U.S. High-Technology Small Businesses

Many of the new technologies and industries seen as critical to U.S. economic growth are also closely identified with small businesses, i.e., those employing fewer than 500 people. Biotechnology, the Internet, and computer software are examples of industries built around new technologies that were initially commercialized by small businesses. Operating within commercial environments characterized by fast-moving technology and rapidly changing consumer needs, small businesses learn from their customers, suppliers, and government labs and universities, and innovate based on what they have learned. This agility makes high-technology small businesses a key sector for developing, adopting, and diffusing new technologies within the U.S. economy.

This section covers patterns and trends that characterize small businesses operating in high-technology industries, based on data from the Census Bureau and Corporate Technology Information Services, Inc. (Corptech). The section reports on the number of companies, their formation, and employment figures. Two sources of financing for high-technology small businesses are examined, using data from the National Venture Capital Association and the University of New Hampshire's Center for Venture Research.

Back to top

Employment in High-Technology Small Businesses

According to Census Bureau data, U.S. small businesses employed slightly more than half of the total labor force and accounted for one-third of employment in high-technology industries[54] in 2004 (table 6-25table.). Small businesses operating in high-technology industries numbered nearly one-half million firms and employed 5 million workers in 2004.[55]

In 2004, most workers in high-technology small businesses (67%) were in the service sector (table 6-26table.; appendix table 6-52Excel.). Service-sector employment is concentrated within six industries: architecture, computer systems design, consulting, management, commercial equipment and services, and R&D. These service industries collectively employed more than four-fifths of workers employed by all small businesses in high-technology service industries in 2004. The manufacturing sector employs most of the remainder of workers in high-technology small businesses (31% in 2004).

Employment in manufacturing is similarly concentrated within a relatively small number of industries: motor vehicle parts, metal working, semiconductors, other machinery, fabricated metals, and navigational and measurement tools. These six industries collectively employed more than half of all workers employed by all manufacturing high-technology small businesses and 16% of the entire high-technology small business labor force in 2004.

Back to top

Formation of High-Technology Small Businesses

Corptech has created a database on the formation of high-technology businesses by technology area. Corptech identifies 17 industry areas as high technology (using a classification that is not comparable to the Bureau of Labor Statistics definition of high-technology businesses used in the previous section).[56] Formations of U.S. high-technology small businesses sharply increased in the mid-1990s, rising from around 1,000 annually to an annual average of about 1,400 from 1995 to 1999 (figure 6-39figure.). Coinciding with the end of the dot.com boom in 2000, formations declined steeply and have remained at half or less of 1990s levels.

Changes in the share of high-technology small business formations by technology area may indicate emerging areas of technologies. Factory automation accounted for the largest share of formations (15%) between 2003 and 2004, which was 9 percentage points higher than during the 2000–02 period (figure 6-40figure.; appendix table 6-53Excel.). Computer software had the second highest share during the period 2003–04 (10%), sharply down compared with its 25% share from 1997 to 2002. The shares of three industries that rank just below computer software, i.e., computer hardware, manufacturing equipment, and subassemblies, have at least doubled compared with their shares from 1997 to 1999. The most dramatic change was the decline in new telecommunications and Internet-related small businesses. This industry's share from 2003 to 2004 was 6%, which is 20 percentage points lower compared with the period from 2000 to 2002, and down 35 percentage points compared with the period from 1997 to 1999.

Back to top

Financing of High-Technology Small Businesses

Entrepreneurs seeking to start up or expand a small firm with new or unproven technology may not have access to public or credit-oriented institutional funding. Two types of financing, angel and venture, are often critical to financing nascent and growing high-technology and entrepreneurial businesses. (In this section, business denotes anything from an entrepreneur with an idea to a legally established operating company.)

Angel investors tend to be wealthy individuals who invest their own funds in entrepreneurial businesses, either individually or through informal networks, usually in exchange for ownership equity. Venture capitalists manage the pooled investments of others, typically wealthy investors, investment banks, and other financial institutions in a professionally managed fund. In return, venture capitalists receive ownership equity and almost always a say in managerial decisions.

