the investor's paradigm

Most investors understand how venture capital (VC) promotes economic growth. The flow of equity into innovative start-ups can fuel job creation and drive industry development. It lays a foundation for a breeding ground for innovation and inventions. Therefore, the amount of VC money spent in a country is a telling metric to grasp the growth potential and sustainability of this country's economy. Indices exist to compare the VC climate in various countries. We at Verve Capital Partners were curious, what is the VC spent per capita in European countries; and subsequently, does the actual VC spent per capita correlate with attractiveness rankings?

Expecting that the "most attractive" countries would yield the highest VC per capita, some of our findings were surprising.

The analyzed European countries fell within five distinct groupings according to the actual amount of VC spent per capita.

GROUP ONE: $70-$60

Switzerland ($69) and the Netherlands ($62) had the highest VC spent per capita in Europe. As a benchmark, the U.S was calculated at $67. Switzerland's leadership regarding actual VC invested is clearly reflected in its high attractiveness rank (#6) according to the Global IESE Venture Capital Attractiveness index. According to IESE, Switzerland scores well across all "VC attractiveness" dimensions analyzed - among those the quality of deal opportunities (i.e. a flow of technology spin-offs from its world-leading research universities) as well as its attractive taxation. But Switzerland's top position is also made possible due to the help of foreign investors (Switzerland is a net importer of VC) and the expansive wealth of Swiss citizens. The Netherlands' top position has to do with a similarly high VC attractiveness index (#9) and - very much like Switzerland - with a high GDP per capita.

GROUP TWO: $60-$50

Some Scandinavian countries - Sweden, Finland (both $59) and Denmark ($53) - also performed well above the $35 European average. Like group one, these countries' excellent ranks regarding their actual VC spent are well founded by their VC attractiveness indices: #8, #12 and Denmark ranking #11. And again not surprisingly, their attractive VC environments are complemented by above-average GDP per capita.

GROUP THREE: $40-$30

The European average ($35) is exemplified by the U.K. and Ireland (around $39), Belgium ($33) as well as France ($31), whose actual VC spent already positions these countries well behind the second group. This group is the first to deviate from our expectations as most of these countries' actual VC spent per capita is notably lower than their attractiveness rating would suggest. Especially the U.K. is commonly perceived to be one of the leading VC spots in Europe and its VC attractiveness ranking (#3) suggests the same. Much like France (#15 of the globally most attractive), this counter-intuitive finding might have to do with their centralistic economies focused on its large capitals. While especially London remains a leading VC breeding ground, peripheral regions and populations deflate the actual figures of VC spent per capita. There have been attempts to artificially create start-up hubs in the periphery, but more time might be needed for these initiatives to bear fruit.

The (ordinary and extraordinary) shareholder meeting (SM) with all its formalities once was designed to be the place where shareholders gather, eat and drink, discuss agenda items and where the corporate decision-making process takes place.

Today's SMs show a quite different reality: Companies with just one or a few share-holders usually hold SMs where all shares are represented and the manifold formal requirements for ordinary SMs don't have to be followed (“Universalversammlung” as defined in art. 701 Swiss Code of Obligations). Large, often listed, companies hold a SM, but the horde of small shareholders present in the meeting only represents a minor stake in the company - they shout and cry, often unheard. In large companies, the decision-making process is, for good reasons, completed before the gates to the SM open and the shares are represented by a third party which was instructed earlier and has to vote according the instructions.

To adapt the legislation to today's SM reality as well as to the new communication technologies, in particular the internet and videoconferencing possibilities, the provisions governing SMs will be updated. Due to the ongoing debate in the Swiss parliament, it is not foreseeable when this revision comes into effect and how the exact wording of the amended articles will be. But I have summarized a short overview of possibilities under the new legislation based on the most recent revision draft version and the appertaining report by the Swiss Federal Council.

