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Factors affecting equity capital acquisition: The demand side
FACTORS AFFECTING EQUITY CAPITAL
ACQUISITION: THE DEMAND SIDE RONALD J. HUSTEDDE University of Kentucky
GLEN C. PULVER University
of Wisconsin-Madison
This article summarizes a study of 318 private entrepreneurs who have sought equity capital in amounts of $1oO,ooO or more. These individuals are normally considered prime clients of venture capitalists. Entrepreneurs’ success in acquiring funding is related to four general variable categories: (I) characteristics of the entrepreneurs including education, experience, and age; (2) characteristics of the enterprise including stage, industry type, and location (e.g., rural or urban): (3) characteristics of the request including amount, business plan, and prospective capital source; and (4) sources of advice including technology, preparation of the business plan, and places to seek funding. The study is unique because it includes many entrepreneurs who were unsuccessful in acquiring capital, thereby reducing the survey bias. In fact, only 59% of those surveyed actually acquired funding. This article provides specific insights into businesses seeking capital. For example, the entrepreneurs who are most successful in acquiring funding are those who are prepared to surrender a larger percentage of equity and who are very aggressive in going directly to a number of potential equity providers at an early stage. Contrary to common belief, older and more experienced entrepreneurs seem to have more dtfliculry acquiring financing. Likewise, entrepreneurs attempting to start businesses in rural areas are more apt to have dt#iculty acquiring equity capital in amounts of $100,000 or more. Entrepreneurs may experience dt#iculty in acquiring equity capital for certain business types in spectfic capital markets. Firms in the healthlmedical technology and communication fields, for example, have much more success acquiring funding in Minnesota and Wisconsin than those in electronics and factory automation. It is vital that the entrepreneur get to the proper source of capital,
EXECUTIVE SUMMARY
Address correspondence to Ronald J. Hustedde, 500 Ganigus Building, Sociology Department, College of Agriculture, University of Kentacky, Lexington, KY 405464215. This research was funded by the College of Agticulhm and Life Sciences at the University of WisconsinMadison and the U.S. Department of Agriculture.
Joumal of Business Venturing 7. 363-374 8 1992 Elsevier Science Publishing Co., Inc., 655 Avenue of the America.s, New York, NY 10010
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wherever it is to be found, as quickly as possible. This study also indicates that private investors not identt$ed as formal venture capitalists are the primary source of financial assistance. The study revealed that the quality of advice provided to entrepreneurs may need improvement. Entrepreneurs who fail to seek assistance are less successful in acquiring equity capital. It is less clear where good advice is to be found. Attorneys appear to ofJeerpositive advice regarding marketing and referrals to non-venture capital sources. Bankers, in contrast, are more frequently associated with advice that fails to secure capital. Public agencies and university-related organizations are, in some cases, also associated with a failure to acquire capital. It may be that the weakest cases ultimately find their way to these sources of consultation. The article provides a number of spectfic public policy recommendations for those governments interested in improving equity capital market eficiency. For example, as entrepreneurs seeking equity capital in small amounts seem to have dtfjiculty, public governments might choose to facilitate the movement of equity capital in smaller amounts by bundling several small requests together and then selling them to interested investors. The public might choose to improve information linkages between entrepreneurs and capitalists by educating intermediaries such as accountants, attorneys, and bankers regarding sources of equity capital or by developing publicly supported linkage networks to whom entrepreneurs might turn. Special information programs on sources of equity capital might also be instituted in rural areas or with spectfic groups experiencing capital access problems. Private equity capital markets are not apt to serve adequately certain types of businesses. There may be some need for providing direct capital subsidization to firms that are expanding or to those with growth potential that, for some reason, are unattractive to private capitalists (e.g., the entrepreneurs are older, the expected growth rate is slow). These businesses may have the potential of making a substantial contribution to a regional economy but lack the short-term, high-growth impact that attracts venture capitalists.
INTRODUCTION The availability of equity capital is a critical factor in the start-up and early stage expansion of many high-risk businesses with high-growth potential. The financing of these businesses is important because they represent an increasingly important source of new jobs in the United States. As a consequence the availability of equity capital may have a profound effect on the future economic well-being of some regions. There is evidence of wide variation in the regional allocation of funds from equity capital institutions that serve high-risk, highgrowth businesses (Mason 1987; Thompson 1989). A fundamental regional economic development concern, therefore, is whether the variation in acquisition of equity capital is a consequence of market failure or simply differences in entrepreneurial activity (Vaughan et al. 1985). This article examines a set of demand variables that may affect the ability of firms to acquire equity capital. Variables included are the characteristics of the entrepreneurs, the enterprises, and the requests as well as the sources of advice. The analysis relies on data from a survey of 318 firms in Minnesota and Wisconsin that have been identified as seekers of equity capital in amounts exceeding $100,000.
Theoretical Insights Neoclassical economic theory argues that capital flows to businesses that offer the highest marginal rate of return without regard to geographic location of the activity (Mikesell and Davidson 1982). However, financial markets in the United States may contain spatially related factors that might restrict capital flow. Market imperfections such as variations in taxes, government regulations, information, and attitudes among investors and entrepreneurs influence the flow of both debt and equity capital.
DEMAND AND EQUITY CAPITAL ACQUISITION
365
Individual firms may have difficulty acquiring capital for a number of reasons. Certain information and transaction costs increase with distance; thus, firms located in geographically isolated areas may be at a disadvantage in attracting capital. Smaller firms may be at a competitive disadvantage because of high administrative costs per unit of capital transaction. Financial intermediaries tend to be cautious regarding unfamiliar products, people, or locations. They are also often reluctant to participate in relatively new financial mechanisms such as venture capital financing. Venture capital is broadly defined as equity or “risk” money that is invested in relatively new or expanding firms that promise high growth rates and investment returns (Gladstone 1983). Only a few businesses fit this niche. Venture capitalists tend to seek partial ownership rights and often a role in management. Not all those seeking capital are prepared to share these rights; neither are all equally prepared to develop a fundable business proposal. For the purpose of this article, venture capitalists are considered only one source of equity capital. Other equity providers include private corporations, investment bankers, consultants, and other private investors. Variations in the nature of enterprises that can be successful in specific regions and entrepreneurial attitude, experience, and knowledge may influence rates of capital acquisition. For example, equity capital providers consider bankers, accountants, and attorneys important sources of new business deal referrals (Pulver and Hustedde 1988). Intermediaries who know little about equity capital sources may not direct clients to appropriate sources, thus reducing overall market efficiency. An individual firm’s success in acquiring equity capital is therefore likely to be affected on the demand side by the characteristics of the entrepreneurs including education, experience, and age; characteristics of the enterprise including stage, industrial type, and location (e.g., rural or urban); characteristics of the request including amount, business plan, and prospective capital source; and sources of advice including technology, preparation of the business plan, and places to seek funding.
METHODOLOGY The Survey Data from a survey of business executives who have sought $100,000 or more of equity capital were analyzed. References to equity capital, therefore, imply amounts of $100,000 or more. These funds are generally intended for research and development, and for firm start-up, expansion, or bridge financing. They include capital from the formal venture industry, private corporations, and other investors. The names of Minnesota and Wisconsin firms that had been seeking equity capital were identified by investment companies, public agencies, and other financial intermediaries. Minnesota and Wisconsin were chosen because of the similarities in population, economic base, and geographic region, and the great difference between the two in venture capital acquisition. Minnesota firms receive nearly six times more in venture capital per capita than those in Wisconsin (Wade and Place 1985). This difference increases the prospects of substantial variation in success in capital acquisition among firms in the sample.
