THE New Economic Model (NEM) characterises Malaysia in 2020 as market-led, entrepreneurial and innovative. A deliberate move towards a more competitive society, dedicated to value-adding to achieve high-incomes. A year ago, I wrote in this column: “The centrepiece to promote recovery and quality growth during hard times is to drive innovation.”
The key element here being the Government’s will to make some fundamental changes, including “a stubborn resolve to change mindsets in order to instil and build (and effectively put on the ground) a creative and innovative culture, and a national entrepreneurial spirit.”
A year later, I wrote: “…we can’t be expected to grow efficiently by simply doing more of the same. To become an increasingly higher income nation, we need to shift to an economy that is innovation led.”
Innovation simply means fresh thinking and approaches that add value to consistently create wealth and social welfare. In the end, “innovation drives productivity, and productivity drives the flow of real income.” I ended with a remark on venture capital: “From Asean to North-East Asia and from India to Japan, the big risk to innovative ventures remains the lack of ready access to finance.” Policy makers have turned to creating tomorrow’s jobs rather than saving yesterday’s. The buzzwords in government are entrepreneurship, innovation and venture capital.
Asian environment is set in a culture that does not take on risk easily. Thomas Watson (founder of IBM), when asked about risk taking, said: “If you want to succeed, raise your error rate.”
I believe our Government has to become a bold enabler when it comes to nurturing the build-up of risk capital. I also believe any government that takes no risk in promoting innovative ventures is likely to make the bigger error of not trying hard enough. Accept the hard-headed Sun Tzu rule that making omelettes will require breaking egg shells.
Venture capital vs private equity
Venture capital (VC) and private equity (PE) are not the same. VC provides development funding to early stage firms in high-technology and bio-technology. In contrast, PE backs established enterprises using equity and debt.
VC helps fund innovation – to grow seed and start-ups into major break-throughs that dazzle. PE thrives at the other end of the spectrum – offering equity and leveraged finance to spin deals. PE backed enterprises are usually run by the same executives who ran them before PE moved in.
Essentially, PE teams up with entrepreneurs to create value. However, VC managers bring professional advice and managerial and organisational support to the table, help manage start-ups and “teenage” ventures.
PE executives make money from fees; capital gains are just a bonus. The standard “2 & 20” fee structure, whereby managers charge investors 2% on monies managed and 20% of profits earned, is lucrative. They also charge transaction fees and fees for monitoring portfolios.
In contrast, VC takes are more modest since their fund size pales in comparison. VC ventures do fail but occasionally they get a hit – returns of 10 to 50 times. In the end, VC is all about real big successes.
PE is never easy; funding and executing private investment is hard. Competition is fierce and much financial engineering has already been tried. Only operators who are talented – and lucky – can keep producing high returns. Similarly, VC funding is difficult in terms of staying power.
The easy-to-profit schemes of 1990s created impatient investors. But building new ventures take perseverance. Most 100 largest publicly traded US software companies took six years or more to generate enough revenue to reach IPO (initial public offering). Microsoft and Oracle, which went public in 1986, were founded in 1975 and 1977 respectively.
VC fuses innovators and entrepreneurs with intelligent capital (and business know-how) in a combination that’s capable of spectacular successes, such as Apple, Google, Intel and FedEx. This also needs enlightened government policies. That’s how wealth creation takes place.
Be that as it may, NEM needs a dynamic VC and PE industry to meet its goals. Innovation and finance go hand in hand. With economic recovery, VC and PE must get back to providing growth capital – from seed to start-ups and then, on to expansion, refinancing, buy-outs, in the drive to maturity. Indeed, recession has left them with lots of “dry powder” (uninvested committed capital) before they need to raise new money. Yet, many have fallen victims of a world-wide reshuffle. Survivors will have to get used to a diet of smaller deals and lower returns, at least until economies fully recover.
