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Procedia - Social and Behavioral Sciences 235 (2016) 630 - 637
12th International Strategic Management Conference, ISMC 2016, 28-30 October 2016, Antalya,
Turkey
Venture Capital and Business Angels: Turkish Case
Suat TEKERa, Dilek TEKERb*
aI§ik University, Istanbul, 34363, Turkey _bI§ik University, Istanbul, 34363, Turkey_
Abstract
Venture capital (VC) may be defined as a support to entrepreneurial talents and appetite by turning ideas and basic science into products and services which are expected to envy the world. Although venture capitalists and business angels supply external funding for risky investments, the aspects of venture capitalists and business angels are different approaching the investment candidates.Business angels in the last decade have become undispansible players providing external capital for risky start-ups and contributing technological advancements and economic growth. Business angels could be either private wealth individuals or institutional venture capitalists. Private angels invest their own money that's why their invested capacity are limit ed while venture capitalists invest others'money with an extensive source. This research examines the the way of doing business for venture capitalists and business angels. Furthermore, venture capital market and business angels are reviewed for the Turkish case.
© 2016 The Authors. PublishedbyElsevier Ltd. This is an open access article under the CC BY-NC-ND license
(http://creativecommons.Org/licenses/by-nc-nd/4.0/).
Peer-reviewunderresponsibility ofthe organizingcommitteeofISMC2016.
Keywords: Venture captal, angel investors, startup companies, technology advancements, entrepreneurship.
1. Introduction
Venture capital (VC) may be defined as a support to entrepreneurial talents and appetite by turning ideas and basic science into products and services which are expected to envy the world. Venture capital funds are able to build companies from the simplest form to mature organizations (Teker et al (2016). Businss angels play an important role in the economy and in many countries substitute the largest source of external funding in newly established ventures. This has put angel investors in the center of attention for policy makers, who acknowlege their increasing improtance providng risk capital as well as contributing to economic growth and technological advances (Murray, 2007). Business angel investment activities are actually not a recent phenomenon. Private individuals have always had a tendency to invest in high-risk projects. One famous example is the decision by Queen Isabella of Spain to finance the voyage of Christopher Columbus. This turned out to be a highly profitable investment for Spain. Moreover, it may be argued that the investments made by the private individuals affected the industrial revoluition during the 19th and early 20th centuries. The business angel market first attracted the attention of US policy makers and in the late 1950s the Ferderal
* Corresponding author. Tel. + 90-532-241-9477 Email address: dilek.teker@isikun.edu.tr
1877-0428 © 2016 The Authors. Published by Elsevier Ltd. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).
Peer-review under responsibility of the organizing committee of ISMC 2016. doi: 10.1016/j.sbspro.2016.11.041
Reserve investigated initial financing of new technology-based firms and preceeded the Small Business Act in 1958. The interest in early financing of technology-based firms pointed the focus on angels as an important external source of finance for entrepreneurial ventures.
This reserach is organized as follows. The next section reviews the related literature. The following section examines the characteristics of business angels. The later section covers the Turkish case of angel investors. The final part presents the concluding remarks.
2.Literature Review
The first pioneering academic work conducted by Wetzel's study (1983) "Angels and informals risk capital" published in Sloan Management Review. He proposed that new technology-besed firms encountered problems when raising small amounts of early stage financing. The evidence indicated that business angels played a role in solving this problem. Wetzel put forward the common traits of business angels; wealthy, self-made, male, highly active investors who invested in close geographic proximity to their home and relied heavily on their network of friends and business associates.
The issue of angel investors is characterized by a growing number of research questions of interest, hence limiting the issue to one definition. Initially, a distinction between investments made by institutional venture capital investors and investments made by business angels. Wright and Robbie (1998) defines institutional venture capital as "Professional investors of long-term, unquoted, risk equity finance in new firms where the primary reward is eventual capital gain supplemented by dividends". Mason and Harrison (1999) states that "the institutional venture capital industry companies full-time professionals who raise finance from pension funds, insurance companies, banks and other financial institutions to invest in entrepreneurial ventures. Institutional venture capital firms take various forms: publicly traded companies, 'captive' subsidiaries of large banks and other financial institutions, and independent limited partnerships."
