THE INFORMAL VENTURE CAPITAL MARKET IN NORWAY
—INVESTOR CHARACTERISTICS, BEHAVIOR AND PREFERENCESBjörnar
Reitan, Ernst & Young Management Consulting
Roger Sörheim, The Norwegian
University of Science and Technology
ABSTRACT
INTRODUCTION
METHODS
INFORMAL INVESTORS IN NORWAY
IMPLICATIONS
FIGURE 1
TABLE 1
TABLE 2
TABLE 3
TABLE 4
TABLE 5
CONTACTS
REFERENCES
In Norway, there is widespread recognition that the reliance of SMEs on debt financing must be reduced and that sources of equity finance need to be increased. Through a number of recent studies in various countries it has been established that a well developed informal venture capital market plays a major role in meeting the financing needs of smaller companies. There has been little knowledge about the informal venture capital market in Norway until recently. The findings reported in this paper are based on a large survey comprising 6,618 persons. A questionnaire based on those developed by Mason & Harrison (UK) and Landström (Sweden) was used. The response rate was 15.6%. Out of all the respondents, 425 could be classified as business angels and comprise the data material which this paper is based upon. The paper describes the Norwegian business angels according to demographics, investment activity, preferences and behavior. A comparison is given between the results from the Norwegian survey and findings from the UK and Sweden.
Norwegian business angels have a high investment activity. On average, they have invested in 3.7 businesses the last three years. The average investment per investor is almost $300,000, while the average amount per investment is $76,300, 62.8% are serial investors, clearly preferring to invest in new ventures and young businesses in close geographic proximity. Their personal and business networks largely determine the behavior of business angels. Norwegian business angels are relatively passive in their personal involvement with the businesses. Compared to business angels in the UK and Sweden, Norwegian business angels are quite similar in their characteristics, preferences and behavior. However, they have lower average income and net worth and fewer have new venture experience. They are more exposed to investments at the seed and start-up stage as well as investments in technology-based businesses than the business angels in the UK and Sweden. Finally, they are much less involved in the businesses than their foreign counterparts.
During the last 15 to 20 years greater attention has been given to the importance of small and medium-sized enterprises (SMEs) for financial development, and thus there has also been more focus on this type of company. One of the central elements when looking at SMEs will then be whether there is a capital market which functions for SMEs in an expansion phase (which quite frequently would be synonymous with newly established and young companies). One actor about whom we have had very little information until recently was the informal investor, but considerable research efforts have been expended on this in Great Britain, the USA and Sweden.
By informal investors (or business angels) in this context we mean individuals who offer venture capital to unlisted companies where they have no previous formal or family-related connections. A number of studies have concluded that business angels represent the most important source of venture capital for SMEs, and thus may help in covering parts of the “capital gap” which appears to exist. Traditionally new and small companies have turned to the institutional financing market for their loan capital and equity capital, that is banks, venture companies and investment companies, in addition to public financing institutions. Even if some companies are able to access the required capital through these sources, quite a few have encountered problems when trying to attract capital during the earliest stages of their company development, the so-called seed stage (before sales) and the start-up phase. Business angels have proven to invest in the company at an earlier stage than the more traditional financing institutions (see Figure 1). This means that it is easier for companies to attract small investment amounts on the informal venture capital market.
Previous Research
The attention on business angels has been greatest in the USA and Great Britain, but there has also been considerable research in this area in such countries as Sweden and Finland. Later the interest in business angels has spread to other continents, and surveys of informal investors have been carried out in Great Britain, Sweden, Canada, Denmark, Finland, the Netherlands, Belgium and Australia. In Norway a study on the scope of the business angel phenomenon has been carried out at the Master of Business and Economics College in Bodø (Kolvereid and Landström, 1997). Research on business angels may generally be said to be descriptive, as researchers have considered it important to catalogue the existence and extent of this type of investor. This is also the aim of this first major study in Norway, which in turn will prepare the groundwork for in-depth studies of Norwegian business angels.