RESULTS The Entrepreneurs Survey instruments were mailed to 560 active equity capital seekers in early 1987. Sixteen were returned as non-deliverable and 62 reported they had not sought equity capital. Of the
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remaining 482 firms, 3 18 provided usable survey data for a response rate of 66%. Of the firms, 195 were from Wisconsin and 123 were from Minnesota. The ages of the respondents ranged from 25 to 72 years; 6% were female and 94% were male; and 88% were from metropolitan counties and 12% were from non-metropolitan areas. Approximately 59% of the firms studied were successful in acquiring equity funding and 41% wet-c not. Although all were reported as seeking at least $100,000 in equity capital, 20% of those who acquired funding received less than $100,000. Another 15% received between $100,000 and $249,999; 16% between $250,000 and $499,999; and 13% between $500,000 and $999,999. Over $1 million in equity capital was received by 36% of respondents. The survey respondents often reported receiving equity capital from more than one source. The sources most frequently identified were private investors other than formal venture capitalists, consultants, or investment bankers. In-state private investors provided funds to 63% of firms, whereas 32% reported receiving funds from out-of-state private investors. Private investors other than formal venture capitalists, investment bankers, and corporations are often referred to as “angels” (Haar et al. 1988). They are obviously a vital part of this market. Other funding sources include in-state venture capitalists, 26%; out-ofstate venture capitalists, 13%; in-state consultants/investment bankers, 17%; out-of-state consultants/investment bankers, 13%; in-state corporations, 16%; and out-of-state corporations, 9%. Six major hypotheses about entrepreneurial characteristics and success in acquiring equity capital monies were formulated: Hla:
Individuals
who are older are more successful
Hlb:
Individuals capital.
with more education
Hlc:
Individuals
with families in business arc more successful
Hld:
Individuals who are willing to surrender higher percentages successful in acquiring equity capital.
Hle:
Individuals who have more experience equity capital.
in business
in acquiring
equity capital.
are more successful
in business
in acquiring
in acquiring
equity
equity capital.
of firm equity are more
are more successful
in acquiring
Generally, entrepreneurs who have more business experience, more education in business, and are older should be better able to determine the viability of the business they are developing, write effective business and marketing plans, and have a positive track record when seeking financing. Chi-square tests relating a series of individual characteristics to success in acquiring equity capital indicate that five of the variables arc significant at the 5% level (Table 1). Contrary to expectations, the age of an individual is negatively related to success in acquiring equity capital. That is, older entrepreneurs arc less likely to obtain financing. Education directly related to business practices is not a significant variable. A college degree in a nonbusiness field is negatively related to success in acquiring equity funding. In addition, the mote business experience individuals have, the less likely they arc to acquire financing. Of the respondents, 75% have five or more years experience. In contrast, two characteristics
DEMAND AND EQUITY CAPITAL ACQUISITION
TABLE 1
367
The Relationship of Entrepreneurial Characteristics to Success in Acquiring Equity Capital Characteristic(9%of successful seekers)
Age (median, 45 years; standard deviation, 10 years) Education B.S. in business (20%) Graduate degree in business (18%) Degree in non-business (44%) High school diploma (22%) Vocational business education (6%) Special institutes on business (13%) On-the-job training (33%) Family in business Parents (42%) Sisters/brothers (22%) Aunts/uncles (21 S) Grandparents (26%) Percentage of equity willing to surrender (positive with higher percentage; 42% are willing to surrender5 1% or more equity) Aggressiveness in seeking equity capital (41% have sought money from 20 or more firms) Experience in business (positive with less experience; 30% have less than 5 years of business experience)
Significance level -0.001* 0.157 0.830 -0.046* -0.998 -0.888 0.618 -0.257 -0.231 - 0.420 -0.282 - 0.984 o.OcKl* o.OOO* 0.028*
*Significance p 3 0.05. Percentages in categories may exceed 100% because respondents sometimes checked more than one response in each cluster.
of entrepreneurs are positively related to their success in acquiring equity capital in amounts exceeding $100,000. The higher the percentage of equity entrepreneurs are willing to surrender to outside investors, the more likely they are to be successful in acquiring funding. Approximately 38% of entrepreneurs are prepared to give up 50% or more of the ownership of their firms. Similarly, the more aggressively entrepreneurs seek equity capital, as measured by the number of contacts made in search of funding, the higher the likelihood they will succeed. Of the respondents, 32% made 20 or more contacts. All the other variables including family business experiences are not significantly related to capital acquisition. Of the women, 58% were successful in acquiring capital compared with 59% of the men. There are, however, not enough women in the sample to provide an adequate test of statistical differences between men and women.
The Enterprises We expected certain characteristics of an enterprise to affect the entrepreneurs’ success in acquiring equity capital. Firms at the seed and start-up stages offer more potential for rapid economic gains than firms in other phases of development. Venture capital markets are generally focused on high-growth industries involving advanced technology because they more frequently offer the potential for rapid gains in stock value. Previous surveys of venture capital firms indicate that enterprises in rural areas are less favored than those in urban areas (F’ulver and Hustedde 1988). We generated several hypotheses about firm characteristics from these observations:
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H2a:
Enterprises capital.
at the seed or start-up stages are more successful
H2b:
Enterprises at the expansion, acquiring equity capital.
H2C:
Enterprises capital.
H2d:
Enterprises involved with computers cessful in acquiring equity capital.
H2e:
Enterprises
that focus on electronics
H2f:
Enterprises capital.
that focus on factory automation
are more successful in acquiring
equity
H2g:
Enterprises capital.
that focus on food or beverages
are less successful
in acquiring
equity
H2b:
Enterprises that focus on health or medical technology quiring equity capital.
are more successful
in ac-
bridge financing,
that focus on communications
or computer-related
are more successful
Enterprises that focus on non-electronic equity capital.