Lerner (2000) defines a business angels as "a wealthy individual who invests in entrepreneurial firms. Although angels perform many of the same functions as venture capitalists, they invest their own capital rather than that of institutional or other individual investors"
Mason and Harrison (1994) describes business angels as "a high net worth individual, acting alone or in a forma lor informal sydicate who invests his or her own Money directly in an unquoted business in which there is no family connection and who , after making the investment, generally takes an active involvement in the business, for example, as an advisor or member of the board of directors".
Mason et al. (2004) emphasizes the business plan as the first step for the decision of angel investors. They point out that business plans should be prepared under different perpectives since bankers, venture capitalists and business angels consider different investment criteria. Bankers consider financial aspects as more important while giving less weight on entrepreneurs, amrket and other issues. Venture capitalists and business angels put a balanced weight on financial and market issues. Furthermore, business angels emphise entreprenurs and "investor-fit" more comparing to venture capitalists. Finally, they suggest that entreprenurs must prepare a business plan taking into account of seeking financing from business angels, venture capitalists or bankers.
Mitteness et al. (2012) investigate whether angel investors perceived passion play a significant role in investor funding decision making. They screened 64 angel investors in California region in the period of 2006- 2010. The angel investors examined 241 companies and made 3502 evaluations within the period. Angel investors deciden to fund 41 companies (17% of 241 companies). Out of 64 angels, 3 were femaile with a masters of PhD, and 42 had some startup experience, and more than half of angels held a graduate degree. The reserachers find a strong relationship and further state that the relationship is even stronger if angel investors are older, more intuitive, have open personality, those who are motivated to mentor.
Ding et al. (2014) try to explain why angel investors may have different selection criteria under different institutional environment. The work on Denmark and China to examine the comparetive institutional environment. They find that the relationship-based institutions are more common in China while rule-based intitutions are more common in Denmark. Angel investors in China give risks less wieght compared to those in Denmark and they tend to keep strong ties with the startup teams.
Aernoudt (2005) states that government policy to stimulate growth, innovation and creation of new companies/employment is mainly related to Access to finance through increasing suplly of capital. Hence, business angels play an important role in financing of seed and early stage of startups. The author suggests that government find out innovative ways to stimulate angel financing, and propeses seven ways for it; investor readiness, corporate
orientation, business angel networks, business angel academies and the integrated finance concept to cope with information asymmetry in between start-ups and investors.
Collewaert (2014) investigates how perceptions of entrepreneurs and business angels about the degree of trust in their relationships affect the further assessments. He studied 54 cases for venture investments. His findings support that the performance of of ventures is evaluated more positively if angel investors perceive high trust. Morever, the information quality exchanged in between angel investors and entrepreneurs has an impact on the level of perceived trust. He concludes that the level of perceived trust and quaility of information exchanged may result in further benefits or threts in relationships of angel investors and entrepreneurs.
Collewaert et al. (2016) examines 58 Belgian companies and 123 pres-money valuation investment rounds to see whether human capital of angel investors afftect the valuation. A higher level of human capital of angels is defined by studied in college longer years, have a business degree and more experience in entrepreneurship. They argue that a higher level of human capital of angels supports more value creating options, a higher value adding potential postinvestment and anhanced ligitimacy provided to the venture.
By using 419 exited angel investment in the period of 1972 and 2007, DeGannaro et al. (2014) calculated the expected returns for angel investors. They found that the expected returns for angel investors for the period are around 70% per year in excess of the risk free rate.
3. Characteristics of Angel Investors
Business angels differ from venture capitalists. Venture capitalists raise funds through private or public money to invest in businesses using managed funds. Venture capital firms incur a significant administrative cost that's why they need to be more selective to ensure a good return on the invested funds. Hence, they make less investments in startups and at seed stage. Therefore, business angels become more valuable by funding smaller amounts to businesses that can not be economically funded by the venture capital market. Angel investors normaly take equity shares in a business in return for providing funds. Angel investors do not only provide money to grow but also bring their experience and knowledge to push for success. Angels seek to exit over a period of 3-8 years. Table 2 shows the selection criteria of angel investors.