A number of the empirical studies have worked on the same issues. The following themes have often been dealt with in various international studies: the size of the market, investor characteristics, decision processes, information channels/investor networks, informal investors vs. venture capital funds and private and public initiatives to stimulate the informal venture capital market (cf. for example Freear and Wetzel, 1992 and Freear et al. 1997 for “State-of-the-art” descriptions of the research field). The international studies have shown how business angels are a considerable source of capital. Freear et al. (1997) claimed that business angels contribute up to three to five times as much capital as traditional venture capital companies. Moreover, it is suggested that the size of the informal venture capital market could potentially be ten to twenty times bigger than it is today (Mason, 1994; Freear et al., 1997). Furthermore, many of the studies have concluded that business angels provide capital to newly established and young companies (Mason and Harrison, 1994). This is precisely the type of company that appears to encounter problems obtaining financing through traditional sources (Binks, 1996; Mason and Harrison, 1994). A final point which recurs in many studies is that the business angels involve themselves actively in the companies they buy into, thus contributing more than finance capital to the companies (see also the section on international comparisons). Mason and Harrison (1994) use the term “smart money” to illustrate this.
The Aim of the Study
The present study is the first major attempt to catalogue the informal venture capital market in Norway. The prime aim of the study has been to describe the Norwegian business angels in terms of demographic characteristics, investment activities, investment preferences and involvement in the projects they invest in. Furthermore, in the conclusion we intend to compare the findings of this study with those of studies carried out in Great Britain (Harrison and Mason, 1992) and Sweden (Landström, 1993). The results from the study are documented in two reports (Reitan et al., 1998a, 1998b).
It may be very difficult to identify business angels as they quite often prefer to remain anonymous. This makes it virtually impossible to draw a statistically representative picture of the population of informal investors (Harrison and Mason, 1992). Harrison and Mason (1992) describe three methods of identifying business angels: 1) Sending questionnaires to a large number of persons assumed to have made this type of investment (this is the most common method), 2) Contacting business angels through the companies where they have made investments, 3) Identifying investors by using the “snowball method,” which simply means that when one investor is found, he or she will know of others who may also be contacted. A combination of the different methods has also been used (Harrison and Mason, 1992). Needless to say, different methods of identifying investors may lead to completely different findings, even within the same country. A case in point is the studies of Harrison and Mason (1992) and Stevenson and Coveney (1994) in Great Britain which have in part yielded different views on the British investor market.
In much the same way as Harrison and Mason (1992), in our study we combined a large-scale distribution of questionnaires to persons assumed to be investors, based on mailing lists from three different organizations, with the “snowball” method to identify possible investors for our own database. The questionnaire contained a total of 27 questions, and was based on the questionnaires used by Harrison and Mason (1992) and Landström (1993). We sent our questionnaire to a total of 6,618 individuals, including 5,180 members of Aksjesparerforeningen i Norge (the Norwegian Share Investment Association), 1,000 individuals in the Fortunia AS network (a private consulting firm that specializes in capital acquisition), 47 members of Norsk Investorforum (Norwegian Investors’ Forum) and 391 others from our own databases.
The response rate was 15.6% which must be seen in the light of the relatively invisible nature of this type of investor. When comparing with similar studies from other countries, for example Great Britain (Harrison and Mason, 1992), the response rate is adequate. The reason for basing the study largely on member lists of established organizations is that it is difficult to identify business angels, again because of their apparent preference for anonymity. Of the 1,030 persons who answered the questionnaire, 424 had never invested in an unlisted company. Out of the remaining 606 (58.8%), 181 had considerable investments (more than 1/3) in companies where they had formal or family-related connections. This left us with 425 persons (41.3%) who came within the established international definition of a business angel, and these constitute the basis for this paper. As far as we are aware, this is the second largest study of business angels in an international context (when considering the number of investors studied).