1. In the past years, many companies have held their SMs in different locations simultaneously. Xstrata, for instance, held its main SM in Zug, Switzerland (where its headquarters are) providing an audio and video live stream to a second location in London (where the capital is). Therefore, the revision of the OR (new art. 701a para. 2 - 4) in this matter reflects just an update to what has already been exercised.
2. According to the new art. 700 para. 1 OR, the convening of a SM can be made by e-mail or facsimile, if the shareholder agrees. Independent of the invitation to the SM, the company has to give notice to its shareholders on the possibility to inspect the annual report and the audit report at the domicile of the com-pany (art. 696 para. 1 OR) at least 20 days prior to the SM. In case of bearer shares, this notice has to be published in any event in the Swiss Official Gazette of Commerce (SOGC). In case of registered shares, a notification in written form (regular or priority mail, e-mail) is sufficient. Hence, it is obvious that the cost cutting effect as well as the efficiency of an e-mail invitation is higher in a company with registered shares because no additional publication in the SOGC is necessary by law. The Swiss lawmaker is of the opinion that a company is not allowed to impose an electronic invitation on the shareholder if he/she didn't agree in advance, even if stated in the bylaws - in opposition to today's possibilities. The provision for the time being (art. 700 para. 1 OR) just demands a convocation according the bylaws - whether by regular or priority mail or e-mail. Especially smaller companies invite to the shareholder meeting by e-mail today.
3. In any case, it stays necessary to deliver not only an (electronic) invitation but additional (electronic) documentation: list of agenda items, shareholder motions, information about the assignment of the independent voting proxy, proposals and comments of the board of administration and optionally the annual report.
4. The board of directors lays down the procedure for obtaining the approval for the electronic invitation. It is the company that is responsible for the correct transmission of the electronic documents. Further, the board of directors has to make sure that every shareholder who accepted the convocation by electronic means receives the invitation and documentation in time by using some kind of electronic notice of receipt. Erroneous or failed transmission may infringe the shareholder's participation rights. Based on today's practises, the company shouldn't be responsible in case the shareholder didn't inform the company correctly about his/her up-to-date e-mail address.
5. To ease the participation in SMs, shareholders - if expressly stipulated in the bylaws – will be able to attend a "traditional" SM via electronic instruments (internet, videoconference). In extremis, only the chairman of the shareholder meeting, probably members of the board of directors as well as the keeper of the minutes and, if applicable, the public notary and the auditor have to physically gather at the venue, depending on the agenda items. We could call this a “hybrid” GM.
6. The last step of the electronification is the entirely virtual SM or “e-general assembly” (new art. 701d OR) without a physical venue. Such a virtual SM can be held under the conditions that (a) all shareholders agree and (b) no public deed is necessary for a vote's validity on an agenda items (e.g. in case of a capital raise, art. 650 para. 2 OR). Hence, due to the de facto veto right of every single shareholder, an “e-general assembly” should only be considered for small and medium sized companies. It is the board of director's task to obtain the consent of all shareholders for the virtual SM. As the SM must be convened at least 20 days in advance, it should be possible to invite the shareholders some days in advance (assuming a month prior to the SM) with the remark that the SM will be held virtually except a shareholder informs the board of administration about his or her refusal within the next few days.
7. In any case, shareholders who are electronically joining a “hybrid” or entirely virtual SM have to be identified by the company - ideally via a virtual signature that is approved by the regulator (art. 14 para. 2bis OR). With the launch of suisseID, the lawmaker has already layed the groundwork. The board of directors is well advised however, to give the shareholders some kind of guidelines for obtaining of the virtual signature and the identification with the company. Furthermore, shareholders present via electronic means must be able to file motions, participate in discussions and the company has to assure that the votes are correct.

But what if the internet connection lags, the server of the company crashes and shareholders are no longer able to "attend" the SM? What if a shareholder talks and talks but forgets to switch on the microphone at home?

In case of technical problems, the “law without exception” demands a repetition of the SM (new art. 701f OR). This absoluteness is hardly justified. If the company's server is overloaded and shareholders are rejected "entering" the virtual SM, a repetition seems adequate. On the contrary, it shouldn't be made the company's problem if the internet connection of an individual shareholder’s residence is interrupted, simply too slow or if his/her hardware isn't set up properly. In such case, a repetition of parts or the whole SM is not justifiable.

If today, a shareholder misses the bus or loses his or her entry card to the SM, no one would accuse the company of infringement of shareholder participation rights.

You missed our continuous blog posts? Sorry for that, but we have been busy fixing another problem: the lack of Swiss venture capital.