Apart from venture capitalists, business angels have different approach and smaller size of capital for risky funding. Business angels are concerned less about quick returns and exit over a short period of time but concerned more about engaging directly in due diligence, meeting in entrepreneurs and structuring legail investment documents. Angel investors may do these by themselves or in a sydicate. Later, angel investors actively involve in the investments by taking a sit on the board or cloesely supporting the business or acting passiveley as part of a group with a lead angel executing this role on their behalf. Table 1 below presents the differences in between venture capitalists and business angels.
Table 1. Comparison of Institutional Venture Capitalists and Business Angels
Key features Institutional Venture Capitalists Business Angels
Source of funds Primarily institutional investors who act as limited partners invest others'money. Private individuals that invest their own money
Responsibility Limited personal financial responsibility but responsibility to management and owners Significant personal financial responsibility
Investment experience and capacity Considerable investment experience and investment capacity Little investment experience and limited investment capacity
Time for due diligence Extensive time for due diligence Limited time for due diligence
Investment stage Mostly later stage Early stage
Operational engagement Some hours per month Some hours per week
Exit strategy Very important Less important
Length of holding period 3-5 years 3-8 years
Source: Avdeitchikova, S., H. Landstrom, N. Mansson, (2008)
Companies can be candidates for angel investors at the stage of pre-revenue, pre-profit or profit-generating. The candidates at the stage of pre-revenue need to prove their concept. The candidates should build a defensive position by acquiring use of copyrights, legal registration of brands or patents. The candidates at the idea stage of idea are generally not in the scope if angel investors. Family members or friends may be the investors for this stage.
What angel investors look for in an investment candidate is listed below. The most significant aspect for angel investors evaluating a business for investment is the composition of the startup team; their experience, skills, motivation, what brings them together. Angel investors also carefully examine the core aspects of the business plan. A startup candidate may not meet all of the considerations below but is expected to meet at least five of these to have a good starting point for a positive evaluation. (www.ukbusinessangelsassociation.org.uk/services-for-entrepreneurs)
1. Whether the technology, service or product solving a problem.
2. Whether it is likely to make a real impact in the market.
3. Whether the technology or product has an identifiable intellectual property.
4. Whether it possesses a defensible market position. Whether it has first mover advantage.
5. Whether there exists a clear and identifiable money generating model. Whether profits margins are satisfactory.
6. Whether the business model is scalable and can achieve explosive growth.
7. Whether the business model has been tested with potential customs.
8. Whether the market size is sufficient to achieve a realistic market share.
9. Whether the deal is legally eligible.
10. Whether the entrepreneurs have desire and strategy to exit.
11. Whether the entrepreneurs willing to give up shares in return for investment and to have new investors on the board.
Table 2 below shows the selection criteria of angel investors. The table presents simplified evaluation descriptions for criteria considered by angel investors.
Table 2. Selection Criteria of Angel Investors
Variables Description
Source of business plan Startup Team / Personal Friends / Professionals
Investment return Low / Medium / High Return
Risk of failure Low / Medium / Huge Losses
Relationship between investors and members of startup teams Strangers / Friends / Family
Compatibility with investor expertise and interest Low/ Medium / High Compatibility
Startup team capabilities and track record No Good / Good / Very Good
Opportunity for involvement in new venture Not at All / Likely / Very Likely
Exit plan No Exit Plan / Exit Plan Exists
Source: Ding, Z., S. L. Sun, K. Au. (2014).
