Click here for printer friendly page
Investor performance in Israeli high-tech08/08/2007. Source: IVCJ (Israel Venture Capital Journal).
 In this IVCJ article, Gil Avnimelech, lecturer and PhD candidate at the School of Management, Ben-Gurion University, examined investor performance in high-tech start-ups and uncovered both expected and surprising data.
Is the success or failure of a start-up influenced by the make-up of its investors? I recently undertook a study to examine this question in relation to Israeli start-ups. Using the IVC Online database, 2,462 Israeli hightech firms – the entire high-tech start-up population of the years 1991-2000 – were examined. This population was divided into 10 overlapping groups according to the type of investor in each firm. The groups included startups backed by:
• No investors (495 start-ups)
• Technological incubators (531 start-ups)
• The Office of the Chief Scientist (OCS) (764 start-ups)
• Academic technology transfer offices (TTOs) (69 start-ups)
• Business angels (544 start-ups)
• Investment companies (892 start-ups)
• Local VCs (690 start-ups)
• Foreign VCs (313 start-ups)
• Local corporate venture capital (CVC) firms (217 start-ups)
• Foreign CVCs (112 start-ups)
The "performance" of the various financial supporters was compared, based on the current (September, 2006) status of the portfolio companies. Each firm was given one of three possible rankings: (1) high success (start-ups that had an IPO or were a target of a significant acquisition); (2) moderate success (start-ups that didn’t have an IPO and were not acquired, but are still active); and (3) failure (start-ups that closed).
In the entire Israeli start-up sample, the failure rate is 46.2 percent, and the success rate is 15.1 percent (3.6 percent IPOs and 11.5 percent M&As). Foreign CVCs had the best success rate (33.9 percent), followed by foreign VCs (31.7 percent), local CVCs (26.3 percent), local VCs (25.6 percent), business angels (23.9 percent), investment companies (19.1 percent), TTOs (14.4 percent), OCS (9.3 percent), no investors (8.3 percent), and incubators (3.5 percent).
It is interesting to note that while VCs and business angels had similar success rates, the failure rate of business angels was much lower (25.4 percent versus 35.1 percent). The main finding of the research is that all types of private financial supporters provide some "added value" to their portfolio companies e.g. start-ups backed by private financial supporters have improved performances, compared with other start-ups in the population.
This added value may be attributed to adverse selection (in which "higher quality" start-ups choose private investors and "lower quality" start-ups choose public investors), to improved selection processes, to effective monitoring or to operational added value. Whatever the cause, the result is a significant contribution to the economy at the macro level. Moreover, sophisticated investors have superior performance.
For example, VC funds are superior to investment companies, and strategic investors are superior to financial investors. However, there are some negative effects related to the investment activity of professional financial supporters. These drawbacks include an extremely narrow technological focus and the absence of investment in start-ups located in peripheral geographic areas.
Findings
Foreign financial supporters (both VC funds and CVC funds) have superior performance to their domestic fund counterparts. However, it is not clear whether this superior performance is declining or growing as local industry develops. On one hand, Israeli VC backers have gained more experience, generating a global reputation and building valuable networks. On the other hand, foreign financial supporters have become more familiar with Israeli high-tech, and have expanded their local involvement. In addition, it was found that syndications of Israeli and foreign VCs achieved a success rate of 33 percent, only 1.3 percent higher than the success rate of foreign VCs alone.
Start-ups backed by CVC funds have higher success rates and lower failure rates than start-ups backed by VC funds or any other investor. Interestingly, when CVCs syndicate with foreign VCs, CVCs appear not to add value as the success rate is 28 percent, yet syndications of CVCs and Israeli VCs have a higher success rate of 34.8 percent.
The performance of professional business angels in the Israeli VC market is impressive. While business angels enter start-ups much earlier than VC funds, they have similar success rates to VCs and much lower failure rates. Moreover, their investment patterns seem to be more diversified across technology sectors. Note that this research ignored the issue of dilution, so these results do not suggest that business angels necessarily have high returns on their investments.
The performance of start-ups supported by the government is similar to that of start-ups with no investors. This result is reasonable as government support in Israel is given to any start-up that undertakes R&D activities and has no operational added value. Spinouts from academic institutions perform similarly to the entire population of start-ups. This result is quite encouraging, considering the cultural barriers inherent in academic spinouts.
The technological incubators have an extremely low success rate and an enormous failure rate. This could mostly reflect three factors – (1) that incubators invest at the pre-seed and seed stages and therefore the companies are inherently more risky; (2) that only low quality and/or very risky startups approach incubators and (3) an inefficient operation and business model. Incubator graduates that attract investment from VCs or CVCs have improved performance (10.8 percent and 10.5 percent, respectively). These results, however, are still well below average.
Policy implications
The VC industry has made significant contributions to economic growth and high-tech development. However, it also has created some not insignificant drawbacks such as narrow technological and regional focus. These drawbacks may have a negative impact on long-term economic growth.
Therefore, better understanding of the differences between various financial backers in terms of investment patterns, added value and performance may have significant policy implications. In the public domain this new knowledge may lead to the development of a more diversified and balanced venture capital market. In the private domain, this knowledge may lead to new patterns of syndication.
Comments and requests for a copy of the entire study can be sent to gilavn@bgu.ac.il
This article appeared in the Israel Venture Capital & Private Equity Journal (IVCJ). IVC Research Center publishes the Israel Venture Capital & Private Equity Journal, a quarterly review of trends and developments in the Israeli-related venture capital industry. IVCJ, distributed worldwide, is dedicated to provide wide-range coverage of Israel's venture capital industry. For more information please visit www.ivc-online.com
|
