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Summary of "Policy Lessons from Financing Innovative Firms"

Core Content

This OECD policy paper, Policy Lessons from Financing Innovative Firms (No. 24), explores the challenges and policy responses to financing young innovative firms, with a focus on seed and early stage equity investment. It draws on OECD research from 2011 to 2014, including a 2012 questionnaire and a series of policy workshops hosted by several OECD member countries.

The paper outlines the importance of young innovative firms in job creation and economic growth, and highlights the increasing concern among policymakers regarding their access to finance. It identifies the role of various financing instruments, the impact of regulatory environments, and the significance of both supply and demand side policies in supporting these firms.

Main Views

• Financing Challenges for Young Innovative Firms: Young innovative firms face significant difficulties in accessing finance, especially in the seed and early stages. These challenges are exacerbated by the financial crisis, which has led to reduced bank lending, and by the shift of venture capital firms toward later-stage investments.

• Role of Angel Investors: Angel investors are increasingly important in the seed and early stage financing market. They are often experienced entrepreneurs or business professionals and provide not only capital but also valuable "smart money" through their expertise and networks. However, they still face challenges and are often less visible than venture capital firms.

• Policy Rationales for Intervention: There are several policy rationales for supporting seed and early stage finance, including:

  • Capital Market Failures: Information asymmetry between entrepreneurs and investors leads to adverse selection and agency problems.
  • Spill-over Effects and Externalities: The success of innovative firms can generate positive externalities for the broader economy.
  • Policy Mix: A combination of supply and demand side measures is necessary to support the growth of these firms.
  • Public-Private Balance: There is a need to balance public and private sector investments to avoid distorting market incentives.

Key Information

Supply Side Measures

• Grants, Loans and Guarantees: Most OECD countries have implemented these measures, with support increasing significantly after the 2008 financial crisis.
• Tax Incentives: Several countries have introduced tax incentives for young innovative firms (YIC), front-end and back-end tax incentives, and other fiscal measures to encourage investment.
• Equity Instruments: Public equity funds, fund-of-funds, and co-investment funds are being used more frequently. These approaches aim to leverage private capital and reduce the burden on public funds.

Framework Conditions

• Regulatory Barriers: These can significantly affect the availability of seed and early stage financing. Restrictions on institutional investors, securities legislation, and capital requirements can limit the supply of venture capital.
• Exit Markets: The development of exit markets, such as IPOs and mergers and acquisitions, is crucial for the growth of venture capital and angel investment. These markets provide investors with the potential for returns and encourage investment in high-growth firms.

Demand Side Measures

• Entrepreneurial Culture: A supportive entrepreneurial culture is essential for the success of seed and early stage financing. It includes reducing the fear and cost of failure and promoting a mindset of innovation and risk-taking.
• Entrepreneurial Ecosystems: The development of incubators, accelerators, and business angel networks plays a key role in fostering an environment where innovative firms can thrive.
• Human and Social Capital: These are critical components of a successful entrepreneurial ecosystem. Training and development for entrepreneurs and investors help build the necessary skills and networks for innovation and growth.

Data and Evaluation

• Data Challenges: The lack of comprehensive and standardized data on seed and early stage financing hampers the evaluation of policy effectiveness.
• Evaluations of Instruments: There is limited evidence on the impact of public financing instruments and whether they crowd out private investment. However, some studies suggest that a mix of public and private capital can be beneficial.
• Need for Evaluation: The paper emphasizes the importance of evaluating and adjusting policy instruments regularly to ensure they are effective and aligned with market dynamics.

Conclusions

• Complexity of Financing: Innovative start-ups require a variety of financing instruments tailored to their different stages of development.
• Systems Approach: Policy interventions should be viewed as part of a systems approach, considering both supply and demand side measures, as well as the broader regulatory and market framework.
• Long-term Consistency: Consistent and long-term policies are important for creating the right incentives and ensuring sustainable growth of young innovative firms.
• Need for Further Research: The paper calls for continued research and monitoring to better understand the impact of seed and early stage financing policies across OECD countries.

Recommendations

• Streamlining Policies: Countries should consider streamlining their seed and early stage financing policies under one umbrella to improve coordination and effectiveness.
• Investor Training: Investing in the development of both entrepreneurs and investors is crucial for building a robust entrepreneurial ecosystem.
• Data Collection: Improved data collection and standardization are needed to better evaluate the impact of financing instruments and policy mixes.

Key Takeaways

• Seed and early stage financing is essential for the growth of innovative firms.
• A combination of public and private financing instruments is necessary.
• Regulatory and administrative barriers must be addressed to facilitate investment.
• Entrepreneurial culture and ecosystems play a critical role in the success of these firms.
• Evaluation and adjustment of policies are essential for long-term success.