A study of the different views on the financial gap issues for university spin-offs A tri perspective study on the views of the investor, founder and technology transfer office on spin-offs at Lund University and Chalmers University of Technology Master of Science Thesis in the Master Degree Programme Management and Economics of Innovation NILS ÅSHEIM CARL-FREDRIK HÅRSMAR Department of Technology, Management and Economics Division of Management of Organizational Renewal and Entrepreneurship CHALMERS UNIVERSITY OF TECHNOLOGY Gothenburg, Sweden, 2014 Report No. E2014:057 MASTER’S THESIS E2014:057 A study of the different views on the financial gap issues for university spin-offs A tri perspective study from the views of the investor, founder and technology transfer office on university spin-offs at Lund University and Chalmers University of Technology NILS ÅSHEIM CARL-FREDRIK HÅRSMAR Tutor, Chalmers University of Technology: Tomas Karlsson Tutor, Lund University: Jonas Gabrielsson Department of Technology Management and Economics Division of Management of Organizational Renewal and Entrepreneurship CHALMERS UNIVERSITY OF TECHNOLOGY Göteborg, Sweden 2014 A study of the different views on the financial gap issues for university spin-offs Nils Åsheim and Carl-Fredrik Hårsmar © Nils Åsheim and Car-Fredrik Hårsmar, 2014 Master’s thesis E2014:057 Department of Technology Management and Economics Division of Management of Organizational Renewal and Entrepreneurship Chalmers University of Technology
 SE-412 96 Göteborg, Sweden
 Telephone: + 46 (0)31-772 1000 Chalmers Reproservice Göteborg, Sweden 2014   i       Preface   Our  study  was  conducted  during  the  summer  of  2013  with  early  preparations  in  the  spring  and   touch-­‐ups  in  the  fall.  It  has  been  our  master  dissertation  at  Lund  University  respectively  Chalmers   University.  Working  together  from  two  different  universities  is  not  very  common  but  it  has  certainly   been  very  resourceful.   First  of  all,  we  would  like  to  thank,  Jonas  Gabrielsson  and  Tomas  Karlsson,  for  supervising  and  guiding   us  through  the  process.  Your  knowledge  and  feedback  certainly  contributed  to  the  quality  of  the   study.  We  would  also  like  to  thank  all  our  interviewees,  who  gave  us  their  time  and  participated  in   the  study  and  we  hope  this  study  will  come  to  your  use.   Our  interests  in  entrepreneurship  and  venture  capital  brought  us  together  to  write  this  thesis  and  the   work  has  given  us  a  lot  of  new  knowledge  about  the  industry.  This  is  certainly  a  field  that  we  will   work  with  and  be  part  of  in  our  future  professional  careers  and  we  very  much  enjoyed  doing  this   study.  We  hope  that  some  new  insights  from  the  study  could  be  useful  to  policymakers  and  others   involved  in  making  the  entrepreneurial  climate  better  and  that  the  study  could  spur  future   interesting  research  in  the  field.   Lund  and  Gothenburg,  April  2014                                          Carl-­‐Fredrik  Hårsmar       Nils  Åsheim         ii     Abstract   Stimulation  of  innovation  is  a  hot  topic  around  the  world.  The  developed  economies  are  nowadays   significantly  dependent  on  innovation  for  further  growth.  One  central  source  of  innovation  is   universities  and  their  ability  to  turn  new  knowledge  into  value-­‐adding  innovations.  One  of  these   technology  transfer  measures  is  through  the  creation  of  university  spinoffs  (USOs).  High-­‐tech   startups,  however,  often  require  a  significant  amount  of  capital  invested  during  the  formative  stages,   which  can  be  hard  to  acquire.  The  purpose  of  this  study  is  to  contribute  with  knowledge  that  could   help  understand  how  to  narrow  the  financial  gap  between  USOs  and  the  venture  capital  market.  The   study  will  approach  this  financial  gap  from  the  three  involved  actors  in  USOs:  the  founders,  the   investors  and  the  technology  transfer  office  (TTO).  The  scope  of  this  study  is  Chalmers  University  of   Technology  and  Lund  University.   The  methodology  used  to  explore  this  area  and  get  an  overview  of  the  actors’  different  views  were   in-­‐depth  interviews  with  people  from  the  different  actor  groups  according  to  an  interpretivist   approach,  also  known  as  the  actor’s  view.  This  approach  supports  the  pragmatic  objective  of  the   study  to  first  gain  a  deep  understanding  of  the  different  actors’  views  on  the  financial  gap  to  later   draw  conclusions  and  induce  theories.  A  total  of  14  interviews  were  conducted,  with  investors,   academic  founders,  and  technology  transfer  offices.   In  order  to  build  a  theoretical  framework  for  the  subsequent  analysis,  an  extensive  exploratory   literature  search  yielded  four  areas  that  all  relates  to  the  financial  gap  issue.  The  theories  chosen   were  financial  gap  theory,  choice  of  financing  in  small  business  theory,  negotiation  theory  and   governmental  intervention  theory.     The  results  show  that  most  of  the  financial  gap  theory  can  be  confirmed.  It  is  the  risk  connected  to   the  information  asymmetry  and  the  uncertainties  that  are  the  most  important  reasons  and  much  of   that  have  to  do  with  time  and  competence.  The  small  size  and  thereby  the  lack  of  competition  in  the   venture  capital  industry  is  another  reason  why  institutional  investors  move  forward  in  the  venture   life  cycle,  which  increases  the  financial  gap.  This  leaves  more  space  to  be  filled  by  private  investors   such  as  business  angels,  and  public  money.  Unfortunately,  they  are  too  few.  The  founders  have  to   spend  a  significant  amount  of  time  to  find  and  attract  venture  capital,  resulting  in  less  time  spend  on   developing  the  core  business.   The  conclusion  of  the  study  is  that  academic  founders  should  try  to  fund  their  projects  as  a  research   project  as  long  as  they  can.  Once  incorporated,  the  company  should  have  a  clear  business  model  with   a  customer  and  potential  market  in  mind,  minimizing  technical  risk  and  maximizing  the  chances  of   attracting  venture  capital.  The  government  needs  to  revise  the  employee  stock  option  regulation  to   make  it  more  transparent  and  easier  to  use.  It  should  also  accept  the  proposed  investment  credit  to   stimulate  seed  investments.  Most  importantly,  the  government  should  make  more  public  capital   available  in  the  seed  phase  together  with  the  private  investors,  i.e.  hybrid  investment.       iii     Table  of  Contents   Preface  .....................................................................................................................................................  i   Abstract  ...................................................................................................................................................  ii   List  of  Figures  .........................................................................................................................................  vi   List  of  Tables  ...........................................................................................................................................  vi   1  Introduction  .........................................................................................................................................  7   1.1  Background  ...................................................................................................................................  7   1.2  Problem  discussion  ......................................................................................................................  10   1.3  Purpose  .......................................................................................................................................  10   1.4  Delimitations  and  focus  areas  .....................................................................................................  11   1.5  Relevance  and  target  group  ........................................................................................................  11   1.6  Disposition  ...................................................................................................................................  11   2.  Methodology  .....................................................................................................................................  12   2.1  Research  approach  ......................................................................................................................  12   2.2  Research  process  .........................................................................................................................  12   2.2.1  Exploratory  interviews  .........................................................................................................  12   2.3  Research  design  ...........................................................................................................................  12   2.3.1  Research  method  .................................................................................................................  12   2.3.2  Choice  of  research  objects  ...................................................................................................  13   2.3  Reliability  and  validity  of  the  study  .............................................................................................  14   3  Theoretical  framework  .......................................................................................................................  16   3.1  Financial  gap  ................................................................................................................................  