Figure 1. Stages of Startups
Figure 1 above illustrates the stages of startup company. Project evaluation is the first evaluation of market and technology. This stage includes a brief definition of R&D program and first assesment of the team and missing skills. The second stage is the developing a business concept. This stage covers a detailed definition of R&D programs, exit strategy, capital needs, and writing a business plan including detailed evaluation of markets and techology. The third stage is the team assesment including identification of missing skills, and recruitment of additional team members.The fourth stage is need for seed financing to pay for initial activities and secure the position. It is generally financed by entrepneurs or founder angels. The fifth stage is for the establishment of the startup company. The entrepreneurs evaluate the options about the legal form of the company and steer the founding process. The stage six is about building up the organization. The entrepreneurs evaluate the needs and constraints and then define the company processes and structures. The stage seven requires a business development based on the industry experience and network. The stage eight is for planning of investment round and searching for suitable investors, business angels or venture capitalists. This stage involves negotiations of conditions, contracts nad growth financing for the company. The stage nine is the movement to a structured comany by recruitment of additional management team members.The stage ten is for evaluating convinient exit options and planning of exit strategy.
4. Angel Investors in Turkey
4.1. Qualifications of being an Angel Investor in Turkey
Angel investor system is introduced in Turkish markets by June 2012. New law enacted by the Turkish Parliament in June 2012. Business angels are approved to operate in Turkey under the authorization of Treasury. The same law launches a temporary article in relation to tax incentives for business angels. The tax incentives for business angels indicates 75% participation shares qualifying Turkish resident joint stock companies held by business angels can be deducted from business angels annual income tax base in the related calender year which is capped at TRY 1,000,000. In order to benefit from tax reliefs, business angels is obliged to get a license from Treasury. Operations of the corporations financed by business angels should make a declaration to the treasury before the investment is made. Treasury underlines the features of the investors for licensing as wealth and experience (PWC, Business Angels in Turkey, Asset Management Bulletin, February 2013). For wealth qualifications; investors whose annual income is at least TRY 200,000 within the last two fiscal years or investors whose total amount of wealth including every type of moveble and immovable assets is at least TRY 1,000,000 are licensed.
Qualifications related to experience of angel investors; ■S investors are required to have at least 2 years of experince as fund manager
investors who work at least as deputy general manager or a higher position in a company with the annual turnover of at least TRY 50,000,000.
Investors who have been members of an business angels network for 2 years and who have been shareholders in a non-public firm as angel investors for 3 years before getting the license.
Table 3 below show the number of licences are approved by the Turkish Treasury over years. The table indicates that the number of angel inevstors licenced in 2013 and 2014 were high compared to the ones later years.
Table 3. Number of Angel Investor Licences Approved in Turkey
Year Number of Licenses
2013 155
2014 120
2015 69
2016 (april) 29
Total 323
3.2 Investment Outlook for Turkish Ecosystem
According to Treasury statistics, the licenced business angels have invested TRY 277,500 on the average for a average of 10% shares since June 2013. The firms that business angels invested consist of 92% of micro firms (less than 10 employees) and the other 8% of fims with 10-50. The number of founder/owners of firms receiving external funding from angel investors is listed in Table 4. It looks that the most startups have less than 5 entrepreneurs in the founders team.
Table 4. Number of Founder/Owners of Firms Received External Funding from Angels Investors
Number of founders / owners Percentage
< 5 42%
5-10 23%
>10 35%
Table 5 and 6 below present the industries that startups initiates and allocation of invested funding among expense items. The most attactive industry for startups in Turkey is the software creation and developing. More than half of startups initiated in software sector. E-trade and data mining appear to be two other popular industries attarcting angel investors. The startups allocate a half of external funding received for staff expenses (50%). The startups leave only 10% for equipment and 7% for marketing and sales activities.
Table 5. Industries of Startups Received External Funding
Operations Percentage
Software and developing 54%
E-trade 23%
R&D 4%
Database mining 11%
Other 20%
Table 6. Budget Allocation of Invested Capital
Expense Item Budget Share
Staff Expenses 50%
Machinery and Equipment 10%
Marketing and Sales 7%
Inventory 4%
Other Operating Expenses 5%
Rent 3%
R&D 1%
Other 20%
Table 7 presents the average net income expectations for the next three years of the startups received angel funding.The startups are expected to report an average loss of TRY285,000 in the first year, then an average of profits of TRY 611,000 and TRY 2,580,000 in the second and third year, respectively.
