firm innovation
• Investment in education that is relevant to business.
• Support to investment in R&D by both government and business.
• Business investment in innovation strategies.
• Specific policy measures to create a conducive environment for firms to engage in the commercialization of innovative business opportunities.
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What determines the prevalence of IE?
• Overall R&D environment – R&D intensity
– Innovation leaders, followers, catching-up, trailing
• Attractiveness of entrepreneurship as a career – Attitudes and aspirations towards risk and growth
– Workforce mobility
• Favorable environment of early stage financing and support (in particular for SME)
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• It starts with an individual (group) and an idea
• Exploration of technical feasibility, market potential, and economic viability
• Product development
• Start-up of operations; market introduction
• Market and organizational expansion
• Growth
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How innovative enterprises develop?
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• Seed stage – initial R&D, business concept refinement, feasibility analysis
• Start-up stage – prototype development, market research and outreach, formal organization.
• Early-growth – small-scale commercialization, platform for scalability
• Expansion – substantial growth in scale and market impact.
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Financing needs in different stages
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Risks and roles on the journey to market
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Risks sharing in financing innovation
Basic Research
Public Support
Grants,
innovation
vouchers,
tax incentives
Discovery
Invention
Applied R&D
Public and private
initiatives
Equity (BA,
seed finance),
convertible
loans,
guarantee
schemes
Patenting and
licensing
Prototyping
Industrialization
Private Intervention
VC, IPO
Risk
Level
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• High uncertainty – No track record, no collateral – Limited evidence for feasibility and viability – Possible high-rates of obsolescence
• Information asymmetry – The entrepreneur’s knowledge is tacit – Hard to distinguish high- and low-quality opportunities
• Value is entirely based on the long-term growth potential
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Challenges of attracting mainstream finance
This is why we need specialized financial
institutions for early stage financing!
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The dynamics of financing needs
Development stage
Cas
h F
low
Seed Start-up Early growth Expansion
“Valley of death”
Founder, 3Fs
Business angels
Venture capital funds
Public stock markets
Debt / Bridge loans
Feasibility grants
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Innovation, risk and finance at different stages
Turnover Innovation style Funding regime
Early stage €0 to €500,000.
Likely to pursue radical innovation. Possibly drawing on externally mobilised expertise
Equity funding –proof of concept / early stage fund
Early development €500,000 to
€20m
Likely to develop radical innovation. Possibly drawing on externally mobilised expertise
Equity funding – angel or venture
capital
€20m to €100m
Radical and incremental but at upper end of the turnover range. May suppress radical change if it
damages an existing market
Self funding from revenue or floatation
> €100m
Radical, incremental and open innovation, but may suppress radical change if it damages an existing market. May seek innovation from other sources such as universities, consultants or small radical
innovation based companies.
Self funding from mature markets
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• “Grants” for assessing the commercial potential of the innovative idea/research
• Proof of concept (pre seed - FFF)
• Seed (Angel Groups; public funds)
• Start up (VC; public funds)
• Expansion (Private VC funds; Bank loans)
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Types of finance in different stages
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The financing sources of new firms
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The financing sources by stages
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• The stage of greatest uncertainty and risk
• Innovative enterprises ideally need financing that does not seek guaranteed repayment
• The 3F (Family, Friends, Fools)
• Merit-based awards (grants)
– Funding decisions are based on meeting pre-specified criteria
– Often provided by public agencies
– Substantial administrative and decision burden
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Seed funding (the «valey of death»)
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• Match between risk profile and potential payoffs
• Investors have claims on the residual value of the enterprise (i.e. they share the upside)
• Investors also share the downside (i.e. they can lose their money entirely)
• Various mechanisms ensure that they get paid before the entrepreneurs do (e.g. convertible preferred stock)
• Examples: business angels, seed funds, incubators, venture capital funds
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Seed funding (contd.): external equity
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Framework conditions
Capital
Specialized intermediaries
Entrepreneurs
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2. Private Early-Stage
Financing of IEs.
Business Angel Financing
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• What is a "Business Angel“
• What is the role of Business Angels and
how do they operate?