H2j:
Enterprises
H2k:
Enterprises that are located in metropolitan equity capital.
in other service businesses
equity
or other stages are less successful
are more successful
H2i:
in acquiring
machinery
in acquiring
products
in acquiring
are less successful
in
equity
are more suc-
equity capital.
in acquiring
are less successful in acquiring equity capital. areas are more successful
in acquiring
Statistical tests support the hypothesis that firms in the seed and start-up stages are more successful in acquiring venture capital (Table 2). Type of business also proved important. Enterprises in the health and medical technology industries and in communications are positively related to success in acquiring venture capital at the 10% confidence level. One-third of the firms reported that they engage in these industries, but it should be noted that they were allowed to report in more than one category. We anticipated that business in electronics, computers, and computer-related fields would also be significantly related to capital acquisition success, but this was not borne out. Of the firms, 43% indicated that they were in these industries, and only a few of the businesses surveyed were not in hightechnology industries. As noted earlier, firms often receive equity capital from more than one source. Of the enterprises, 57% sought and received part of their equity capital from a source less than 30 miles from their office, 30% received some of their capital from a source 30 to 100 miles away, and 40% of the seekers received some of their equity capital from a source more than 100 miles away. Proximity to urbanized settings is critical in the acquisition of equity capital. The location of an enterprise in standard metropolitan statistical areas is significant and
DEMAND
TABLE 2
AND EQUITY CAPITAL
The Relationships of Enterprise Characteristics Characteristic
(8 of successful
369
ACQUISITION
to Success in Acquiring Equity Capital
seekers)
Significance
level
Business stage 0.003* 0.088* -0.500 0.106 0.103
Seed (29%) Start-up (65%) Expansion (38%) Bridge financing (10%) Other (12%) Type of business Communications ( 15%) Computers/computer-related (24%) Electronics (22%) Factory automation (7%) Food/beverages (5%) Health/medical technology (25%) Non-electronic machinery (16%) Other service businesses (other business types were identified but there were too few cases for valid statistical tests; 16%) Location in standard metropolitan statistical area (62% are located in SMSAs)
0.093* 0.269 0.659 0.585 0.190 0.044* -0.392 - 0.929 0.003*
*Significance p P 0.10.
Percentages in categories may exceed 100% because respondents sometimes checked more than one response in each cluster.
positively related to success in acquisition; 62% of the firms in metropolitan funded, whereas only 37% of those in non-metropolitan areas were successful.
areas were
The Requests The nature of the request for financing, such as the amount of funding sought, the contents of the written plan, and the places from which funds are sought, were expected to influence capital-acquisition success rates. The suppliers of equity capital carefully examine each request for funding before deciding to invest. They are often appraising untested technology, firms with short track records, or managers with limited experience. New products (i.e., goods or services) are frequently in the early stages of market development. Financial losses for two or three years are commonly expected. Because of the high transaction costs associated with these high-risk investments, we anticipated that success in acquisition would be positively related to the amount of capital requested. A written business plan for seeking equity capital is also expected to be related to equity capital acquisition. Several hypotheses about these funding requests were generated: H3a:
Those seeking higher amounts capital.
of funding
are more successful
in acquiring
equity
H3b:
Enterprises capital.
that have a written business plan are more successful in acquiring
equity
H3C:
Enterprises that have a written business plan containing a balance sheet, list of product competition, marketing plan, and cash flow projections for three years are more successful in acquiring equity capital.
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R.J. HUSTEDDE
TABLE 3
AND G.C.
PULVER
The Relationship of the Characteristics of the Requests to Success in Acquiring Equity Capital Characteristics(% of successful seekers)
Amount of dollars sought (44% have sought more than $1 million) Written business plan (98%) Balance sheet (95%) List of product competition (94%) Marketing plan (98%) Cash flow projections for 3 years (94%) Where firms seek equity capital In-state venture capitalists (85%) Out-of-state venture capitalists (58%) In-state corporations (40%) Out-of-state corporations (34%) In-state private investors (79%) Out-of-state private investors (47%) In-state consultants/investment bankers (57%) Out-of-state consultants/investment bankers (31%) Other (9%)
Significance level 0.001* 0.008* 0.002* 0.770 0.575 0.111 0.492 0.080* 0.912 0.035* o.O01* 0.001* 0.090* 0.015* 0.981
*Significance p 2 0.10. Percentages in categories may exceed 100% because respondents sometimes checked more than one response in each cluster.
H3d:
Enterprises that seek funding from sources other than in-state venture capitalists more successful in acquiring equity capital.
are
Analysis of the data reveals a significant positive relationship between the amount of capital sought and success in equity capital acquisition (Table 3). Statistical tests of the relevance of business plans and various components of plans are difficult because most of the survey respondents claim to have written plans. Of the 95% who indicate they have written business plans, 91% include balance sheets, 93% list competitors, 98% include marketing plans, and 92% have cash flow projections. Chi-square tests indicate that the presence of written business plans and balance sheets are statistically related to success. Fiis seek capital from a variety of sources. Of the respondents, 88% have sought capital from in-state venture capitalists, which is the most common source. Other common sources are in-state private investors, 74%; out-of-state venture capitalists, 55%; and in-state consultants and investment bankers, 54%. The sources from which capital is sought are positively correlated with success in capital acquisition. Firms that seek equity capital from out-of-state venture capitalists and corporations, in-state and out-of-state private investors, and in-state and out-of-state consultants/investment bankers are more successful in acquiring equity capital.
!!Sourm of Advice Capital markets vary in efficiency depending on the ease of information flows. The free flow of information is a fundamental assumption of an efficient market. Entrepreneurs interested in developing a successful business often require assistance with their new technology, help in preparing a written business plan, and knowledge of prospective sources of funding.
DEMAND AND EQUITY CAPITAL ACQUISITION
371
Equity capital seekers who look for technical assistance from reputed sources were hypothesized as being most successful in acquiring capital. No outside technical assistance was sought by 58% of the firms in the survey. Analysis indicates that the failure to seek assistance is negatively correlated with success in acquiring funding (Table 4). In other words, acquiring technical assistance is important to a positive outcome. Contrary to expectations, it is difficult to relate success in funding to specific technical assistance sources. Seeking technical assistance from a public agency is negatively correlated to success, but all other variables are insignificant. In addition, business owners may seek help in writing business plans and marketing proposals. We hypothesized that entrepreneurs who seek assistance with their business and marketing plans from bankers, attorneys, accountants, universities, and other public and private agencies are more successful in acquiring equity capital than those who seek funding from others. A high percentage of the firms (68%) did not seek direct information regarding financing, business plans, or marketing from bankers, whereas 57% did not seek assistance in preparing a marketing plan. Further, 59% did not seek help from attorneys, and 56% did not seek assistance from accountants. The results of the statistical analysis are varied. Contrary to expectations, entrepreneurs who did not seek assistance from bankers and those who did seek an attorney’s help with a marketing plan were more successful in acquiring equity capital. In contrast, those who sought such help from university-related organizations were less successful in obtaining financing. None of the factors relating to accountants were significant. It is probable that the enterprises with the least chance of success are ultimately referred to public agencies or university-related organizations for consultation. There may be little advice that can turn these entrepreneurs’ ideas into fundable projects. Entrepreneurs who operate advanced technology, high-risk, start-up businesses frequently have little idea of where to acquire the required equity capital. Those who seek such information from reputable sources were expected to be more successful in acquiring funding. The nature of referrals received by entrepreneurs from various institutions does influence success rates in capital acquisition. Firms that are referred by attorneys to private investors other than formal venture capitalists, both in-state and out-of-state, are more successful in receiving equity funding than are firms that are referred by bankers to in-state venture capitalists or other in-state investors. The same is true for entrepreneurs who are advised by bankers to seek debt capital or to sell/merge their firms. It is possible that the bankers identify the weakest prospects for technological or managerial reasons and advise the entrepreneurs to turn over control of their business to others. None of the referrals of accountants are statistically correlated to success.
