2.4 Business start-up financers

In the previous pages, the attention has been placed on the difficulties which the entrepreneur encounters in finding the financial sources:
1. the perception of risk on behalf of the investor, which as aforesaid, varies with the firm's growth;
2. the insufficient presence of the investors willing to assume such risk.

Rather, it is to be underlined the circumstance which in the reference overview of the more evolved financial markets, there are individuals who devolve a great part of their financial resources in favour of the small and medium sized enterprises, supporting in such, the needs of the firms which have been financed based on the development route coupling with the firm's stage of growth- financial need as described in the previous paragraph.

Two types of investors are generally identified, the Venture Capitalist and the Merchant Banking.

The aim of these individuals is the investment in firms under the form of capital through assumption, management and disinvestment of the sharing, primarily in minority and in companies with non listed shares, they execute professionally activities of investment in venture capital with the objective of achieving, in a temporal horizon, of average period, an earning towards capital, so called capital gain, constituted from the difference between the value of assumption of participation and that of their successive cession plus eventual dividends.

The two individuals' work is very expanded, therefore, the main discriminant essentially concerns the phase of intervention during the life of the enterprise: the venture capitalist is specialised in investments for the start-up and/or the growth of small dimension firms which represent a high development potential in terms of new products or services, new market conceptions, productive technology and process. The merchant banking, instead aims above all on investments in medium-sized enterprise already started-up to sustain the development.

This paragraph will exclusively address the role and the working modalities of the venture capitalist.
There are three types of investors:
1. Public Institutional investors;
2. Private Institutional investors;
3. Informal investors.

The first example include individuals who are directly or indirectly appointed by the Government, who, as their institutional goal, have that of revitalising certain geographic areas of the Country characterised by occupational and productive unbalance, promoting and sustaining the development of the entrepreneurship.
Intervention of investment can be addressed either towards small and medium-sized enterprises which are going through a phase of crisis, and therefore need new funds to carry on the economical activity, as well as towards enterprises in an embryonic stage, in order to promote new entrepreneurship. Such individuals operate following a double finality:

• Pursuit of "public" goal, sustaining the birth and development of entrepreneurship in depressed areas, and however characterised occupational and productive imbalance;
• The observance of management economy principles, for which the intervention of the initiative is subsequent to a series of studies and comparisons which testify the economic convenience.

According to some authors, such individuals present some limitations which unavoidably end by reducing the impact on the business structure.
1. In the first place, being subjects of "public" nature, they operate with funds given to them by competent authority. Often, said funds are not sufficient to get all the opportunities "worthy" of investment which are presented.
2. Such individuals, frequently are not in a position to cover the financial gap left by venture capitalist of private matrix in certain business sections.
3. Their work is territorially limited, therefore, they are forced to catch only the opportunities of investment coming from certain areas.
4. The firms which go through the start-up phase, and however the enterprises which are in difficult, need, besides the financial funds, also accurate and specific consultation. Often such "additional" services are not supplied by such individuals considerably reducing the positive impact of intervention.
5. Finally their work is too often influenced by "external" wills such as the politicians or that of the "bureaucrats".

The second example refers to private "institutional" inventors (such as common funds, etc.).In this case their optic of intervention is led by the prospective to maximise the rapport risk-performance.

In the course of the past years, such individuals have shown less attitude in investments towards firms in the start-up phase. The causes of this attitude are to be researched in the start-up peculiarity, which presents penalising factors in respect to alternative investments:
1. high fixed costs;
2. existence of a double risk;
3. difficult way out.