Various studies have undertaken comparisons of business angels in different countries based on average figures from the studies (see for example Harrison and Mason, 1992; Landström, 1993). It is a matter of debate how fertile this type of discussion may actually be. Firstly, the studies have been carried out at different points in time and with different types of samples of investor. Secondly, this type of comparison may give the impression that business angels are a homogenous group, while in actual fact they are very heterogeneous. These are factors to be taken into consideration when comparing different studies of informal investors.
The Norwegian Context
Norwegian business and industry is dominated by small companies (by this we mean companies with less than 100 employees). 96% of all Norwegian companies have less than 20 employees, and 99.5% have less than 100 employees. More than 70% of the labor force is employed in small and medium-sized companies. The portion of total employment in small businesses has also increased from 1970 to 1990.
The Norwegian venture capital market is poorly developed when it to comes to the stock exchange market and particularly the unlisted section of the market where we find the vast majority of companies. Using various methods of calculation, White Paper no. 40–1997/98 shows that listed companies only comprise a very small part of Norwegian business. The value of the Oslo stock exchange thus only amounted to 36% of the GNP in 1996, while the corresponding figure for Sweden was closer to 100%. There are a number of reasons for this: this is in part due to a number of large state-owned ventures and unlisted joint-stock companies (including Statoil, Telenor), moreover, Norway has a large proportion of SMEs. Compared to other countries the state is a large owner and operator in the stock market, indeed the publicly-owned owners’ share totaled one sixth of the total value of the stock exchange in 1996 (White Paper no. 40–1997/98). In spite of some positive changes in the capital market in recent years, including coordination, simplification and user orientation, experts have pointed to the availability of long-term venture capital as a major restriction on the establishment and development of new and young companies (Reve, 1996; Waagø, 1997).
Demographic Characteristics
Norwegian business angels are typically males between 35 and 55 years of age with high education, long work experience and solid finances. The average age of the 425 investors in our study is 47 years, and 97% are men. They are well off with ample gross incomes (on average $76,300) and average worth (not including their homes) of close to $410,000. As to the share of their assets placed in unlisted companies, more than 50% of the investors state that they have invested less than 25% of their assets in this type of company, but we also find that there is a considerable portion (20%) with more than 50% of their assets in this type of company.
Norwegian business angels have extensive job experience and education. Their job experience is significantly in the area of managerial experience and experience with new ventures/company ownership. More than one fourth are self-employed, and almost 46% have management experience. Furthermore, 34.9% have stated that they have management experience from a small unlisted company. As to field of experience, 33% of the investors have acquired experience from industry/technology. Moreover, 26% have their work experience from personal or business services, and approximately 16% have their background in financial operations.
Virtually half (48.7%) of the 425 investors in our study live in the central-eastern part of the country (Oslo, and Akershus, Vestfold and Østfold counties). However, the business angels display good geographical distribution so that there is no basis for claiming that Norwegian business angels are rarely found outside of this central-eastern area.
Investment Activities
The business angels have considerable investment activities (see Table 1). The 425 business angels on which this study is based have invested around $40 million annually during the last three-year period for a total of $119 million. The activity levels are high in our sample, and 62.8% are “serial investors,” that is they have invested in more than three projects. On average the business angels have invested in 6.9 projects, with 3.7 of these having taken place during the last three years. The average invested amount per investor exceeds $292,000 in the last three years. Average investment per project is approximately $76,300 in the last three years.
There was a considerable amount of unreleased potential in the market during the last three years, even if the activity level for the same period was especially high. A high proportion of business angels believe that they would have invested in more projects if more had existed in their areas of preference. Almost 40% of investors would have invested in more unlisted companies in the last three years if more investment opportunities had been available in their preferred areas. Interestingly, around 31% of non-investors say that they would have invested in unlisted companies in the last three years if they had been aware of more projects. Thus a considerably higher number may be stimulated into investing in an unlisted company than what is the case today.
