Think at London Business School
Thursday 13 February 2020
How research into entrepreneurial finance is shaping the world
By Luisa Alemany
I’ve always been interested in investors who are drawn to risk, disruption and new innovations.
Most investors like some risk in their portfolio as more risk, in general, translates into more return. At least, this is what traditional corporate finance theory teaches us.
What does it mean when risk capital investors take risks? Is it an individualistic and selfish endeavour or does society benefit? I believe we should not just understand the entrepreneurial, risk-taking mindset but harness it for society.
In my previous life as a venture capital (VC) and private equity (PE) investor, I was intrigued to learn whether these investors were creating value for the society as a whole or merely making huge returns for themselves and their backers.
In fact, I have devoted several years of my life to this question. Many academics before me have tried to measure the economic and social impact of venture capital and private-equity-backed companies and it wasn’t an easy task.
Firstly, it is difficult to identify the companies that receive venture financing. Secondly, even if you have the list, these are small private companies, so data on them is not easily or publicly available.
Those who had tried to measure the economic impact looked at companies that have made it to the capital markets through an IPO. But those firms don’t represent the universe of companies that receive venture funding. They are the best in class, the ‘home-runs’, the outliers. If things go well, only one out of 10 start-ups might make it to the very top.
The main challenge was to have objective data of a representative sample of the companies that received this alternative type of financing, compared to traditional debt from banks. The sample needs to include companies that have already failed, or have been bought.
“We are looking now at some theories from psychology, such as double bind theory, role congruity and stereotyping to try to make sense of the results”
Then, we need to measure the growth in terms of sales, employment, innovation, or even amount of taxes paid.
But what if the numbers were looking great because the economy was booming? Would I be measuring correctly the impact of the venture capital and private equity in the economy? Clearly not. We needed to compare the results to a similar group of companies that were financing their growth with traditional sources and then analyse the differences.
The results were dramatic in terms of the economic impact of VC and PE on the economy. My PhD dissertation became the basis for an annual study that has strengthened the argument better for legislation and in the medium term boosted investment into the sector.
Another topic of research that caught my interest in 2007 was the then-emerging field of what is now known as ‘impact investing’.
I wanted to understand the business models and the motivations of these new venture capitalists who were willing to take lots of risks without expecting a financial return. These investors were applying the same techniques in VC financing but to social enterprises.
The main issue in VC investing is ‘moral hazard’ and ‘agency theory’, or how to protect the investor from an unscrupulous entrepreneur’s deeper knowledge.
But, in the case of philanthropic venture capital, we are referring to investors who are in the search for social impact. They are interested in supporting high-growth social enterprises until they are self-sustaining.
From studying these investors for more than 10 years now, I have some findings that have some wider implications. For example, agency theory (the idea that the entrepreneur/management team might want to steal my money) does not apply. Here, rather, it is stewardship theory, where the investor becomes a steward to the social enterprise.
The main implication of this finding is the type of instruments and contracts used between the parties are very different and have to be adjusted to the different goal.
Currently, I’m researching the influence of human capital on the risk profile of venture philanthropy investors. The preliminary results are very intriguing, and we are now in the process of explaining them.
“Having an entrepreneurial mind-set is not only about starting companies, but a way of meeting life’s challenges”
Contrary to expectations, the more experience the team has in commercial, financial or consulting, the less risk they take. Those coming from the social sector and teams with more women on their teams are more willing to take risks.
We are looking now at some theories from psychology, such as double bind theory, role congruity and stereotyping to try to make sense of the results.
Why would somebody who has been working in finance most of their life suddenly as a social investor take less risks? Are they trying to seem less aggressive?
Why do teams with more women and those coming from the social sector take more risks when investing in social ventures? I’ll keep you posted on the final results.
Finally, another topic that I’ve worked on in the past and that I will be embracing again is the subject of entrepreneurship education among schoolchildren.
In fact, having an entrepreneurial mindset is not just about starting companies, it is a way of meeting life’s challenges. It is about being creative, taking risks, believing in oneself, being optimistic and not being scared of failure.
Back in 2010, with a team of experts in pedagogy and philosophy, we launched a project in Spain with the Princess Girona Foundation to develop a programme to help teachers in schools maintain and develop entrepreneurial traits and skills in children from the age of four up to university.
It is too early to tell what long-term impact this project will have. But I believe equipping children with these skills is important work because those who understand, manage and above all take risks push society forward.
Luisa Alemany is Associate Professor of Management Practice in Strategy & Entrepreneurship and the Academic Director of the Institute of Innovation and Entrepreneurship at LBS. She is a co-author on Entrepreneurial Finance: The Art and Science of Growing Ventures, the first European textbook on the topic.