16   3.1.1  The  meaning  of  the  financial  gap  .........................................................................................  16   3.1.2  Agency  theory  ......................................................................................................................  17   3.1.3  Uncertainty  ...........................................................................................................................  18   3.1.4  Financial  gap,  agency  theory  and  uncertainty  ......................................................................  19   3.1.5  Financial  gap  summary  .........................................................................................................  20   3.2  Financial  choice  in  small  businesses  ............................................................................................  20   3.2.1  View  on  venture  capital  ........................................................................................................  20   3.2.2  Access  to  finance  ..................................................................................................................  21   3.2.3  Pecking  order  theory  ............................................................................................................  21   3.2.4  Reverse  pecking  order  theory  ..............................................................................................  21   3.2.5  Financial  bootstrapping  ........................................................................................................  21   3.2.6  Financial  choice  in  small  businesses  summary  .....................................................................  22     iv     3.3  Negotiation  theory  ......................................................................................................................  22   3.3.1  Basic  concepts  of  negotiation  theory  ...................................................................................  22   3.3.2  Structural  approach  ..............................................................................................................  23   3.3.3  Integrative  approach  ............................................................................................................  23   3.3.4  Negotiation  theory  summary  ...............................................................................................  23   3.4  Governmental  Intervention  Theory  ............................................................................................  24   3.4.1  Why  governments  should  intervene  ....................................................................................  24   3.4.2  How  governments  should  intervene  ....................................................................................  25   3.4.3  How  governments  should  not  intervene  ..............................................................................  26   3.4.4  Summary  of  governmental  intervention  theory  ..................................................................  27   3.5  Theoretical  framework  summary  ................................................................................................  27   4.  Results  ...............................................................................................................................................  30   4.1  Investors’  view  ............................................................................................................................  30   4.1.1  Perceptions  of  the  financial  gap  ...........................................................................................  30   4.1.2  Society’s  support  systems  ....................................................................................................  31   4.1.3  The  universities’  support  systems  ........................................................................................  31   4.1.4  Other  key  insights  .................................................................................................................  32   4.1.5  Summary  investors’  view  .....................................................................................................  32   4.2  TTO’s  view  ...................................................................................................................................  33   4.2.1  Perceptions  of  the  financial  gap  ...........................................................................................  33   4.2.2  Society’s  support  systems  ....................................................................................................  33   4.2.3  Universities’  support  systems  ..............................................................................................  34   4.2.4  Other  key  insights  .................................................................................................................  35   4.2.5  Summary  TTO’s  view  ............................................................................................................  35   4.3  Founders’  view  ............................................................................................................................  35   4.3.1  Perceptions  of  the  financial  gap  ...........................................................................................  35   4.3.2  Society’s  support  systems  ....................................................................................................  36   4.3.3  The  universities’  support  systems  ........................................................................................  37   4.3.4  Summary  founders’  view  ......................................................................................................  37   5.  Analysis  ..............................................................................................................................................  38   5.1  Views  on  the  financial  gap  and  agency  issues  .............................................................................  38   5.2  Views  on  financial  choice  in  USOs  ...............................................................................................  39   5.3  Views  on  negotiation  theory  .......................................................................................................  39   5.4  Views  on  governmental  intervention  ..........................................................................................  40     v       5.4.1  Views  on  TTO’s  role  ..............................................................................................................  40   5.5  Summary  of  analysis  ....................................................................................................................  41   6.  Conclusions  .......................................................................................................................................  42   6.1  Financial  gap  ................................................................................................................................  42   6.2  Financial  choice  in  USOs  ..............................................................................................................  42   6.3  Negotiation  theory  ......................................................................................................................  42   6.4  Governmental  intervention  .........................................................................................................  43   7.  Recommendations  ............................................................................................................................  44   8.  Comments  .........................................................................................................................................  45   8.1  Comments  on  methodology  ........................................................................................................  45   8.2  Comments  on  credibility  .............................................................................................................  45   8.3  Future  research  recommendations  .............................................................................................  45   Bibliography  ..........................................................................................................................................  46   Appendices  ............................................................................................................................................  51   Appendix  A  –  Interview  guides  ..........................................................................................................  51           vi     List  of  Figures   Figure  1:  Start-­‐up  funding  and  life-­‐cycle  phases  .....................................................................................  8   Figure  2:  The  research  process  ..............................................................................................................  12   Figure  3:  Overview  of  the  theoretical  framework  .................................................................................  16   Figure  4:  Illustration  of  the  agency  theory  ............................................................................................  17   Figure  5:  Fixed  pie  .................................................................................................................................  23   Figure  6:  Expanding  pie  .........................................................................................................................  23   Figure  7:  The  analytical  model  ..............................................................................................................  