It is also interesting to witness how Norwegian business angels to a great extent choose to invest in new and young companies. More than 50% of investments included in this study were made within two years after the first sale. A rather modest proportion was invested in companies more than ten years old.
The Investment Behavior of Business Angels
Personal networks are decisive for activities in the unlisted market. Business angels generally use external sources of information to identify their projects (see Table 2). The most important sources of information include the personal network, media and banks/brokers/venture companies. Friends/acquaintances and magazines/newspapers/media have been information sources for 40.9% of the investments.
More than half of the business angels have experience with syndication, and a total of two thirds of all projects have been financed by co-investments involving a number of parties. The phenomenon “lead investor” is widespread in the informal venture capital market in Norway, and a “lead investor” has been in the picture in approximately one third of all projects. Furthermore, almost 40% of the investors have invested following initiatives from a “lead” investor in the last three years.
There is a wide degree of variation in the sample as to time horizons for investments and profit expectations. 42.6% expected to hold an investment in an unlisted company for three to five years. 33.9% are relatively impatient and expect to have sold their shares within two years. Expected yield varies a good deal, but most have relatively moderate expectations. 77.6% expect less than 50% annual yield, and 55.1% expect less than 30% annual yield.
Norwegian business angels are relatively passive in relation to the companies they invest in. For a large portion of the projects (65.5%) the business angel partakes in no other activity than receiving periodic financial status reports, and perhaps attending shareholders’ meetings. Such passive involvement represents limited value for the company beyond the capital the investor has provided. Less than one third of business angels are active on the boards, and less than one tenth carry out consultant assignments for the company.
A Comparison Among Business Angels in the UK, Sweden and Norway
The type of comparison made here may present problems as different studies are based on different types of sample at different points in time. In this paper our basis is average figures for all the investors studied, but if we distribute the responses on the different samples we see that there are clear differences, which in turn underscores the point that business angels are in no way a homogenous group. In order to undertake real comparisons, a multinational study based on as similar samples as possible would be required. Moreover, the time factor is of significance. It may be assumed, for example, that the number of investment proposals received will be larger during a period with a high degree of activity in the economy. When we choose to compare with the studies made in other countries, the natural choice is to compare with studies made in Great Britain (Harrison and Mason, 1992) and Sweden (Landström, 1993). The questionnaires in these studies were the basis of our study.
As to investor characteristics, Norwegian investors generally exhibit somewhat smaller net worth and income than investors in other countries (see Table 3). However, it may be more interesting that Norwegian investors have less experience as founders and are to a lesser degree owners of their own companies.
Table 4 shows that the different studies have quite different findings as to investment activity. Regarding the number of received investment proposals in the last three years (average: 20), the figure for Norway is twice that of Sweden, while the figure for Great Britain is approximately midway between these two. As to the average invested amount, the study by Harrison and Mason (1992) stands out with its very low amount, while the findings in Norway are in line with the Swedish findings. In Norway, very many investors want to invest more.
Table 5 shows that Norwegian business angels invest more in industry/technology than the business angels in other countries. What also appears clear is that Norwegian investors invest in established companies to a lesser degree than what is indicated by other studies. However, the most interesting factor is how Norwegian business angels appear to involve themselves less actively in the various projects compared to findings in the other countries (see Table 5). In studies from Great Britain, the USA, Canada and Sweden, the proportion of those actively involved varies from slightly under 70% to slightly over 90%. In Norway this figure is only 32% when considering the total number of investors. As to the form of involvement, Norwegian investors only modestly provide consultant services to the company, while when it comes to participation on the board, it is clear that Norwegian business angels generally display less involvement than what is the case in the other countries.