Venture capital firms have categorized their investments into four broad financing stages, which are also relevant for discussion of angel investment:

  • Seed and startup funding, referred to as seed-startup throughout this section, provides financing at the earliest stage of business development. Seed funding develops proof of a concept, and startup funding supports product development and initial marketing.
  • Early funds provide financing to companies that have exhausted their initial capital and need funds to initiate commercial manufacturing and sales.
  • Expansion financing includes working capital for the initial expansion of a company, funds for major growth expansion (involving plant expansion, marketing, or development of an improved product), and financing for a company expecting to go public within 6–12 months.
  • Later-stage funds include acquisition financing and management and leveraged buyouts. Acquisition financing provides resources for the purchase of another company, and a management and leveraged buyout provides funds to enable operating management to acquire a product line or business from either a public or private company.

Angel investor funds are concentrated in the seed-startup and early stages. During the period 2005–06, they provided 92% of investment for these stages compared with 8% in later stages. Venture capital, however, is provided primarily in the expansion and later stages (figure 6-41figure.).

This section examines angel and venture capital investment patterns in the United States, focusing on the period from 2001 to the present and examining: (1) changes in the overall level of investment, (2) investment by stage of financing, and (3) the technology areas that U.S. angel and venture capitalists find attractive.

Back to top

U.S. Angel Capital Investment

According to data from the Center for Venture Research, angel investors provided $25.6 billion in financing in 2006, an 11% increase compared with 2005 and the fourth consecutive annual increase since 2002 (figure 6-42figure.; appendix table 6-54Excel.).[57] An estimated 51,000 businesses received financing from angel investors in 2006, 1,500 more compared with 2005, and 3,000 more compared with 2004. The average investment per business from 2004 to 2005 increased from about $470,000 to $500,000 in 2006 (table 6-27table.).

Although angel investors continue to concentrate on the riskier stages of business development, they have become more conservative in their investment patterns. Slightly more than half of all angel investment financing was seed-startup financing in 2006, down from nearly 60% in 2002 (figure 6-43figure.). Conversely, angel investment financing in the early stage grew from 41% to 47% during this period.

Changes in the technology areas that attract angel investment may indicate changes in the parts of the economy that offer future growth opportunities. Healthcare and medical devices received the largest share of angel investment in 2006 (21%), 5 percentage points higher than its 2004 share (figure 6-44figure.). Biotechnology received 18% of total angel investment in 2006, 8 percentage points higher than its 2004 share. Software also received 18% share of total angel investment during the same period, 4 percentage points lower than its share in 2004.

Businesses receiving angel investment in 2006 employed about 200,000 workers. This figure is about the same as employment in 2005, but 60,000 jobs greater compared with the 2004 level (appendix table 6-54Excel.). Each business employed an average number of four workers from 2005–06, up from three workers in 2003.

Back to top

U.S. Venture Capital Investment

U.S. venture capitalists invested $26 billion in 2006, a 14% gain compared with the level in 2005 (figure 6-42figure.; appendix table 6-55Excel.). The amounts of angel and venture capital investment have been very similar for the last 5 years. Since declining sharply in 2002 following the end of the dot.com boom, angel and venture capital investment have been strengthening.

Venture capitalists financed 2,910 firms in 2006, far fewer than the number of businesses financed by angel investors (51,000). The average venture capital investment was $8.9 million per firm, much larger than the corresponding figure for angel investors (table 6-27table.; appendix table 6-56Excel.).

The number of businesses funded by venture capital and the average amount of investment have been increasing during the last several years. The number of businesses in 2006 was 10% higher than in 2005 and 13% higher than the 2004 level. Average investment per business in 2006 was about $300,000 higher compared with 2005 and 2004, and approximately $750,000 higher compared with 2003.

Like angel investment, venture capital investment has become generally more conservative and moved toward later stages of business development. As noted previously, the bulk of venture capital is provided for expansion and later-stage financing; from 2002 to 2006 these stages accounted for a combined share of 80% (figure 6-45figure.; appendix table 6-56Excel.). Expansion financing has typically been the single largest stage financed by venture capital funds, accounting for approximately half or more of all venture investment from 1996 through 2004. Expansion financing's share, however, declined to 41% between 2005 and 2006. Later-stage investment, on the other hand, more than doubled from 15% during the mid-1990s to 31% from 2002 to 2004, before rising to 39% between 2005 and 2006, a level nearly equal to the share of expansion financing.