29     List  of  Tables   Table  1:  Venture  capital  investment  as  percentage  of  GDP  per  country  in  2009  (OECD,  2011)  .............  9   Table  2:  Venture  capital  invested  in  the  early  phases  in  Sweden  from  2005  to  2011  (Svenska   Riskkapitalföreningen,  2011;  Tillväxtanalys,  2013)  .................................................................................  9   Table  3:  Investor  interviews  ..................................................................................................................  13   Table  4:  Technology  transfer  offices  interviews  ....................................................................................  13   Table  5:  Academic  founders  interviews  ................................................................................................  14       7     1  Introduction   1.1 Background   The  objective  of  this  study  is  to  contribute  with  knowledge  that  could  help  understand  how  to   narrow  the  financial  gap  between  university  spin-­‐offs  and  the  venture  capital  market.  This  study  will   approach  the  financial  gap  from  the  three  involved  actors  in  university  spin-­‐offs:  the  entrepreneur,   the  investor,  and  the  technology  transfer  office.  By  taking  a  tri-­‐perspective  approach  towards  the   financial  gap,  new  insights  can  be  found  that  could  help  narrow  the  gap.  Furthermore,  the   conclusions  drawn  here  could  hopefully  be  applied  to  enhance  the  general  entrepreneur-­‐investor-­‐ incubator  relationship  and  also  provide  a  basis  for  better  policymaking.   Stimulation  of  innovation  has  become  a  hot  political  topic  around  the  world  (OECD,  2007;  Atkinson  &   Ezell,  2012;  The  Economist,  2013;  Nesta,  2012).  The  developed  economies  have  become  considerably   more  dependent  on  innovation  as  a  source  of  economic  growth.  This  has  led  to  a  stronger  focus  on   innovation  as  a  competitive  instrument  of  growth.  Innovative  companies  tend  to  grow  faster  (35%   yearly  sales  growth  compared  to  14%)  and  create  more  jobs  (30.5%  annual  employment  growth   compared  to  3.8%)  than  the  average  company  (EVCA,  2002;  Achleitner  &  Klockner,  2005).  They  also   pay  higher  gross-­‐wages  and  offer  more  training  opportunities  than  other  firms  do  (Achleitner  &   Klockner,  2005).     One  central  source  of  innovation  is  universities  and  their  ability  to  turn  new  scientific  knowledge  and   technological  inventions  into  value  adding  innovations  (Audretsch,  2005).  The  past  two  decades  have   seen  a  considerable  rise  in  the  number  of  high  tech  start-­‐ups  aimed  at  commercializing  university   invented  technologies.  High  tech  start-­‐ups,  however,  require  a  significant  amount  of  capital  invested   during  the  formative  stages.  In  many  cases  it  will  take  several  years  before  a  potential  investor  can   make  an  exit  and  get  a  return  on  the  investment  (Dimov  &  Murray,  2006).  As  a  result,  most  private   investors  are  reluctant  to  take  on  the  uncertainties  involved  in  this  type  of  projects  (Dimov  &  Murray,   2006).   Many  universities  have  set  up  a  technology  transfer  office  to  support  the  commercialization  of   academic  research.  The  academic  entrepreneurs  usually  have  more  formal  education  in  their  field  of   expertise  (Siegel,  Waldman,  &  Link,  2003;  Ndonzuau,  Pirnay,  &  Surlemont,  2002)  but  less  managerial   skills  (Shane  &  Khurana,  2003;  Shane,  2004;  Vohora,  Wright,  &  Lockett,  2004)  than  other  start-­‐ups   outside  universities.  Also,  both  prior  entrepreneurial  experience  and  private  sector  work  experience   significantly  influence  university  professors’  ability  to  identify  and  develop  business  ideas  based  on   their  research  (Gabrielsson,  Politis,  &  Tell,  2012;  Karlsson  &  Wigren,  2012).  The  technology  transfer   office  provides  services  and  skills  to  the  academic  entrepreneurs  needed  to  increase  the   commercialization  rate  of  the  start-­‐up  (Golub,  2003).   One  major  obstacle  for  high  tech  start-­‐up  is  to  find  and  attract  capital  to  develop  and  grow  the   business.  Debt  finance  is  almost  impossible  to  get  for  high  tech  start-­‐ups  because  banks  perceive   them  as  very  risky  and  they  often  lack  collateral  (Murray,  1999;  Gompers,  1994).  Another  source  of   finance  is  equity  finance,  where  the  investor  provides  capital  for  a  share  of  the  company  in  return,   thus  sharing  both  risks  and  rewards  of  the  venture.  Seed  financing  –  investment  in  the  early  stage   (see  figure  1)  –  is  a  complex  process,  especially  when  it  comes  to  high  tech  companies.  Investors  face     8     many  issues  when  evaluating  a  prospect,  e.g.  due  diligence  is  problematic  for  cutting  edge   technologies,  market  assessment  is  difficult  since  the  market  might  not  exist  or  change  very  fast,  and   future  financing  might  be  tough  to  obtain  (Storey  &  Tether,  1998).  Information  asymmetry  between   the  entrepreneur  and  investor  makes  it  hard  for  investors  to  invest  because  the  entrepreneur,  who   sits  on  more  information  about  the  business  than  the  investor,  could  use  this  information  to  achieve   its  own  goals  instead  of  the  investor’s.  It  could  also  be  the  other  way  around,  that  the  investor  knows   more  of  the  aggregated  market  opportunities,  which  can  be  advantageous  on  his  behalf  (Winborg,   2000).       Figure  1:  Start-­‐up  funding  and  life-­‐cycle  phases   Previous  research  suggests  that  early  venture  capital  involvement  is  crucial  for  the  success  and   growth  of  high  tech  start-­‐ups  (Bygrave  &  Timmons,  1986;  EVCA,  2002).  The  venture  capital  market   can  not  only  contribute  with  finance  but  also  knowledge  about  the  market,  access  to  networks,  and   management  capabilities.  This  creates  a  paradox.  The  venture  capitalists  are  reluctant  to  invest  early   in  high  tech  start-­‐ups  because  of  the  uncertainties  and  at  the  same  time  venture  capitalists  are   viewed  as  the  most  important  success  factor  for  these  very  same  start-­‐ups.  The  term  venture  capital   can  have  several  meanings  but  in  this  study  it  is  defined  as  what  is  generally  called  formal  venture   capital  or  professionals  who  raise  funds  to  invest  and  produce  a  return  on  investments  in  start-­‐ups   (Landström,  2007).   The  existence  of  a  financial  gap  between  start-­‐ups  and  investors  has  been  discussed  for  a  long  time   and  there  are  many  different  definitions  of  the  financial  gap.  In  this  study  we  use  the  definition  used   by  the  OECD:  “…the  term  is  basically  used  to  mean  that  a  sizeable  share  of  economically  significant   SMEs  cannot  obtain  financing  from  banks,  capital  markets  or  other  suppliers  of  finance.  Furthermore,   it  is  often  alleged  that  i)  many  entrepreneurs  or  SMEs  that  do  not  currently  have  access  to  funds   would  have  the  capability  to  use  those  funds  productively  if  they  were  available;  ii)  but  due  to   structural  characteristics,  the  formal  financial  system  does  not  provide  finance  to  such  entities”   (OECD,  2006).     Sweden’s  venture  capital  industry  has  developed  significantly  in  the  last  decade.  Today  Sweden  has  a   high  share  of  venture  capital  in  relation  to  GDP  compared  to  other  countries  (see  Table  1).       9       Table  1:  Venture  capital  investment  as  percentage  of  GDP  per  country  in  2009  (OECD,  2011)   However,  the  amount  of  early  venture  capital  invested  has  decreased  in  recent  years,  especially  in   the  seed  and  start-­‐up  phases  (see  Table  2).  The  decrease  in  early  stage  venture  capital  in  Sweden   comes  mainly  from  a  decrease  in  private  investments  (Svenska  Riskkapitalföreningen,  2011).  One   public  measure  to  counter  this  trend  and  encourage  higher  private  venture  capital  investment  is  the   proposed  investment  tax  credit  (The  Swedish  government,  2012)  for  individuals  investing  in  small   businesses.     Table  2:  Venture  capital  invested  in  the  early  phases  in  Sweden  from  2005  to  2011  (Svenska  Riskkapitalföreningen,  2011;   Tillväxtanalys,  2013)   The  lack  of  research  on  the  contributions  from  the  technology  transfer  office  to  narrow  the  financial   gap  in  Sweden  led  up  to  this  thesis.  Most  previous  research  approaches  the  financial  gap  phenomena   from  either  the  entrepreneur  or  the  investor  perspective.  Earlier  research  somewhat  lacks  the  multi-­‐ perspective  this  study  includes  to  fully  understand  the  social  construction  that  results  in  a  financial   0,00 0,02 0,04 0,06 0,08 0,10 0,12 0,14 0,16 0,18 Is ra el U S A S w ed en S w itz er la nd Ire la nd B el gi um Fi nl an d N or w ay A us tra lia D en m ar k Fr an ce U K N et he rla nd s A us tri a C an ad a G er m an y K or ea P or tu ga l S pa in C ze ch R ep . E st on ia G re ec e Ita ly S lo ve ni a Lu xe m bo ur g H un ga ry P ol an d % Seed / Start-up / Other early stage Other venture capital 1 269 2 773 2 522 3 471 1 455 1 291 1 109 810 1 241 1 266 2 086 1 462 1 319 858 83 75 188 246 70 53 22 43 932 73 709 0 30 000 60 000 90 000 0 2 000 4 000 6 000 2005 2006 2007 2008 2009 2010 2011 Mkr Expansion capital Start-up capital Seed capital Number of new businesses (rhs)   10     gap.  There  is  little  previous  research  on  the  technology  transfer  office  role  in  bridging  the  financial   gap  between  university  spin-­‐offs  and  venture  capital  in  Sweden.   