How to create an entrepreneurial ecosystem

August 27, 2018 Entrepreneurs, Start-ups, Small Businesses, Innovation and Resources, Research No comments

University of Oxford | Aug 2, 2018

Should governments promote entrepreneurship by targeting policies at entrepreneurs or investors? Thomas Hellmann discusses the findings of his research.

Governments across the globe are intent on creating their own versions of Silicon Valley. We’ve got Silicon Gorge (UK), Glen (Scotland), Fjord (Norway), Wadi (Israel), Savannah (Kenya), and many more. The reasons are easy to understand: they want to create economic growth and increase employment and innovation. However, you can’t create an entrepreneurial ecosystem just by sticking ‘Silicon’ in front of a natural geographical feature: you need policies. And so far there is considerable debate on the best approaches to take.

Policies basically fall into two categories: founding policies that encourage entry by entrepreneurs, and funding policies that encourage financing by investors. Founding policies can include training, access to mentoring and expertise, or a reduction of bureaucratic red tape. Funding policies use a variety of methods to encourage investors to channel more funding into start-ups. The latter are usually interpreted by the public as giving more money or tax breaks to already-rich people, so can feel difficult for governments to justify.

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However, as my research shows, there are various reasons why funding policies are actually most effective – not just in creating today’s successful start-ups, but in encouraging generations of new businesses into the future.

This is because financing of entrepreneurial ventures requires ‘smart’ or ‘experienced’ money – that is, money invested by people who know about starting new entrepreneurial businesses, and who adopt an active investment style. This knowledge is best acquired by experiencing the entrepreneurial process itself, which is why a large proportion of the so-called ‘angel’ investors in Silicon Valley were themselves successful entrepreneurs.

So the wealth created by one generation of entrepreneurs determines the supply of angel capital for the next generation.

Founding policies are very effective at creating and encouraging large numbers of entrepreneurs. However, they are then competing for a limited supply of funds. This results in less favourable investment terms for entrepreneurs – in other words, lower valuations. By contrast, funding policies create a more abundant supply of capital which is then looking for entrepreneurs to invest in. This results in more favourable investment terms for entrepreneurs – that is, higher valuations.

Higher valuations resulting from funding subsidies therefore increase the amount of wealth that successful entrepreneurs can invest in the next generation of entrepreneurs, at the same time as increasing the amount of entrepreneurial expertise within the ecosystem. Funding subsidies also encourage successful entrepreneurs to become angel investors rather than putting their wealth into a safe asset. This creates a virtuous cycle that permanently increases entrepreneurial activity, and that is what is at the heart of an entrepreneurial ecosystem.

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