VC in Malaysia
In Malaysia, chronic risk aversion defines the financial landscape. So much so the VC industry remains grossly under-developed, unwilling to take on seed and early-stage big-bang bets. In the 1970s, Bank Negara took small steps to set up VC funds. The first real move was Bank Industri’s joint venture (JV) fund with San-Francisco based Walden International to finance nascent ICT ventures. The JV later set up two additional venture funds in the 1980s.
Since then, the Government has introduced a wide array of VC funds, soft loans and tax incentives. But according to Prof N. Takahashi of Musashi University, Malaysia today ranks very low among 54 countries with less than 0.5% of those aged 18-64 involved in start-up activities, compared with 10% in US, 6% in Britain and 4% in Japan.
Structurally, the VC industry in Malaysia is very skewed and weak. Among 114 players, 104 were 100% locally-owned, nine joint-ventures and one, 100% foreign-owned. Together they managed RM5.36bil of funds at end-2009 (less than 1% of gross national product), of which only 48% (RM2.6bil) was invested.
In 2009, only RM597mil was invested; 80%-85% of committed funding came from government and only 12.6% from banks, financial institutions and individuals. Of the funds invested in 2009, only 24% went to seed (3%), start-ups (6%) and early stage (15%). The bulk was utilised to fund expansion (53%) and bridging (17%). Not only is VC funding highly reliant on government, but the ecosystem presents difficulties in private fund raising because of risk averse institutional investors, restricted regulations on asset allocation, and VC firms lack track record.
While entrepreneurs recognise there are improvements in start-ups, changes are in small and many barriers remain. The lack of “real” venture funding is a problem and funds are highly risk averse. About 85% of VC funds is provided by the Government. Since the mandate is to lend, they just do so and quickly take them to IPO, rather than take on the risk to nurture them, as in the US and Europe.
In the Government, the culture is to avoid taking risk. Malaysia is not unique here. VC companies in Japan have long suffered from a dearth of “risk” capital with a conservative attitude. According to Prof S. Kagani of Tokyo University, Japanese VC firms do not take risk even though they offer “risk” capital. Typically, they invest with other VC, scatter their funds widely and keep them small to minimise risk.
Japan invested US$2bil in 2008 (as against US$25bil in the US), of which only 10% was in start-ups (18% in the US). In Malaysia, the ratio is 6%. Like Japan, Malaysian VC still has much “dry-powder” in hand, totalling RM2.7bil (or 52% of capital committed). They still have money to spend.
Compelling challenges
US President R. Reagan used to joke that the nine most terrifying words in the English language are: “I’m from the government and I’m here to help.” To be fair, government has helped ignite entrepreneurship. It also helped develop the VC industry – warts and all. Indeed, most great entrepreneurial hubs, from Bangalore to Hangzhou, from Singapore to Seoul bear the stamp of public intervention.
In Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurships & Venture Capital Have Failed – and What to Do About It, Prof J. Lerner (Harvard Business School) points to two foolish tendencies among politicians.
First is temptation to spread wealth to regions and interest groups. France, for example, tried to transform Brittany (a backward region) into a hive of high-tech activity but failed miserably. Second is suspicion of foreign investors. In the 1990s, Japan lavished billions on start-up VCs but was reluctant to embrace foreign VCs or invest in non-Japanese VCs. Today, Japan has the rich world’s weakest VC market. Sound familiar?
Start-Up Nation by D. Senor and S. Singer tells the story of how Israel plugged itself into the global VC market in 1992 with a US$100mil publicly funded VC. It was designed to attract foreign VC and foreign expertise to do the job. This market-driven fund attracted foreign VC to participate. The nascent high-tech industry boomed, domestic VCs learnt from this experience and foreign expertise was passed on. Its VC industry flourished. In 2009, Israel attracted as much foreign VC as France and Germany combined; and had more companies listed on Nasdaq than China and India combined.
New approach to VC
The Malaysian VC community is too government-centric: the Government provides funding and calls the tune on what to invest, who to invest in, how to invest and whom to manage.
Funds are risk averse in practice, reflecting conflict between its developmental and commercial agenda. But, they are risk averse by necessity because VC lacks risk management skills; activities are largely insulated from global inter-connectivity, with only a limited window abroad. As a result, it has poor deal flows. Its overall performance has been dismal.