1.2  Problem  discussion   In  recent  years  the  venture  capital  invested  in  the  early  stages  has  declined  year  over  year  in  Sweden   (see  Table  2).  During  the  same  period  the  number  of  new  businesses  in  Sweden  has  increased   steadily.  This  suggests  that  the  financial  gap  has  widened  as  more  entrepreneurs  compete  for  less   equity  venture  capital.  This  creates  a  significant  hurdle  for  high  tech  start-­‐ups  who,  on  average,  rely   heavier  on  external  funding  and  venture  capital  to  increase  its  survival  rate  and  boost  growth  (Politis,   Gabrielsson,  &  Shveykina,  2012).     University  spin-­‐offs  (USO),  start-­‐ups  based  on  university  research,  are  a  subcategory  of  start-­‐ups  that   generally  is  highly  innovative,  knowledge-­‐based,  with  high  growth  potential.  Since  the  researcher   owns  the  intellectual  property  from  academic  research  in  Sweden,  the  university  does  not  get  any   equity  or  licensing  fees  from  these  companies.  The  technology  transfer  offices  (TTO)  at  Swedish   universities  provide  support  services  to  the  USOs  such  as  business  development,  intellectual  property   and  legal  services,  investor  contacts,  and  funding  that  partially  covers  the  seed  stage.   The  objective  of  this  study  is  to  contribute  with  knowledge  that  could  help  narrow  the  financial  gap   experienced  by  academic  entrepreneurs  trying  to  attract  venture  capital.  Most  previous  discussions   (Winborg,  2000;  Dimov  &  Murray,  2006)  take  a  one-­‐sided  perspective  (Landström,  2007)(e.g.  from   the  entrepreneur  or  the  investor)  on  the  financial  gap  and  assume  it  is  perceived  uniformly  by  all   actors.  This  study  will  approach  the  financial  gap  from  the  three  involved  actors  in  USOs:  the   entrepreneur,  the  investor,  and  the  TTO.  The  main  focus  will  be  on  the  government  and  the  TTO’s   role  and  how  they  can  contribute  to  narrow  the  financial  gap.  The  study  will  contribute  with  a   renewed  view  on  the  financial  gap  experienced  by  the  different  actors  and  how  their  views  might   differ  from  each  other.     The  TTOs  at  Lund  University  and  Chalmers  University  of  Technology  are  selective  in  the  projects  that   they  fund  and  help  develop.  They  also  take  a  level  of  ownership  in  the  projects.  Taking  ownership  in   the  projects  influence  the  control  the  research/idea  provider  can  exert  on  the  project.  In  some  cases   the  entrepreneur/commercializer  and  idea  provider  are  separate  people.  In  relation  to  the  financial   gap,  that  concerns  venture  funding,  this  study  will  not  differentiate  between  the  person  who   commercializes  and  the  idea  providers  and  will  regard  them  as  one  entity  -­‐  a  founding  team,  which   we  will  refer  to  as  the  (academic)  founder.   The  research  question  can  be  summarized  as  followed:   RQ:  How  do  the  views  on  the  financial  gap  differ  from  the  academic  founder,  investor   and  TTO?   1.3  Purpose   The  purpose  of  the  study  is  to  investigate  the  current  views  on  the  financial  gap  for  USOs  at  Lund   University  and  Chalmers  University  of  Technology  from  the  involved  actors.  By  taking  a  multiple   perspectives  approach  on  the  financial  gap  new  insights  can  be  found  that  could  help  narrow  the   gap.  Furthermore,  the  conclusions  drawn  here  could  hopefully  be  applied  to  enhance  the     11     interactions  between  founders,  investors  and  incubators  in  terms  of  financing  and  also  provide  a   basis  for  better  policymaking.   An  objective  is  also  to  determine  the  role  and  importance  of  a  third  party  intermediary,  e.g.  the   government  or  TTO,  in  the  financing-­‐related  interactions  between  the  founders  and  the  investors.   1.4  Delimitations  and  focus  areas     The  term  investor  in  this  study  refers  to  formal  (professional)  venture  capital  firms  and  business   angels  –  wealthy  individuals  whom  invest  their  time  and  money  in  start-­‐ups  –,  thus  excluding   corporate  venture  capital,  since  this  was  never  occurring  in  our  sample  of  USOs.   The  phases  considered  will  be  the  early  stages  in  the  venture  life  cycle:  seed  and  start-­‐up.  The  other   development  phases  are  left  out  of  the  study,  since  investments  in  those  phases  are  more  considered   expansion  capital  than  venture  capital.  The  scope  of  all  three  actors  will  be  delimitated  to  USOs.   1.5  Relevance  and  target  group   Any  conclusions  drawn  that  can  enhance  the  entrepreneurial  environment  will  have  a  large  socio-­‐ economic  impact  due  to  higher  economic  growth  and  more  jobs  created.   This  thesis  is  targeted  to  entrepreneurs,  investors  and  all  forms  of  incubators,  in  academia  as  well  as   in  society  in  general.  It  will  hopefully  also  serve  as  an  input  for  future  policy  making  for  regulators.   1.6  Disposition   • Chapter  1  –  Introduction   • Chapter  2  –  Theoretical  framework   • Chapter  3  –  Methodology   • Chapter  4  –  Empirics   • Chapter  5  –  Analysis   • Chapter  6  –  Conclusions  and  recommendations   • Chapter  7  –  Comments           12     2.  Methodology   2.1  Research  approach   The  interactions  between  individual  founders,  investors,  and  TTOs  are  probably  best  observed  using   an  interpretivist  approach  (Bryman  &  Bell,  2011)  instead  of  a  positivist  approach.  An  empiricist  or   positivist  view  has  been  predominant  in  venture  capital  research.  An  alternative  to  a  positivist  view  is   to  look  at  the  individual  situation  of  the  participant  actors  and  their  social  interactions  with  each   other.  This  view,  called  the  actor’s  view  (Arbnor  &  Bjerke,  1994),  is  characterized  by  being  open-­‐ ended,  innovative,  and  understanding.  This  view  can  contribute  to  improve  the  understanding  of  the   enigmatic  persistency  of  the  funding  gap,  as  no  such  gap  should  actually  exist  under  positivist   (equilibrium  assumptions  in  economics)  assumptions.  However,  even  if  no  gap  should  exist  under  the   positivist  view  the  founders  could  still  perceive  that  there  is  a  lack  of  external  capital.  This  study  takes   an  actor’s  view  to  first  try  to  understand  the  individuals  and  then  to  induce  a  theory.     2.2  Research  process   To  adopt  the  actor’s  view  a  deep  understanding  of  the  individual  actors  is  required.  This  view   supports  the  pragmatic  objective  of  the  thesis  to  first  try  to  gain  an  understanding  of  the  different   views  on  the  financial  gap  and  then  to  suggest  practical  actions  for  the  TTOs  to  close  the  financial   gap.  The  chronological  research  process  of  the  thesis  can  be  illustrated  in  figure  2  below.     Figure  2:  The  research  process   2.2.1  Exploratory  interviews   Two  exploratory  interviews  have  been  held  with  a  business  angel  and  a  representative  of  a  formal   venture  capital  firm.  The  interviewees  were  asked  general  questions  on  the  subject  and  were  asked   to  elaborate  freely  on  the  issues  they  regarded  important  and  that  they  thought  required  attention.   2.3  Research  design   The  empirics  used  consist  of  primary  sources  in  the  form  of  interview  data  of  different  actors   involved  in  the  academic  technology  transfer  process:  founders,  investors,  and  TTOs.   2.3.1  Research  method   Primary  sources  of  data  are  qualitative  interviews  of  the  actors  involved  in  the  investment  process  of   USOs:  founders,  investors,  and  TTOs.  Fourteen  interview  objects  have  been  selected  for  an  in-­‐depth   interview.  This  qualitative  method  allows  the  interviewer  to  ask  open-­‐ended  questions  that  hopefully   lead  to  new  insights  and  does  not  limit  the  answers  to  a  number  of  pre-­‐specified  answer  choices  as  in   quantitative  studies  (Ghauri  &  Gronhaug,  2002).  The  intention  with  this  approach  is  to  enter  the   interview  without  any  biases  and  hypothesis  but  hopefully  draw  hypothesis  subsequently  in  the   analysis  of  the  interviews.   Recommendation  Data   collection   Literature   study   Problem   definition   Analysis  Research   design   Research   problem   Choice  of   research   topic     13     The  interviewer  asks  open-­‐ended  questions  and  let  the  interviewee  choose  the  direction  of  the   interview.  In  case  the  discussion  gets  too  far  off-­‐topic  the  interviewer  steers  it  back  to  the  research   questions  following  an  interview  guide  (see  Appendix  A).  The  semi-­‐structured  interview  allows  the   interviewer  to  dig  deep  enough  and  also  get  reasonable  comparable  data.  This  is  very  suitable  for   exploratory  research  (Ghauri  &  Gronhaug,  2002).     The  results  will  be  very  subjective  and  cannot  be  unconditionally  assumed  to  apply  to  the  whole   population  (Bryman  &  Bell,  2011).  However,  the  research  question  is  complex  and  can  be  better   understood  using  qualitative  research  instead  of  quantitative  statistics.  There  are  two  ways  to   structure  the  interview:  unstructured  interview  or  a  semi-­‐structured  interview.  The  semi-­‐structured   model  fitted  the  purpose  better  and  allowed  the  interviewers  to  ask  follow-­‐up  questions  and  dig   deeper  into  each  questions  during  the  interview.   2.3.2  Choice  of  research  objects   The  investor  research  objects  were  found  through  Svenska  Riskkapitalföreningen’s  (2013)  member   database  and  all  members  matching  the  criteria’s  were  contacted.  