Hence we see that Norwegian business angels are generally similar to foreign informal investors. However, the Norwegian business angels appear to differ from their counterparts abroad in some key areas:
Norwegian business angels have a considerable investment activity. The 425 informal investors that constitute the basis of this study have on average made 3.7 investments in the last three years, and the investors surveyed in this study have invested a total of NOK 930 million during the last three years. The average amount per project was NOK 595 000 the last three years.
A very high rate of the investments are placed in young and newly established companies, and only modestly in companies ten years old or more. This is rather interesting, as studies in other countries indicate that new ventures and young companies are precisely the enterprises which appear to experience a “financing gap” (Cressy and Olofsson, 1996; Binks, 1996). These findings suggest that Norwegian business angels are willing to assume somewhat larger risks than investors in Sweden and Great Britain.
The phenomenon “lead investor” appears to be comparatively widely found in the informal venture capital market in Norway, and such investors have been in the picture in more than 30% of the projects. Furthermore almost 40% of investors during the last three years have invested following the initiative of a “lead investor.” Needless to say, this must be seen in relation to the fact that a large proportion of the investors responded that personal and business networks are important information sources when it comes to investment projects.
In comparison to business angels in Great Britain and Sweden, Norwegian business angels are relatively similar to the investors in the other studies. Some interesting differences may nevertheless be pointed out. Norwegian investors are much less personally involved in terms of serving as members of the board/consultants than is the case in Sweden and Great Britain. Moreover, Norwegian business angels have slightly lower incomes and less assets, they have less venture experience, they invest more in technology-based projects and Norwegian investors make more investments during the seed and start-up stages.
Even if the study shows that Norwegian investors have displayed considerable investment activity in the last three years, there appears to be a significant unreleased potential in the Norwegian informal venture capital market. Almost 40% of investors would have made more investments if more interesting investment projects had been available. Moreover, more than 30% of non-investors stated that they would have invested in unlisted companies if they had been aware of interesting projects. The study thus suggests that it is the availability of good business ideas, not capital, which drives the market. When there is a lack of ideas, all the available venture capital will not be released. The considerable unreleased potential in the market for unlisted shares may indicate that there is a great degree of inefficiency in the market. This may in part be due to an actual shortage of good business ideas, but it may also be that founders and others who need venture capital do not want to have business angels as the owners of their company. However, it may be just as probable that good projects are unable to identify interesting business angels, and vice-versa. There appears to be a general lack of overview of the actors in the market both on the demand and the supply side, which leads to a less efficient market than what is potentially feasible.
Our research has proven that the informal venture capital market in Norway is an important source of equity finance for new ventures and growing small businesses. However, it is evident that the market is largely ineffective, and that the potential for investments in unlisted companies is several times greater than the actual investment activity. Although the government has focused attention on the market the last two years, for example by building up five regional seed funds, there is still a need to consider various mechanisms to make the market more effective. According to the business angels themselves, 65.5% would increase their activity level if good meeting places between SMEs/entrepreneurs and investors existed. Moreover, 63.1% would increase their activity level if the exit channels had been better, and 45.3% would increase their activity level if tax incentives were better.
This should suggest that Norway should establish various forms of “match-making” organizations to match interesting projects with investors. However, the study also confirms that the business angels are heterogeneous. Thus further research would appear to be called for before this type of “meeting-place” could be established on a larger scale. Further research will indicate more about the groups of investors who are interested in this type of organization. Furthermore, we need an overview of the type of company that should be the target group for this type of “match-making” organization. Interestingly, we see how Norwegian business angels to a large extent invest in geographical proximity to their place of work/home. This would tend to suggest that any “meeting-places” for investors and capital-seeking projects should have some form of regional anchoring. However, considerable research would be needed on this as well to ascertain more precisely why such a large proportion of investments are made locally.
CONTACTS: Björnar Reitan, Ernst & Young Management Consulting, Leiv Eiriksson Senter, N-7005 Trondheim; (T) +47 73546800; (F) +47 73546801; bjornar.reitan@ey.no
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