Fundraising practices for technology-oriented SMEs in Belgium, with a comparison in the US

Details

Supervisors

HENRARD, Luc

Faculty

Louvain School of Management

Degree label

Master [120] en ingénieur de gestion

Abstract

The main objective of this thesis was to analyze the fundraising practices of the Belgian technology-oriented SMEs. At the same time, given their leadership and large dominance in this area, similar American small firms have been researched too, for a matter of comparison. The idea was to define which type of funding method was the most commonly used, at each development stage of such type of firms. Moreover, the results obtained from this research have been compared to both the Pecking order and Lifecycle theories, in order to confirm whether or not these statements were still valid for technology-oriented SMEs, both in Belgium and in the US. Once the owner’s funds, the personal savings and the capital brought by FFF has become not sufficient anymore in order to finance the operations of the tech SMEs, equity investing from business angels remains the most important source of external capital at this stage of development. Moreover, business angels are significantly more relevant for SMEs that are operating in the technology sector. Indeed, 80% of the Belgian angels are active in the high-tech sector, which makes it the main target of these private investors. Among the few reasons for this observation, the fact that the technology sector is a source of large potential growth, is one of the most important, as well as the strong barriers of this market and the patentability of tech projects which allows investors to protect themselves in case of success. Another interesting finding is the disparity between Flanders and Wallonia. On the €321 million raised in 2017, only 8% were from the south of the country. Pierre Rion, President of a network of angels, claimed in answer to this that investors were ready to provide capital in Wallonia, but the region was lacking high-potential projects. Concerning the situation in the US, where the tech sector has been ranked at the first place among the five most common industry sectors for angels (51%), business angels seem to have a strong connection with such type of SMEs too. Concerning the Pecking Order and Lifecycle theories, these results obviously go against the statements of both theoreticians, who suggested that equity was the last choice for SMEs when raising external capital. Indeed, a strong mutual connection and dependence between the business angels and technology-oriented SMEs have been observed in this thesis, both in Belgium and in the US. The importance that venture capital funds have in Belgium, especially for technology firms, is definitely questioning the validity of the two theories analyzed in this thesis. Indeed, a lot of research and studies, as well as the direct testimonies I had the chance to hear during the redaction of this paper, confirmed the fact that today, the fundraising of tech SMEs is mostly made through VCs investment, especially during their early growth. It has been proven by a study carried on by Bozkaya & Van Pottelsberghe in 2008, and confirmed both by Pierre Rion, a well-known business angel, and Alessandro Mazzocchetti, CFO of Odoo. While debt financing seems to be a relevant source of funding for SMEs of any kind, the situation looks slightly different for tech oriented-ones; not much room is available for banks and other financial institutions, at least for companies in early growth. However, despite the importance of VCs in this sector, the results of the conducted research seem to indicate that there would be an exodus of tech SMEs towards foreign VCs, such as from France, the UK or the US, when larger amounts are needed. Belgium is indeed a small country, and even though many VCs are asking for similar investments, many of them are unable to provide larger amounts of capital. In the US, given the size of the country, VCs are of course able to provide larger capitals when needed, and are also adept of equity financing. A study that has analyzed the financing preferences of small tech firms from their creation up to over a 6-year period has confirmed this hypothesis. So, just like in Belgium, tech SMEs do not seem to have the same financing pattern as non-technology-based ones, and use more equity than debt in the beginning of their operation. All this being said, the role of debt financing seems to play a less important role for tech SMEs. Banks and other financial institutions are indeed more reluctant to lend money to such risky enterprises. To consider obtaining a loan from Belgian banks, tech SMEs should reach a certain level of maturity and provide strong guarantees. As illustrated by the Odoo example, when the company was facing difficulties, even gathering money from VCs was challenging, and unthinkable from banks. But once good cashflow and results were recorded, VCs from all over the world were, and are still fighting to invest in their firms. In the US, the situation is exactly the same. Raising capital through debt adds financial risks to the company, which is not very appreciated by the managers, who prefer gathering money through equity, even if it involves giving up some shares. However, given the low interest rates that are applied in the world, it could be likely that tech SMEs take advantage of the trend and increase their indebtedness. In the US, the situation could be slightly different, as suggested the study of Robb et al. While analyzing financing preferences of American small tech firms, statistics seemed to indicate that debt financing was more commonly used by these type of companies at a more advanced stage. Indebtedness would be therefore somewhat more important than in Belgium. Finally, when a certain level of maturity has been reached, IPOs are a common way to raise larger amounts of capital. Or at least, they used to be. Indeed, going public was a common practice at the time, especially in the US during the early 2000s. But today, tech companies stay private longer than before, as they are able to raise large amounts. Become public is now used more as a sign of maturity and stability towards shareholders, rather than a financial need. In Belgium, a few exceptions still go public, particularly in the biotech sector, as these firms are constantly looking for as much cash as possible, to finance R&D. But globally, the number of Belgian tech IPOs has largely decreased. In the US, the situation looks the same. Only 40 tech IPOs were operating in 2018, which seems paltry compared to the 400 ones in 2000. As a conclusion, based on all these results and the feeling I have had during the several meetings I organized with people from the field, technology-oriented small firms have a promising future. Many aids have been implemented by the national government in Belgium, but also in the US, to help SMEs access pre-seed and seed capital. Business angels are also ready to invest, and are looking for promising and patentable projects. If an SME responds to these criteria, it should therefore not be challenging to obtain seed capital. Then, if the company is still operating and needs capital to finance its growth, venture capital funds seem to be the most commonly used solution in Belgium, as well as in the US. Considering both of these countries, although they look relatively different on paper, their fundraising practices for tech-SMEs surprisingly look very similar. This strengthens the statement that we live in an increasingly globalized world.