The  criteria’s  used  was  investors   investing  in  the  seed  and  start-­‐up  phase  in  Sweden  and  that  have  made  an  investment  in  a  USO.   Three  investors,  also  matching  the  criteria’s,  were  found  using  the  authors’  personal  connections.   Both  formal  venture  capital  firms  and  business  angels  were  contacted.  Each  interviewee  either   invests  his  own  money  or  is  a  senior  investment  manager.   Representatives  from  Lund  University’s  and  Chalmers  University  of  Technology’s  transfer  offices  to   be  interviewed  were  chosen  by  recommendations  from  the  supervisors.  The  representatives  were   well  experienced  and  well  informed  of  its  respective  office  operations.   Investors   Name   Type  of  investor   Interview   type   Interview     length   Date   Anonymous   Business  Angel   Face-­‐to-­‐face   75  min   11.07.2013   Nordic  Investment   Solutions   Venture  Capital  Advisory  Firm   Telephone   60  min   05.08.2013   Scope   Venture  Capital  Firm   Telephone   20  min   05.08.2013   P.U.L.S.  Invest   Venture  Capital  Firm   Face-­‐to-­‐face   60  min   08.08.2013   Creandum   Venture  Capital  Firm   Telephone   25  min   15.08.2013   Almi  Invest   Public  Venture  Capital  Firm   Telephone   30  min   15.08.2013   Table  3:  Investor  interviews   Technology  transfer  offices   University   Organization   Interview  type   Interview  length   Date   Lund  University   LU  Innovation  System   Face-­‐to-­‐face   60  min   13.08.2013   Chalmers  University   Chalmersinvest   Face-­‐to-­‐face   30  min   05.08.2013   Chalmers  University   Innovationskontor  väst   Face-­‐to-­‐Face   60  min   11.09.2013   Table  4:  Technology  transfer  offices  interviews         14     Academic  founders   Company   Origin  university   Industry   Interview  type   Interview   length   Date   A1M  Pharma   Lund  University   Life  sciences   Telephone   30  min   07.08.2013   CarpoNovum   Lund  University   Life  sciences   Telephone   30  min   09.08.2013   Arterion   Chalmers  University   Technology   Face-­‐to-­‐face   60  min   05.09.2013   Tajitsu   Chalmers  University   Technology   E-­‐mail   -­‐-­‐   10.09.2013   TEKNOPOL   Lund  University   Technology   Telephone   60  min   20.09.2013   Table  5:  Academic  founders  interviews   Academic  founders  to  be  interviewed  were  found  using  the  TTOs’  databases.  Only  entrepreneurs   that  had  used  the  transfer  office’s  services  were  contacted  and  that  had  successfully  received   venture  capital.   2.3  Reliability  and  validity  of  the  study   According  to  Cuba  &  Lincoln  (1994)  the  primary  criteria  for  assessing  a  qualitative  study  is:   trustworthiness  and  authenticity.    Trustworthiness  is  made  up  by  four  critria:  credibility,   transferability,  dependability,  and  confirmability.  Each  of  these  criteras  will  be  reflected  upon  in  the   context  of  this  study.   To  ensure  the  first  criteria  of  trustworthiness  –  credibility  –many  academics  use  triangulation.  This   necessitate  the  use  of  multiple  methods  or  sources  of  data  in  studies  of  social  phenomenas.  Denzin   (1970)  define  the  approach  to  the  use  of  ”multiple  observers,  theoretical  perspectives,  sources  of   data,  and  methodologies”.  The  nature  of  the  problem  definition  and  the  approach  to  attack  the   financial  gap  phenomena  from  the  perspectives  of  the  different  actors  is  a  form  of  triangulation.   Also,  the  use  of  different  theoretical  perspectives  helps  give  this  study  credibility.  The  empirics  and   analysis  were  conducted  in  such  a  manner  that  themes  and  patterns  were  first  identified  in  the  three   groups  (i.e.  founders,  TTOs,  and  investors).  Then  similarities  and  differences  between  the  different   groups  was  analyzed   Transferability  refers  to  the  degree  that  the  findings  can  be  applied  to  other  contexts.  Since  the   qualititative  approach  study  a  small  group  and  focus  on  deep  insights  it  is  not  certain  that  any   derived  findings  will  be  general  findings.  To  prove  that  these  findings  is  true  in  general  is  not  the  goal   of  qualitative  research.  Instead  qualitatvie  research  is  meant  to  produce  what  Geertz  (1973)  calls   thick  description  –  a  detailed  description  of  a  culture.  This  study  provides  a  “thick  description”  of  the   social  construct  that  needs  to  be  validated  in  another  study  using  more  quantitative  measures  so   that  it  can  be  considered  transferable.  “Thick  description”  is  deep,  dense,  and  detailed  accounts  of   problematic  experiences.  These  accounts  often  state  the  intentions  and  meanings  that  organize   action  (Denzin,  2001).  By  looking  at  the  financial  gap  from  three  different  actors  and  asking  open-­‐ ended  questions  the  results  were  a  “thick  description”  of  the  social  construct  that  would  probably   have  been  missed  if  only  one  viewpoint  was  studied.  Only  academic  founders  that  have  been   successful  in  attracting  venture  capital  were  included  in  the  study.  The  motivation  for  this  is  that  they   have  worked  with  venture  capitalists  and  experienced  not  only  the  process  of  trying  to  attract   venture  capital  but  also  the  involvement  and  influence  of  venture  capitalists  on  the  start-­‐up.   However,  this  creates  a  success  bias  in  the  selection  of  research  objects  and  the  academic  founders’   views  presented  in  the  findings  might  not  be  fully  transferable  and  apply  to  the  general  academic   founder.  Instead  the  findings  better  reflect  the  views  of  successful  academic  founders.     15     Dependability  could  be  considered  qualitative  research’s  comparison  of  reliability  in  quantitative   research.  Cuba  &  Lincoln  (1994)  propose  that  researchers  should  adopt  an  ”auditing”  approach  in   that  complete  records  are  kept  of  all  phases  of  the  research  process  and  provided  in  an  accessible   way.  The  reason  for  this  is  to  make  the  work  easily  assesed  and  “audited”  by  peers.  However,  in   management  and  business  studies  this  has  not  become  a  popular  approach  to  improve  dependability   since  it  is  very  demanding  in  qualitative  research  (Bryman  &  Bell,  2011).  The  authors  audio  recorded   and  transcribed  each  interview.  In  this  study  the  interview  guide  and  interview  profiles  are  presented   but  the  full  interview  transcripts  are  left  out.   Cuba  &  Lincoln  (1994)  suggest  that  researchers  should  act  to  achieve  confirmability.  Confirmability   entails  trying  to  achieve  complete  objectivity  when  performing  the  study.  As  previously  pointed  out,   this  is  impossible  in  business  studies  but  the  authors  should  act  in  good  faith,  i.e.  it  is  obvious  that   the  author  has  not  allowed  personal  values  or  theoretical  preferences  to  influence  the  research   process  or  the  results  derived  (Bryman  &  Bell,  2011).  The  authors  of  this  study  attempt  to  achieve   confirmability  by  scanning  a  variety  of  literature,  using  a  broad  theoretical  base,  and  bouncing  ideas   off  the  supervisors.  The  theoretical  base  is  connected  to  the  questions  asked  in  the  interviews  and   thus  opens  up  to  many  possible  explanations  for  the  problem  explored.  Also,  cross-­‐checking  the   interview  guide  with  supervisors  has  further  improved  the  objectivity  of  the  study.  The  authors   conducted  two  exploratory  interviews  to  check  the  theoretical  base  early  in  the  process.   The  last  criterion  for  assessing  qualitative  research  is  authenticity.  The  term  comprises  five  points   that  raise  concerns  of  a  wider  political  impact  (Bryman  &  Bell,  2011);  first,  does  the  research  fairly   represent  different  viewpoints  among  members  of  the  social  setting?  The  approach  of  the  research   to  view  the  financial  gap  from  the  involved  actors  in  the  investment  process  in  itself  represents  the   viewpoints  of  different  members.  Second,  does  the  research  help  members  arrive  at  a  better   understanding  of  their  social  environment?  Third,  does  the  research  help  members  to  more   accurately  appreciate  the  perspectives  of  other  members  in  their  social  setting?  Fourth,  has  the   research  acted  as  an  impetus  to  members  to  engage  in  action  to  change  their  circumstances?  Fifth,   has  the  research  empowered  members  to  take  the  steps  necessary  for  engaging  in  action?  The   objective  to  bridge  the  financial  gap  between  the  involved  actors  satisfies  the  last  four  issues  well.  By   getting  a  better  understanding  of  the  views  on  the  financial  gap  the  research  can  educated  the   involved  actors  of  the  others  situation  and  it  can  also  point  out  what  areas  need  to  be  worked  on  to   bring  the  involved  parties  closer.  This  analysis  will  in  itself  suggest  areas  were  practical  action  can  be   taken  to  improve  the  conditions  for  USOs.         16     3  Theoretical  framework   This  chapter  will  present  four  theories,  illustrated  in  the  orientation  graphic  below  (figure  3),  that   relates  to  the  financial  gap  issue.  Together,  they  will  build  the  theoretical  framework  on  which  the   later  analysis  will  be  based.  The  theories  are,  in  order  of  presentation,  financial  gap  theory,  financial   choice,  negotiation  theory  and  governmental  intervention  theory.  The  chapter  is  concluded  with  an   elaborate  summary  together  with  a  graphical  illustration  of  this  study’s  analytical  model.     