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140. Samuele Murtinu: How Low Time Preference Elevates the Investment Returns of Family Corporate Venture Capital

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Family businesses play a major role in the US economy. According to the Conway Center, family businesses comprise 90% of the business ventures in the US, generate 62% of the employment in the nation, and deliver 64% of US GDP.

And, they’re good at venture capital. Samuele Murtinu, Professor of Law, Economics, and Governance at Utrecht University, visits the Economics For Business podcast to share the findings and insights from his very recent analysis of venture capital databases.

Key Takeaways and Actionable Insights

Corporate venture capital is a special animal.

There are many types of venture capital. Professor Murtinu focused first on the distinction between traditional or independent venture capital (IVC) and corporate venture capital (CVC). Independent venture capital funds are structured with a general partner in the operational, decision-making role, and investors in the role of limited partner.

Corporate venture capital funds are fully owned and managed by their parent corporation. The CEO or CFO of the corporation typically appoints a corporate venture capital manager, who selects targets, conducts due diligence and so on from a subordinate position in the corporate hierarchy.

The important difference between IVC and CVC lies in objectives and goals. IVC goals are purely financial — the highest capital gain in the shortest possible time. CVC funds often have strategic goals in addition to, or substituting for, financial goals. These strategic goals might include augmenting internal R&D capabilities and performance, and accessing new technologies and new innovations, or entering new markets.

Another form of CVC licenses patented technologies to startups in cases where the corporate firm does not have the capacity to exploit the IP, but can oversee the implementation at the startup with a view to further future investment or acquisition. This is the method of Microsoft’s IP Ventures arm, for example.

Typically, IVC investments are easy to measure against financial performance benchmarks or targets. CVC’s strategic investments are harder to measure. Goals such as technology integration are too non-specific to measure, and normal VC guardrails like specified duration of investments are not typically in place and so can’t be used as benchmarks. On the other hand, CVC investments often expand beyond the financial into strategic support via corporate assets such as brand, sales and distribution channels and systems.

Corporate venture capital out-performs traditional venture capital in overall economic performance.

Professor Murtinu’s performance metric in his data analysis was total factor productivity — performance over and above what’s attributable to the additions to capital and labor inputs. IVC’s performance for its investments was measured in the +40% range, and CVC’s was measured at roughly +50%. IVC performs better in the short term, while CVC performs better in the longer term. This difference reflects the lower time preference of CVC. It extends to IPO’s: corporate venture capital funds stay longer in the equity capital of their portfolio companies in comparison to independent venture capital.

Family CVC is another animal again — and even higher performing than non-family CVC.

Professor Murtinu separated out family-owned firms (based on a percentage of equity held) with corporate venture capital funds for analysis. Some of his findings include:

  • They prefer to maintain longer and more stable involvement in the companies in which they invest.
  • They prefer to maintain control over time (as opposed to exiting for financial gain).
  • They look to gains beyond purely financial returns, including technology acquisition / integration into the parent company and/or learning new processes.
  • They are more likely to syndicate with other investors, for purposes of portfolio risk mitigation.
  • They target venture investments that are “close to home” both in geographic terms and in terms of industries closely related to their core business.

The resultant outcomes are superior: a higher likelihood of successful exits (IPO or sale to another entity), and a greater long term value effect on the sold company after the IPO or exit. Further, there is evidence from the data of a higher innovation effect for Family CVC holdings, as measured by the post-exit value of the patent portfolio held by the ventures.

Family CVC is resilient in economic downturns. During the last economic downturn, family CVC invested at double the amount of corporate venture capital, reflecting family businesses’ preference for long-term investing and for control.

The lower time preference of family businesses and family CVC is crucial for the achievement of superior financial performance, especially in the longer term.

Family CVC’s lower time preference and longer investment time horizons result in beneficial effects. Ownership in the venture companies is more stable, and the value effect after IPO (when family CVC stability continues because these funds stay in the post-IPO company longer) is significant.

