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Financing Best Practice

Assessing Venture Capital Funding for Small and Medium-Sized Enterprises

by Alain Fayolle and Joseph LiPuma

Executive Summary

  • Entrepreneurs and small and medium-sized enterprise (SME) managers capitalize their firms with debt equity investments, or a combination of both.

  • Equity investments such as venture capital can erode executive control but can enable access to the investor’s knowledge, advice, and networks.

  • Venture capital can be provided by business angels, independent venture capital firms (IVCs1), corporations, or universities.

  • The sources’ differing investment objectives, backgrounds, and control mechanisms deliver varying levels of added value to the SME.

  • Companies seeking venture capital should select investors whose objectives, potential to add value, and expectations of control mesh most closely with those of the entrepreneur.


Entrepreneurs and SME managers face two key choices when financing their ventures: debt or equity. Debt in the form of personal loans (including credit cards) and bank loans, key sources for most nascent ventures, gives efficient incentives for managers to exert effort and allow entrepreneurs to maintain control. The availability and utility of debt vary significantly with economic conditions, which, in turn, will have an impact on the supply and cost of capital. To a lesser extent, entrepreneurs rely on equity financing,2 in which parties external to a venture obtain partial ownership (and control) in exchange for financial capital, thus diluting managers’ incentives to expend effort. Equity financing is particularly important for high-growth ventures, since the amount of debt financing available may not permit sufficiently rapid growth in volatile industries (for example, technology). Objectives and incentives that are well aligned between investor and manager are the most efficient and facilitate additional value for the venture.

Venture Capital

Venture capital (VC) refers to independently managed, dedicated pools of capital which the providers channel into equity or equity-linked investments in privately held, high-growth companies.3 Worldwide, more than $30 billion is invested annually as venture capital,4 with the most intensive use in the United States, Europe, and Israel (with $28 billion, $6 billion, and $.7 billion invested respectively in 2007).5 Venture capital represents a bundle of productive, value-adding resources, comprising the human capital (knowledge and experience) and social capital (network) of the venture capitalist—who oversees the investment—in addition to the financial capital. The value and productivity of these nonfinancial aspects of VC can be significant, influencing a venture’s offering, geographic diversity, and growth. Venture capitalists can help to professionalize a new venture through representation on the board of directors, executive recruiting, or by exerting rights of control (over, for example, cash flow and liquidation) in exchange for capital. Despite modest levels of investment,6 venture capital-backed companies7 accounted for over ten million jobs and $1.8 trillion in revenue in the United States in 20038—approximately one-sixth of GDP.

Venture capital can come from business angels, independent VC firms (IVCs), corporate venture capital (CVC) programs, and universities. The different ways in which these are funded, investments are managed, and partners are compensated (see Table 19) result in varying allocations of control rights between the investor and the venture. Angel investors, for example, rarely require representation on corporate boards, whereas IVCs generally do seek directorships. Investment objectives influence the nature of companies in which VCs invest and, correspondingly, the value they are able to add. Independent VC firms invest solely for financial reasons and may best add value to SMEs by helping them to recruit key executives or access additional capital. Corporations that provide CVC often invest for strategic reasons, frequently in ventures with complementary offerings. These corporations are generally multinational, enabling them to add more value in the development of foreign networks of customers, suppliers, and partners. However, CVC investors generally do not invest in early-stage ventures, usually waiting until an IVC invests before committing their resources.

Table 1. Characteristics of the different providers of venture capital

Typical background Ex-entrepreneur Ex-entrepreneur or financial Large, tech-savvy multinational Patent holder
Motivation Financial and “giving back” Financial Strategic and financial Commercialize patents
Fund source Self Limited partners Corporate University, government
Investment method Direct Direct Direct and indirect Direct and indirect
General partner compensation Gain from exit or early buyout Percentage of valuation increase Salary plus bonus Salary plus bonus
Average invested per venture ~$10,000a ~$8 millionb ~$4.5 millionc <$250,000d

a Allen, Kathleen A. Launching New Ventures: An Entrepreneurial Approach. Boston, MA: Houghton Mifflin Company, 2006.

b PricewaterhouseCoopers/National Venture Capital Association. “MoneyTree™ report.” Data: Thomson Reuters.

c Ibid.

d Miles, Morgan P., John B. White, and Eve White. “University sponsored venture capital: An exploratory study.” Journal of Business and Entrepreneurship 13:1 (2001): 129–134.

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Further reading


  • Gompers, Paul A., and Josh Lerner. The Venture Capital Cycle. Cambridge, MA: MIT Press, 1999.
  • Maula, M., and G. C. Murray. “Corporate venture capital and the creation of US public companies: The impact of sources of venture capital on the performance of portfolio companies.” In Michael A. Hitt, Raphael Amit, Charles E. Lucier, and Robert D. Nixon (eds). Creating Value: Winners in the New Business Environment. Oxford: Blackwell Publishing, 2002.
  • McNally, Kevin. Corporate Venture Capital: Bridging the Equity Gap in the Small Business Sector. London: Routledge, 1997.


  • Maula, Markku V. J., Erkko Autio, and Gordon C. Murray. “Corporate venture capitalists and independent venture capitalists: What do they know, who do they know and should entrepreneurs care?” Venture Capital 7:1 (January 2005): 3–21. Online at:
  • Sapienza, Harry J., Allen C. Amason, and Sophie Manigart. “The level and nature of venture capitalist involvement in their portfolio companies: A study of three European countries.” Managerial Finance 20:1 (1994): 3–17. Online at:
  • Smith, Gordon. “How early stage entrepreneurs evaluate venture capitalists.” Journal of Private Equity 4:2 (Spring 2001): 33–45. Online at:
  • Van Osnabrugge, Mark, and Robert J. Robinson. “The influence of a venture capitalist’s source of funds.” Venture Capital 3:1 (January 2001): 25–39. Online at:


  • National Venture Capital Association (NVCA):
  • European Private Equity and Venture Capital Association (EVCA):

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