Startup financing has become even more challenging as the private equity sector is still struggling after the financial crisis. According to Swiss private equity organisation SECA, annual investment volumes have decreased from 600 million CHF in 2007 to just about 400 million in 2009.

This decline is even more dramatic for new ventures if one takes into consideration that the lion’s share was used for later stage investments. Only about one third of 2009’s venture capital flowed into companies in seed or early stages – down from two thirds in 2007! As a result, lots of ideas and innovations simply could not be commercialized. “For our long-term competitiveness venture capital is essential”, SECA General Secretary Maurice Pedergnana, concluded in an interview for cash.ch.

Steffen mentioned in one of our previous posts that over a period of ten years (1998 – 2007), only 27% of ETH Zurich startups managed to obtain venture capital funding, whereas close to 60% of the UK university spin-offs were backed by venture capital. This puts the SECA figures in perspective - especially when taking into account that the data was collected before the financial crisis started to affect startup financing. So if the share of venture capital funded companies was already on an insufficient level before the crisis – with more potential capital available and a higher share of seed and early stage investments – we do have a real problem at the moment!

On the other side, Swiss Universities have done a good job fostering innovation. In particular the Ecole Polytechnique Fédérale de Lausanne (EPFL) has done a great job in linking research and business to bring technology transfer forward. Since Patrick Aebischer took over the presidency in 2000, EPFL diversified its portfolio both in technical sciences and the bio-tech/med-tech-sector. Despite the past turbulent years they were able to retain their annual numbers of about 30 spin-offs.

If it takes both innovation and early stage capital to substantiate Switzerland position as an innovation hub, then EPFL gives an wonderful example how the first aspect can be addressed. But with respect to the early stage capital needed, a paradigm shift in the early stage financing market is overdue! We should have a close look not only towards the US, where seed stage funding is comparatively strong, but also on alternative financing concepts coming up. We will be sharing some experience from the first funding rounds on investiere.ch in another blog post.

Read the rest of this post »

Today, we launched investiere.ch - globally the first platform providing small investors access to direct investment opportunities in non-listed companies. Unlike business angel clubs and networks, our offering is not restricted to "accredited" or so-called "qualified" investors.
On the platform, even small amounts can be invested in some of the most promising Swiss startups and it guides investors through a well structured investment process. As a start, three exciting young technology companies have been selected.
With this step, we will continue to support a culture of entrepreneurship in the general public and to realize our vision of a social economy. We help innovative entrepreneurs in early stages to bridge the equity gap and allow small investors to take a stake in the SME economy.

An article in yesterday's NZZ pointed out that the number of Swiss university spinoffs is continuously growing. Even more interesting is the fact that Swiss university spinoffs could be the most solid worldwide, outperforming even MIT in Boston or Oxford. An LSE study analyzing 130 ETH Zurich spinoffs over 10 years suggests that about 90% of these startups survived the first 5 critical years resulting in an average annual IRR of more than 43%. Recent examples are Esbatech, a University Zurich spinoff or Glycart, an ETH Zurich spinoff that both were sold to large corporates for a couple of hundred million dollars. The NZZ author concludes that "these results are positive signals for many investors that by now in Switzerland you can do profitable investments in startups". Also noteworthy is the fact that only 27% of ETH Zurich startups managed to obtain venture capital funding in the past. With UK university spinoffs this ratio is 60%. To close this gap, innovative funding approaches are needed.

In part 1 of our survey findings, we presented three distinct groups of ordinary investors. In part 2, we discussed common concerns among likely and less likely SME investors. But what are the main reasons for small investors that would justify investing hard-earned money in alleged risky startups and SMEs?

Not surprisingly, for all survey participants, risk/return as well as diversification considerations are the main drivers for such an investment.

For those individuals who are likely to invest, based on interest, risk profile and willingness to invest time (group 3 = 8.5% of investors), the joy of contributing own skills and expertise to the venture is seen to be another important factor. This non-economic factor, however, is closely related to economic considerations as the majority of this group is confident of being capable of adding value through their personal involvement in business matters (often referred to as “smart money”).

In addition, individuals from this group (as opposed to groups 1 and 2) underline the importance of diversification, indicating that having an investment outside the established financial markets would be an important factor.

Being confronted with other potential non-economic or altruistic motivations, group 3 reacts at best neutral. As if to underline the paramount importance of economic considerations, the average group 3 investor even disputes that the promotion of the local economic development through support of SMEs and young entrepreneurs would be an important reason to get involved.