CONCLUSIONS The results of this study indicate there are a number of demand-side
factors that affect the likelihood of firms being successful in acquiring equity capital. As expected, enterprises that are in the early stages of development in high-technology industries are most likely to be successful in acquiring funding. Similarly, entrepreneurs who seek larger amounts of financial support and have a written business plan, including a balance sheet, are apt to gain support. Years of experience in business is not critical to capital acquisition. In fact, less experienced entrepreneurs who are aggressive in seeking financing and who are willing to surrender higher percentages of their business to equity providers are most successful. In
372 TABLE
R.J. HUSTEDDE
4
AND G.C. PULVER
The Relationship
of Sources
of Advice
Source of advice (% of successful
to Success in Acquiring Equity Captial
seekers)
Technical advice No assistance (54%) Individuals (49%) Private consultants (28%) Private corporations (35%) Public agencies (6%) University-related organizations (30%) Vocational, technical, and adult organizations (6%) Other (13%) Help with business plan Accountants (25%) Attorneys (13%) Bankers (5%) Help with marketing plan Accountants (8%) Attorneys (5%) Individuals (45%) Private consultants (37%) University-related organizations (12%) Other (13%) Referrals to capital sources Accountants Referred to in-state venture capitalist (15%) Referred to out-of-state venture capitalist (17%) Referred to other in-state investors (13%) Advised to seek debt capital (8%) Attorneys Referred to in-state venture capitalist (19%) Referred to out-of-state venture capitalist (5%) Referred to other in-state investors (20%) Referred to other out-of-state investors (4%) Advised to seek debt capita1 (7%) Advised to sell public stock (5%) Bankers Referred to in-state venture capitalist (22%) Referred to out-of-state venture capitalist (5%) Referred to other in-state investors (7%) Referred to other out-of-state investors (1%) Advised to seek debt capital (7%) Advised to sell/merge firms (3%) (Tests of other factors are invalid because of low cell counts.)
Significance
level
-0.061*
0.432 - 0.230 0.697 - 0.002* -0.359 -0.270 -0.264 0.663 0.673 -0.174 0.952 0.068* -0.648 0.363 -0.025* 0.259
- 0.683 0.320 0.775 0.304 -0.941 0.124 0.005 0.068* 0.411 0.463 -
0.057* 0.790 0.088* 0.355 0.059* 0.065*
*Significance p 3 0.10.
Percentages in categories may exceed 100% because respondents sometimes checked more than one response in each cluster.
DEMAND AND EQUITY CAPITAL ACQUISITION
373
contrast, older entrepreneurs with more business experience are apt to have difficulty acquiring funding. We anticipated that business education and experience would make capital more easily accessible. This does not, however, appear to be true. In addition, firms in more remote rural regions are less successful in acquiring venture capital, but it is not clear whether or not this finding is related to specific industries. The analysis indicates that entrepreneurs pay a penalty for not seeking technical assistance; however, it is not clear from where this advice should come. Attorneys appear to be useful sources of advice in developing marketing plans and in referring entrepreneurs to private non-venture investors for financing. Advice offered by accountants and bankers, on the whole, appears to offer little success in obtaining funding for high-risk start-ups. Public agencies and universities seem to do no better. Firms headed by aggressive young entrepreneurs who take their business proposals directly to private non-venture investors are more successful in acquiring equity capital. Perhaps those with the weakest proposals, from a venture capital standpoint, tend to persist longer, seeking help from public agencies, bankers, and others. In other words, the quality of the advice received may not be poor, it may simply be that those who seek advice from intermediaries and public agencies have more difficult cases and are thus less likely to ultimately succeed in acquiring funding. Some weaknesses appear to exist in equity capital markets. Because some of the factors affecting venture capital acquisition are policy-sensitive, the public could choose to influence specific market variables. The fact that the market appears to discriminate positively in favor of larger transactions in high-technology industries is as expected. One policy option might be for the public to facilitate the movement of equity capital in smaller amounts by bundling several small requests together and then selling them to interested investors. Linking entrepreneurs directly to private investors early in the process seems critical to successful acquisition of capital. This factor may be a severe barrier for uninformed entrepreneurs. Venture capitalists consider accountants, attorneys, bankers, those who have received previous investments, and other private investors primary sources of contacts with new investments. Venture capitalists and other investors often specialize by industry type. In addition, private investors may be less visible. Under these conditions it is often difficult for the entrepreneur to find the right investor at precisely the right moment. This is a special problem for those in more remote areas and for those who are less likely to be informed of capital sources. Another policy option is for the public to improve these linkages by educating intermediaries such as accountants, attorneys, and bankers about sources of equity capital or by developing publicly supported linkage networks to whom entrepreneurs might turn. The public could also develop educational and technical assistance programs aimed directly at entrepreneurs. High-risk small businesses with high growth potential could provide assistance in acquiring technology and in writing business and marketing plans. They could also receive specific advice regarding appropriate sources of capital. It appears important that this assistance reach entrepreneurs in the early stages of development. Special programs could be instituted in rural areas or with other groups lacking access to this information. Private equity capital markets are not likely to adequately serve certain business types. Therefore, direct public capital subsidization to firms that are expanding and to those in industries with substantial growth potential (e.g., factory automation, food and beverage) that are unattractive to private capitalists could be provided. Public capital could also be provided to entrepreneurs in less competitive capital markets or to those who are older.
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Great care should be taken not to interfere publicly with private markets that are already operating efficiently. These findings could be greatly enriched by further research. The interrelationships between factors influencing capital acquisition need examination. For example, it would be useful to know why entrepreneurs in non-metropolitan areas have difficulty acquiring capital. Accountants, attorneys, bankers, and public agency advisors in rural areas may be less well prepared to provide assistance with a wide range of business types because of the narrow economies of their regions, or the enterprises in rural areas may be experiencing slower growth. Is the rural problem simply one of distance, or is it the quality of advice or enterprise type? Another example of research that might prove useful would be the determination of feasibility of differentiating between those firms that acquire equity capital from venture capitalists and those that are funded by other private investors on the basis of specific entrepreneurial, enterprise, or request characteristics. This differentiation, if possible, could improve the quality of advice provided to entrepreneurs. The quality of equity capital markets is important to the economic well-being of most regions. There are many opportunities for improving market efficiency and equity. Further research and some public invention is likely to prove useful.
REJTERENCES Gladstone, D.J. 1983. Venture Capital Handbook. Reston, VA: Reston. Haar, N.E., Starr, on the East Mason, C. 1987. Westminster
J., and MacMillan, I.C. 1988. Informal risk capital investors: Investment patterns Coast of the U.S.A. Journal of Business Venturing 3( 1): 1 l-29. Venture capital in the United Kingdom: A geographical perspective. National Bank Quarterly Review pp. 47-59.
Mikesell, J., and Davidson, S. 1982. Financing rural America: A public policy perspective. In Rural Financial Markets: Research Issuesfor the 1980s. Federal Bank of Chicago, Public Information Center. Pulver, G.C., and Hustedde, R.J. 1988. Regional variables which influence the allocation of venture capital: The role of banks. The Review of Regional Studies 18(2):1-9. Thompson, C. 1989. The geography of venture capital. Progress in Human Geography 13(1):62-98. Vaughan, R., Pollard, R., and Dyer, B. 1985. The Wealth of States. Washington, DC: Council of State Planning Agencies. Wade, R., and Place, F. 1985. Entrepreneurial culture in Wisconsin. Technical Reports, (85-l). Madison, WI: Wisconsin Department of Development.