The fundamental weakness lies in a lack of focus on seed and start-up enterprises; these account for 9% of total VC funding. Including early-stage, their combined share is about 24%. But there are only a handful of professionally managed, genuine early-start VC funds – targeting pre-revenue, unproven businesses. Organised angel investing, where affluent individuals invest in seed and early start-ups, is rare.
Yet, early-stage funds play a critical role; they create jobs and new industries as well as generate high returns. Importantly, without continuing flows of early-stage funds, later-stage funds would be starved in subsequent years. So why aren’t there more early-stage funds? Two main reasons. First, there is genuine lack of expertise. Second, most VC funds effectively force them to do deals of RM2mil or more to ensure a manageable number of investments.
Indeed, a few smaller-ticket early-stage deals are done as an afterthought. While VC investing traditionally has been a “home-run” business, venture firms are backing far safer investments. What’s needed are smaller funds of RM50mil and a fresh outlook from investors willing to take calculated risks on small but good opportunities and strong teams, and patience to wait for real value creation.
To succeed VC has to dramatically change direction. Creating a more dynamic environment must be high on the agenda. Here, taking risk and managing risk have to be seen in a more positive light in the Malaysian business culture.
To begin with, VC needs to be market driven. To survive, the business must be risk-, people- and innovation-driven. The Government will be needed to act as an enabler: a funder with private investors and markets; and a provider of incentives to deepen business commitment. VC focus must be on seed and start-ups.
To better serve and service the business, VC’s structure and organisation (systems processes and skills) have to be re-vamped within a more friendly ecosystem. Also, VC must be regionalised and globalised in scope.
To complete the chain, PE must also be restructured but approached differently to complement VC growth in vital areas of re-financing, mergers and acquisitions, and buy-outs.
All these simply mean a complete mind-set and culture change. In the end, VC and PE business must be seen to be talent- and skill-oriented, with the world as its marketplace. Transformation of the VC-PE landscape (restructured to up-skill with due emphasis on generating deal flows) becomes critical. Finally, VC-PE needs to find its niche business on the Islamic finance radar screen.
The key element here being the Government’s will to make some fundamental changes, including “a stubborn resolve to change mindsets in order to instil and build (and effectively put on the ground) a creative and innovative culture, and a national entrepreneurial spirit.”
A year later, I wrote: “…we can’t be expected to grow efficiently by simply doing more of the same. To become an increasingly higher income nation, we need to shift to an economy that is innovation led.”
Innovation simply means fresh thinking and approaches that add value to consistently create wealth and social welfare. In the end, “innovation drives productivity, and productivity drives the flow of real income.” I ended with a remark on venture capital: “From Asean to North-East Asia and from India to Japan, the big risk to innovative ventures remains the lack of ready access to finance.” Policy makers have turned to creating tomorrow’s jobs rather than saving yesterday’s. The buzzwords in government are entrepreneurship, innovation and venture capital.
Asian environment is set in a culture that does not take on risk easily. Thomas Watson (founder of IBM), when asked about risk taking, said: “If you want to succeed, raise your error rate.”
I believe our Government has to become a bold enabler when it comes to nurturing the build-up of risk capital. I also believe any government that takes no risk in promoting innovative ventures is likely to make the bigger error of not trying hard enough. Accept the hard-headed Sun Tzu rule that making omelettes will require breaking egg shells.
Venture capital vs private equity
Venture capital (VC) and private equity (PE) are not the same. VC provides development funding to early stage firms in high-technology and bio-technology. In contrast, PE backs established enterprises using equity and debt.
VC helps fund innovation – to grow seed and start-ups into major break-throughs that dazzle. PE thrives at the other end of the spectrum – offering equity and leveraged finance to spin deals. PE backed enterprises are usually run by the same executives who ran them before PE moved in.
Essentially, PE teams up with entrepreneurs to create value. However, VC managers bring professional advice and managerial and organisational support to the table, help manage start-ups and “teenage” ventures.
