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The Finnish Venture Capital Market Performance and Development

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Aalto University School of Science Master’s Programme in Industrial Engineering and Management Julia Jutila The Finnish venture capital market performance and development Master’s Thesis Helsinki, April 5, 2021 Supervisor: Markku Maula, Professor Thesis advisor: Matias Kaila, M.Sc., Suomen Teollisuussijoitus Oy (Tesi) AALTO UNIVERSITY SCHOOL OF SCIENCE INDUSTRIAL ENGINEERING AND MANAGEMENT Author: ABSTRACT OF MASTER’S THESIS Julia Jutila Title of the thesis: The Finnish venture capital market performance and development Number of pages: Language: 90 English Major: Major code: Strategy and Venturing SCI3050 Supervisor and instructor: Prof. Markku Maula Thesis advisors: Matias Kaila, Director of Fund Investments at Tesi The Finnish venture capital (VC) market and startup ecosystem are booming. 2019 was a record year in terms of the amount of funding Finnish startups attracted and the amount fundraised by Finnish VC funds. However, research on the financial performance and development of the Finnish venture capital market is scarce. For limited partners (LPs) and general partners (GPs) the lack of data can cause inefficient capital allocation. This study focuses on assessing the development and the financial performance of the Finnish venture capital market. The financial performance of the market is studied in terms of returns and their distribution, value development of companies after the initial investment and the effect of staging an investment on returns. The literature review provides background to the development of the Nordic VC market and benchmarks the Finnish VC market against other venture capital markets. The empirical analysis is done employing the Finnish Industry Investment (Tesi) database, with annual data from 2005 to 2019. The sample includes 483 initial investments and their follow-on investments, made by 33 Finnish VCs between 1997 and 2019. The results show that the positive development of the Finnish VC market and startup ecosystem has translated to higher financial returns from the asset class. Investments by fund vintages 1997-2001 have a multiple on invested capital (MOIC) of 0,6, while investments made by fund vintages 2008-2013 have a MOIC of 1,7. Investments made between 2012-2019 show earlier and higher value development than investments made between 2005-2011, indicating that the returns of funds that are currently active in the market have the potential to outperform earlier fund vintages. The results also show that VC returns are highly skewed and exhibit some degree of power-law abiding behaviour. Individual venture capital investments to startups are risky, but LPs can effectively reduce risk by diversifying their investments to several VC funds or through funds-of-funds vehicles. VCs can manage the risk related to the highly skewed nature of returns by staging investments, and a majority of a VC fund’s capital is allocated through follow-on investments. However, negative value development of startups is visible later than upside value development and defensive follow-on investing may be the only means to continue the operations of a company. Defensive follow-on investing can lead to avoiding losses, and thus the escalation of commitments is a phenomenon to be taken seriously. Keywords: private equity, venture capital, financial performance, return distribution, value development, staging of investments i AALTO-YLIOPISTO PERUSTIETEIDEN KORKEAKOULU TUOTANTOTALOUS Tekijä: DIPLOMITYÖN TIIVISTELMÄ Julia Jutila Työn nimi: Suomen venture capital markkinan tuotto ja kehitys Sivumäärä: Julkaisukieli: 90 Englanti Pääaine Pääaineen koodi: Strateginen johtaminen ja kasvuyrittäjyys SCI3050 Työn valvoja ja ohjaaja Prof. Markku Maula Työn ohjaaja: Matias Kaila, Johtaja, Rahastosijoitukset, Tesi Suomen aikaisen vaiheen kasvuyritysten pääomasijoitusmarkkina (VC-markkina) ja startup-ekosysteemi kukoistavat. 2019 oli ennätysvuosi mitattaessa suomalaisten kasvuyritysten ja suomalaisten VC-sijoittajien keräämän rahoituksen määrää. Tästä huolimatta Suomen VC-markkinan tuotoista on vain rajoitetusti tutkimusta. Tutkimuksen puute voi aiheuttaa pääomarahastoihin sijoittavien institutionaalisten sijoittajien (LP-sijoittajien) ja aikaisen vaiheen kasvuyritysten pääomasijoittajien (GP-sijoittajien) pääomien epätehokasta allokoitumista. Tämä tutkimus keskittyy Suomen VC-markkinan kehityksen ja taloudellisen performanssin tutkimiseen. Taloudellista performanssia tutkitaan tuottojen, tuottojakauman ja yritysten arvonkehityksen kautta. Lisäksi työssä tutkitaan sijoitusten porrastamisen vaikutuksia tuotto-odotukseen. Työ sisältää sekä kirjallisuuskatsauksen, että empiirisen tutkimuksen. Empiirinen tutkimus on tehty käyttäen Tesin tietokantaa, joka sisältää vuotuista kohdeyritysdataa vuosille 