In short: the majority of group 3 couldn’t care less about non-economic factors. Being clear-cut homines oeconomici, they consider SME investments to be yet another investment opportunity economically competing against other offerings. No time for romance.

Group 2, all individuals with an interest to invest but not belonging to group 3 (35%), also attributes paramount importance to risk/return considerations but their motivational profile is much more complex. So far, all participants within that group indicated at least some degree of agreement with respect to all altruistic and most non-economic factors. In particular, they are more likely to become involved if two non-economic factors are taken into the equation: The average group 2 investor aims to support innovative ideas and young entrepreneurs.

In consequence, there is a huge potential for raising risk capital from an even broader public and beyond the homines oeconomici, if capital seekers succeeded to address two issues. Firstly (and as discussed in our previous post), the most common concerns of group 2 have to be dispelled. And secondly, the innovativeness and social relevance of a business opportunity needs to be communicated.

Participants were asked to give answers even if they did not indicate an interest in SME investments. And given the hypothetical nature of this scenario to group 1, results need to be interpreted very carefully. One finding however is noteworthy: altruistic and non-economic factors play an even more important role than for group 2 and 3 participants.

If we take into consideration some of our previously published findings, we can draw some first conclusions on how motivations of small investors differ from those of formal VCs and other informal investors.

1. Small investors are equally focused on the economics of an investment but have more patience/long-term orientation than formal VCs
2. As opposed to formal players, the majority of potential small investors take additional non-economic factors into the equation
3. However, in comparison with other informal investors in the friends and family space (often driven by friendship and favors), small investors are clearly more economically minded

Quite clearly, if we want to pinpoint typical behavioral profiles of likely investors, it will be necessary to do a more detailed segmentation based on our data. Come back, we will do that soon – and in the meantime, let us know your thoughts on what could be feasible dimensions to slice and dice groups 2 and 3!

Survey: N=176, including only participants from Germany, Switzerland and Austria in evaluations

An entrepreneur in need for capital might be confused. In the finance industry as well as the media, two buzz words make the round: “equity gap” and “equity overhang”.

Equity gap and overhang are not two sides of a coin. In general, the term “equity overhang” refers to the gap between funds raised and funds invested and thus to a problem institutional investors are facing.  The term “equity gap” is used in reference to the gap between funds required and funds invested and thus relates to a problem entrepreneurs are facing.

Based on these definitions, a first answer to the question raised in the title of this post is: both! Depending on a company’s industry, stage within the company life cycle, and amount of capital required, today’s capital seekers find themselves in one of three clusters of the graph shown on top.

The red cluster of our “private equity cube” indicates which companies typically suffer most under the equity gap. According to the OECD, these are mostly seed and early stage innovative SMEs (“ISMEs”). While figures are difficult to obtain, in the U.S., this gap is said to be around $40 billion. Within this red cluster, first and foremost, entrepreneurs requiring between 200k € and 2 m € are affected, as these amounts are too large for informal players such as business angels but too small for VCs and private equity firms (corresponding to the medium layer of the red cluster). Currently, the only cure for these young and innovative SMEs are business angel syndicates and publicly backed funds, such as CTI Invest in Switzerland or the “Enterprise Capital Funds” in the UK. But the volumes provided by these players are still way too small.

The green cluster, on the other hand, indicates which companies in need for capital are most fought over: expanding or turnaround companies requiring >2m € capital. Only players of the formal private equity industry, such as venture capital firms (“VCs”) and private equity funds, or funds of funds respectively, play in this field. As of April 2009, current figures for the U.S. indicate an aggregated overhang of $400 billion. While the numbers differ, this situation applies globally: VCs are sitting on loads of cash but for two reasons hesitate to invest - due to the economic slowdown and due to a tendency of increasing minimum deal sizes in the formal private equity industry.

But what if an entrepreneur finds himself in the white cluster? First of all: he or she will have to rely on his own funds and capital from informal investors. And three rules of thumb apply: (a) the bigger the required capital, the more difficult it will be to find FFF or angel money; (b) the riskier the business model, the more difficult; (c) the earlier in the business lifecycle, the more difficult. Thus, even white cluster companies are confronted with an equity gap, just less severe than red cluster companies.