PE executives make money from fees; capital gains are just a bonus. The standard “2 & 20” fee structure, whereby managers charge investors 2% on monies managed and 20% of profits earned, is lucrative. They also charge transaction fees and fees for monitoring portfolios.
In contrast, VC takes are more modest since their fund size pales in comparison. VC ventures do fail but occasionally they get a hit – returns of 10 to 50 times. In the end, VC is all about real big successes.
PE is never easy; funding and executing private investment is hard. Competition is fierce and much financial engineering has already been tried. Only operators who are talented – and lucky – can keep producing high returns. Similarly, VC funding is difficult in terms of staying power.
The easy-to-profit schemes of 1990s created impatient investors. But building new ventures take perseverance. Most 100 largest publicly traded US software companies took six years or more to generate enough revenue to reach IPO (initial public offering). Microsoft and Oracle, which went public in 1986, were founded in 1975 and 1977 respectively.
VC fuses innovators and entrepreneurs with intelligent capital (and business know-how) in a combination that’s capable of spectacular successes, such as Apple, Google, Intel and FedEx. This also needs enlightened government policies. That’s how wealth creation takes place.
Be that as it may, NEM needs a dynamic VC and PE industry to meet its goals. Innovation and finance go hand in hand. With economic recovery, VC and PE must get back to providing growth capital – from seed to start-ups and then, on to expansion, refinancing, buy-outs, in the drive to maturity. Indeed, recession has left them with lots of “dry powder” (uninvested committed capital) before they need to raise new money. Yet, many have fallen victims of a world-wide reshuffle. Survivors will have to get used to a diet of smaller deals and lower returns, at least until economies fully recover.
VC in Malaysia
In Malaysia, chronic risk aversion defines the financial landscape. So much so the VC industry remains grossly under-developed, unwilling to take on seed and early-stage big-bang bets. In the 1970s, Bank Negara took small steps to set up VC funds. The first real move was Bank Industri’s joint venture (JV) fund with San-Francisco based Walden International to finance nascent ICT ventures. The JV later set up two additional venture funds in the 1980s.
Since then, the Government has introduced a wide array of VC funds, soft loans and tax incentives. But according to Prof N. Takahashi of Musashi University, Malaysia today ranks very low among 54 countries with less than 0.5% of those aged 18-64 involved in start-up activities, compared with 10% in US, 6% in Britain and 4% in Japan.
Structurally, the VC industry in Malaysia is very skewed and weak. Among 114 players, 104 were 100% locally-owned, nine joint-ventures and one, 100% foreign-owned. Together they managed RM5.36bil of funds at end-2009 (less than 1% of gross national product), of which only 48% (RM2.6bil) was invested.
In 2009, only RM597mil was invested; 80%-85% of committed funding came from government and only 12.6% from banks, financial institutions and individuals. Of the funds invested in 2009, only 24% went to seed (3%), start-ups (6%) and early stage (15%). The bulk was utilised to fund expansion (53%) and bridging (17%). Not only is VC funding highly reliant on government, but the ecosystem presents difficulties in private fund raising because of risk averse institutional investors, restricted regulations on asset allocation, and VC firms lack track record.
While entrepreneurs recognise there are improvements in start-ups, changes are in small and many barriers remain. The lack of “real” venture funding is a problem and funds are highly risk averse. About 85% of VC funds is provided by the Government. Since the mandate is to lend, they just do so and quickly take them to IPO, rather than take on the risk to nurture them, as in the US and Europe.
In the Government, the culture is to avoid taking risk. Malaysia is not unique here. VC companies in Japan have long suffered from a dearth of “risk” capital with a conservative attitude. According to Prof S. Kagani of Tokyo University, Japanese VC firms do not take risk even though they offer “risk” capital. Typically, they invest with other VC, scatter their funds widely and keep them small to minimise risk.
Japan invested US$2bil in 2008 (as against US$25bil in the US), of which only 10% was in start-ups (18% in the US). In Malaysia, the ratio is 6%. Like Japan, Malaysian VC still has much “dry-powder” in hand, totalling RM2.7bil (or 52% of capital committed). They still have money to spend.
