1. Strategic Innovation Management Prof. Marc Gruber January 27 th, 2011

2. Financing & Controlling of Innovation- What can we learn from Venture Capital?

3. Financing/Controlling of innovative opportunities: Lessons from VCs What can we learn from Venture Capital ? Characteristics of Venture Capital: Equity (not debt); hence, shares risk of the entrepreneur Duration until exit: about 5-10 years (longer these days) Typically no (bank-type) securities No periodic payments of dividends/interest; instead, VC shares in the firm’s value increase Comes typically with (some) management support (“smart capital”)  Investment into innovative new firms („innovation projects“)  VCs assemble a portfolio of new firms  Management / Performance of Portfolios VC

4. Background: Why Venture Capital? “Venture capital’s niche exists because of the structure and the rules of the capital markets. Someone with an idea or a new technology often has no other institution to turn to.” (p. 132) Due to usury laws, banks can not charge interest rates high enough to make up for the high level of risk. Public capital markets are severely restricted: sales must be above some threshold, and there must be a track record. Neither banks nor public capital markets can assess the prospects of a new venture, particularly in a new industry. “Venture capital fills the void between sources of funds for innovation [...] and traditional, lower-cost sources of capital available to ongoing concerns.” (p. 132) Source: Zider, HBR 1998

5. Seed financing develop- ment, product concept market analysis Start-up financing foundation, ramp-up of production marketing concept First stage financing start of production market launch own funds business angel bank loans Stage Cash Flow Source t Depending on the stage of firm development, different financing sources dominate. Case of a high-growth venture Source: B. Rudolph, 2001, p. 507 +–+– building / expanding distribution channels Second stage financing Third stage financing Fourth stage financing public support, venture capital private equity bank loans, IPO expanding production and distribution / sales re-definition of corporate governance Early stage financing Expansion stage financing

6. Investors (pension funds, banks, insurance companies, university endowments, individuals,...) VC firms as mediators: Raise funds from investors willing to take calculated risks Find and select investment opportunities (right industry, team, idea) Build a portfolio (trade-offs: diversification, industry competence) Finance growth of the start-ups Provide advice, network, and management support Goal: Exit (trade sale, IPO) with high returns Start-ups VC firms act as mediators between investors and start-ups, collecting and investing funds into risky but promising new ventures.

7. Venture capital firms, example: Wellington’s portfolio Source: www.wellington-partners.com

8. Steps in the VC Evaluation Process Eingehende Businesspläne InitialScreening SecondScreening Due Diligence Verhandlungen Abschluß Beteiligung Persönlicher Kontakt Incoming business plans InitialScreening SecondScreening Due Diligence Verhandlungen Abschluß Beteiligung Persönlicher Kontakt Screening* Due Diligence Negotiations Deal Personal contact 100% 80%60% 40%20%0% 100 80 20 10 5-7 1-4 “Survival rate” 100% 80%60% 40%20%0% 100 80 20 10 5-7 1-4 Read (e.g.): “80 percent of submitted b. pl. enter the screening phase” Sources: Schröder (1992), Wupperfeld (1996), Geigenberger (1999), Roberts (1991). * 20% do not even enter the screening phase due to poor formal quality of the business plan.

9. Performance of a VC portfolio

10. Example: „10 in 5“ Example: Financing in 2005 Valuation 2009100 Mio. Discount rate60 % Financing5 Mio. Valuation 2005 100 Mio. = 15,3 Mio. 1,6 4 Equity Share of VC 5,0 = 32,7 % 15,3 Source: Extorel, Falk Strascheg

11. 1st round of financing11/96 2 Mio. DM 1 Mio. DM Technologieholding 1 Mio. DM BTU Programme (via tbg) 2nd round of financing09/97 20 Mio. DM 1 Mio. DM Technologieholding 6 Mio. DM Vertex/TDF Singapur 13 Mio. DM Public Funds (BTU and Pre-IPO Programme via tbg) Valuation 9,3 Mio. DM Valuation 144 Mio. DM 3rd round of financing09/98 80 Mio. DM 80 Mio. DM New Market Valuation514 Mio. DM Example: BROKAT Infosystems AG Source: Extorel, Falk Strascheg

12. So: Which Lessons can be drawn from the VC industry about the strategic innovation management ? Conclusions: VC and strategic innovation mgmt. Innovation is risky and differs from other functions of the firm Required competencies of firms differ by phase of the innovation process „Let a thousand flowers bloom“ Ex ante vs. ex post Innovation manager – performance evaluation? Strategic Approach to Innovation Management: Portfolios of Real Options

13. Thank you!