Figure  3:  Overview  of  the  theoretical  framework           3.1  Financial  gap     USOs  from  technical  universities  are  usually  attempts  to  commercialize  a  piece  of  the  research   conducted  at  the  institution.  During  the  initial  pre-­‐market  years,  the  start-­‐up  needs  to  finance  its   operations  through  other  means  than  sales.  In  the  following  subchapter  the  financial  gap  will  be   explained  in  detail.  Then  the  agency  theory  and  the  important  uncertainty  variable  will  be  presented   as  two  theories  explaining  the  financial  gap.   3.1.1  The  meaning  of  the  financial  gap   The  term  financial  gap  is  used  to  illustrate  that  often-­‐times,  when  it  comes  to  start-­‐ups  and  small   businesses,  like  USOs,  the  managers  experience  problems  when  trying  to  attract  smaller  amounts  of   long-­‐term  external  finance  from  financiers,  such  as  banks  and  new  owners  (Winborg,  2000).  The   problem  can  be  viewed  both  from  a  supply  side  and  a  demand  side  perspective.  Supply  side  refers  to   the  investors  and  their  willingness  to  invest  in  small  businesses  and  demand  side  refers  to  the   businesses’  need  for,  and  interest  in,  external  funding.     Many  private  investors,  especially  the  institutional,  think  it  is  too  early  to  invest  in  a  USO  at  the  early   stages,  with  biotechnology  USO’s  as  exceptions  (Shane,  2004).  They  want  to  wait  until  proof  of   principle  is  done  and  a  prototype  is  developed,  product  development  is  initiated  and  the  company  is   closer  to  its  targeted  market.  This  is  mainly  because  of  the  time  horizon  issues  regarding  a  possible   exit  either  through  acquisition  or  initial  public  offering.  Thus,  there  is  a  financial  gap  between   Financial  gap   Financial   choice   Negoqaqon   theory   Governmental   intervenqon   Financial  gap   Financial  choice   Negoqaqon   theory   Governmental   intervenqon     17     founding  of  a  USO  and  when  it  is  attractive  enough  for  private  investors  to  acquire  a  share.    Also,  the   entrepreneur  would  have  to  give  up  a  very  big  share  in  the  earliest  stages,  which  could  have  negative   influence  on  his  or  her  motivation,  and  is  thus  not  considered  an  option.   To  enable  entrepreneurs  to  build  up  enough  value  to  not  have  to  give  up  a  major  part  of  the  shares   for  smaller  amounts  of  money  and  simultaneously  make  the  company  attractive  enough  for  the   investors,  there  are  public  funds  available  to  at  least  partly  bridge  the  gap.  Government  grants,   subsidies  and  contracts  are  often  the  major  source  of  revenue  for  USO’s  during  the  initial  period.  It   has  even  been  shown  that  government  funding  is  necessary  for  spin-­‐offs  to  be  founded  and  to   survive  (Shane,  2004).  Government  funding  can  be  used  for  further  development  of  the  technology   and  to  find  commercial  uses  for  the  technology,  because  many  USO’s  are  created  to  exploit   technologies  for  which  the  founders  have  not  yet  been  able  to  identify  a  commercial  use.   Government  funds  also  facilitate  the  acquisition  of  private  sector  financing  by  serving  as  a  catalyst  for   future  investment  and  also  by  providing  a  subsidy  to  reduce  the  private  sector  financing  costs.  It  is   also  a  way  to  manage  the  sometimes  overwhelming  risk  inherited  in  USO’s,  because  they  often  are   cutting  edge  and  thus  are  exposed  to  both  technical  and  market  risk.  This  will  be  discussed  in  more   detail  in  chapter  3.4.   It  is  important  to  distinguish  between  the  terms  gap  and  credit  rationing,  as  well  as  between  an   objective  and  a  subjective  gap.  The  capital  market  might  be  functioning  perfectly  in  the  sense  that  it   is  cleared  by  interest  rate  or  required  rate  of  return,  but  managers  could  still  perceive  it  as  impossible   to  attract  capital  on  what  they  think  is  fair  terms.  In  this  sense,  there  is  and  will  always  be  a  gap.  This   could  happen  even  though  no  credit  rationing  has  taken  place  (Winborg,  2000).  However,  the  market   is  said  to  be  dysfunctional  if  relatively  more  risky  businesses  cannot  attract  capital  at  any  terms.   Then,  credit  rationing  is  said  to  take  place  (Stiglitz  &  Weiss,  1981).   3.1.2  Agency  theory   The  illustration  below  (figure  4)  shows  the  basic  idea  of  agency  theory.     Figure  4:  Illustration  of  the  agency  theory     18     The  key  idea  is  that  principal-­‐agent  relationships  should  reflect  efficient  organization  of  information   and  risk-­‐bearing  costs  (Eisenhardt,  1989).  Agency  theory  provides  a  unique,  realistic  and  empirically   testable  perspective  on  problems  of  cooperative  effort  (Fama  &  French,  2002).  The  agency  model   applied  to  venture  capital  focuses  on  the  arrangement  where  control  and  ownership  are  separated.   One  party,  the  principal  (investor),  delegates  work  to  another,  the  agent  (entrepreneur),  who   performs  work  on  the  principal’s  behalf,  in  this  case  runs  the  business.  In  this  set-­‐up  there  are  certain   vital  pieces  of  information  that  is  only  available  to  the  agent,  which  leads  to  asymmetric  information.   It  is  difficult  for  the  principal  to  know  if  the  agent  is  using  this  information  for  self-­‐interest  purposes   or  for  the  advantage  of  the  firm  and  the  principal.  This  leads  to  a  number  of  problems  (Van   Osnabrugge,  2000).   3.1.2.1  Contracts   The  agency  relationship  is  basically  individuals  who  try  to  cooperate  but  with,  to  varying  extents,   different  preferences.  To  limit  the  agency  costs  contracts  are  employed.  Contracts  specify  important   statutes,  such  as  performance  criteria,  payoffs  and  the  right  of  the  agent.  However,  contracts  can   neither  be  written  nor  enforced  without  costs  involved,  which  leads  to  agency  problems.  Contracts   imply  costs  such  as  structuring,  bonding  and  monitoring,  and  these  costs  may  exceed  the  benefits  of   the  contract.  This  is  especially  true  when  it  comes  to  USO’s  in  early  stages,  where  no  product  is  ready   for  the  market,  no  cash  in-­‐flows  yet  present  etcetera.  The  information  asymmetries  are  impossible  to   completely  contract  away,  which  yields  two  agency  problem  causes  -­‐  goal  alignment  and  verification   conflicts,  and  conflicts  in  risk  sharing.   3.1.2.2  Incomplete  contracts   As  an  alternative  to  the  principal-­‐agent  approach  there  is  the  incomplete  contracts-­‐approach,  which   suggests  that  contracts  are  always  incomplete.  Therefore  it  is  rather  the  ex-­‐post  allocation  of  control   that  is  of  importance,  than  the  ex-­‐ante  screening  and  contract  writing.  The  approaches  place   emphasis  on  different  stages  in  the  investment  process,  where  the  incomplete  contracts-­‐approach   implies  gaining  control  at  later  stages.  Particularly  in  high-­‐risk  ventures,  such  as  USO’s,  it  is  suggested   that  the  best  way  to  gain  control  and  exert  power  over  the  investment  is  through  active  involvement   after  the  investment  has  been  made.   3.1.3  Uncertainty   Uncertainty  makes  financing  spinoff  companies  difficult  in  three  ways.  First,  it  makes  the  evaluation   of  opportunities  by  investors  complicated.  Second,  it  creates  bargaining  problems  between   entrepreneurs  and  investors  because  it  often  leads  to  disagreement  between  entrepreneurs  and   investors  on  the  profitability  of  the  venture  (Wu,  1989).  Third,  it  leads  investors  to  seek  collateral  to   decrease  the  loss  in  event  of  failure.  This  uncertainty  makes  it  very  important  for  the  entrepreneurs   to  demonstrate  the  values  of  their  ventures.  Investors  in  USO’s  are  looking  at  founder  attributes  in   search  for  entrepreneurial  talent,  but  also  at  factors  that  the  founders  do  not  control,  namely   evidence  of  a  large  market,  the  presence  of  proprietary  technology  and  the  existence  of  a  platform   technology  (Low  &  Abrahamson,  1997;  Kaplan  &  Stromberg,  2001;  Carter  &  Van  Auken,  1990;  Amit,   Glosten,  &  Muller,  1990).   3.1.3.1  Founder  attributes   Private  sector  investors  in  university  spinoffs  favor  ventures  founded  by  people  who  fit  the  profile  of   successful  entrepreneurs  (Shane,  2004).  The  research  conducted  previously  suggests  that  investors   prefer  founders  with  the  industry  and  management  experience  to  identify  and  exploit  successfully     19     entrepreneurial  opportunities  in  new  technology.  As  a  result,  prior  research  suggests  that  founders   of  university  spinoffs  with  more  management  and  industry  experience  are  more  likely  to  obtain   financing  than  those  without  that  experience  (Vohora,  Wright,  &  Lockett,  2004).  At  a  minimum,   observers  explain  that  investors  seek  entrepreneurs  with  a  sufficient  level  of  business  skills  to  allow   them  to  work  effectively  with  business  people,  preferring  those  with  significant  research  funding   from  industry,  since  investors  believe  this  demonstrates  sensitivity  to  the  demands  of  industry   personnel.  Moreover,  professional  investors  tend  to  favor  companies  whose  founders  have   knowledge  of  customer  needs.  While  USO  founders  often  have  limited  knowledge  of  whether   customers  are  interested  in  their  technologies  (Vohora,  Wright,  &  Lockett,  2004),  private  investors   tend  to  select  those  spinoffs  whose  founders  have  greater  knowledge  of  markets  and  customers.   