Professor Murtinu relates this phenomenon to Austrian economics. The longer time horizon permits a closer relationship between investor and entrepreneur — it develops over time — and their subjective judgment about the future state become more aligned. Frictions and information asymmetries are reduced, and a shared view of the future emerges. This stability can scale up to the industry level and national level when there are more family CVC funds at work. Instead of pursuing unicorns and gazelles, an environment more conducive to duration and resilience is created.

Additional Resources

“Types of Venture Capital” (PDF): Download PDF

“Families In Corporate Venture Capital” by Samuele Murtinu, Mario Daniele Amore, and Valerio Pelucco (PDF): Download Paper

129. Samuele Murtinu on How and Why Governments Fail in Venture Capital

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Governments would like to take credit for the level of entrepreneurship in their countries. Entrepreneurship leads to value creation (happier voters) and economic growth (more to tax). But, as Per Bylund points out in the Seen, The Unseen And The Unrealized, governments’ actions restrain entrepreneurship.

Dr. Samuele Murtinu joins the Economics For Business podcast to explain both how and why governments fail in their best efforts to help entrepreneurial businesses succeed.

Key Takeaways And Actionable Insights

Europe has an entrepreneurship problem.

European economies exhibit lower growth rates than the US. At the firm level, there are fewer unicorns, and fewer new technology-based firms or innovative startups and innovative ventures in general. Venture capital markets are very thin, and most venture financing is debt, which is (as Sergio Alberich described in Episode #123: Mises.org/E4B_123), a poorer choice for startups and young firms than equity.

Consequently, European countries see a lower level of innovative startup behavior. Existing firms have low levels of R&D spending. And, generally, there is an inability to turn the innovative inputs that are available into innovative outputs — new markets and industries tend not to emerge in Europe first.

And the European mindset tends to favor the idea of the entrepreneurial state — the state is thought to be where good ideas and good initiatives come from.

Governments see launching their own venture capital funds as a new means.

The key idea of the entrepreneurial state is deep involvement in economic affairs, including funding basic research, financing, shaping and directing R&D investments, and thereby creating new markets. The centrally coordinated state is seen as the driving force for the development of innovation and technological progress. For this mindset, government venture capital seems to be an available means. So governments start and implement venture capital funds — the terminology is Public Venture Capital.

These are companies and funds that are fully owned, fully funded (no limited partner structure) and fully managed by government bureaucrats, with the purpose of investing in innovative startups.

Firstly, Governments get the concept wrong at a fundamental level: they have the wrong goals.

Private venture capital funds and even hybrids like sovereign wealth funds have clear goals: rapid, high-level capital appreciation by investing in startups at an early stage and exiting as quickly as possible in a liquidity event such as a commercial sale or an IPO.

Government venture capital may have “social” goals such as encouraging industry sectors, favoring regional technological development, boosting economic growth, and providing jobs. These are vague and unclear, and may contradict individual company business plans (such as automation and minimization of labor costs). With the wrong goals, it’s impossible to succeed.

For example, the selection process for private VCs choosing firms for fund portfolios is rigorously goal-directed and VC firms have honed their candidate identification and due diligence processes in order to maximize their chances of winning from the very first steps in the investment process. Government funds lack this clarity and therefore can’t develop the requisite expertise.

Governments have difficulty letting go of control.

Private VC’s have also honed the role of the contract between them and the firms in which they invest, and with the limited partners who provide the investment capital. The contract with the startup firms is as “hands-off” as possible (see, for example, the SAFE contract — Simple Agreement For Future Equity — available for free download and free use from the Y-Combinator website: YCombinator.com/Documents) and the contract with Limited Partners gives them no role in the management of the fund. Private VC’s understand that high levels of control are not appropriate to the adaptive management of immature firms in rapidly changing environments.

Government bureaucrats directing investments in startups are averse to this kind of hands-off management.

Governments can’t get incentives right, and consequently can’t hire the best executives.

Private VC managers are highly incentivized. In the largest and most successful funds, they receive high salaries and a 20% participation in fund appreciation. The best individuals from the most prestigious business schools are hired to compete with their peers for promotions and partnerships. The most successful funds attract the most capital from the deepest pocketed sources, and the cycle of success rolls on.

