Financial System and Innovations: Determinants of Early Stage Venture Capital in Europe

This paper highlights the role of financial development in producing innovative products and services. Venture Capitalists (VCs) seem to play a crucial role in achieving product and service innovation. Young entrepreneurs particularly face the problem of financial constraints if starting their business, and risk capital could be their sole solution. However, the level of early-stage venture capital (VC) investments across European countries differ profoundly. I employ a panel analysis to illustrate whether technical and innovative opportunities as well as entrepreneurial environment influence early-stage venture capital investments. In addition, I emphasize the role of the financial system in attracting early stage VC. The empirical analysis was conducted in 15 European countries and looked at the period from 1995 to 2005. The results show that technical and innovation opportunities as well as entrepreneurial environment influence the level of early-stage risk capital. Taking the financial system also into account, the analysis revealed that a bank-based system has a negative impact on the relative amount of early stage VC investments, as a market-based system attracts risk capital for young entrepreneurs. Assumedly, venture capital and debt provided by banks are found not to be complements but rather substitutes.