State Subsidies Motivate Business Angels to Increase Their Involvement in Start-Ups

Investors supporting start-ups have been entitled to government subsidies since 2013. This approach has proven effective, as a study by ZEW Mannheim has shown. In recent years, the promise of receiving a subsidy has not only motivated new investors to invest in start-ups, it has also considerably increased the level of participation of these so-called business angels. At the same time, these state subsidies have not had any negative effects on the extent to which business angels advise and support start-ups, as might have been expected.

Using data from the IAB/ZEW Start-up Panel on roughly 1,000 start-ups and data from the Mannheim Enterprise Panel, the study analyses the INVEST subsidy programme’s effect on the financial and economic support that business angels provide to start-ups after its introduction in 2013. “Subsidies for business angels aim to improve access to financial and management resources for young and innovative companies. We show that this is an effective instrument to provide start-ups with venture capital and entrepreneurial know-how in an early market phase,” says Dr. Sandra Gottschalk, researcher at ZEW’s Research Unit “Economics of Innovation and Industrial Dynamics” and co-author of the study.

The ZEW research results show that start-ups that qualify for INVEST funding have a 37 per cent higher chance of securing investment from business angels, proving that government funding programmes have a clearly positive impact on business angels’ readiness to invest. This is a positive signal for venture capital activity in Germany. After all, compared to other OECD countries, especially the United States and the United Kingdom, activity has been rather moderate so far, even though investment activity has certainly increased recently.

Regarding the level of investments, the researchers conclude that INVEST-funded start-ups received on average 55 to 61 per cent more financing from their investors than other young, innovative companies. The effects of INVEST funding have been found to be significantly stronger for smaller amounts of financing: The companies that received the lowest ten per cent of investments received 176 per cent of the average amount of external equity financing.

It is interesting to note that 41 per cent of state-subsidised investments were made by relatively inexperienced, new business angels (“virgin angels”) and not by well-established investors. “The government funding programme has encouraged new investors to enter the market. We also observe that new investors are increasingly making investments in cooperation with established investors,” explains Gottschalk. Of all the investments funded by INVEST, 72 per cent were made jointly with other investors. For virgin angels, this share was over 80 per cent.

Furthermore, the researchers analysed the funding programme’s impact on the provision of entrepreneurial knowledge by investors. Such support can range from informal management advice to strategic support in the advisory board, the development and commercialisation of products and access to the investors' network. The researchers found no evidence that the programme had a negative impact on the amount of support provided by business angels, as might have been expected. Some were concerned that state incentives to increase investment and attract new investors could lead to start-ups receiving less support from their investors on average. However, this fear is not confirmed by the ZEW study, as the joint activities of the investors ultimately create new synergies.