Table 7. Average Expected Net Income of Startups for the Next 3 Years
Year Average Expected Net Income (TRY)
1 -285,000
2 611,000
3 2,580,000
Source: Turkish Treasury
Table 8. Angel Investmets by Country (Year 2013)
#BAs # BANs BA Investment M€ BA Inv. 2012 M€ Jobs Created Ave. Investment Per Company (€) Ave. Investment Per BA (€) Ave. Investment Per BAN (M€)
UK 4350 38 84,4 68,3 2354 157.757 19.402 2,2
Spain 2520 63 57,6 62,5 1485 235.102 22.857 0,9
Russia 220 13 41,8 N/A 808 253.030 189.773 3,2
France 4320 83 41,1 40,9 1807 109.176 9.502 0,5
Germany 1510 37 35,1 27,9 916 189.838 23.258 0,9
Finland 490 12 26,4 28,4 916 126.683 53.776 2,2
Sweden 762 11 19,4 23,2 506 175.909 25.394 1,8
Turkey 450 10 14,7 10,5 400 240.984 32.667 1,5
Portugal 611 13 13,8 11,6 497 189.000 22.581 1,1
Switzerland 424 7 13,3 11,6 130 302.273 31.368 1,9
Ireland 480 6 13,2 12,1 286 222.966 27.406 2,2
Denmark 155 5 11,8 N/A 539 115.882 76.258 2,4
Belgium 350 6 10 5,1 332 149.254 28.571 1,7
Italy 760 11 9,9 11 282 230.233 13.026 0,9
Netherland 810 11 9,8 10,1 281 169.310 12.123 0,9
Poland 160 4 6,6 N/A 233 173.158 41.125 1,6
Estonia 52 1 4,7 N/A 457 56.108 89.558 4,7
Norway 110 3 4,2 N/A 88 222.105 38.364 1,4
Austria 240 2 2,9 N/A 132 121.000 12.100 1,5
Bulgaria 52 2 2,9 N/A 163 77.027 54.808 1,4
Greece 52 2 2,1 1,5 99 116.667 40.385 1,1
Lithuannia 80 1 2 10,9 77 112.556 25.325 2
Luxembourg 80 1 1,6 0,3 59 94.118 20.000 1,6
Crotia 25 1 0,8 N/A 42 75.000 30.000 0,8
Serbia 25 1 0,7 0,7 28 108.333 26.000 0,7
Cyprus 39 1 0,6 N/A 14 310.000 15.897 0,6
#BAs : Number of Busines Angels
# BANs: Number of Business Angels Networks
Table 8 presents a country wise comparison of number of angel investors, angel investor networks and some average investment indicators. As exhibited in the table, UK, France, Spain and Germany have higher number of business angels and angel networks. UK and France have 4,350 and 4,320 business angels, and 38 and 83 angel networks, repectively. Turkey has 450 business angels while having 10 anhel networks. Business angels investment amounts are about €84 million and €41 million in UK and France, respectively, while it is about €15 million in Turkey. The business angels in Turkey financed a total of 61 companies and created 400 new jobs. The average amount of investment per company is around €158,000 in UK while it is around €241,000 in Turkey. The average investmen amount per business angel is around €19,000 in UK while it is around €33,000. These figures show that Turkey has much less number of business angels compared to UK but business angels in Turkey employ higher amount of capital for their invetsments.
5. Conclusion
The practical contribution of this research may be to help policymakers promote and create good entrepreneurship policies and environment. Although weak legal protections and contract enforcement may force entrepreneurs and investors to have strong ties/relationships, it is not an institutional solution. Institutional rule based environment could extend the scale and scope of angel investors. The legal environment in Turkey for venture capital market is introduced with the national act of 2013. Since then the market has soared quickly. This is evitable in the number licensed angel investors, number of business angels and amount of angel investments. It is widely accepted in the literature that venture capital and business angels provide significant contribution in economic growth and technological advancement. Hence, the policymakers in Turkey ought to notify the importance of venture capital and provide a strong support for the enhancement of the ecosystem.
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