The venture capital industry has been criticized in a joint US/European report that says it is ignoring early-stage start-ups and is instead investing in more mature companies. The report asks governments on both sides of the Atlantic to do more to increase the flow of investment to early-stage firms.
According to the report, produced by a joint working group set up between the US Department of Commerce and the European Commission, this lack of investment in early-stage start-ups represents a fundamental market failure. The findings call for more public sector and policy maker involvement in the VC process. The working group is made up of representatives of venture capital funds, industry advisers, academics, and specialists.
The report warned that the failure of the VC market on both sides of the Atlantic is so significant that public intervention is desirable. It also suggested that public money should go to large, well-established funds that can command economies of scale, rather than creating a proliferation of small funds.
Small firms need investment capital but the market has failed to provide it – public sector support is needed, the report stated. The work of the group confirmed that there is a fundamental market failure in the provision of early-stage financing in both the US and the EU. Venture capital funds are concentrating on larger and larger deals, leaving the small and risky early-stage deals aside.
The report blamed the attractive returns and lower risks that come with later-stage investments in more established firms and in buyouts of larger companies, and warned that this could become a self-reinforcing cycle.
Because few venture capital funds are active in the seed and early-stage area, they don’t have any longer the necessary knowledge to operate there. The few remaining seed funds and the business angel investors cannot by themselves cover the demand for equity investments. The recognized benefits from the birth and growth of innovative small firms to the economies are such that public sector measures are justified to overcome this market failure in seed and early stage investments.
At the same time as saying the public authorities should step in to what has traditionally been a free market, the report also concluded that politicians need to be educated on the importance of the venture capital and private equity markets to wealth generation.
Looking at the venture capital industry as a whole, the working group said it believes it is in a healthy state, and it reported recent total VC investment in the US was $20.5bn and in Europe $13.4bn.