Innovative Entrepreneurs & SMEs and Economic Growth Sofia, Bulgaria June 24, 2014

Giuseppe Gramigna [email protected]

The statements, findings, conclusions, and recommendations in this study are those of the author and do not necessarily reflect his position as the Chief Economist at the United States Small Business Administration.

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Summary

1. Innovative Entrepreneurs and SMEs are particularly adept at introducing disruptive innovation that lead to new economic paths and greater economic growth; 2. The role of the U.S. government is to play a supporting role, create a favorable environment, and were needed, address market failures.

• Some examples: The role of the SBA; the latest legislation; assisting innovative manufacturers; • What’s Missing: A legal and accounting framework, new financial products.

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Innovative Entrepreneurs and SMEs and Economic Growth

1. The Fundamental Proposition: Innovative Entrepreneurs and SMEs are ideas rich but current capital poor. 3

Innovative Entrepreneurs and SMEs and Economic Growth

1. The Fundamental Proposition: Innovative Entrepreneurs and SMEs are ideas rich but current capital poor.

2. Thus, they have much to gain but little to lose by the introduction of disruptive innovation that may leap-frog them to the top of the economic pyramid.

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Innovative Entrepreneurs and SMEs and Economic Growth

1. The Fundamental Proposition: Innovative Entrepreneurs and SMEs are ideas rich but current capital poor.

2. Thus they have much to gain but little to lose by the introduction of disruptive innovation that may leap-frog them to the top of the economic pyramid. 3. As such, they are particularly adept at creating new economic paths, that lead to New Economic Growth.

4. “The Engine of Economic Growth”

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Innovative SMEs in the U.S.

SBA Research show that: 1. Small Innovative firms are 17 times more “Innovative “than Large firms.

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Innovative SMEs in the U.S.

1. Small Innovative firms are 17 times more “Innovative “than Large firms.

2. More specifically: “Small innovative firms with fewer than 500 employees produced 27 patents per 100 employees, compared with 1.6 patents per 100 employees in large firms with 500 or more employees”...

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Innovative SMEs in the U.S.

1. Small Innovative firms are 17 times more “Innovative “than Large firms.

2. More specifically: “Small innovative firms with fewer than 500 employees produced 27 patents per 100 employees, compared with 1.6 patents per 100 employees in large firms with 500 or more employees”...

3. “Patents of the small firms in the study were cited 79 percent more by recent patents than is typical for other patents of the same age and patent classification”.

• For more details see (1) SBA Office of Advocacy, “Analysis of Small Business Innovation in Green Technologies”. Research Number SBAHQ-09-M-02; October 2011(2) SBA Office of Advocacy, “Small Serial Innovators: The Small Firm Contribution To Technical Change” , Research Number SBAHQ-01 C-0149, February, 27 2003. < http://www.sba.gov/advocacy/7540 > 8

Financing Innovative Entrepreneurs and SMEs

Venture capital investments as a percentage of GDP (US dollars 2012 prices) Source: OECDiLibrary, Entrepreneurship at a Glance, 2013.

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U.S Venture Capital

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The U.S. Government Role

SBA’s Role: Financing Innovative SMEs throughout their

life-cycle.

1. Basic Research & Development Grant Funding (SBIR/STTR); 2. Venture Capital Markets, Especially in Seed and Early Stage Risk Financing (SBIC); 3. Training of young, High-Potential SMEs (E-200 Initiative); 4. Traditional Loan Guarantees for all SMEs (7(a), 504 and Microloans).

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The SBA Role: Basic R&D Funding

Small Business Innovation Research (SBIR) Program: Federal agencies with extramural R&D budget in excess of $100 million annually must reserve 2.5% for competitive bid to small businesses.

1. Small Business Technology Transfer (STTR) Program: Federal agencies having an extramural R&D budget in excess of $1 billion annually must reserve 0.3 percent for competitive bid to small businesses.

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SBIR Program Structure...

T he SBIR Program is structured in three phases: Phase I

months.

: Awards of up to

$150,000

are made to evaluate the f

easibility

and scientific and technical merit of an idea, for a period of up to six

Phase II

: Phase I projects having the most potential are funded for

further development

, up to

$1,000,000

, for a period of up to two years.

Phase III

: No SBIR funding is provided. Private-sector investment and support are used to bring the innovation to market. However, Phase III funding may include follow-up contracts for

production of Phase

II innovations.