• BAs and BA networks in Europe
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Issues covered in the module
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The 3F (Family, Friends and Fools)
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Who are the Business Angels
• Wealthy individuals, often cashed-out entrepreneurs
• Make equity investments of $25-50k (up to $1-2m for syndicated deals) in promising ventures
• Provide substantial portion of the seed and start-up capital of innovative enterprises
• Provide more than capital (expertise, support)
• Active & passive; novice & experienced
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Added Value of Business Angels
• Business angels bring more than just capital:
– usually have extensive business and entrepreneurial experience
– provide strategic, operational, and market advice
– can offer insights on the specific industry
– can introduce the entrepreneur to major stakeholders such as customers and suppliers
– can offer much moral support to an entrepreneur
– BA’s reputations may carry a lot of weight in attracting high-quality deals
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• Atmosphere of trust between individuals
• Credible business plan in the eyes of the BA
• Good management team
• Fiscal incentives
• Market knowledge of the entrepreneur
• Availability of exit route
• Return on investment (capital gain)
How business angel investment works?
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How much they matter? (US example)
0
5
10
15
20
25
30
Businessangels
Venturecapital
Early-stage Later-stage
0
10'000
20'000
30'000
40'000
50'000
60'000
Businessangels
Venturecapital
Amount invested (Billion USD) Number of enterprises financed
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Key decision criteria for BAs
• Is proposal unsolicited or through referral?
• Does the business have solid fundamentals?
– Potential market impact
– Sustainable competitive advantage
• Is the person qualified to run the business?
• Does the business operate in familiar area?
• Is it close enough for face to face interaction?
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Business angel networks (BAN)
• Pool the financial, knowledge, and information resources of a group of angels
• Alleviate the inefficient flow of information between (individual) angels and entrepreneurs
• Attract bigger deal flow
• Allow individual angels to diversify their portfolios and participate in more deals
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The operation of BANs
• Local, regional or national in scope
• Organized around interests in particular sectors
• Offer a number of key services
– Matchmaking
– Business plan coaching to entrepreneurs
– Training to both investors and entrepreneurs
– Syndication support
– Co-investment funds and opportunities
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Factors affecting BA investing
• Potential for promising returns
– Availability of growth capital
– Lucrative exit routes
• Supply of high quality enterprises
• Tax conditions (tax relief, capital gains tax, dividend tax)
• Economic conditions (growth, interest rates, inflation)
• Stock market conditions
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Number of BA networks in Europe
Source: EBAN
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European BA investment
Source: EBAN
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European BA investment by country, %GDP
Source: EBAN
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European BA investment by country
Source: EBAN
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Average Investment Amount by BANs (mn €)
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Advantages Disadvantages
Major source of funds Less visible on the market
Possible “leverage effect” on other investors
More limited investment experience
Willing to provide small amounts of funding Less extensive networks
Less restricted investment criteria Danger of extensive intrusion in business
More opportunistic – less formal analysis Less professional experience
Lower ROI expectations Less prestigious than VC investment
Cheaper in fees to obtain finance May have hidden motives
Provides know-how, advice and contacts May become “Business Devils”
More “patient money” – less pressure to exit
Invests in own locality
Pros and cons of BAs vs. later stage investors
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3. Private Early-Stage
Financing of IEs.
Venture Capital Financing
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• What is "Venture Capital"
• How VC investment works?
• The VC investment cycle
• VC in Europe and the US
• Crowdfunding: introducing the issue
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Issues covered in the module
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What is Venture Capital?
• VC performs an intermediary function, channelling funds from institutional investors to high-potential enterprises
• VC provides specialized investment expertise
– Identify potential investments
– Monitor, provide financing in stages
– Add value through oversight and guidance
• Depend on smooth flow of funds from institutional investors and back (with returns)
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• Provision of professionally managed equity
capital to promising enterprises
• Anticipation of exit (liquidity event) in 5-7
years
• “Patient” capital – illiquid before exit
• The bulk (70-80%) goes to early-growth or
expansion-stage companies
Main functions of VC
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The levers of VC finance
Institutional
investors VC firms
Entrepreneurial
firms
FUNDRAISING INVESTING
EXITING RETURNS
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Venture Capital and Private Equity
• Private equity - provision of equity capital to enterprises not quoted on a stock market. Often associated with buy-outs or buy-ins.
