Venture Capitalists' Investment Selection Criteria in CEE Countries and Russia

By Zinecker, Marek; Bolf, David | Business: Theory and Practice, March 2015 | Go to article overview

Venture Capitalists' Investment Selection Criteria in CEE Countries and Russia


Zinecker, Marek, Bolf, David, Business: Theory and Practice


Introduction

When starting a business, the first problem the founders have to face is acquiring the starting capital. The initial capital can be accumulated in various ways such as self-financing by the owner, loans from friends or relatives, private stock issue, forming a partnership, venture capital funds or angel investors. Conventional financing by bank loans seems to be rather unavailable due to a fairly high degree of information asymmetry between the external capital provider and the investee company (Khatiashvili et al. 2009).

In well-developed market economies, a lack of conventional funds during the early life stages of a company is, in addition to various forms of state subsidies, covered by formal and informal venture capital. The venture capital market, as a part of the private equity market, is primarily devoted to equity or equity-linked investments in young growth-oriented ventures. The venture capital market consists of two main segments: institutional venture capital (also called "formal venture capital"), and informal venture capital with business angels (Landstrbm 2007). Business angel investments are "the single most important source of early-stage equity capital for small- and medium-sized enterprises" in the US as well as in other well-developed countries (Riding 2008). Prelipcean and Boscoianu (2011) see applying financial innovations in SME's financing, especially in the case of venture capital and private equity financing as a very important task. They point out the critical importance of this aspect in emerging markets, where the access to funds is very restricted.

Venture capital is traditionally associated with the USA and the UK, from where private investment in various forms began spreading around the entire world. The total VC investment volume in the EU countries was just under 3.2 [euro] billion in 2012, which represents 0.023% of GDP. However, there are significant disparities between the EU countries when considering total venture capital investments scaled by GDP. The Nordic countries and the United Kingdom have been scoring the highest investment in venture funding. 2007-2011 annual average venture capital investments scaled by GDP reached 0.090% in Sweden, 0.058% in Denmark, 0.041% in Finland, 0.055% in Norway and 0.060% in the UK (compared to 0.038% which represents the European average) (Pan-European Private ... 2013).

Compared to the European average, the venture capitalists' activity in the Central and Eastern European (CEE) and Russian venture capital markets is still at very low levels and the recent development does not support its long-term sustainability and establishing an appropriate infrastructure (e.g. specialist legal and accounting firms, attractiveness of market for entrepreneurs, liquidity of capital markets, etc.). 2007-2011 total venture capital investment scaled by GDP reached 0.018% in Hungary, 0.015% in the Baltics, 0.012% in the Czech Republic and Romania, 0.08% in Poland and 0.04% in other CEE countries (Pan-European Private ... 2013). On the basis of data published by the World Data Bank (2013) and in the RVCA Yearbook 2012 (2012) we calculated that in the period 2007-2011 the VC investments in Russia including seed, start-ups and other early stages reached $819 million. Scaled by GDP, this represents 0.011%.

Thus, CEE countries and Russia seem to face macroeconomic challenges similar to Spain and Italy. Redoli and Mompo (2006) use the Ventakaraman's Vicious Cycle to explain the situation in the Spanish venture capital market where politicians and board directors are concerned about poor Spanish R&D results compared to other EU countries. Public R&D policies try to alleviate the problem, but the result is worthless given the lack of high quality firms that are consistent with these policies. Moreover, best talent is not pushed to create new business models based on novel ideas but is driven to comfortable ones. …

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