False expectations: Reconsidering the role of informal venture capital in closing the regional equity gap1

1. An earlier version of this article was presented at the 25th Babson Entrepreneurship Research Conference, Boston, Massachusetts, 9-11 June 2005.

Abstract

The role of informal venture capital in entrepreneurial process and economic development is increasingly recognized by scholars and policy-makers around the world. Much of the attention that this form of financing has received during the last couple of decades is due to its potential to bridge the regional equity gap. This study is concerned with regional distribution of informal venture capital and factors explaining the allocation of informal investments, and it is based on a large random sample of informal venture capital investors in Sweden. The key findings are that the informal venture capital market in Sweden shows a considerable concentration in metropolitan areas and university cities. Further, investments conducted in these places are allocated in proportion to the new business formation rate and concentration of technology-based firms, while the only factor that provides some explanation for the location of informal investments in the peripheral regions is the proportion of the regional population that is considering starting their own business. Finally, there is a small but significant reallocation of informal venture capital from peripheral regions to metropolitan areas and university cities, which shows that the informal venture capital market in Sweden contributes rather to sustaining the regional equity gap than to bridging it.

Keywords:

• informal venture capital
• equity gap
• capital flows
• regional economic development

Acknowledgements

I would like to thank the Swedish Agency for Economic and Regional Growth (NUTEK) and the Swedish Foundation for Small Business Research (FSF) for the funding that made this research possible. I would also like to thank Hans Landström, Ola Jonsson, the editor, and two anonymous reviewers for their useful comments on the earlier version of this paper.

Notes

Notes

1. An earlier version of this article was presented at the 25th Babson Entrepreneurship Research Conference, Boston, Massachusetts, 9-11 June 2005.

2. Here, and throughout this paper, I make a conceptual distinction between informal investors and business angels based on their investment activity and level of resource contribution, in accordance with typologies suggested by, among others, S⊘rheim and Landström (2001) and Avdeitchikova (2005, 2008). The differences between these concepts are explained in more detail in section 2.

3. As some of the individuals in the population can be expected to have low investment activity (Avdeitchikova 2005, 2008; Maula, Autio, and Arenius 2005), the choice was also made to extend the cut-off period for being considered as an active investor from the usual three to five years (Coveney and Moore 1998; Månsson and Landström 2006).

4. See Gehrig (1998) and Porteous (1999) for the discussion of fixed costs of operating in a certain geographical location for institutional financial actors.

5. Even if debt financing is available, it may be inappropriate for the small growing firms to depend on this alone. Making regular payment of principal and interest is a heavy burden for the company, and can lead to undercapitalization and business failure (Mason and Harrison 1995).

6. See Mason (2007) for a review of long-distance investing.

7. Pr (investor) = [1 − exp(− 0.585 + 1.011 ∗ Gender − 0.371 ∗ Education)]⁁(−1).

8. The percentage of informal investors among non-respondents was estimated to be 63% compared to 69% for respondents. Only individuals with the probability of being informal investors of over 0.65 were labelled as such. The pre-testing of the model resulted in the accuracy of prediction of 71.5% given the chosen cut-off point.

9. See Appendix 1 for the calculation of the market size.