• Venture capital – provision of equity capital for the launch, early development, or expansion of a business (i.e. a subset of private equity)
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VC investment process
• Provide incentives – Capital infusion tied to achievement of milestones
– Entrepreneurs are vested in the residual value
• Provide expertise – Discern opportunities and threats
– Operational and strategic guidance
– Professionalization of management
• Provide network and legitimacy – Lend extensive network of relationships
– Ease the concerns of customers or suppliers
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• Pre-investment
– Origination, prospecting
– Screening and due diligence
– Structuring
• Post-investment
– Monitoring and oversight
– Value adding
– Exiting
How do VC firms add value?
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• Detailed evaluation – Potential market impact
– Strength of competitive position
– Management team quality
• Initial screening – Does it meet the fund’s basic investment criteria?
– Is there a personal referral?
– Quality of the business plan (executive summary)
• Due diligence – Third-party opinions on underlying technology
– Corroboration of estimates and assumptions
Investment decision considerations
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• Business plan credibility
• Business plan with patent technology
• Track record (over previous years)
• Ability to grow fast and deliver quick ROI
• Management team quality
Some important criteria for VC investment
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Deal Generation
Pipeline Process
• 2weeks-1month
• “Mini Due Diligence Process”
• NDA: Non Disclosure Agreement
Internal Due
Diligence
Non Binding
Offer
Due Diligence
Process
•Information to the Investment Committee.
•If what you say is true, I will be able to pay you... $/.
Final Process
• Analysis Process
•Exclusivity Period (3 months)
• DD+Legal Contracts
Sample VC financing process
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• Enticing institutional investors Education on VC nature and return profile
Qualms about new funds, new managers
Natural cycles of ebbs and flows
• Regulatory issues Existence of dedicated or suitable structure
Exemption for cross-border fundraising
Capital gain taxation
• Tax issues Third-party opinions on underlying technology
Corroboration of estimates and assumptions
Issues in fundraising
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Availability of investment opportunities R&D environment
Entrepreneurship as a career option; relevant
education
Availability of seed capital
Recognition and selection of opportunities Support network for deal referrals and due diligence
Industry specific skills and connections of VC
managers
Proper risk-return profile
Effective contracts Tax treatments of convertible preferred stock
Rule of law in enforcing contractual provisions
Issues in investing
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Incentives to provide value added
Stake in the upside
Loss guarantees can be counter-productive
Leveraging of lower-cost, public funds
Ability to provide follow-on financing
Small funds can be diluted in later rounds
Possession of proper skills by the VC
investors
Career paths from high-technology settings
Mobility of managers across firms and countries
Issues in value adding
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IPOs and trade sales are most lucrative
routes
Returns are sensitive to 1-2 big hits
Successful IPOs require active stock
markets, open to new securities
IPO windows are sensitive to economic
conditions (e.g. 2008-2009)
Issues in exiting
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The fate of VC investments
Source: Cochrane (2005)
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Europe VC investment by stage (€ mn)
Source: EVCA
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Europe private equity investment by stage (€ mn)
Source: EVCA
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Sources of new VC in Europe (% new funds raised)
Source: EVCA
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EU VC investment by country, %GDP
Source: EVCA
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VC vs. BA investment, %GDP
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VC investment in the United States
Source: PwC/NVCA MoneyTree Report, Thomson Reuters
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Crowdfunding:
Introducing the issue
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What is crowdfunding?
• Crowdfunding is a way of raising money to finance projects and businesses.
• It enables fundraisers to collect money from a large number of people via online platforms
• Crowdfunding is a broad concept that may apply to many different types of projects
• But it is also an approach to fund innovative entrepreneurial projects
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Three main crowdfunding compnents
1. The project Initiator who proposes the idea and/or project to be funded
2. The Crowd/Community (individuals or groups who support the idea with money)
3. The online Platform that brings the parties together to fund and launch the idea
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Crowdfunding vs. traditional funding
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Types of crowdfunding
• Peer-to-peer lending – the money will be repaid with interest.
• Equity crowdfunding – Sale of a stake in a business to a number of investors
• Rewards-based crowdfunding – expectations of receiving in return a non-financial reward
• Donation-based crowdfunding – no financial or material return.
• Profit-sharing / revenue-sharing – sharing future profits with the crowd in return for funding now
• Debt-securities crowdfunding – Individuals invest in a debt security such as a bond.
• Hybrid models
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The magnitude of crowdfunding