Enhancing Capital Availability for Startups: A Toolkit for Policy-Makers | Global Policy

Dieser Beitrag erschien bei Global Policy. 

Katrin Suder, Lea Thiel and Julian Kirchherr from McKinsey & Company explain which initiatives cities need to undertake in order to increase funding opportunities for startups.

In the world of startups, the rule of thumb is that American startups raise twice as much capital in each round of financing as European ones.

For many years, European policy-makers believed there was not much one could do about this discrepancy. After all, capital follows ideas, the thinking went. If there was only more gifted entrepreneurs in Berlin, London or Paris, more funding would be available.

But does this conventional wisdom really hold true? This was one of the questions we attempted to answer in the past seven months.

To do so, a team of consultants conducted an in-depth case study on Berlin’s startup ecosystem (jointly published by McKinsey & Company and the Senate of Berlin this October) which included more than 100 structured interviews with entrepreneurs, venture capitalists, corporations, policy-makers and academics from all around the world. We attempted to understand what really constitutes a vibrant startup ecosystem – and what role capital availability plays in such a system. This new study constitutes a follow-up of „Berlin 2020- Fostering Competitiveness and Innovation„, our 2010 report on Berlin outlining strategic approaches to regional development for Germany’s capital.

The key capital policy insights in our new study:

Capital is a startup ecosystem’s most decisive asset. No young company will be scaled if only insufficient funding is available. Thus, capital availability highly correlates with a city’s reputation as a startup hub.

Interestingly, there may be a lack of funding in a city despite many great business ideas, though. The root causes, also evidenced by the interviews we conducted:

First, the risk aversion of venture capitalists (VCs) is highly variable. Indeed, many studies and surveys profile investors in countries such as Austria, Denmark and Italy as „hesitators“ sticking to business models with a proof of concepts, whereas American VCs with a „lower aversion to risk“ are much more likely to invest in dicey business ideas.

Second, the horizon and awareness of VCs is limited. Indeed, VCs –limited in their resources – tend to only track the deal flow in cities already known as startup hubs; they may not investigate startup activities in emerging hubs because they do not expect any promising companies here.

VCs complained for many years that legal hurdles in Europe would also impede VC investments. However, a range of studies and investigations evidence that this alleged root cause does not hold true. First, investors truly interested in a startup are likely to overcome legal disadvantages. In addition, Europe continuously harmonizes its VC legislation and makes it more business-friendly. The latest European VC legislation was only implemented this July.

Policy-makers can impact both the risk aversion and the horizon and awareness of VCs. And policy-makers have increasingly done so in the past few years. One example is London with its East London Tech City Initiative.

Indeed, the rule of thumb on cash for startups does not hold any longer: London, for instance, is now almost comparable with Palo Alto when it comes to early-stage and growth financing (cf. Exhibit 1). In Berlin the typical volume in late funding rounds is now nearly as high as in Silicon Valley.

Admittedly, room for improvement remains: Matching VC investment portions in European and American cities still displays a vast gap in total VC investments, for instance: While in Silicon Valley VC investment amounts to 1.5 percent of the state’s real GDP, it is still less than 0.1 percent in Berlin.

EXHIBIT 1: AVERAGE DEAL INVESTMENTS IN SELECTED CITIES

A VC taskforce dedicated to encouraging venture capital activities may be the ideal tool to enhance capital availability. Such a unit usually consists of 3-4 individuals placed within a public administration who are recruited both from the public and private sector. The unit is typically led by an established VC directly reporting to a city’s mayor.

In order to enhance the availability of private capital, VC taskforces may follow two paths:

Path 1: More private capital

First, policy-makers may enhance the availability of private capital via promotional efforts or via helping new private funds to launch.

Promotional Efforts: The leanest option to attract more and less risk-averse private capital: Raising awareness for a city’s pool of startups. For instance, London’s Tech City Investment Organization (TCIO), the city’s official startup unit, formally engaged with more than 29 United States VCs in 2011/2012 via calls, meetings and conferences significantly increasing the city’s access to international capital. An influx of international investors may also decrease the risk aversion of domestic VCs in the medium-term via spillover effects.

Launch of new Private Funds: A more ambitious approach to attract more private capital and to address high risk aversion in Europe may be launched in Berlin soon. Indeed, we recommended to the city to help creating a privately managed „Berlin fund“ which ought to grow to a size of 100 Mio. EUR until the end of 2014. Large German corporations as well as small and medium sized companies ought to invest in the fund (at least 1 Mio. EUR/corporation) in order to gain insights in the city’s startup deal flow. Investing in the fund resembles a risk diversification for most companies involved which would usually only be able to invest in one or two startups at the same time.

Path 2: More public capital

Second, policy-makers may directly invest public funds in the city’s startups. However, such investments are usually limited to a company’s seed phase. Indeed, a range of European laws prohibit any public investments beyond 3 Mio. EUR per ticket.

Matching private with public capital: Matching is one public capital option. For instance, Singapore now matches every Singapore dollars invested by a VC (up to 3 Mio. EUR per ticket) in one of the country’s focus cluster as part of its National Framework for Innovation and Enterprise (NFIE). Such an instrument may increase the return on investment (ROI) for private investors via accelerating a startup’s scaling phase.

Public Funding Instruments: Launching a public funding instrument is a second public capital option. Berlin’s VC fund „Technologie Berlin“ is a promising example of such a tool. With a total fund volume of 52 Mio. EUR and a ticket investment of up to 3 Mio. EUR it supports leading startups from Berlin such as OctreoPharmmysportgroupand madvertise.

To ensure sustainable benefits, public funding instruments must build a decent reputation, though. Indeed, many private investors assume that those entrepreneurs receiving public capital were unable to raise any private capital on the market. Thus, they may refuse to finance them at later stages. Only if a public funding instrument manages to build a decent reputation, private capital may follow.

If there are innovative business ideas in a city, VC taskforces can help that capital follows. Nevertheless, VC taskforces are not the silver bullet against capital shortages in a startup ecosystem. Only if a city manages to generate spectacular exits – the result not only of capital availability, but also great infrastructure and talent, vast networks, great ideas and a great deal of fortune – the startup cycle will function. In the end, only spectacular exits create business angels and signal to investors all over the world that big money can be made here – which then attracts more and more VCs.

The pro-bono-report “Berlin builds businesses: Five initiatives for Europe’s start-up hub“ was published October 7th 2013. Katrin Suder is Director at McKinsey & Company. She currently leads McKinsey’s Berlin office as well as Germany’s Public Sector Practice. Lea Thiel is Fellow Senior Associate at McKinsey & Company, Munich. Julian Kirchherr is Fellow at McKinsey & Company, Berlin.

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