1. With reference to this first point, it is referred to the existence of the transition costs and management costs.
Whichever investment before it's realised must be subject to profound and often costly study and analysis of feasibility.
In addition, it is often necessary to account for the presence of a side manager internally of the financed firm or alternatively, plan an efficient informative circuit which allows the investor to know the conditions of the financed firm at each moment. Such actions obviously entail a sensible increase in the "fixed" costs, which during the start-up phase, and up increasing with their impact on the total cost of their initiative, reducing, by counter, the investors' earning potentiality.
2. For what concerns the presence of a double risk, it is made reference respectively to the risk of selection and to the operative one.
The risk of selection concerns the selection difficulties of the investment opportunities to catch, choice which is even more difficult due to complete lack of parameters to refer to, which for example the market comparison with respect to the entrepreneur's idea, to the technology applied, to the competitive strategy and to the managerial capacity of the executive and/or of the entrepreneur.
The operative risk, instead, concerns the risk towards the carrying out of any economical activity, due to which the venture capitalist could see the investment where he has profused great financial, management, advisory and review efforts.
3. Finally, the last factor which penalises the accomplishment of investments towards the start-up, is represented by the difficulty of retirement from the share acquired, which is proportionally opposite to the youth of the firm.
Such difficulties are to be attributed to the lack, or however inefficiency, of the security market bound to the negotiation of such securities. The only retirement options are reduced therefore, to the operations of:
a. trade sale;
b. buy back.
The first refers to the possibility of selling the stock to third industrial partners interested in entering into the business, while the buy back operations attain to the possibility to re-purchase the stock by the entrepreneur. Both options present, however, high risks of accomplishment, which in some cases could boil down to high income losses.

The relationship between the firm and the venture capitalist presents some management difficulties already in the beginning of the research phase of partnership.
As a matter of fact, the research of a financial and/or industrial partner not only involves a loss of time, energy and money (between the first contacts and the finalisation of the partnership rapport even 7/8 months may go by and it's often necessary to go to external advisors who will carry out a business plan to the financers' expectations), but even after the partnership realisation , there may be the possibility of management diseconomy:
1. inefficient employment due to excessive resources;
2. inflexibility of action.

In the first case, the joint ventures are conditioned by an excess of financial resources respect to the need, therefore they are induced to commit strategic errors: the decisions are often taken following the criteria of forced employment with the available resources, which are often used not for instrumental investments for the execution of the business activity.

With reference to the second point, we refer to the communication difficulty which exists between the entrepreneur and the financer.
The uncertainty degree linked to the good result of the initiative is very high in the start-up phase, therefore it's necessary for the entrepreneur to be able to catch all the opportunities which are presented to him, while the venture capitalist is often linked to the original idea, therefore in lack of good communication capacity between financer and entrepreneur, not always the latter can modify the business strategy, ending up in some cases to continue an activity in which he himself doesn't believe in anymore.

For what concerns the informal investments, such individuals have only come about on the financial scene recently and they are commonly indicated with the term "business angels".
They are professionals who have financial resources to invest and the necessary competence to select the initiative potentially profitable.

Their range of intervention is addressed above all towards those sectors neglected by exempted dealers, and in particular in the corporate start-up stage.

The type of intervention is often not exhausted with the payment by the financial sources, but it is to be carried out with the contribution of know how necessary for the initiative's success, particularly important in the start-up stage.
In particular, the business angel contributes to the definition of the corporate strategies, utilising its own commercial competence, on its eventual previous business experience, on the existence of privileged contacts with financial and/or commercial interlocutors, etc.

Such peculiarity is a big advantage for he, who takes the funds, as well as it's an opportunity for the financer to directly monitor.
To participate to the business enterprise, not only as a lender of funds, but also as assistant, means being able to monitor in every moment the welfare state of the business.

Furthermore, the informal venture capitalists present an additional indisputable advantage respect to the institutional investors: while as the latter are generally concentrated in some territorial areas, the business angels guarantee a major range coverage, being spread out on the territory.
The business angels limit their action range within 50/100 miles, for the following reasons:
1. the local investment guarantees a better knowledge of the economic structure in general and productive in particular, facilitating the propagation of the information "investment opportunities";
2. the long range operations would at first make the availability of the investment opportunities , after which, increasing the necessary times and costs for the financer to meet the entrepreneur, they would end up damaging the economic convenience of the operation.

The difficulties regarding the conciliation between the funds availability and the investment opportunities constitutes, unfortunately, the major limit for spreading the informal venture capital.
It's necessary to constitute anew an informative circuit which allows the meeting of the parts. According to some authors, it would be suitable to constitute "Financial marriage bureaux", where to create opportunities for a profitable meeting.