3.1.3.2  Evidence  of  large  market   Private  sector  investors  favor  university  spinoffs  that  are  developing  products  or  services  for  a  large   market.  The  standard  venture  capital  model  of  investing  holds  that  private  investors  should  favor   ventures  that  operate  in  large  markets,  which  can  provide  greater  financial  returns  if  the  company   successfully  introduces  its  product,  given  a  relatively  high  cost  and  uncertainty  of  technology  and   market  development  by  spinoffs.  Therefore  most  private  sector  investors  that  finance  USO’s  prefer   spinoff  companies  that  are  aiming  at  large  markets.   3.1.3.3  Proprietary  technology   Private  sector  investors  in  USO’s  also  favor  those  spinoffs  with  strong  patent  protection  on  their   technologies.  In  general,  USO  investors  prefer  to  finance  companies  with  patented  technologies   because  patents  provide  externally  verifiable  evidence  of  a  competitive  advantage  (Bhide,  2000).  As   a  result,  investors  can  have  some  confidence  that  a  spinoff  that  they  finance  would,  in  fact,  be  able   to  appropriate  the  returns  of  the  innovation,  should  it  succeed  in  commercializing  its  technology.   Several  observers  have  shown  that  patents  enhance  the  ability  for  USO’s  to  raise  money.  One  large   sample  statistical  study  of  USO’s  supports  this  proposition.  Focusing  on  variation  in  the  effectiveness   of  patents  across  different  industries,  Shane  and  Stuart  (2002)  examined  the  performance  of  134   spinoffs  from  MIT  from  1980  to  1996  and  found  that,  the  more  effective  patents  were  at  preventing   imitation  of  a  technology  in  an  industry,  the  more  likely  a  spinoff  was  to  raise  venture  capital.   3.1.3.4  General-­‐purpose  technologies   Private  sector  investors  in  USO’s  also  favor  those  spinoffs  that  possess  general-­‐purpose  technologies   that  can  be  applied  in  a  variety  of  different  markets.  The  possession  of  a  general-­‐purpose  technology   facilitates  the  financing  of  USO’s  because  of  the  market,  technology  and  competitive  uncertainty   associated  with  this  type  of  ventures.  Entrepreneurs  cannot  know  with  certainty  whether  they  will  be   able  to  produce  new  technology  products  or  services,  whether  there  is  a  market  for  those  products   or  services,  or  whether  the  firm  or  its  competitors  will  capture  the  returns  from  introducing  those   new  products  or  services.  Consequently,  the  founders  of  USO’s  need  to  be  flexible  and  adapt  to   changing  circumstances  and  a  general-­‐purpose  technology  suits  that  need.   3.1.4  Financial  gap,  agency  theory  and  uncertainty   The  primary  reason  for  the  financial  gap  in  the  capital  markets  for  USOs  is  information  asymmetry   and  the  inherent  uncertainties  in  the  ventures.  According  to  Shane  (2004)  there  are  specifically  four   problems  that  this  information  asymmetry  creates  in  the  process  of  financing  USO’s.  First,  the   entrepreneur  wants  to  keep  his  or  her  superior  information  about  an  opportunity  secret  because  this   information  is  what  constitutes  the  start-­‐ups  potential  competitive  advantage.  Thus,  the     20     entrepreneur  will  not  disclose  everything  to  potential  investors  and  the  investors  have  to  make   decisions  on  limited  information  (Casson,  1995).  Second,  the  entrepreneur  can  use  this  information   advantage  to  extract  resources  that  fully  informed  investors  would  not  have  provided  (Shane  &   Cable,  2002).  Third,  the  entrepreneur  can  use  this  information  asymmetry  and  the  limits  on  investor   monitoring  that  it  imposes  to  expose  the  invested  capital  to  excessive  risk  (Shane,  2003).  Fourth,   information  asymmetry  creates  potential  for  adverse  selection  because  it  makes  it  difficult  for   investors  to  distinguish  between  talented  entrepreneurs  pursuing  valuable  opportunities  and   untalented  entrepreneurs  pursuing  opportunities  of  limited  value  (Sahlman,  1990).   3.1.5  Financial  gap  summary   The  financial  gap  refers  to  the  problem  for  small  businesses  to  raise  external  capital  to  fund  its   business.  The  agency  theory  is  a  popular  explanation  of  the  problem,  where  information   asymmetries  cause  the  principal  (investor)  and  agent  (entrepreneur)  to  act  in  self-­‐interest.  Two  tools   to  minimize  the  effects  of  the  information  asymmetries  are  contracts  and  incomplete  contracts.   Finally,  uncertainty  in  the  business  creates  problems  for  the  investor  to  fully  evaluate  the  business   and  its  potential  profitability,  creates  a  bargaining  problem  between  the  entrepreneur  and  investor,   and  leads  the  investor  to  seek  collateral  to  decrease  the  loss  in  case  of  failure.  This  will  be  further   elaborated  in  a  subsequent  chapter  about  Negotiation  theory.                 3.2  Financial  choice  in  small  businesses   As  previously  mentioned,  the  financial  gap  can  be  viewed  from  two  perspectives:  the  supply  side  and   the  demand  side.  The  problem  is  not  only  a  supply  side  problem  with  insufficient  capital  available   from  investors  but  also  a  demand  side  problem.  The  entrepreneurs  may  lack  the  information  and   knowledge  to  seek  out  investors.  Also,  the  entrepreneur  may  have  a  negative  attitude  towards   external  financing  and  giving  up  equity.  In  this  subchapter  theories  and  previous  research  regarding   the  financial  choice  of  funding  made  by  managers  of  small  businesses  will  be  presented.   3.2.1  View  on  venture  capital   In  a  study  by  Saetre  (2003)  two  entrepreneurial  views  on  venture  capital  are  presented.  In  a  venture   capital  investment,  the  entrepreneur  can  either  view  capital  as  a  scarce  resource,  meaning  that  the   capital  itself  is  of  importance,  or  the  entrepreneur  can  view  capital  as  a  commodity,  meaning  that   other  factors  than  the  capital  itself  are  of  higher  importance.  The  entrepreneurs  that  take  the   commodity  view  are  far  more  restrictive  of  whom  they  let  invest  and  demand  more  competent   investors  with  relevant  industry  experience  and  network  (Saetre,  2003).     Financial  gap   Financial  choice   Negoqaqon   theory   Governmental   intervenqon     21     One  motive  for  the  entrepreneur  to  start  his  or  her  own  company  is  the  notion  of  being   “independent”  of  others  (Landström,  2004).  Per  Davidsson  (1989)  points  out  that  growth  is  not   always  a  primary  objective  for  the  entrepreneur.  Also,  in  a  study  from  Chalmers  University  of   Technology  by  McQueen  &  Wallmark  (1982)  that  surveyed  founders  of  spinoffs  found  that  most  of   them  did  not  found  their  company  because  of  a  desire  to  generate  wealth  but  to  fulfill  their  desire  to   commercialize  their  technology.   3.2.2  Access  to  finance   Founders  of  small  businesses  may  lack  sufficient  knowledge  of  investments  and  a  network  to  acquire   external  capital.  There  are  many  different  and  dispersed  sources  of  capital  available  in  the  market.   This  is  positive  because  it  contributes  to  a  well-­‐functioning  market  but  it  also  creates  a  problem  for   the  entrepreneur:  to  identify  the  different  alternatives  and  gain  knowledge  of  the  sources  and  what   they  demand  might  be  too  overwhelming  for  the  entrepreneur  (Landström,  2003).   3.2.3  Pecking  order  theory   Many  studies  (Calof,  1985;  Holmes  &  Kent,  1991;  Norton,  1991;  Scherr,  Sugrue,  &  Ward,  1993)  of   small  business  managers’  financial  preferences  have  supported  the  pecking  order  theory  presented   by  Myers  (1984).  What  these  studies  have  shown  is  that  small  business  managers’  financial   preferences  are  aligned  with  the  preferences  of  managers  of  large  quoted  companies.  The  pecking   order  theory  is  based  on  the  principle  of  least  effort,  meaning  that  the  path  of  least  effort  or  struggle   will  be  the  preferable  choice.  The  pecking  order  theory  suggests  that  when  making  capital  structure   decisions  managers  rank  the  source  of  funding  in  the  following  way:  (1)  internally  generated  equity,   (2)  debt  financing,  and  (3)  external  equity  provided  by  a  new  owner.  However,  the  underlying   explanation  for  financial  preferences  in  small  business  is  more  complex  than  was  initially  implied  by   Myers  (1984)  for  large  listed  companies  –  that  evaluation  of  financial  opportunities  are  strictly  due  to   relative  costs  to  the  owner.  In  small  businesses  the  management  and  ownership  are  often   integrated,  which  will  influence  the  interpretation  of  financial  sources  in  that  more  emphasis  will  be   put  on  retaining  control  over  operations  and  assets  as  long  as  possible  (Holmes  &  Kent,  1991).   Although,  it  should  be  noticed  that  the  pecking  order  is  constrained  for  most  small  business  as  the   option  of  raising  external  equity  might  not  be  available  at  all  (Holmes  &  Kent,  1991).   3.2.4  Reverse  pecking  order  theory   As  an  alternative  to  the  traditional  pecking  order  theory,  Aernoudt  (2005)  presented  a  “reverse   pecking  order  theory”.  He  showed  that  start-­‐ups  have  an  excessive  demand  for  external  equity   explained  by  two  reasons.  First,  without  revenue  and  cash-­‐flow  internal  financing  is  impossible  to   utilize.  