Risk capital and innovation - venture capital literature review

Samantha Sharpe
Work package: 
WP 3
Publication number: 
01 August 2009

Synopsis: Work Package 3 explores the connection between modes of innovation financing and the innovative performance of firms. Different sources and forms of capital are committed to risky investment in innovation and the way in which these are translated into value can vary considerably, as do the outcomes of innovation venturing from the viewpoint of firm growth. A variety of capital and credit instruments, and different combinations thereof, are used across countries and sectors of the economy. Our first objective towards the overarching goals of the FINNOV research programme is to gather, structure and discuss what the state-of-the-art literature posits and/or show about risk capital and innovation. The specific focus of this review is venture capital.

Venture capital is an important source of finance for a small number of technology focused firms. These firms require intensive periods of R&D and market development and face the prospect of negative revenues in the first few years of the firm. This limits access to other sources of external finance such as debt finance.

The financial constraints of new technology based firms (NTBFs) have long been a focus for public policy. Recently the focus has turned to public money invested in private early stage VC funds. These so called government-backed or hybrid funds now account for a significant component of early stage investment activity in Europe. However hybrid models present both a commercial and public policy challenge; continuing poor commercial performance of early stage funds have diminished private investors interest in early stage VC, whilst arguments of market failure as a reason for public intervention have also been questioned. This review provides an overview of VC activity in Europe; who invests, what they invest in and how these investments perform. The review also covers the institutional foundations of VC in Europe and the US and public policy issues surrounding the hybrid model.