ACQUISITION: THE DEMAND SIDE RONALD J. HUSTEDDE University of Kentucky
GLEN C. PULVER University
of Wisconsin-Madison
This article summarizes a study of 318 private entrepreneurs who have sought equity capital in amounts of $1oO,ooO or more. These individuals are normally considered prime clients of venture capitalists. Entrepreneurs’ success in acquiring funding is related to four general variable categories: (I) characteristics of the entrepreneurs including education, experience, and age; (2) characteristics of the enterprise including stage, industry type, and location (e.g., rural or urban): (3) characteristics of the request including amount, business plan, and prospective capital source; and (4) sources of advice including technology, preparation of the business plan, and places to seek funding. The study is unique because it includes many entrepreneurs who were unsuccessful in acquiring capital, thereby reducing the survey bias. In fact, only 59% of those surveyed actually acquired funding. This article provides specific insights into businesses seeking capital. For example, the entrepreneurs who are most successful in acquiring funding are those who are prepared to surrender a larger percentage of equity and who are very aggressive in going directly to a number of potential equity providers at an early stage. Contrary to common belief, older and more experienced entrepreneurs seem to have more dtfliculry acquiring financing. Likewise, entrepreneurs attempting to start businesses in rural areas are more apt to have dt#iculty acquiring equity capital in amounts of $100,000 or more. Entrepreneurs may experience dt#iculty in acquiring equity capital for certain business types in spectfic capital markets. Firms in the healthlmedical technology and communication fields, for example, have much more success acquiring funding in Minnesota and Wisconsin than those in electronics and factory automation. It is vital that the entrepreneur get to the proper source of capital,
EXECUTIVE SUMMARY
Address correspondence to Ronald J. Hustedde, 500 Ganigus Building, Sociology Department, College of Agriculture, University of Kentacky, Lexington, KY 405464215. This research was funded by the College of Agticulhm and Life Sciences at the University of WisconsinMadison and the U.S. Department of Agriculture.
Joumal of Business Venturing 7. 363-374 8 1992 Elsevier Science Publishing Co., Inc., 655 Avenue of the America.s, New York, NY 10010
363
364
R.J. HUSTEDDE
AND G.C. PULVER
wherever it is to be found, as quickly as possible. This study also indicates that private investors not identt$ed as formal venture capitalists are the primary source of financial assistance. The study revealed that the quality of advice provided to entrepreneurs may need improvement. Entrepreneurs who fail to seek assistance are less successful in acquiring equity capital. It is less clear where good advice is to be found. Attorneys appear to ofJeerpositive advice regarding marketing and referrals to non-venture capital sources. Bankers, in contrast, are more frequently associated with advice that fails to secure capital. Public agencies and university-related organizations are, in some cases, also associated with a failure to acquire capital. It may be that the weakest cases ultimately find their way to these sources of consultation. The article provides a number of spectfic public policy recommendations for those governments interested in improving equity capital market eficiency. For example, as entrepreneurs seeking equity capital in small amounts seem to have dtfjiculty, public governments might choose to facilitate the movement of equity capital in smaller amounts by bundling several small requests together and then selling them to interested investors. The public might choose to improve information linkages between entrepreneurs and capitalists by educating intermediaries such as accountants, attorneys, and bankers regarding sources of equity capital or by developing publicly supported linkage networks to whom entrepreneurs might turn. Special information programs on sources of equity capital might also be instituted in rural areas or with spectfic groups experiencing capital access problems. Private equity capital markets are not apt to serve adequately certain types of businesses. There may be some need for providing direct capital subsidization to firms that are expanding or to those with growth potential that, for some reason, are unattractive to private capitalists (e.g., the entrepreneurs are older, the expected growth rate is slow). These businesses may have the potential of making a substantial contribution to a regional economy but lack the short-term, high-growth impact that attracts venture capitalists.
INTRODUCTION The availability of equity capital is a critical factor in the start-up and early stage expansion of many high-risk businesses with high-growth potential. The financing of these businesses is important because they represent an increasingly important source of new jobs in the United States. As a consequence the availability of equity capital may have a profound effect on the future economic well-being of some regions. There is evidence of wide variation in the regional allocation of funds from equity capital institutions that serve high-risk, highgrowth businesses (Mason 1987; Thompson 1989). A fundamental regional economic development concern, therefore, is whether the variation in acquisition of equity capital is a consequence of market failure or simply differences in entrepreneurial activity (Vaughan et al. 1985). This article examines a set of demand variables that may affect the ability of firms to acquire equity capital. Variables included are the characteristics of the entrepreneurs, the enterprises, and the requests as well as the sources of advice. The analysis relies on data from a survey of 318 firms in Minnesota and Wisconsin that have been identified as seekers of equity capital in amounts exceeding $100,000.
Theoretical Insights Neoclassical economic theory argues that capital flows to businesses that offer the highest marginal rate of return without regard to geographic location of the activity (Mikesell and Davidson 1982). However, financial markets in the United States may contain spatially related factors that might restrict capital flow. Market imperfections such as variations in taxes, government regulations, information, and attitudes among investors and entrepreneurs influence the flow of both debt and equity capital.
DEMAND AND EQUITY CAPITAL ACQUISITION
365
Individual firms may have difficulty acquiring capital for a number of reasons. Certain information and transaction costs increase with distance; thus, firms located in geographically isolated areas may be at a disadvantage in attracting capital. Smaller firms may be at a competitive disadvantage because of high administrative costs per unit of capital transaction. Financial intermediaries tend to be cautious regarding unfamiliar products, people, or locations. They are also often reluctant to participate in relatively new financial mechanisms such as venture capital financing. Venture capital is broadly defined as equity or “risk” money that is invested in relatively new or expanding firms that promise high growth rates and investment returns (Gladstone 1983). Only a few businesses fit this niche. Venture capitalists tend to seek partial ownership rights and often a role in management. Not all those seeking capital are prepared to share these rights; neither are all equally prepared to develop a fundable business proposal. For the purpose of this article, venture capitalists are considered only one source of equity capital. Other equity providers include private corporations, investment bankers, consultants, and other private investors. Variations in the nature of enterprises that can be successful in specific regions and entrepreneurial attitude, experience, and knowledge may influence rates of capital acquisition. For example, equity capital providers consider bankers, accountants, and attorneys important sources of new business deal referrals (Pulver and Hustedde 1988). Intermediaries who know little about equity capital sources may not direct clients to appropriate sources, thus reducing overall market efficiency. An individual firm’s success in acquiring equity capital is therefore likely to be affected on the demand side by the characteristics of the entrepreneurs including education, experience, and age; characteristics of the enterprise including stage, industrial type, and location (e.g., rural or urban); characteristics of the request including amount, business plan, and prospective capital source; and sources of advice including technology, preparation of the business plan, and places to seek funding.
METHODOLOGY The Survey Data from a survey of business executives who have sought $100,000 or more of equity capital were analyzed. References to equity capital, therefore, imply amounts of $100,000 or more. These funds are generally intended for research and development, and for firm start-up, expansion, or bridge financing. They include capital from the formal venture industry, private corporations, and other investors. The names of Minnesota and Wisconsin firms that had been seeking equity capital were identified by investment companies, public agencies, and other financial intermediaries. Minnesota and Wisconsin were chosen because of the similarities in population, economic base, and geographic region, and the great difference between the two in venture capital acquisition. Minnesota firms receive nearly six times more in venture capital per capita than those in Wisconsin (Wade and Place 1985). This difference increases the prospects of substantial variation in success in capital acquisition among firms in the sample.