Public VCs can’t attract the same quality of human capital. Typically, managers are paid a fixed salary, which can’t be seen as out-of-bounds from the perspective of bureaucratic rules and standards. If there are bonuses, they are calculated in what Professor Murtinu called a “gloomy” way. No-one is going to break any income-equity norms.

Professor Murtinu’s rigorous data-rich analysis proves beyond any doubt the failure of Public Venture Capital.

In order to analyze Public Venture Capital performance, Professor Murtinu utilized the VICO database, a comprehensive data set about venture capital backed companies in high tech industries in seven European countries. He reinforced it with additional data sources, and was able to run a comparison of the performance of firms that received public venture capital backing and those that received no venture capital. The data sets covered 25 years.

The result: no statistical difference between the performance of the two sets of firms. Public Venture Capital had no effect. It was a waste. This was true across all possible variables: productivity, whether total factor productivity or partial factor productivity like labor or capital, sales growth, employment growth, innovation outcomes, exits.

The opposite is the case for private venture capital backed firms. In the same kind of analysis, private venture backed firms are statistically superior on every dimension. The overall impact of private venture capital is very clear and highly positive.

There is one possible step in the right direction: government becomes a limited investor.

Public venture capital can syndicate with private venture capital, and so long as the investment is less than 50% of the fund total, and has no say on selection of investments, on due diligence, on governance, on monitoring, and on timing or type of exits, it is possible that the investment outcome can be positive. The European Commission is currently considering this role for Public Venture Capital.

Additional Resource

“Public vs. Private Venture Capital” (PDF): Download PDF

123. Sergio Alberich on Capital Structure and Capital Flexibility

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The proper selection of a firm’s financial source does not guarantee its success, but the wrong one assures its failure.

Austrian capital theory delivers actionable insights for business. Austrian theory emphasizes capital’s economic role in generating customer revenue flows. Since these flows are variable, entrepreneurial capital must exhibit a capacity for agile and flexible combination and re-combination to keep revenue flows refreshed and current, Since capital structure plays an important role in entrepreneurial judgment, decisions, and action, it must support fast, flexible and unconstrained decision making. Businesses can benefit from their understanding of capital through this Austrian lens. Sergio Alberich helps the Economics For Business podcast listeners, and business practitioners in all kinds of businesses at all stages for their development, to Think Austrian in matters of capital structure.

Download The Episode Resource “Austrian Capital Financing” (PDF) – Download

Key Takeaways & Actionable Insights

Entrepreneurs designing a firm’s capital structure should view their choices through the twin lenses of ownership and control.

Ownership and control are tradeable assets for the entrepreneurial firm. In order to obtain capital financing, one or the other or both might be offered up by the entrepreneur or requested by the financier.

How will shared ownership play out now and in the future? Will ownership imply only a share in any future returns? How great a share is the entrepreneur willing to trade? What will it feel like to receive only a portion of the return the entrepreneur worked for? How much more ownership will be given up in future financing rounds?

Can ownership be traded without any loss of control over decision-making and future investments? Alternatively, how much control should be traded? A board seat? An investment committee? The financier wants the entrepreneur to be free to make the decisions for which he or she is best-informed and most capable, and yet wants to be protected from managerial error.

There are many factors that can stand in the way of capital flexibility, and organizational issues of ownership and control become paramount.

Debt and equity are the basic choices as building blocks of capital structure.

Debt and equity are basically different kinds of contracts between the individuals managing / operating a project and those funding it. Debt is a fixed claim with a known annual return to the debt holder. Typically, the debt holder has no control over management decisions and is not involved in managing the company (although there are some covenants that can be written to provide some distant control).

The return on equity for the financial investor is residual, after debt repayments are made, leaving entrepreneurs relatively free to allocate costs and direct operations. But equity holders typically hold voting rights, and can therefore exercise some control in some circumstances. They may also exert strong influence on management decisions based on relationships. For example, family and friends investors may exert special relationship influence.

There are some debt-equity hybrids — most notably convertible notes, debt that is convertible into equity at some future stage or event. The negotiation of this instrument brings more complexity to the ownership-control debate, while giving the entrepreneur leeway to consider issues of valuation in the future rather than at the current financing.