Compelling challenges
US President R. Reagan used to joke that the nine most terrifying words in the English language are: “I’m from the government and I’m here to help.” To be fair, government has helped ignite entrepreneurship. It also helped develop the VC industry – warts and all. Indeed, most great entrepreneurial hubs, from Bangalore to Hangzhou, from Singapore to Seoul bear the stamp of public intervention.
In Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurships & Venture Capital Have Failed – and What to Do About It, Prof J. Lerner (Harvard Business School) points to two foolish tendencies among politicians.
First is temptation to spread wealth to regions and interest groups. France, for example, tried to transform Brittany (a backward region) into a hive of high-tech activity but failed miserably. Second is suspicion of foreign investors. In the 1990s, Japan lavished billions on start-up VCs but was reluctant to embrace foreign VCs or invest in non-Japanese VCs. Today, Japan has the rich world’s weakest VC market. Sound familiar?
Start-Up Nation by D. Senor and S. Singer tells the story of how Israel plugged itself into the global VC market in 1992 with a US$100mil publicly funded VC. It was designed to attract foreign VC and foreign expertise to do the job. This market-driven fund attracted foreign VC to participate. The nascent high-tech industry boomed, domestic VCs learnt from this experience and foreign expertise was passed on. Its VC industry flourished. In 2009, Israel attracted as much foreign VC as France and Germany combined; and had more companies listed on Nasdaq than China and India combined.
New approach to VC
The Malaysian VC community is too government-centric: the Government provides funding and calls the tune on what to invest, who to invest in, how to invest and whom to manage.
Funds are risk averse in practice, reflecting conflict between its developmental and commercial agenda. But, they are risk averse by necessity because VC lacks risk management skills; activities are largely insulated from global inter-connectivity, with only a limited window abroad. As a result, it has poor deal flows. Its overall performance has been dismal.
The fundamental weakness lies in a lack of focus on seed and start-up enterprises; these account for 9% of total VC funding. Including early-stage, their combined share is about 24%. But there are only a handful of professionally managed, genuine early-start VC funds – targeting pre-revenue, unproven businesses. Organised angel investing, where affluent individuals invest in seed and early start-ups, is rare.
Yet, early-stage funds play a critical role; they create jobs and new industries as well as generate high returns. Importantly, without continuing flows of early-stage funds, later-stage funds would be starved in subsequent years. So why aren’t there more early-stage funds? Two main reasons. First, there is genuine lack of expertise. Second, most VC funds effectively force them to do deals of RM2mil or more to ensure a manageable number of investments.
Indeed, a few smaller-ticket early-stage deals are done as an afterthought. While VC investing traditionally has been a “home-run” business, venture firms are backing far safer investments. What’s needed are smaller funds of RM50mil and a fresh outlook from investors willing to take calculated risks on small but good opportunities and strong teams, and patience to wait for real value creation.
To succeed VC has to dramatically change direction. Creating a more dynamic environment must be high on the agenda. Here, taking risk and managing risk have to be seen in a more positive light in the Malaysian business culture.
To begin with, VC needs to be market driven. To survive, the business must be risk-, people- and innovation-driven. The Government will be needed to act as an enabler: a funder with private investors and markets; and a provider of incentives to deepen business commitment. VC focus must be on seed and start-ups.
To better serve and service the business, VC’s structure and organisation (systems processes and skills) have to be re-vamped within a more friendly ecosystem. Also, VC must be regionalised and globalised in scope.
To complete the chain, PE must also be restructured but approached differently to complement VC growth in vital areas of re-financing, mergers and acquisitions, and buy-outs.
All these simply mean a complete mind-set and culture change. In the end, VC and PE business must be seen to be talent- and skill-oriented, with the world as its marketplace. Transformation of the VC-PE landscape (restructured to up-skill with due emphasis on generating deal flows) becomes critical. Finally, VC-PE needs to find its niche business on the Islamic finance radar screen.
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