In wrapping up posts 1 to 4 on the investor’s paradigm, it seems that market inefficiencies are the overarching problem: from an entrepreneur’s perspective, if your business does not match the preferences of formal VCs and private equity firms, and from an investor’s perspective if you do not happen to qualify as an “accredited” or “qualified” investor. In other words: the majority on both sides relies on the quality of their personal networks.

As a result of our survey on investor behaviour, three distinct groups of ordinary investors emerged (see post Survey findings, part 1: A different take on small investor interests). Group 1- individuals who would not invest in SMEs or startups (56.5%), group 2 - individuals with an interest to invest (35%), and group 3 - individuals who are ready to invest, based on interest, risk profile and willingness to invest time (8.5%).

We will be analyzing investors’ concerns along these groups. With respect to group 1, we will try and establish key reasons that are keeping people from considering this type of investment (besides other aspects like for instance lack of interest). Regarding group 3 (people who are likely to invest), we will try to find out where they would lay emphasis on in the due diligence phase - given an appropriate SME or startup could be identified. And as for group 2, we will try to assess to what degree and under which circumstances these people would become likely investors in the future.

The chart below gives an overview of concerns along with a rating (strongly disagree to fully agree) for each group. The three groups consistently express different levels of concern throughout all questions. Each group corresponds to a distinct concern profile which we will enlarge upon.

People not considering an SME or startup investment (group 1) share all concerns listed, the top three being:

1. “Due to a lack of own experience, I do not feel comfortable with such an investment”
2. “I would be concerned that the information I have available when deciding on the investment are not comprehensive or not entirely correct”
3. “I would generally be afraid to loose money with such an investment and stick to traditional investments”

This expresses a general fear or hesitation, relating to a lack of experience or a fundamental mistrust in such kind of investment. Based on these fundamental barriers, a more in-depth discussion of more specific concerns would bear no additional insights.

For those ready to invest (group 3), only two concerns are seen to be of some importance:

1. “As I do not know the owners or the management of the company, I am afraid that they may not be up to their management task”
2. “I would be concerned that I would not be kept informed regularly”

Individuals from this group do not share any of the other potential concerns (a value of zero indicating a neutral attitude, this group rates concerns not mentioned above below zero). This of course does not imply that these people deem the majority of concerns as illegitimate, but rather as resolvable. Clear disagreement is expressed, if we are insinuating a lack of experience or fear with respect to such kind of investments. Their concerns are specific to a given opportunity, circling around trust in the management team and post-deal reporting.

Let’s take a closer look at group 3. Strikingly enough, the so-called exit option, the way in which a private equity investment can be liquidated, is not overly high on the agenda of small investors. This finding is particularly interesting, as it is well known to be an important factor for business angels and institutional players, when placing their investments. Typically, the latter are seeking an exit in 3-8 years in order to free up resources – in the case of institutionals also pressed by their own investors, and generally are mostly motivated by purely economic factors. It appears that in this regard, the small investor distinguishes itself through increased patience and potentially different/additional investment motivations – an assumption we will be validating in a subsequent post on the survey results. It is important to note, however, that many small investors are simply not familiar with various aspects of such an investment; this most certainly includes the divestment mechanics.

Also noteworthy is the fact that likely SME and startup investors state, they would not be frustrated if an investment turned out to be unsuccessful. Taking into account the potential high risk associated with an SME or startup investment this is another confirmation of their entrepreneurial mindset.  

To complete the picture, let’s cast some more light on group 2 and assess how high a barrier their concerns pose and under what circumstances they would still adopt this type of investment. The group indicates that they would feel quite comfortable with this type of investment and that they would not be afraid of loosing money. Nevertheless, as opposed (and in addition) to group 3 (people likely to invest), there are a number of concerns shared with group 1 that would have to be addressed: comprehensiveness and correctness of information, potential liquidation difficulties, coordination with other small investors and fraud risks.

In summing up, we are seeing quite fundamental concerns for group 1, making it quite clear that they would only take the plunge in exceptional cases. Group 2 feels generally comfortable with such an investment. Before they would invest in an SME or startup, however, probably most of them would want to get more clarity around what such an investment entails. Group 3 clearly has the mindset of the entrepreneur and SME / startup investor.

