A Model of Community-Based Venture Capital Formation to Fund Early-Stage Technology-Based Firms

By Auken, Howard Van | Journal of Small Business Management, October 2002 | Go to article overview

A Model of Community-Based Venture Capital Formation to Fund Early-Stage Technology-Based Firms


Auken, Howard Van, Journal of Small Business Management


This paper suggests a model of capital formation that concurrently establishes a mechanism to fund early-stage technology-based firms and meets the economic development needs of rural communities. Investors in a community capital investment fund can gain high rates of return on investment while firms realize all of the benefits associated with the investment, community support, and expanded network. The model includes factors associated with the community environment (community-based factors that impact community members' participation) and external support environment (factors that facilitate the accumulation of investment capital within a community). The result of a community effort can be an environment in which members of the community contribute to an investment fund, cooperate in attracting firms, and provide networking assistance to new business owners. Communities benefit through job creation and economic stability Community members benefit through wealth creation.

Introduction

The restructuring of the U.S. economy from an industrial-based economy to an entrepreneurial-based economy is well under way. Small firms are an integral part of the transition process and have been the engine of economic growth for over a decade. Over 90% of all businesses are small businesses, and record numbers of new firms are being started. Small firms provide approximately 51% of private sector output, employ 52% of private workers, provide 76% of net new jobs, employ 38% of high-technology workers, and generate 55% of all innovations. Many of these firms are the creators and leaders of entirely new industries. Most of the job-creating firms are fast-growing firms that are generating a disproportionate amount of innovations, patents, and commercialization of new technology in the market (Office of Advocacy 1998; Kuratko and Hodgetts 1998; Timmons 1999). Evidence indicates that the trend toward an entrepreneurial society is accelerating (Sohl 1999).

Two important challenges have accompanied the transition of the U.S. economy First, the lack of seed capital to fund early-stage technology-based firms has been an obstacle to business creation and growth (Bygrave and Timmons 1992). The challenge of capital acquisition among small firms is well documented in the literature. However, the challenge is even greater for new technology-based firms due to the long lead time of product development and high risk associated with the transfer of technology into the marketplace (Van Auken 2001).

Freear, Sohl, and Wetzel (1995) estimated that the equity financing requirements of new technology-based firms is approximately $60 billion per year but that less than $15 billion per year is invested. Also, the migration of businesses from rural to urban areas has caused deterioration in the business vitality of rural communities. The decline in rural economic viability and competitiveness is a consistent trend since the 1980s (Wortman 1990).

Ayres, Leistritz, and Stone (1992) believe that the decline of rural trade centers is a result of many factors, including road improvements, school consolidations, and urban shopping centers. The process has been a cycle of economic, demographic, and public sector decline reinforcing each other. The impact of these trends is a challenge to new business creation in rural communities due to the lack of a critical mass in market size and resource availability.

This paper suggests a model of capital formation that concurrently establishes a mechanism to fund early-stage technology-based firms and meets the economic development needs of rural communities. The capital needs of early-stage technology-based firms may be met by progressive communities that are willing to pursue innovative approaches to economic development. In turn, new technology-based firms can add to the economic viability of small communities. This complementary and supportive relationship results in benefits to both rural communities and small technology-based firms. …

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