Debt  financing  is  often  approved  when  the  loan  is  secured  by  assets,  which  many  start-­‐ups   lack  and  thus  making  it  difficult  for  start-­‐ups  to  get  debt  financing.  Second,  debt  entails  interest  costs   and  fixed  payback  obligations.  Aernoudt  (2005)  suggests  that  for  start-­‐ups  there  are  many  positive   aspects  with  business  angel  financing,  e.g.  the  absence  of  financial  expenses  and  easier  access  to   second  round  financing.  According  to  the  theory,  business  angel  financing  can  no  longer  be   considered  as  a  last  resort  of  financing.  Which  of  the  two  pecking  order  theories  that  holds  true  for   USOs  will  be  analyzed  in  the  analysis  section.   3.2.5  Financial  bootstrapping   Many  small  businesses  are  often  extensively  and  sometimes  entirely  financed  from  other  sources   than  institutional  financers,  applying  different  kinds  of  bootstrapping  methods  (Thorne,  1989).   Financial  bootstrapping  has  been  defined  as  the  behavior  of  attracting  the  resources  needed  without     22     the  involvement  of  external  long-­‐term  finance  (Freear,  Sohl,  &  Wetzel  Jr,  1995).  More  precisely,  the   term  financial  bootstrapping  refers  to  means  for  securing  the  use  of  necessary  resources  at  low  or  no   cost.  Examples  of  financial  bootstrapping  are  borrowing  equipment,  sharing  resources,  delaying   payments,  negotiating  favorable  conditions  with  suppliers  and  customers  and  using  resources  of  the   owner.  Most  small  businesses  face  many  difficulties  in  obtaining  debt  and  equity,  which  are  often   more  costly  than  internal  financing,  leading  the  company  to  use  financial  bootstrapping  more   frequently  (Ebben  &  Johnson,  2006).  Winborg  (2000)  and  Gibson  (1992)  argue  that  bootstrapping   methods  can  help  reduce  the  financial  gap  for  small  businesses.     Financial  bootstrapping  is  often  considered  an  undesirable  consequence  of  small  businesses  not   being  able  to  acquire  financing.  However,  there  is  research  arguing  that  it  could  also  be  a  positive   thing.  Greene  et  al.  (1999)  propose  that,  given  the  financial  situation  a  small  firm  is  in,  bootstrapping   becomes  a  fundamental  block  in  building  the  new  venture.  Timmons  (1999)  even  argues  that   bootstrapping  will  give  firms  a  competitive  advantage  by  creating  “a  discipline  of  leanness”  and   methods  of  maximizing  stockholder  value.  However,  too  much  focus  on  bootstrapping  and  cost-­‐ awareness  in  the  company  strategy  can  hamper  small  businesses’  ability  to  really  grow  (Winborg,   2000).   3.2.6  Financial  choice  in  small  businesses  summary   In  contrast  to  venture  capital  investors,  the  entrepreneur’s  main  motive  is  not  always  growth.  His  or   her  main  driver  might  be  to  commercialize  the  technology  or  become  “independent”.  Those  seeking   venture  capital  may  lack  the  network  and  can  have  a  hard  time  finding  the  dispersed  sources   available.  The  pecking  order  theory  suggests  that  entrepreneurs  seek  external  equity  finance  as  a  last   resort.  In  response,  the  reverse  pecking  order  suggests  the  opposite  that  start-­‐ups  have  an  excessive   demand  for  external  equity.  Financial  bootstrapping  methods  develop  in  small  business  as  methods   to  limit  its  need  for  finance.         3.3  Negotiation  theory   Noted  statesman  and  negotiator  Henry  Kissinger  defined  negotiation  as,  “a  process  of  combining   conflicting  positions  into  a  common  position,  under  a  decision  rule  of  unanimity”  (Kissinger,  1969).  In   this  subchapter  the  fundamentals  of  negotiation  theory  and  the  two  branches  of  negotiation  theory   will  be  presented.   3.3.1  Basic  concepts  of  negotiation  theory   There  are  two  different  fundamental  branches  of  negotiation  theory.  The  parties  are  either   negotiating  over  a  fixed  amount  (i.e.  a  piece  of  a  fixed  pie,  zero-­‐sum),  which  generally  produces  win-­‐ lose  situations,  or  they  try  to  create  win-­‐win  situations  by  enlarging  the  pie  (see  figure  5  and  6   below).   Financial  gap   Financial  choice   Negoqaqon   theory   Governmental   intervenqon     23       Figure  5:  Fixed  pie     Figure  6:  Expanding  pie   These  branches  are  called  distributive  (fixed  pie)  and  integrative  (expanding  pie).  Zartman  (1988)   describes  the  main  school  of  thoughts  in  negotiation  theory  as  five  different  levels  of  analysis.  These   are  the  structural,  the  strategic,  the  processual,  the  behavioral  and  the  integrative  approaches.  It  is   important  to  acknowledge,  however,  that  most  negotiators  use  a  combination  of  approaches  and   borrow  from  all  kind  of  schools  of  thoughts  when  they  are  negotiating.  For  the  purpose  and   relevance  of  this  study,  the  two  extremes,  the  structural  and  the  integrative,  will  be  described   further.   3.3.2  Structural  approach   Structural  approaches  to  negotiation  consider  negotiated  outcomes  to  be  a  function  of  the   characteristics  or  structural  features  that  define  each  particular  negotiation.  The  structural  approach   finds  explanations  of  outcomes  in  patterns  of  relationships  between  parties  or  their  goals  (Zartman  ,   1976).  In  this  view,  the  relative  power  of  each  party  affects  their  ability  to  secure  their  individual   goals  through  negotiations.  The  definition  of  power  can  however  vary.  Sometimes  it  is  the  ability  to   win,  or  alternatively,  as  the  possession  of  “strength”  or  “resources”.  The  central  idea  is  the  notion   that  the  strong  will  prevail,  or,  in  the  language  of  classical  realism,  that  “the  strong  do  what  they  can   and  the  weak  suffer  what  they  must”  (Thucydides,  1910).  Yet  even  in  situations  when  there  is  one   very  strong  and  one  very  weak  party,  the  range  of  outcomes  is  very  wide.  Therefore,  analysts  of  this   approach  have  looked  at  additional  structural  properties  such  as  symmetry-­‐asymmetry,  the   availability  of  alternatives,  or  the  role  of  tactics.     Other  factors,  such  as  negotiating  skill,  can  play  a  key  role  in  shaping  negotiated  outcomes.   Negotiators  should  be  aware  that  a  blind  attachment  to  “winning”  all  you  can  from  a  negotiation   regardless  of  the  other  parties’  satisfaction,  can  be  a  poor  long-­‐term  strategy  if  it  means  that  the   other  side  will  lose  its  will,  or  ability  to  maintain  its  side  of  the  negotiated  agreement.   3.3.3  Integrative  approach   Integrative  approaches,  in  contrast  to  distributive  approaches,  frame  negotiations  as  interactions   with  win-­‐win  potential.  Instead  of  a  zero-­‐sum  view,  integrative  theories  and  strategies  look  for  ways   of  creating  value  or  expanding  the  pie  as  in  the  picture  above,  so  that  there  is  more  to  share  between   the  parties  as  a  result  of  negotiation.  Integrative  approaches  use  objective  criteria,  look  to  create   conditions  of  mutual  gain,  and  emphasize  the  importance  of  exchanging  information  between  parties   and  group  problem-­‐solving  (Lewicki,  Barry,  Saunders,  &  John,  2003).  Therefore,  integrative  strategies   call  for  participants  to  work  jointly  to  create  win-­‐win  solutions.  They  involve  uncovering  interests,   generating  options  and  searching  for  commonalities  between  parties.  Negotiators  may  look  for  ways   to  create  value,  and  develop  shared  principles  as  a  basis  for  decision-­‐making  about  how  outputs   should  be  claimed  (and  who  claims  them).   3.3.4  Negotiation  theory  summary   Negotiation  theory  gives  a  foundation  for  understanding  critical  aspects  of  financing  agreements   between  founders  and  financiers.  The  two  different  views  on  Negotiation  theory  are  known  as     24     distributive  and  integrative.  The  former  regards  negotiations  as  a  zero-­‐sum  distribution  of  a  fixed   amount,  whereas  the  latter  focuses  on  expanding  the  value  of  which  to  share.  It  is  important  to  know   both  the  power  structures  of  the  negotiators  as  well  as  how  to  work  for  value  creation  when   analyzing  early  venture  capital.         3.4  Governmental  Intervention  Theory   Certainly,  the  governments  in  the  developed  countries  of  the  world  have  the  means  to  decrease  the   financial  gaps  in  their  countries.  But  is  it  reasonable  to  expect  government  officials  to  help   freewheeling  entrepreneurs  and  venture  investors?   3.4.1  Why  governments  should  intervene   The  need  for  innovation  is  widely  accepted  by  governments  around  the  world.  Virtually  every  area  of   cutting-­‐edge  entrepreneurial  activity  in  the  world  had  its  origins  in  proactive  government   intervention.  Similarly,  the  venture  capital  industry  in  many  nations  has  been  profoundly  shaped  by   government  intervention  (Lerner,  2009).  With  a  few  exceptions,  small  firms  did  not  invent  the  key   genetic  engineering  techniques  or  Internet  protocols.  These  enabling  technologies  were  developed   with  government  funds  at  academic  institutions  and  research  laboratories.  However,  it  was  the  small   entrants  that  first  seized  upon  the  commercial  opportunities.  Venture  capital  clearly  serves  as  an   important  source  industry  for  innovation,  reflecting  the  fact  that  these  investors  both  provide   important  guidance  to  young  firms  and  relieves  all-­‐too-­‐common  capital  constraints.   A  first  rationale  for  government  intervention  lies  in  the  fact  that  there  is  a  “virtuous  cycle”