RESULTS The Entrepreneurs Survey instruments were mailed to 560 active equity capital seekers in early 1987. Sixteen were returned as non-deliverable and 62 reported they had not sought equity capital. Of the
366
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remaining 482 firms, 3 18 provided usable survey data for a response rate of 66%. Of the firms, 195 were from Wisconsin and 123 were from Minnesota. The ages of the respondents ranged from 25 to 72 years; 6% were female and 94% were male; and 88% were from metropolitan counties and 12% were from non-metropolitan areas. Approximately 59% of the firms studied were successful in acquiring equity funding and 41% wet-c not. Although all were reported as seeking at least $100,000 in equity capital, 20% of those who acquired funding received less than $100,000. Another 15% received between $100,000 and $249,999; 16% between $250,000 and $499,999; and 13% between $500,000 and $999,999. Over $1 million in equity capital was received by 36% of respondents. The survey respondents often reported receiving equity capital from more than one source. The sources most frequently identified were private investors other than formal venture capitalists, consultants, or investment bankers. In-state private investors provided funds to 63% of firms, whereas 32% reported receiving funds from out-of-state private investors. Private investors other than formal venture capitalists, investment bankers, and corporations are often referred to as “angels” (Haar et al. 1988). They are obviously a vital part of this market. Other funding sources include in-state venture capitalists, 26%; out-ofstate venture capitalists, 13%; in-state consultants/investment bankers, 17%; out-of-state consultants/investment bankers, 13%; in-state corporations, 16%; and out-of-state corporations, 9%. Six major hypotheses about entrepreneurial characteristics and success in acquiring equity capital monies were formulated: Hla:
Individuals
who are older are more successful
Hlb:
Individuals capital.
with more education
Hlc:
Individuals
with families in business arc more successful
Hld:
Individuals who are willing to surrender higher percentages successful in acquiring equity capital.
Hle:
Individuals who have more experience equity capital.
in business
in acquiring
equity capital.
are more successful
in business
in acquiring
in acquiring
equity
equity capital.
of firm equity are more
are more successful
in acquiring
Generally, entrepreneurs who have more business experience, more education in business, and are older should be better able to determine the viability of the business they are developing, write effective business and marketing plans, and have a positive track record when seeking financing. Chi-square tests relating a series of individual characteristics to success in acquiring equity capital indicate that five of the variables arc significant at the 5% level (Table 1). Contrary to expectations, the age of an individual is negatively related to success in acquiring equity capital. That is, older entrepreneurs arc less likely to obtain financing. Education directly related to business practices is not a significant variable. A college degree in a nonbusiness field is negatively related to success in acquiring equity funding. In addition, the mote business experience individuals have, the less likely they arc to acquire financing. Of the respondents, 75% have five or more years experience. In contrast, two characteristics
DEMAND AND EQUITY CAPITAL ACQUISITION
TABLE 1
367
The Relationship of Entrepreneurial Characteristics to Success in Acquiring Equity Capital Characteristic(9%of successful seekers)
Age (median, 45 years; standard deviation, 10 years) Education B.S. in business (20%) Graduate degree in business (18%) Degree in non-business (44%) High school diploma (22%) Vocational business education (6%) Special institutes on business (13%) On-the-job training (33%) Family in business Parents (42%) Sisters/brothers (22%) Aunts/uncles (21 S) Grandparents (26%) Percentage of equity willing to surrender (positive with higher percentage; 42% are willing to surrender5 1% or more equity) Aggressiveness in seeking equity capital (41% have sought money from 20 or more firms) Experience in business (positive with less experience; 30% have less than 5 years of business experience)
Significance level -0.001* 0.157 0.830 -0.046* -0.998 -0.888 0.618 -0.257 -0.231 - 0.420 -0.282 - 0.984 o.OcKl* o.OOO* 0.028*
*Significance p 3 0.05. Percentages in categories may exceed 100% because respondents sometimes checked more than one response in each cluster.
of entrepreneurs are positively related to their success in acquiring equity capital in amounts exceeding $100,000. The higher the percentage of equity entrepreneurs are willing to surrender to outside investors, the more likely they are to be successful in acquiring funding. Approximately 38% of entrepreneurs are prepared to give up 50% or more of the ownership of their firms. Similarly, the more aggressively entrepreneurs seek equity capital, as measured by the number of contacts made in search of funding, the higher the likelihood they will succeed. Of the respondents, 32% made 20 or more contacts. All the other variables including family business experiences are not significantly related to capital acquisition. Of the women, 58% were successful in acquiring capital compared with 59% of the men. There are, however, not enough women in the sample to provide an adequate test of statistical differences between men and women.
The Enterprises We expected certain characteristics of an enterprise to affect the entrepreneurs’ success in acquiring equity capital. Firms at the seed and start-up stages offer more potential for rapid economic gains than firms in other phases of development. Venture capital markets are generally focused on high-growth industries involving advanced technology because they more frequently offer the potential for rapid gains in stock value. Previous surveys of venture capital firms indicate that enterprises in rural areas are less favored than those in urban areas (F’ulver and Hustedde 1988). We generated several hypotheses about firm characteristics from these observations:
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H2a:
Enterprises capital.
at the seed or start-up stages are more successful
H2b:
Enterprises at the expansion, acquiring equity capital.
H2C:
Enterprises capital.
H2d:
Enterprises involved with computers cessful in acquiring equity capital.
H2e:
Enterprises
that focus on electronics
H2f:
Enterprises capital.
that focus on factory automation
are more successful in acquiring
equity
H2g:
Enterprises capital.
that focus on food or beverages
are less successful
in acquiring
equity
H2b:
Enterprises that focus on health or medical technology quiring equity capital.
are more successful
in ac-
bridge financing,
that focus on communications
or computer-related
are more successful
Enterprises that focus on non-electronic equity capital.
H2j:
Enterprises
H2k:
Enterprises that are located in metropolitan equity capital.
in other service businesses
equity
or other stages are less successful
are more successful
H2i:
in acquiring
machinery
in acquiring
products
in acquiring
are less successful
in
equity
are more suc-
equity capital.
in acquiring
are less successful in acquiring equity capital. areas are more successful
in acquiring
Statistical tests support the hypothesis that firms in the seed and start-up stages are more successful in acquiring venture capital (Table 2). Type of business also proved important. Enterprises in the health and medical technology industries and in communications are positively related to success in acquiring venture capital at the 10% confidence level. One-third of the firms reported that they engage in these industries, but it should be noted that they were allowed to report in more than one category. We anticipated that business in electronics, computers, and computer-related fields would also be significantly related to capital acquisition success, but this was not borne out. Of the firms, 43% indicated that they were in these industries, and only a few of the businesses surveyed were not in hightechnology industries. As noted earlier, firms often receive equity capital from more than one source. Of the enterprises, 57% sought and received part of their equity capital from a source less than 30 miles from their office, 30% received some of their capital from a source 30 to 100 miles away, and 40% of the seekers received some of their equity capital from a source more than 100 miles away. Proximity to urbanized settings is critical in the acquisition of equity capital. The location of an enterprise in standard metropolitan statistical areas is significant and
DEMAND
TABLE 2
AND EQUITY CAPITAL
The Relationships of Enterprise Characteristics Characteristic
(8 of successful
369
ACQUISITION
to Success in Acquiring Equity Capital
seekers)
Significance
level
Business stage 0.003* 0.088* -0.500 0.106 0.103
Seed (29%) Start-up (65%) Expansion (38%) Bridge financing (10%) Other (12%) Type of business Communications ( 15%) Computers/computer-related (24%) Electronics (22%) Factory automation (7%) Food/beverages (5%) Health/medical technology (25%) Non-electronic machinery (16%) Other service businesses (other business types were identified but there were too few cases for valid statistical tests; 16%) Location in standard metropolitan statistical area (62% are located in SMSAs)
0.093* 0.269 0.659 0.585 0.190 0.044* -0.392 - 0.929 0.003*
*Significance p P 0.10.
