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Private equity and venture capital

Friday 27 May 2011, by Rose Blackburry

At the beginning of their life, private company can use several means of funding:

  • Personal capital of the entrepreneur (or its friends and family)
  • Business angels
  • Venture capital

This funding can occur during the seed and early stages of the company life cycle.

The venture capital is a subset of private equity. Therefore all venture capital is private equity, but not all private equity is venture capital.

As described by the Private Company Financial Data Authority, “private equity represents a class of investors, their funds, and their subsequent investments, which are made in private companies or in public companies with the goal of taking them private. Private equity investments are primarily made by private equity firms, venture capital firms, or angel investors, each with its own set of goals, preferences, and investment strategies, yet each providing working capital to the target firm to nurture expansion, new product development, or restructuring of the firms operations, management, or ownership.”

Private equity and venture capital in France

As described above, venture capital is involved in early business life. However, this type of funding comes after the intervention of the two types of funding listed above and can not replace them. Indeed, venture capital invests a minimum of generally $2 million while financial needs for firm creation are between $100,000 and $1,500,000 for 95% of companies.

Graph 1 : Firm development depending on their level of capital and source of funding

In addition, the chart below highlights the fact that private equity invests primarily in companies that are already sufficiently developed and that had proven to be successful and venture capital is only a share of private equity (about 7,5%):

Graph 2 : Investments 2008 of private equity depending on investment type


Source: AFIC 2008

Working papers on Business Angels (BA) shows that France desperately misses BA to finance the seed phase of new companies. It seems that this is different for private equity. Indeed, the first consensus is that it seems pointless to put more money into venture capital or growth capital. Firstly because investments on the seed phase is not profitable and, second, because of the lack of profits, venture capital investments stand above $2 million. Then, on the other hand, it does not seem that France suffers from a massive shortage of private equity / venture capital investment, the comparison with Great Britain showing that the difference is about one third (see next section). In addition, private equity crosses borders and can come from other countries and French shortages in venture capital investments comes more from the lack of good projects to fund than a lack of money. The lack of good projects comes directly from the absence of Business Angels in France who are essential in the seed phase of a company. The lack of BA implies that the number of projects reaching the threshold for venture capital is limited.

This causes a scattering of venture capital funding on too many projects trying to replace the Business Angels. Overfinancing venture capital does not seem likely to make any progress. This is highlighted by the results of the 2009 Annual study of the AFIC and Ernst & Young on the net performance of the French private equity sector [1] arguing that the long term cumulative performance of the venture capital / early stage is -2.7% in 2009. In addition, investments in FCPI (innovation funds) and FIP (local investments funds) have a negative average return of -3.2% over 10 years showing that Government intervention favoring such investments did not have the expected effects and had disorganized private equity markets [2].

Comparison France – United Kingdom

Statistical comparisons show some lack in private equity. Indeed, invested growth capital funds (not managed funds) in Great Britain are 50% higher than the invested funds in France. But comparing the difference in the number of business angels is much more dramatic because there is a ratio of 1 to 10 in number (4,000-40,000) and 1 to 20 in the amounts invested.

In fact, the cause of the lack of private equity in France compared to UK is not due to the lack of financial resources but is due to the lack of new SME supported by Business Angels and into which private equity would find an opportunity to invest.

Thus, in terms of level of investments from the private equity, if we take care to distinguish the invested amounts managed by a country and those invested by this country (UK being a major financial hub compared to France, the gap is much larger when considering managed amounts than invested amount) we have:

Share invested in UK
Share invested in France
EVCA report (source Thomson Waterhouse) Total investi 2004: 36 914 M€
9 594 M€ (26% of the total amount invested in Europe)
6 273 M€ (17% of the total amount invested in Europe)
BVCA report
7 790 M€ (5 336 M£)
AFIC report
5 189 M€
EVCA / National source ratio
1,23
1,21
UK / France ratio
1,53
Sources: EVCA (European Venture Capital Association), BVCA (British venture Capital Association), AFIC. Year : 2004.

It seems that, with a moderate uncertainty, we can compare the figures produced by the AFIC and the BVCA.

The categories do not exactly match, but totals are still in a ratio from 1 to 1.5

The details of investments made in France and Great Britain by the venture capital and growth capital is as follows:

UK
France
Investment types
Source : BVCA
Investment types
Source : AFIC
Start-up
96 M£
Seed and creation
396 M€
190 companies
500 000 £ / company
417 companies
Early stage
188 M£
264 companies
950 000 € / company
712 000 £/ company
Expansion stage
789 M£
Growth capital
695 M€
522 companies
423 companies
1,8 M£ / company
1 643 000 €/ company
Total
1075 M£
Total
1091 M€
976 companies
1259 companies
1 100 000£ / company
866 000 € / company

Overall, we can say that there is less venture capital (seed) and growth capital invested in France than in UK and that British projects are fewer, but bigger.

However, the gap in venture capital funding is about 1 to 1.5, and not 1 to 10 as is the gap in Business Angels funding.

Footnotes

[1click here to see the full report

[2See Leonardo Finance. Forum of the 18th May 2005 (page 14)

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