Entrepreneurs must also consider human factors, especially the number of people in the capital structure.

Another major consideration for entrepreneurs is whether to raise debt or equity from a few people or many (e.g., via IPO or a bond that hedge fund investors can buy). Raising capital from large numbers of investors creates categorically different situations for the entrepreneur. An IPO, for example, can not be a highly tailored instrument. Institutional conventions and regulatory rules impose many requirements about how entrepreneurs and their managers communicate, how they frame financial risk, and about the nature of widespread shareholder engagement they take on. Just think of the interaction of Elon Musk on Twitter, with the SEC, and with short sellers.

In general, the fewer the number of investors, the greater the operating flexibility for the entrepreneur. There are fewer people to convince when business seeks to make a major change, or to pivot.

Sergio Alberich outlined 4 levels of consideration for the financial investor providing capital to the entrepreneurial firm.

Level 1: How are the factors of production combined in the firm, and how might the combination change in the future? Elements of this level of consideration include the stage of business in its growth journey and the assessed maturity of its business model, industry, and competitive set; the nature of the business’s relationship with partners, suppliers, channels and customers; and the state of knowledge regarding product, service and market development.

Level 2: What is the nature and scale of cash flows now and in the future? Are there mature, reliable cash flows? Is one part of the business a drain on cash resources? Is cash coming in from investments for operating expenses (which are not really flexible).

Layer 3: What are the possibilities for returns? Both entrepreneurs and investors seek profit – not just accounting profit on the P&L but returns on equity. At an early stage, a company may worry about generating future cash flows and less about the cost of equity (in terms of sacrificed future returns) to finance growth. A more mature company with cash flows in the present pays much more attention to the cost of equity, and to cost of capital in general, seeking to preserve as much return as possible.

It is often the case that entrepreneurs give up too much equity in order to secure early stage venture capital funding, whether directly of via convertible loans. To keep the entrepreneur motivated with equity that promises future returns, it is best for them to deal with just a few investors who understand this motivation.

Organizational design is relevant, too. For example, a law firm with 100 partners, each of whom own 1 share, and limit their business model collaboration to sharing real estate costs and IT expenses, while effectively running 100 projects, might be creating a politicized nest of vipers. A partnership with shared equity in one business, where everyone stands to lose a lot if there is a bad decision, is likely to be much more collaborative, conducting a unified business, rather than acting as a co-operative of individuals sharing costs.

In the end, subjectivism in entrepreneurship prevails.

As we emphasized in episode #108 (see Mises.org/E4B_108), businesses perform best when entrepreneurs are free to make subjective decisions. The proper source of capital is one that most enables this subjective freedom, which may not be the optimum source based on spreadsheet calculations. Subjectivity and entrepreneurial judgement are not math. The best economic role of capital finance lies in helping entrepreneurs make better human subjective decisions. This is the essence of the means-ends calculation for both entrepreneurs and investors. Austrian economics gives by far the best guidance on this economic role of capital.

Additional Resources

“Austrian Capital Financing” (PDF): Download PDF

“Austrian School vs. Neoclassical School” (PDF): Download PDF

114. Pete Farner on Investable Businesses and Investable Entrepreneurs

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Veteran venture capital investor Pete Farner distills experience from four decades of entrepreneurship and investing on the Economics For Business Podcast #114. Passion, perseverance and intelligence are the three critical attributes he looks for in investable entrepreneurs, an insight drawn from a broad survey that we summarize here.

Key Takeaways & Actionable Insights

Download The Episode Resource 10 Attributes of Investable Entrepreneurs and Businesses – Download

1. The entrepreneurial mindset develops in youth. It is averse to the restrictions experienced on the subordinate levels of the corporate hierarchy.

In an early experience that several E4B podcast guests have shared, Pete grew up in an entrepreneurial household and absorbed the approach. He created several independent job opportunities in high school and college, including house painting and taxi driving and trading classic cars. When he joined a corporation, he quickly understood that a life in the hierarchy requires you to do as exactly as ordered by superiors, an experience incompatible with the entrepreneurial mindset.