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• • • •

The SBA Role: Risk Capital

The Small Business Investment Company (SBIC) a, government sponsored investment fund to bridge the gap between entrepreneurs’ need for risk capital and traditional sources of financing: SBA licenses the privately-owned SBIC; invests long-term capital; For every $1 raised by the privately-owned SBIC, the SBA will provide up to $3, but typically, $2 of debt capital; a $150 Mil. Cap.; Once capitalized, SBICs make debt and equity investments in some of America’s most promising small businesses; SBA Guarantees and sells these assets to the private sector.

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The SBIC Program Advantages.

For SBICs:

Patient Capital: Ten-year debenture with semi-annual interest payments

minimizes capital duration mismatch (short-term funding vs. long-term investments).

Rapid Deployment of Funds: can withdraw approved funding on a quarterly

basis, Minimizing the fundraising cycle. Typically able to raise two-thirds of capital from SBA.

Low cost of capital: Interest rates based on the 10-year treasury rate, plus a

market-based premium for liquidity and prepayment risk.

Enhanced Returns to Private Investors: The low cost of capital increases

returns to private investors in good performing funds.

For The Government

No taxpayer cost.

: Leverages SBIC investment expertise and capital to provide risk capital to SMEs.

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The SBA Role: Loan Guarantees

The SBA 7(a) and 504 Small Business Loan Guarantee Programs: Various types (working capital, project finance, micro, revolving, and of different size ($5,000 to $5.0 or $5.5 Mil.) 16

The Federal Government Role: Risk Capital

1.Jumpstart Our Business Startup Act of 2012 (Apr.)(JOBS Act). Liberalizes small equity issuance by allowing SMEs to raise capital via the internet with minimal regulation (Crowdfunding). Increases the minimum issuance that requires SEC oversight form $5.0 Million/500 investors to $50.0 Million/2000 investors . Introduces Emerging Growth Companies.

Allows marketing of issuance via the internet.

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The Federal Government Role: Innovation

Linking and leveraging government and private assets.

1.National Innovation Marketplace. A web-based portal to connect technology requestors and potential suppliers.

2.National Network for Manufacturing Innovation creates a network industry, academic institutions, federal agencies, and states to provide shared access cutting-edge capabilities, educate students and train workers in advanced manufacturing skills.

3.National Design Engineering and Manufacturing Consortium

enables small and medium-sized manufacturers to develop and test their products using advanced modeling and simulation tools that have historically only been available to large companies.

4.Advanced Manufacturing Jobs and Innovation Accelerator

Challenge, a cluster-based investments, bring together educational, research organizations, state and regional economic development authorities, and the private sector to conduct proof-of-concept and commercialization activities 18

• • • • • •

What’s Missing?

Accounting and legal framework to standardize the valuation of Intangible assets.

Intangible assets are an increasingly important part of the value of young, innovative, small firms, perhaps as high as 60 percent; Financial valuation difficulties have undermined the monetization, collateralization and trading of intangible assets; Thus trading of and borrowing based on intangible assets has so far been infrequent and customized; To effectively use intangible assets in the financial system, quantifiable metrics of their characteristics must be available so that markets can calculate those assets’ behavior over time.

Jarboe Kenan P. and Ellis Ian, Innovative Financing for Innovation, Winter 2010. Corrado Carol, Hulten Charles, and Sichel David, Intangible Capital and the U.S. Economy, The Review Of Income and Wealth, Series 55, Number 3, September 2009. Corrado Carol, Hulten Charles, and Sichel David, Intangible Capital and Economic Growth, NBER Working Papers 11948, January 2006. David Haigh, Brand Finance Global 500, Brand Finance, 2010.

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What’s Missing?

New, Creative Instruments that address the strong knowledge asymmetry between insiders and financiers .

• One idea: Create mutual guarantee societies made up of subject matter experts (scientists, successful innovative, entrepreneurs, etc.), who will rate and partially guarantee their ratings, thus addressing the asymmetry of knowledge with “skin in the game”.

• Governments, who are reluctant to make the credit decision, could leverage these ratings and co-guarantees to provide additional partial guarantees for these rated projects/firms.

• These co-guarantees could be used to incentivize private sector risk capital and mezzanine capital to co-invest in these projects/firms.

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