Percentages in categories may exceed 100% because respondents sometimes checked more than one response in each cluster.
positively related to success in acquisition; 62% of the firms in metropolitan funded, whereas only 37% of those in non-metropolitan areas were successful.
areas were
The Requests The nature of the request for financing, such as the amount of funding sought, the contents of the written plan, and the places from which funds are sought, were expected to influence capital-acquisition success rates. The suppliers of equity capital carefully examine each request for funding before deciding to invest. They are often appraising untested technology, firms with short track records, or managers with limited experience. New products (i.e., goods or services) are frequently in the early stages of market development. Financial losses for two or three years are commonly expected. Because of the high transaction costs associated with these high-risk investments, we anticipated that success in acquisition would be positively related to the amount of capital requested. A written business plan for seeking equity capital is also expected to be related to equity capital acquisition. Several hypotheses about these funding requests were generated: H3a:
Those seeking higher amounts capital.
of funding
are more successful
in acquiring
equity
H3b:
Enterprises capital.
that have a written business plan are more successful in acquiring
equity
H3C:
Enterprises that have a written business plan containing a balance sheet, list of product competition, marketing plan, and cash flow projections for three years are more successful in acquiring equity capital.
370
R.J. HUSTEDDE
TABLE 3
AND G.C.
PULVER
The Relationship of the Characteristics of the Requests to Success in Acquiring Equity Capital Characteristics(% of successful seekers)
Amount of dollars sought (44% have sought more than $1 million) Written business plan (98%) Balance sheet (95%) List of product competition (94%) Marketing plan (98%) Cash flow projections for 3 years (94%) Where firms seek equity capital In-state venture capitalists (85%) Out-of-state venture capitalists (58%) In-state corporations (40%) Out-of-state corporations (34%) In-state private investors (79%) Out-of-state private investors (47%) In-state consultants/investment bankers (57%) Out-of-state consultants/investment bankers (31%) Other (9%)
Significance level 0.001* 0.008* 0.002* 0.770 0.575 0.111 0.492 0.080* 0.912 0.035* o.O01* 0.001* 0.090* 0.015* 0.981
*Significance p 2 0.10. Percentages in categories may exceed 100% because respondents sometimes checked more than one response in each cluster.
H3d:
Enterprises that seek funding from sources other than in-state venture capitalists more successful in acquiring equity capital.
are
Analysis of the data reveals a significant positive relationship between the amount of capital sought and success in equity capital acquisition (Table 3). Statistical tests of the relevance of business plans and various components of plans are difficult because most of the survey respondents claim to have written plans. Of the 95% who indicate they have written business plans, 91% include balance sheets, 93% list competitors, 98% include marketing plans, and 92% have cash flow projections. Chi-square tests indicate that the presence of written business plans and balance sheets are statistically related to success. Fiis seek capital from a variety of sources. Of the respondents, 88% have sought capital from in-state venture capitalists, which is the most common source. Other common sources are in-state private investors, 74%; out-of-state venture capitalists, 55%; and in-state consultants and investment bankers, 54%. The sources from which capital is sought are positively correlated with success in capital acquisition. Firms that seek equity capital from out-of-state venture capitalists and corporations, in-state and out-of-state private investors, and in-state and out-of-state consultants/investment bankers are more successful in acquiring equity capital.
!!Sourm of Advice Capital markets vary in efficiency depending on the ease of information flows. The free flow of information is a fundamental assumption of an efficient market. Entrepreneurs interested in developing a successful business often require assistance with their new technology, help in preparing a written business plan, and knowledge of prospective sources of funding.
DEMAND AND EQUITY CAPITAL ACQUISITION
371
Equity capital seekers who look for technical assistance from reputed sources were hypothesized as being most successful in acquiring capital. No outside technical assistance was sought by 58% of the firms in the survey. Analysis indicates that the failure to seek assistance is negatively correlated with success in acquiring funding (Table 4). In other words, acquiring technical assistance is important to a positive outcome. Contrary to expectations, it is difficult to relate success in funding to specific technical assistance sources. Seeking technical assistance from a public agency is negatively correlated to success, but all other variables are insignificant. In addition, business owners may seek help in writing business plans and marketing proposals. We hypothesized that entrepreneurs who seek assistance with their business and marketing plans from bankers, attorneys, accountants, universities, and other public and private agencies are more successful in acquiring equity capital than those who seek funding from others. A high percentage of the firms (68%) did not seek direct information regarding financing, business plans, or marketing from bankers, whereas 57% did not seek assistance in preparing a marketing plan. Further, 59% did not seek help from attorneys, and 56% did not seek assistance from accountants. The results of the statistical analysis are varied. Contrary to expectations, entrepreneurs who did not seek assistance from bankers and those who did seek an attorney’s help with a marketing plan were more successful in acquiring equity capital. In contrast, those who sought such help from university-related organizations were less successful in obtaining financing. None of the factors relating to accountants were significant. It is probable that the enterprises with the least chance of success are ultimately referred to public agencies or university-related organizations for consultation. There may be little advice that can turn these entrepreneurs’ ideas into fundable projects. Entrepreneurs who operate advanced technology, high-risk, start-up businesses frequently have little idea of where to acquire the required equity capital. Those who seek such information from reputable sources were expected to be more successful in acquiring funding. The nature of referrals received by entrepreneurs from various institutions does influence success rates in capital acquisition. Firms that are referred by attorneys to private investors other than formal venture capitalists, both in-state and out-of-state, are more successful in receiving equity funding than are firms that are referred by bankers to in-state venture capitalists or other in-state investors. The same is true for entrepreneurs who are advised by bankers to seek debt capital or to sell/merge their firms. It is possible that the bankers identify the weakest prospects for technological or managerial reasons and advise the entrepreneurs to turn over control of their business to others. None of the referrals of accountants are statistically correlated to success.