In that brief corporate experience, Pete was able to observe that even the highest levels of the executive ladder are occupied by mere humans, with all their quirks and flaws, and not by superhumans. This observation can translate into the self-confidence of being able to tackle any business undertaking oneself.

2. Taking the entrepreneurial route is not risk-taking. In fact it’s the opposite.

Pete suggested that entrepreneurs are not risk-takers. They are, in fact, risk-averse. They typically do not take great personal risk or financial risk. If their business does not achieve the success they imagined, they seldom “lose all”, and their financial risk is often shared with others or syndicated in some way.

Entrepreneurs deal with business uncertainty. They embrace it. They are comfortable with what Pete called the ambiguity of entrepreneurship. That’s not risk.

3. Develop a knowledge space from which to begin your entrepreneurial journey.

Pete’s corporate experience was in the beer industry. That knowledge space included the use of neon signs for advertising and display purposes. He was also able to observe the use of etched mirrors in bars along with other forms of decoration and display such as sports memorabilia.

He launched his first entrepreneurial venture with a technological improvement on the conventional (and also expensive and fragile) neon sign. He merged this venture with a mirror and sports memorabilia company to give it greater breadth and market penetration. His first investor was a beer company.

We all curate a knowledge space as we go through life, and that space can provide the foundation for entrepreneurial initiative.

4. Entrepreneurial success lies on a time-and-place continuum.

What are the determinants of success for an entrepreneurial business? For a venture capitalist who is financing the business, the appropriate metric is a sale to an acquirer, who validates the worth of the entrepreneurial initiative. Surveying his experience of such acquisitions, Pete emphasized the relevance of time and place: being in the right place at the right time. Acquirers are ready for their own reasons at their own time. He discussed the sale of Minute Clinic, a walk-in in-store clinic staffed by nurse practitioners, to the CVS drug store chain. Minute Clinics were under-developed and unprofitable on their own, but a great marketing device to drive traffic to CVS’s highly profitable pharmacies.

On the other hand, Webvan, one of the most spectacular venture-financed startup bankruptcies, was ahead of its time in 2001, but could have been a standout success in 2021.

Business brilliance has a role to play in entrepreneurial success, but so do luck and timing.

5. Entrepreneurs widen and deepen their own knowledge space by making far and wide knowledge connections.

Entrepreneurship is a knowledge process. One entrepreneur, one team, one firm can have only partial knowledge. There might be a surrounding network of investors and partners to supplement the available knowledge. Successful entrepreneurs reach further, making connections in as many directions and to as many knowledge sources as possible. Syndicated investments with a wide range of partners can yield a lot of knowledge sources.

6. Specialization must be balanced with a broad-based understanding of business.

Differentiation can come from a specialized body of knowledge that the entrepreneur and partners bring to bear. In addition to this deep specialization, there must be a broad interest in starting, running, growing and managing a business. Entrepreneurs are T-shaped people — able to combine their specialist knowledge with boundary-crossing interest and capabilities in everything from accounting to HR to marketing, and especially the development of motivational purpose.

7. Personal qualities — and especially integrity — play an important role in success.

In Pete’s summary of success factors, “People are the real key”. As an investor, given the choice between a great business plan, a great idea, and a great person, “I’d choose the great person”. Integrity is a core attribute: the strength to go through growing pains, pivots, disappointments and adverse situations, and maintain belief.

Certainly these personal qualities can be more important to success than what Pete called “pedigree” — the degree from the right school, or the resume with the right corporations, or the well-credentialed board of directors.

8. Different personal qualities are appropriate for different stages of the entrepreneurial journey.

Pete observed that it is rare that the same individual who launches a business or manages it in its earliest formative stages is the same one to manage it to and through maturity. From start up to 8- or 9-figure revenues is a difficult transition for most people to make. It requires both decentralization of decision making and rigorous, detailed and disciplined operational management that are not always the strengths of originating entrepreneurs.

Nevertheless, the founder’s continued presence — in a significant role, not just a symbolic one — is a very important factor in the maintenance of mission and purpose for a young firm.

9. Revenue is king, especially when efficiently generated.

Revenue is the most important indicator of marketplace acceptance for an entrepreneurial service — proof that customers will buy what the business is selling. It’s a harbinger for the future: if there is a revenue stream, it can be grown.

