4.5 Capital raising by start-ups

should be increased to achieve a stable stock exchange based on internal financing.

Chart 4-20: Distribution of ownership of the shares issued by Hungarian non-financial corporations at the end of 2017

58 6 3

4

1

20

8

Non-financial corporations Credit institutions Insurance companies, funds Other financial corporations State Households

Foreign

Source: MNB.

The main reason behind the subdued interest in the Hungarian equity market is not the lack of capital, but a general distrust in the capital market and its institutions and the lack of incentives supporting equity investments.

Moreover, the public’s financial awareness should be enhanced and self-care should improve so that capital market deepening does not become constrained on the demand side.

4.4.2 SPECIFYING THE OBJECTIVES NECESSARY FOR THE 2030 MACROECONOMIC PATH

Having been launched in 2016, the strategy of developing the stock exchange, which is now in Hungarian hands, is around the halfway mark. However, the domestic supply and demand side should be stimulated more to further deepen the capital market, and the state may play a major role in this. The supply side must strengthen considerably until 2030, on both the equity and the bond market. In parallel

with real economic convergence, stock market capitalisation should rise from its current 22–23 percent level to

50–60 percent of GDP. Equivalent in value to this goal and also important in order to avoid excessive concentration is to raise the number of listed firms to around 150–200. This could be mainly achieved by the listing of the medium-sized enterprises prepared for this and state-owned enterprises. Utilisation of the capital market should also increase in terms of loan-type funds, and in connection with this the bond

portfolio of non-financial enterprises should reach HUF

2,000–2,500 billion. To this end, households’ equity holdings should be expanded to 11–16 percent as seen in the countries with more mature capital markets,

while Hungarian institutional investors’ share should increase to

22–27 percent relative to stock market capitalisation.

A sound financing structure means that the external financing of businesses does not depend too much on either bank financing or capital market financing. Currently, almost

90 percent of Hungarian companies’ financing comes from

banks, which indicates a one-sided financing structure. The banking system’s operation is procyclical, and therefore a mature capital market is needed that provides an alternative to companies for acquiring funds during a slowdown in lending.

4.5

Capital raising by start-ups

4.5.1 CAPITAL RAISING PROBLEMS FACED BY START-UPS

Small and medium-sized enterprises (SMEs) are key in sustainable convergence. From the perspective of SME financing or their access to external funds, young companies should be differentiated from mature businesses. Young firms are small, and a large proportion of them cease their operation soon. Providing bank financing to start-ups entails huge risks to credit institutions because the former has no meaningful economic past, both their bankruptcy rate and the number of failed firms are high, which is exacerbated by their limited ability to provide collateral.

Due to the high funding risks, start-ups are usually excluded from the market for bank loans.

One option for acquiring funds instead of bank loans is to raise capital at institutions specialising in this. Among new companies, the capital-raising opportunities of innovative businesses (with high growth potential) are adequate, but the issues of start-ups engaged in traditional activities related to the acquisition of funds can be attributed to both supply-side and demand-side factors. Entrepreneurs are usually overly optimistic regarding the projected earnings potential of their ideas which they seek to implement, while investors focus on the risks of implementation. The access to financing necessary for growth may be hampered by demand-side constraints such as the lack of capacities or competencies related to acquiring the funds, which is most readily observable in the case of administrative tasks and the preparation of business and financial plans. Another constraint is that obtaining the funds may take a long time, on account of the complex,

multi-stage processes. Last but not least, raising capital is frustrated by

owners’ fear of losing ownership control

over the company. One factor constraining direct investments in start-ups from the supply side is that investors have enough capital, but their investment decisions are too risk-averse. Entrepreneurs that once failed find it difficult to obtain funds necessary to launch a new business. Providing a “second chance” would help the economic and social integration of failed entrepreneurs and provide them with a fresh start. Surveys show that “restarting” enterprises are much more successful, viable and survive longer than the average new company, and they also grow faster and employ more workers. According to investors’ experience, SME business plans are often not credible, there are only a few good business ideas that are worthy of venture capital investments. New businesses are weaker than necessary in their financial, digital, foreign higher risk, which limits their ability to obtain funds or completely prevents them from doing so.