CONCLUSIONS The results of this study indicate there are a number of demand-side
factors that affect the likelihood of firms being successful in acquiring equity capital. As expected, enterprises that are in the early stages of development in high-technology industries are most likely to be successful in acquiring funding. Similarly, entrepreneurs who seek larger amounts of financial support and have a written business plan, including a balance sheet, are apt to gain support. Years of experience in business is not critical to capital acquisition. In fact, less experienced entrepreneurs who are aggressive in seeking financing and who are willing to surrender higher percentages of their business to equity providers are most successful. In
372 TABLE
R.J. HUSTEDDE
4
AND G.C. PULVER
The Relationship
of Sources
of Advice
Source of advice (% of successful
to Success in Acquiring Equity Captial
seekers)
Technical advice No assistance (54%) Individuals (49%) Private consultants (28%) Private corporations (35%) Public agencies (6%) University-related organizations (30%) Vocational, technical, and adult organizations (6%) Other (13%) Help with business plan Accountants (25%) Attorneys (13%) Bankers (5%) Help with marketing plan Accountants (8%) Attorneys (5%) Individuals (45%) Private consultants (37%) University-related organizations (12%) Other (13%) Referrals to capital sources Accountants Referred to in-state venture capitalist (15%) Referred to out-of-state venture capitalist (17%) Referred to other in-state investors (13%) Advised to seek debt capital (8%) Attorneys Referred to in-state venture capitalist (19%) Referred to out-of-state venture capitalist (5%) Referred to other in-state investors (20%) Referred to other out-of-state investors (4%) Advised to seek debt capita1 (7%) Advised to sell public stock (5%) Bankers Referred to in-state venture capitalist (22%) Referred to out-of-state venture capitalist (5%) Referred to other in-state investors (7%) Referred to other out-of-state investors (1%) Advised to seek debt capital (7%) Advised to sell/merge firms (3%) (Tests of other factors are invalid because of low cell counts.)
Significance
level
-0.061*
0.432 - 0.230 0.697 - 0.002* -0.359 -0.270 -0.264 0.663 0.673 -0.174 0.952 0.068* -0.648 0.363 -0.025* 0.259
- 0.683 0.320 0.775 0.304 -0.941 0.124 0.005 0.068* 0.411 0.463 -
0.057* 0.790 0.088* 0.355 0.059* 0.065*
*Significance p 3 0.10.
Percentages in categories may exceed 100% because respondents sometimes checked more than one response in each cluster.
DEMAND AND EQUITY CAPITAL ACQUISITION
373
contrast, older entrepreneurs with more business experience are apt to have difficulty acquiring funding. We anticipated that business education and experience would make capital more easily accessible. This does not, however, appear to be true. In addition, firms in more remote rural regions are less successful in acquiring venture capital, but it is not clear whether or not this finding is related to specific industries. The analysis indicates that entrepreneurs pay a penalty for not seeking technical assistance; however, it is not clear from where this advice should come. Attorneys appear to be useful sources of advice in developing marketing plans and in referring entrepreneurs to private non-venture investors for financing. Advice offered by accountants and bankers, on the whole, appears to offer little success in obtaining funding for high-risk start-ups. Public agencies and universities seem to do no better. Firms headed by aggressive young entrepreneurs who take their business proposals directly to private non-venture investors are more successful in acquiring equity capital. Perhaps those with the weakest proposals, from a venture capital standpoint, tend to persist longer, seeking help from public agencies, bankers, and others. In other words, the quality of the advice received may not be poor, it may simply be that those who seek advice from intermediaries and public agencies have more difficult cases and are thus less likely to ultimately succeed in acquiring funding. Some weaknesses appear to exist in equity capital markets. Because some of the factors affecting venture capital acquisition are policy-sensitive, the public could choose to influence specific market variables. The fact that the market appears to discriminate positively in favor of larger transactions in high-technology industries is as expected. One policy option might be for the public to facilitate the movement of equity capital in smaller amounts by bundling several small requests together and then selling them to interested investors. Linking entrepreneurs directly to private investors early in the process seems critical to successful acquisition of capital. This factor may be a severe barrier for uninformed entrepreneurs. Venture capitalists consider accountants, attorneys, bankers, those who have received previous investments, and other private investors primary sources of contacts with new investments. Venture capitalists and other investors often specialize by industry type. In addition, private investors may be less visible. Under these conditions it is often difficult for the entrepreneur to find the right investor at precisely the right moment. This is a special problem for those in more remote areas and for those who are less likely to be informed of capital sources. Another policy option is for the public to improve these linkages by educating intermediaries such as accountants, attorneys, and bankers about sources of equity capital or by developing publicly supported linkage networks to whom entrepreneurs might turn. The public could also develop educational and technical assistance programs aimed directly at entrepreneurs. High-risk small businesses with high growth potential could provide assistance in acquiring technology and in writing business and marketing plans. They could also receive specific advice regarding appropriate sources of capital. It appears important that this assistance reach entrepreneurs in the early stages of development. Special programs could be instituted in rural areas or with other groups lacking access to this information. Private equity capital markets are not likely to adequately serve certain business types. Therefore, direct public capital subsidization to firms that are expanding and to those in industries with substantial growth potential (e.g., factory automation, food and beverage) that are unattractive to private capitalists could be provided. Public capital could also be provided to entrepreneurs in less competitive capital markets or to those who are older.
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R.J. HUSTEDDE AND G.C. PULVER
Great care should be taken not to interfere publicly with private markets that are already operating efficiently. These findings could be greatly enriched by further research. The interrelationships between factors influencing capital acquisition need examination. For example, it would be useful to know why entrepreneurs in non-metropolitan areas have difficulty acquiring capital. Accountants, attorneys, bankers, and public agency advisors in rural areas may be less well prepared to provide assistance with a wide range of business types because of the narrow economies of their regions, or the enterprises in rural areas may be experiencing slower growth. Is the rural problem simply one of distance, or is it the quality of advice or enterprise type? Another example of research that might prove useful would be the determination of feasibility of differentiating between those firms that acquire equity capital from venture capitalists and those that are funded by other private investors on the basis of specific entrepreneurial, enterprise, or request characteristics. This differentiation, if possible, could improve the quality of advice provided to entrepreneurs. The quality of equity capital markets is important to the economic well-being of most regions. There are many opportunities for improving market efficiency and equity. Further research and some public invention is likely to prove useful.
REJTERENCES Gladstone, D.J. 1983. Venture Capital Handbook. Reston, VA: Reston. Haar, N.E., Starr, on the East Mason, C. 1987. Westminster
J., and MacMillan, I.C. 1988. Informal risk capital investors: Investment patterns Coast of the U.S.A. Journal of Business Venturing 3( 1): 1 l-29. Venture capital in the United Kingdom: A geographical perspective. National Bank Quarterly Review pp. 47-59.
Mikesell, J., and Davidson, S. 1982. Financing rural America: A public policy perspective. In Rural Financial Markets: Research Issuesfor the 1980s. Federal Bank of Chicago, Public Information Center. Pulver, G.C., and Hustedde, R.J. 1988. Regional variables which influence the allocation of venture capital: The role of banks. The Review of Regional Studies 18(2):1-9. Thompson, C. 1989. The geography of venture capital. Progress in Human Geography 13(1):62-98. Vaughan, R., Pollard, R., and Dyer, B. 1985. The Wealth of States. Washington, DC: Council of State Planning Agencies. Wade, R., and Place, F. 1985. Entrepreneurial culture in Wisconsin. Technical Reports, (85-l). Madison, WI: Wisconsin Department of Development.