Survey: N=176, including only participants from Germany, Switzerland and Austria in evaluations

Private equity is for affluent individuals with an attitude, as many people see it. And this notion clearly reflects in the portfolios of small investors. Further is it fortified by some recommendations of business journalists and bankers to their readers or clients respectively, to stay away from this kind of investments. Last but not least: under the banner of investor protection, regulators do their best to maintain the status quo.

An ongoing market study we are conducting sheds a new light on small investors' interests in this regard. Our preliminary findings show that over 40% of investors (defined as someone of minimal wealth) have indicated that they would consider a direct private equity investment in an SME or startup and that they would value improved access to such investment opportunities. This is roughly eight times of what reality is showing today.

Even under more restrictive criteria, requiring not only a clear interest but also preparedness to invest time and accept associated risks, 8.4% of investors or roughly 3.64 million people in Germany, Switzerland and Austria would invest part of their money in new ventures or SMEs. This portion includes individuals already invested in private equity today (currently roughly 3%, read here) and, to a large extent, individuals with an entrepreneurial background or advanced investment track record, in the sense that they have invested in more than one asset class.

Note: 56% stated that they would not invest in this type of investment (including a few participants that gave ambiguous answers).

Interested SME investors are almost exclusively in jobs entailing “independent and qualified” or “highly demanding” tasks (job level categories 1 and 2 out of 4 of the Swiss Federal Statistical Office), with a focus – but not predominantly – on economic, finance and law backgrounds. Men are more likely to invest than women whereas the marital status and family situation do not play a significant role.

While it is not surprising that wealth and income play a role in people’s interest to invest, the study shows that there are many people below the threshold of the so-called accredited investor (according to the SEC, a net worth in excess of $1 million or income of >$200k) that are likely to invest. Figure 2 shows the percentage of investors likely to invest by wealth group, increasing sharply and peaking at 16.5% for individuals with of wealth between $100k and $200k. Declining interest with higher net worth could potentially relate to further alternative investment offerings accessible to these individuals.

The apparent demand clearly raises the question of why no corresponding offering for small investors can be found in today’s markets. We will approach this question from a number of perspectives in subsequent posts, including investor concerns (see Survey findings, part2) as well as regulatory and non-regulatory aspects of the market. (See blog the paradigm, part 3: Legitimate concerns or inefficient markets?). Should a corresponding offering emerge, it will be even more interesting to see how many of the 34.9% already considering SME or startup investments today, will take a more active interest.

At this point however, we simply note that the percentage of investors who are likely to invest in private equity is significantly higher than the percentage invested today. It will be an interesting discussion to lead, how and to what extent this additional source of private funds can contribute to funding a larger portion of startups and SMEs in need for financing - today, more needed than ever. Governments are currently evaluating a myriad of options to support this. However, it will be challenging for them to strike the right balance between their mandates to protect small investors and letting small investors take an active and responsible role.

Along those lines: the financial crisis has taught us that too much trust of investors in the “system” or external advice is not only dangerous for the individual investor, but also eliminating some of the checks and balances for the entire economy - controls that, amongst others, regulations were meant to provide. Maybe some of these checks and balances can be put back in place by letting society vote – by means of investing – not only on large corporates but on smaller and/or upcoming enterprises, as well. This voting mechanism works well if voters are experience and well informed. The study shows that people who are likely to invest bring this to the table.

>> Survey findings, part 2: Investor concerns

Check back soon to read additional findings from the market study such as small investors’ motivations with regard to private equity investments as well as how much they are prepared to invest.

Survey: N=176, including only participants from Germany, Switzerland and Austria in evaluations; in these preliminary findings, no corrective factors have been applied to eliminate potential bias in the sample population

The previous two posts on the investor’s paradigm raise an important question. If we take into consideration our findings (a) that today, only a small fraction of investors in OECD countries engage in the SME segment and (b) that in today’s private equity markets only a few offerings are available for ordinary private investors, we need to ask: why not more?

This question on demand and supply breaks down to the following aspects. Firstly, does the number of current SME investors reflect the number of people with a clear motivation to invest in SMEs? Secondly, if this should not be the case, what are the concerns on part of investors keeping them from doing so? Thirdly, is there a shortage on supply of quality investment opportunities? Lastly, if we allow for the possibility of this being an imperfect or inefficient market, what market distorting factors, regulatory and non-regulatory, can be found?