2005–2019. Otos sisältää 33:n suomalaisen VC-sijoittajan tekemää 483 ensisijoitusta, ja jatkosijoitukset näihin yrityksiin vuosina 1997–2019. Tutkimuksen tulokset osoittavat, että Suomen VC-markkinan ja startup-ekosysteemin kehitys näkyy parempana tuotto-odotuksena VC-sijoittajille. Vuosikertojen 1997–2001 VC-sijoittajien rahakerroin (MOIC) on 0,6, kun vuosikertojen 2008–2013 MOIC on 1,7. Lisäksi vuosina 2012-2019 tehdyt sijoitukset osoittavat nopeampaa ja korkeampaa arvonkehitystä kuin vuosina 2005-2011 tehdyt sijoitukset, mikä indikoi että tällä hetkellä aktiivisilla VC-rahastoilla on mahdollisuus ylittää aikaisempien vuosikertojen tuotot. Tulokset osoittavat myös, että VC-sijoitusten tuottojen jakauma on vinoutunut, ja tuotot osoittavat viitteitä potenssijakaumasta. Yksittäiset VC-sijoitukset kasvuyrityksiin sisältävät korkean riskin, mutta LP-sijoittajat voivat merkittävästi vaikuttaa riskiin sijoittamalla hajautetusti VC-rahastoihin tai sijoittamalla VC- markkinaan rahastojen rahastojen kautta. VC-sijoittajat voivat vaikuttaa riskiin sijoittamalla osan rahastosta ensisijoituksina ja osan jatkosijoituksina. Valtaosa VC-rahastojen pääomasta sijoitetaankin jatkosijoituksina yrityksiin. Kasvuyritysten negatiivinen arvonkehitys kuitenkin näkyy myöhemmin kuin kasvuyritysten positiivinen arvonkehitys, ja jatkosijoitus saattaa joissakin tilanteissa olla ainoa keino yritykselle jatkaa toimintaansa. Jatkosijoitukset yrityksen toiminnan jatkamiseksi saattaa kuitenkin johtaa tappioiden välttämiseen, ja sitoutumisen eskalaatio onkin vakavasti otettava ilmiö VC-sijoittamisessa. Asiasanat: pääomasijoittaminen, kasvuyrityssijoittaminen, tuotto, tuottojakauma, arvonkehitys, jatkosijoitukset ii Acknowledgements First and foremost, I want to thank my supervisor and instructor, Professor Markku Maula, for the expertise and support he has offered me throughout the journey. Thank you for all the practical guidance, theoretical background, and technical expertise. I want to give my heartfelt thanks to Matias Kaila from Tesi, for being my thesis advisor and guiding me throughout the process. I am especially thankful for the empathetic support and mentoring. I want to also express my gratitude to Petteri Laakso for helping me with any observations, questions or problems that arose especially while analysing the data. In addition, I would like to thank the rest of the Tesi team for enabling my thesis on this interesting subject. I enjoyed having the opportunity to connect with many of them during the journey. Finally, I want to thank my friends, family, and partner, Tapio. During my years at Aalto University, I have been lucky to find a group of inspiring and empowering friends, and the peer support especially during the thesis process was invaluable. Julia Jutila Helsinki, 25 April 2021 iii Table of Contents Acknowledgements List of Tables Abbreviations 1. Introduction ........................................................................................................................... 1 1.1. Background ................................................................................................................................ 1 1.2. Research objective and questions ............................................................................................. 4 1.3. Research design methodology and scope ................................................................................. 7 2. Literature review .................................................................................................................. 9 2.1. Definition of venture capital and startups ............................................................................... 9 2.2. The development of the Nordic and Finnish private equity market ................................... 10 2.2.1. Early stages of venture capital in the Nordics ...................................................................................... 10 2.2.2. The first and second coming of venture capital in Finland .................................................................. 11 2.2.3. The boom of the venture capital industry in Finland in the 1990’s and the dotcom bubble ................ 12 2.2.4. The modern startup and venture capital environment .......................................................................... 13 2.3. Finnish venture capital market performance ....................................................................... 14 2.3.1. Performance metrics ............................................................................................................................ 14 2.3.2. Finnish venture capital and private equity performance ...................................................................... 17 2.3.3. Comparable venture capital market returns ........................................................................................
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