As the venture capital industry has consolidated, venture capitalists have largely abandoned the seed-startup stage and invested almost exclusively in early, expansion, and later stages. The share of venture capital devoted to seed-startup financing peaked at 19% in 1994 and then declined precipitously, bottoming out just above 1% in 2002 (figure 6-45figure.; appendix table 6-56Excel.). Three factors help explain this shift:

  • Investment in early, expansion, and later stages is usually less risky compared with the seed-startup stage.
  • Venture capital funds in the 21st century generally have a shorter time horizon for closing out their investments compared with the longer time required by seed-startup investments.
  • The amount of investment required for seed-startup is typically below the minimum threshold of venture capital funds.

In 2003, however, the percentage of venture capital invested in the seed-startup stage began to inch up, reaching 4% by 2006. This recent increase has been attributed to two factors: the need for venture capitalists to find new investments after closing out their holdings in mature companies and the emergence of promising new opportunities that spurred investment in new businesses (NVCA 2007a).

Venture Capital Financing by Industry

Computer software had the largest share of venture capital funding of any industry from 2005 to 2006 (20%), a slight decline compared with 2002–04 levels (figure 6-46figure.; appendix table 6-55Excel.). Biotechnology had the second highest share from 2005 to 2006 (18%), more than triple its share during the period 1999–2001. The growth in venture capitalist financing of biotechnology parallels rising interest by angel investors (figure 6-44figure.). Communications, which had the largest share between 1999 and 2001, slipped to second place from 2002 to 2004 and fell slightly below biotechnology from 2005 to 2006. The healthcare and semiconductor industries each received 10%–12% of venture capital investment, about double their levels from 1999 to 2001.

During the late 1990s, the Internet emerged as a business tool, and companies developing Internet-related technologies drew venture capital investments in record amounts. The share of Internet-related companies more than doubled from 35% in 1996 to peak at more than 70% from 1999 to 2000 before falling sharply to a level of about 40% or less in 2004 (appendix table 6-55Excel.). Internet-related companies continue to command a substantial share of venture capital, however, especially in several high-technology industries. For example, in 2006, the share of Internet-related companies in the computer software and communications industries exceeded 65% (table 6-28table.). In retailing and media, Internet-related companies amounted to three-quarters of all companies financed by venture capital. Other sectors have far smaller shares of Internet-related companies, including semiconductors (9%), healthcare (3%), and industrial/energy (1%).

Venture Capital Investment by U.S. States

Venture capital is invested disproportionately in a few states that also perform most of the R&D conducted in the United States and that receive most U.S. patents (table 6-29table.; appendix table 6-57Excel.). California alone received nearly one-half of total venture capital investment in 2006; its 48% share that year was 8 percentage points higher than its share a decade earlier. Massachusetts has the second highest share of investment (11% in 2006); this share has remained steady during the last decade. The remaining top-10 states receiving venture capital have shares between 2% and 5%. These 10 states collectively account for 86% of total U.S. venture capital investment (see Chapter 8).

Venture Capital Financing and Employment

According to the National Venture Capital Association, firms that received venture financing employed an estimated 10 million workers in 2005, more than half of whom worked in R&D and technology-intensive industries including computer hardware (19%), industrial/energy (12%), financial services (9%), and software (9%) (table 6-30table.). Two other R&D-intensive industries, which have close ties to scientific research and academia, employed a combined 4% of the workers in venture capital-financed firms. In 2005, employment in firms with venture capital support was 9% higher than in 2003 and 16% higher than 2000 levels (NVCA 2007b).

Back to top

Footnotes

[54] The high-technology definition used here is from the Bureau of Labor Statistics and differs from that used in earlier sections.

[55] See Hecker (2005) for their definition and methodology for determining high-technology industries. Several industries identified by the Bureau of Labor Statistics as high technology are not available in the Census Bureau's data prior to 2003.

[56] Corptech classifies 17 fields as high technology: factory automation, biotechnology, chemicals, computer hardware, defense, energy, environmental, manufacturing equipment, advanced materials, medical, pharmaceuticals, photonics, computer software, subassemblies and components, testing and measurement, telecommunications and the Internet, and transportation. For more information, see www.corptech.com.

[57] Comparable data on angel capital investment is not available prior to 2001.

Right-click on image to save.
print.PrintCloseclose.
CloseClose.