Let’s start looking at investors’ motivation. We are currently conducting a survey on investment behavior and while it is still ongoing, we already published some interesting preliminary findings. The bottom line is: approximately 40% of survey participants with money to invest would consider investing in ventures and SMEs. And more specifically: in comparison with the few investors already experienced with SME investments (approx. 3% of total investors), more than double (8.4% of investing participants) are clearly motivated to do so. These participants not only indicated an interest in SME investments but also stated that they would accept the associated risks and would be prepared to invest the time it takes to make informed decisions. On top of this, the vast majority of those also has relevant skills and significant experience with investments in other asset classes.

On average, investors participating in our survey indicated a degree of concern over all crucial aspects an SME investment involves - but no concern was seen to be irresolvable. Primary concerns mentioned were: (1.) Comprehensiveness and reliability of information provided on the investment target and (2.) Trust in the capabilities of the management. Fraud risks, concerns related to the liquidation of investments and post-investment monitoring/control were secondary. Surprisingly, the perceived general risk of such investments ranked only second last among all possible concerns. In short: investors’ concerns do play an important role and any approach aimed at promoting SME investments needs to find ways to adequately address them. Survey participants, however, believe all of those could be allayed. Watch out for our detailed survey findings on investor concerns soon to be published.

When it comes to supply, a differentiation of investment opportunities is crucial. While a small percentage of SMEs in need for capital are outnumbered by interested institutional and other accredited investors 10:1, the vast majority of startups and SMEs struggles to find capital. There is general agreement that this “equity gap”, mainly in the space of seed and early stage innovative SMEs (“ISMEs”) which are (in the words of the OECD) “economically significant” and could use this capital “productiv ely”, has largely to do with market inefficiencies in the formal capital markets. The entrepreneur’s perspective thus is important to fully understand the complications of the investor’s paradigm. For that matter, we will focus on the different types of seed, early stage and growth SMEs and discuss related market inefficiencies in part 4 on the investor’s paradigm.

If we wrap up the following interim results: (a) almost double of today’s non-sophisticated investors are qualified and motivated to invest in SMEs, (b) these investors articulate a number of concerns over SME investments, but none of them is seen to be insurmountable, (c) there is no shortage on quality SME investment opportunities, then we are mainly dealing with a problem of market inefficiencies.

Let’s start our analysis on market inefficiencies with a look at potentially distorting regulatory interventions. First and foremost, regulators intend to protect “non-qualified investors” based on the assumption that those are not able to understand and manage risks associated with certain investments. Point taken. A closer look at existing regulations, however, reveals that policy makers settle for damage containment rather than problem-solving. As discussed in the previous post, regulators define a “qualified investor” mainly depending on a person’s salary and wealth. Their logic goes “if rich investors fail, at least they survive”.

The real problem, however, is not one of definition. Instead, the trade-off between investor protection and promotion of SME financing seems out of balance. Many Swiss business angel networks, for instance, grant membership only to “qualified investors” - voluntarily. In other countries, e.g. the UK, business angels are requested by law to sign an official document certifying their capacity as “qualified investors”. For better or worse, our preliminary survey findings underline that many people are qualified and keen to invest long before they make their first million: see our post “A different take on small investor interests”.

Last but not least on non-regulatory market distortions. As mentioned before, the supply side is clearly characterized by market inefficiencies. Formal players (VCs, private equity firms and banks) are not willing to invest in high-cost, high-risk ventures requiring less than €2 million in equity. The OECD therefore acknowledges the need for informal venture capital, especially for innovative companies in their seed and early stages.

In summing up, it’s high noon for governments to not only acknowledge the general importance of informal venture capital, but also the specific importance of private investors not qualifying as business angels, often referred to as friends, family and fools (“FFFs”). Our market study indicates that the last “F” comprises not only fools, but many individuals that are by all means capable to invest. According to our calculations, Swiss business angels made up for only 7-10% of venture capital provided by private individuals in 2008. So with 90-93%, other private individuals (incl. founders) already provided the lions share – despite limited investment possibilities. Let’s make sure they provide even more.

Read part 4 on the investor’s paradigm.