Financial Innovation in the London Markets: Venture capital trusts and the funding of technology firms

Josh Siepel

SPRU, University of Sussex (UK)

j.siepel@sussex.ac.uk

My doctoral research focuses on finance and innovation in the London markets.  Given the common political and legal tradition of the US and UK (La Porta et a,l 1998) and their liquid, lightly regulated, market-based economies, it is often assumed that US and UK markets can be usefully understood in terms of Anglo-Saxon capitalism (Bush, 2006).  It is also widely been assumed that globalisation is leading to a financial convergence on an Anglo-Saxon model. In the context of financing technology-based firms, this implies a model based on venture capital investment leading to exit by IPO (or trade sale) in a liquid market (OECD, 2001).  

My thesis questions these assumptions. It takes the form of a traditional industry study of the UK venture capital trust sector. VCTs are specifically regulated to address the perceived 'funding gap' for high-tech small firms (Boynes et al, 2003; Cumming, 2003) and have a number of interesting features: they represent a form of VC in which there is little or no 'coaching' (as in Hellmann and Puri, 2000), and VCTs are listed and must fully disclose their investments in securities filings. I have taken advantage of this latter characteristic to hand-collect data from every investment made in the twelve-year history of the VCT scheme, for a total of nearly 4000 investments and 1000 exits. As part of this analysis of this unique UK-based dataset I am replicating the methodology of Giot and Schweinbacher (2007) to compare market exits, trade sales, and liquidations, using dummy variables for sector, year of investment, and original deal type.  Initial results suggest that post-IPO market exits - seen as a key platform for Anglo-Saxon venture capital (Black and Gilson, 1998) - generally under-perform compared to trade sales.

This research also highlights some fundamental differences between the NASDAQ and AIM markets and the structure of the VC industries in the UK and US, and in particular suggests that risk management for small technology firms in the UK is different from the US.  In both cases, high tech firms have high failure rates, but in the US this uncertainty is actively managed by the coaching function of the venture capitalist.  In the UK, VCTs (and VCs more generally) provide little coaching and uncertainty is converted to financial risk and managed externally by investors as companies (particularly in the biotechnology sector) repeatedly approach the markets for additional financing through IPOs and stock offerings (Nightingale and Baden-Fuller, 2006).  At the same time, large institutional investors and other specialised investors, such as hedge funds, are financing small technology firms to manage their portfolio risk in large-cap stocks (as suggested by Baden-Fuller et al, 2006).  

Remaining work will seek to more clearly identify and understand these phenomena.  Initial results suggest that this part of the UK's highly innovative finance sector, which is particularly associated with the AIM small-cap market, does not provide liquid exits for VCs (as is the case with NASDAQ) but instead acts as another round of funding for firms, and its more lightly regulated environment provides opportunities for external risk management by larger investors.  If this is confirmed it raises interesting questions about the changing structure of capital markets, and any global convergence toward a single Anglo-Saxon financial system.  While the US and UK may look similar from a distance, it becomes clear upon examination that they are fundamentally different and in this regard, it is unclear whether the US, with its unique securities regulation structure, represents the final point of any convergence. It may instead be that different markets have different strengths and weaknesses: the US markets and active VC may be better for complex, high-tech start ups, while the more lightly regulated London markets may be better for external risk management and simple capital intensive investments.