Revenue — assuming cash flow is well managed — is the guarantor against the worst sin of entrepreneurial businesses, which is running out of cash.

Austrians know that the value of capital is the NPV of the flow of customer revenue it generates. Venture capitalists respect capital efficiency — a high ratio of revenue to capital.

10. Empathic customer understanding underpins revenue generation and capital efficiency.

It is the deep understanding of the customer and market that ultimately is the key to revenue generation. Pete talked about the medical device market where a misunderstanding of the incentives for surgeons — that they might not adopt a superior-performing device if they don’t make as much money using it as they do with the incumbent device — as an example of the battles that have to be fought and won for market acceptance, and might be lost with poor customer understanding.

Revenue generation is the primary indicator of customer understanding at work.

Additional Resources

“10 Attributes of Investable Entrepreneurs and Businesses” (PDF): Download Here

The Austrian Business Model (video): https://e4epod.com/model

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43. Can You Answer The Bar Fight Question? Vito Bialla Defines A Core Attribute Of Entrepreneurship

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When is entrepreneurship like being in a bar fight? Vito Bialla describes his own entrepreneurial experience and tells us how he assesses start-up CEO’s for his venture capital fund. Don’t miss his bar fight story! 

Key Takeaways and Actionable Insights

Immediately after he arrived home from fighting in the war in Vietnam, Vito Bialla started his executive recruiting firm, Bialla And Associates, from scratch. He built it into a professional partnership of the highest repute at the highest level (recruiting CEOs and other C-Suite positions) for the largest global corporations. He also started (and sold) a sportswear company and a Napa Valley winery, launched a venture capital fund, and he holds world records in endurance sports such as long-distance swimming, desert trail running and ultra-marathoning. He shared his thoughts about the pathways to success in growing a business, recruiting high-performing executives, and identifying high-potential entrepreneurs.

Grow Your Business

No hesitation: Quickly identify your field and your customers. Vito started his own recruiting business just 6 months after starting work for the largest global firm in the field. He knew what he wanted to do, and didn’t wait too long to start the journey.

No compromise: Identify the top customers and the highest standards, and choose those as your targets. No-one wants to buy second best.

No barriers: Vito described how he would get the CEO’s of the top global corporations on the phone (tip: call late at night when their gatekeepers have left) and engage them empathetically. He would build relationships with the best executives at the most successful and admired corporations. He built relationships with the best in business.

Recruit Executive Leaders

High Performance: Rather than personality traits or CV’s, Vito looks for performance indicators, especially under difficult conditions. An executive who has “bumped his or her head against the wall” – i.e. encountered unexpected difficulties – has acquired experience that will be tremendously valuable in all future situations, however tough.

High trust: These high-performance executives are found in high-performing corporations. An important signal is to be in a peer group of high performers and to have won their trust and admiration.

High empathy: If these high performers are to transfer into a new position with a new company, it is imperative that they be accepted into the new culture (rather than try to bring one with them). Empathy is key – to understand the new team and develop their confidence, even when (especially when) acting as the implementer of change.

Identify Entrepreneurs With High Success Potential

Un-structured: You can’t learn entrepreneurship in business school, or by working at a large corporation. Structure and process induce a way of thinking that is insufficiently flexible in responding to marketplace changes. The successful entrepreneur knows what to do in a bar fight when market conditions change radically, cash is running out and the current strategy isn’t working. (Don’t miss Vito’s own “bar fight” story.)

Un-plan: Plans are not particularly useful for entrepreneurs, especially those that are difficult to adjust. Adaptiveness beats planning every time. Vito looks for adaptive personalities (and evidence of previous adaptive behavior) in the entrepreneurs that he finances.

Un-deterrable: Vito’s number one rule is: No Fear. Fear of failure, he says, is unhealthy. Just do it, make something happen, set events in motion and learn from the results.

DOWNLOADS & EXTRAS

Vito Bialla’s Patters For Entrepreneurial Success PDF: Our Free E4E Knowledge Graphic

Understanding The Mind of The Customer: Our Free E-Book

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