4.5.2 THE SIGNIFICANCE OF BUSINESS ANGELS

Angel investors are individuals, rather than institutional investors or venture capital companies, who make venture capital-based investments in new companies with high typically make decisions on their investments on a subjective basis. Besides the capital investment, they also provide

intellectual capital, such as financial and management expertise, and strategy to contribute to the development

of the firm, from the beginning of the investment to its end. Business angels usually make medium- or long-term investments in start-ups. Angel investors’ funds foster economic growth and competitiveness through various channels (Chart 4-21).

Chart 4-21: The significance of business angels

language and sales competencies; therefore, they entail

growth potential, usually in start-ups.

Business angels

INCREASE IN BA INVESTMENT

Increase in R&D and innovation Increase in jobs

Macroeconomic Selection of “good” investments Professionalisation of firms

Microeconomic Re-allocation of capital Rise in crisis resilience

Monetary

SMEs account for two-thirds of the total private sector employment in the EU and 85% of newly created jobs INCREASE IN ECONOMIC GROWTH

Business angels provide both financing and managerial experience, which increase the likelihood of start-up enterprises surviving and growing

SMEs face problems accessing finance, particularly at their early stages and in some countries business angels are the largest provider of capital to early stage companies

Source: European Investment Fund.

Providing funds to early-stage companies is extremely important, and

angel investors

play a key role in this,

although

their investments are still relatively small. Approximately 10 percent of the angel investments appear in official statistics.

Based on the currently available data, angel investments should be roughly quadrupled (Chart 4-22).

Chart 4-22: Visible angel investments in 2017

100 90 80 70 60 50 40 30 20 10 0

EUR million EUR million

t e d K i n g d o m S p a i n F i n l a n d G er m a n y T u r k ey F r a n c e R u ss i a D e n m a r k S w e d en A u s t r i a P o r t u g a l I r e l a n d S w i t z e r l a n d I t a l y P o l a n d N e t h er l a n d s B e l g i u m E s t o n i a H un g a r y U k r a i n e B u l g a r i a e c h R e p u b l i c N o r w a y L u x e m b o u r g S l o v e n i a G r e e c e L a t v i a S er b i a S l o v a k i a M a c e d o n i a R o m a n i a U n i C z 100 90 80 70 60 50 40 30 20 10 0

Source: European Investment Fund.

4.5.3 FURTHER EDUCATION OF INVESTORS

Making capital investments in start-ups and young firms involves high risks. When they launch, start-ups usually have one idea that is in many cases not marketable in its planned form, and, as such, it is difficult for investors to evaluate. If investors find a marketable idea and finance a start-up through capital investment, they run quite a high risk and it may easily lead to all their invested money being lost. The risk of the investment is heigh-

tened by the fact that firms do not always have meaningful economic results, a realistic business plan, someone who can credibly implement the idea, and there is a huge disparity between how the entrepreneur and the investor assess the value of the company.

The education of investors would help them assess the risks inherent in a

given business idea or company more accurately, differentiate between new companies in this regard, and mitigate their investment risk by stipulating certain conditions. This would greatly enhance the protection and confidence of investors, which could increase their willingness to invest, and thus over the longer term it would also not let a few negative experiences prevent other promising business ideas from being realised.

References

Beck, Thorsten (2012): Finance and growth – lessons from the literature and the recent crisis. LSE Growth Commission, 2 July 2012.

Beck, Thorsten – Levine, Ross – Loayza, Norman (2000): Finance and the Sources of Growth. Journal of Financial Economics 58: 261–300.

King, Robert G. – Levine, Ross (1993): Finance and Growth: Schumpeter Might Be Right. Quarterly Journal of Economics 108: 717–738.