In reference to the aforesaid it's necessary to make some final considerations.
The relationship between venture capital and start-up, which seemed should have solved a great deal of the problems concerning the obtainment of the capital risk, is going through a phase of mutual incomprehension. During the last years the informal venture capitalists and the "public" investors have above all financed the new business reality.
In particular, the role carried out by the business angels seem to be particularly consistent with the start-up needs; in fact, respect to the institutional investors, they present the following advantages:

• they are more inclined to accept lower returns of the operation;
• selection and improvement times of the intervention are reduced;
• the relationship with the entrepreneur are less formal; there is a lower "coercive" interference on the management activity; and therefore, there are no phenomena of "action's inflexibility" as previously described;
• they are available to stay engaged in the investment for a longer period of time respect to venture capitalist, which is a more consistent solution with the needs of the start-up;
• their financial contribution is more in line with the start-up needs, and it doesn't lead to the problems of the "forced employment".

A particular form of business angel regards the pre-existent and consolidated enterprises. These are industrial realities inclined to finance new business enterprises, sharing with them the business plan and including its development times.
Nevertheless, the role of the public investors is to be reaffirmed, which, although linked to the described limits, is guided by macroeconomic aims (employment's support, particular sectors' support, etc.), which make their contribution indispensable in depressed areas.

Tab. 1: Investments by number and amount - 1997

	Invested Amount		Variation	N. operations		Variation
	1996	1997	1997-'96	1996	1997	1997-'96
U.K.	5.797	8.635	49%	1.715	1.686	- 2%
France	1.726	2.434	41%	1.691	1.551	- 8%
Germany	1.394	2.586	85%	769	1.087	41%
Holland	1.156	1.482	28%	320	425	33%
Italy	998	1.164	17%	198	234	18%
Spain	376	511	36%	158	244	54%
Others	1.789	2.016	13%	835	1.025	23%
Total	13.237	18.827	42%	5.686	6.252	10%

Source: E.V.C.A. 1998

In all the Countries significant increases have occurred in the invested values, in Germany the variation has been equal to + 85%, while in the United Kingdom it has been at + 49%.
With respect to 1996, Italy has maintained, in the special classification of the E.V.C.A., the fifth position for operations' number and amount.
Notwithstanding the position has remained stable, Italy has however shown an increase of the operations: +18% for number of finalised operations (234), and + 17% for invested amount (approximately 1.164 billions).
The distribution for geographic areas according to the Aifi rewards the North, with 61% of finalised operations, 23% in the Centre, and the remaining 16% to the South.
The positivism of this result is, unfortunately mitigated by the following consideration: the United Kingdom, whose financial market together with the United States is the most advanced in the world, has dropped in the number of finalised operations respect to 1996, while the invested amount has increased; this means that the average invested value in every single operation has increased, with additional presumed removal between venture capital and business start-up.
This consideration is supported by the following table, from which is evidenced that in 1997, in Italy, only 12% of the invested funds has been addressed towards operation of seed and start-up capital (approximately 142 billion), while the remaining 88% of the funds has gone to the venture capital .

Tab. 2: Type of investment by amount

	1995	1996	1997
Seed and Start up	18 %	9 %	12 %
Development	54 %	46 %	26 %
Replacement Capital	13 %	18 %	29 %
Management by out	15 %	30 %	33 %

Source: A.I.F.I. 1998

Furthermore, from the same table, it's possible to verify the following:

• funds invested in seed and start-up operations are reduced during the period 1995/97 going from 18 to 12% of the resources completely invested;
• the incidence of the management by out operations is sensitively increased going from 15 to 33%;
• the financing of the business development is the intervention's modality which has undergone the greatest decrease in the considered period of time.

Substantially the activity of the venture capitalists is focusing on the financing of financial operations in favour of more mature enterprises, overlapping, in part, to the merchant banking activity.

The causes which have led to a removal from the investment in the start-up stage have to be researched into the disappointed income's performances, which become worse if it is reflected on the high risk degree.

For what concerns, instead, the results reached with the business angels intervention official statistics comments don't exist, lacking any type of trade association.

In conclusion, the development of the venture capital activity in Italy, is characterised by the insufficient dynamism of the operators specialised in the support of the new entrepreneurship.
The spreading of the institutional investors aimed at in this stage, finds some links in the following factors:
1. the tax regime in Italy is still today most favourable towards alternative financial funds respect to the risk capital;
2. the investor who generally possesses a minority stake, doesn't have effective and efficient control's instruments at his disposal;
3. any culture of society's transparency is missing; therefore all the instruments, as the accountant's certification, suitable to make the business more transparent to the external, are generally mistrusted.

The spreading of the financial operations of the SME's risk capital, must necessarily go through a phase of structural adjustment of our tax, financial and commercial structure.