Transcript HONG KONG’S VENTURE CAPITAL SYSTEM AND THE

HK’S VENTURE CAPITAL SYSTEM
AND
THE COMMERCIALIZATION OF NEW
TECHNOLOGY
Kevin Au
Chinese University of Hong Kong
Steven White
China Europe International Business School
Objectives
• describe and assess the performance of
Hong Kong’s venture capital system
– beyond the strict financial definition of venture
capital (VC) to address the system of actors
and institutions that finances the
commercialization of new technology
• generate actionable recommendations to
improve its efficiency and effectiveness in
increasing the positive role of new
technology in Hong Kong industry
Agenda
• Startup process & financing
• Venture capital system
– General situation of the HK VC industry
– Institutional framework for an evolutionary analysis
• VC Cycle, investment process, VC system
• “West coast” vs “East coast” VCs in the US
• Evolution of HK’s VC industry
– Other key actors: angels, stock market, institutional
investors
• Inhibitors to VC’s support to Commercialization
– Suggestions for the medium term
Financing of New Firms
up to US$0.1M
Pre-start
•With great
idea, you
need finance
for additional
research or
produce a
prototypes
up to US$1.0M
Start-up
•No sales yet,
you need
finance for
working capital
such as,
salary,
development &
testing
US$1 - 3M
Early stage
•Having a few
sales, finance is
required for
marketing and
operations, in
order to make the
business fly
US$3M and up
Expansion
•With profits and
well established
business operation,
funding is required
for new product
development and
exploring new
markets
Cheaper sources of capital, such as bank
financing, are usually not available for
most early-stage ventures, which may be
too small or young to qualify for
traditional loans
Flow of Funds in a VC cycle
VC funds managed
by general partners (and
sometimes with special
partners)
(VCs or GPs)
Portfolio companies
(startups, established
companies, buyouts)
Limited partners
(Investors or LPs)
Exits: IPO or trade sale
(of portfolio companies)
Venture Capital Pool
Number of VC Firms
Investment Stage of VC Funds
Disbursement by Financing Stage in Hong Kong
1% (in $)
17%
Disbursement by Financing Stage in China (in $)
29%
17%
4%
32%
Disbursement by Financing Stage in Singapore (in $)
4%
7% 0%
0%
5%
22%
Startup
Seed
Expansion
Messanine
Buyout
Turnaround
0%
54%
0%
1%
66%
Startup
Seed
Expansion
Messanine
Buyout41%
Turnaround
Startup
Seed
Expansion
Messanine
Buyout
Turnaround
Disbursement of VC Funds –
Local or Overseas
100%
411
102
136
2,776
650
13,417
80%
60%
8,744
3,169
1,668
40%
30,073
20%
0%
509
1,132
HK
Non-Asian Companies
Other Asian Companies
Local Companies
China
Singapore All Asia
countries
General situation of VC Industry
• have the largest pool of venture capital
• Most of them not interested in investing in early
stage
• A lot of funds being parked in HK for investments
outside Hong Kong
– Especially mainland China in recent years
Venture Capital Process
“West Coast” vs “East Coast”
VCs
• West coast VCs are dreamers and want to
see how technology can change the world,
whereas East Coast VCs only treat
venture investment as another asset class.
Udayan Gupta, Author of Done Deals
Larry Sonsini, of the law firm Wilson, Sonsini,
Goodrich & Rosati
• “The West Coast model of venture capitalism
has always been a very intense business
partnership with the entrepreneurs.
• The providing of capital was one function of the
venture capitalist. Being actively involved in
developing the business model, managing the
enterprise, and recruiting management
• They thought of more than investing money.
They thought about mentoring, training, and
providing business solutions. The goal was not
only to make a successful investment but also to
be a part of building a successful venture.”
Morton Collins, founder of DSV Partners in 1968
• “The East Coast, the financial center of the world, has
traditionally been fixated on financial engineering. There,
with a priority placed on the structuring of deals, has
often mattered less what a company did or what would
be involved in ensuring its long-term success than
whether the deal would provide tax benefits and financial
returns.
• On the West Coast, by contrast, the driving spirit has
been innovation in science and technology.
Technologists and investors, many of whom are refugees
from the East, have long gathered around the campuses
of Stanford University and Cal Tech to create a new
economy and a new entrepreneurial culture (p. 293).”
Reasons of the differences
• Early East Coast firms were set up as
Small Business Investment Corporations
– Following governmental guidelines but not
technology
• General partners are bankers and
accountants, not operational managers
• New York & Boston are financial centres,
so lots of money from insurance firms and
pension funds
– Expect regular disbursement; low risk, not
particularly fond of technology
Evolution of HK’s VC System
• Tying evolving institutions to VC
development
• Four stages
– Prior to 1970s
– 1970’s to mid 1990’s
– Mid-1990s to 2001
– 2001 to present
Prior to 1970s
• Trader’s mentality
– Favoring arbitrage
• Refugee mentality
– Short-term oriented
• Colonial government (British were guilty!!)
– Positive non-interventionism
– Supporting indirectly logistics, construction,
trading and financial industries
• Successful lobbying from these industries
1970’s to mid 1990’s
• Background
– British trading firms dominated
– Booming stock market
• First VC firm: Inter-Asia Venture Management
– “transfer strategy”
• 1981: ARRAL & Partners
– succeeded against skepticism
– Listed HK Teawood in NASDAQ, 1984
• 1988: US$150M APAC Fund launched
– Grew industrial firms benefited in the China and Asia
boom
– Invested almost all in late stage ventures
• 1987: HK Venture Capital Association founded
Mid-1990s to 2001
• 1994: US$1.7B Asia Infra-Structure Fund
by AIG
• Tech Boom & then Bust
– Entering many new VC firms, local &
overseas
– Large PEs after the Asia Crisis
– Government VC: Applied Research Fund
– Corporate VCs
• Short-term; risk averse; didn’t know technology
2001 to present
• Dismal investment
– New firms had little technology
– New VCs had little operational background
– Lacking qualified startup management teams
– Overdue government intervention
• Not all was lost
– Some success
• New opportunities & threats
– Rapid development of China & HK’s economy
and financial markets
Summary
• Lots of money but not channeled to tech
ventures
• “…there is not a cohesive financial arrangement,
and entrepreneurs, academics, politicians and
civil servants lack the appropriate skills to
differentiate good ventures from bad. They have
to mature in their decision-making to accept risk
and how return is generated.”
• “By the time China’s stock markets become
mature and the RMB circulates more widely,
Hong Kong as a base for venture funds will be
lost forever.”
Key actors and resource flows
VC-Backed IPO 2000-07
Inhibitors to VC’s Supporting the
Commercialization of New Tech
• Government & Culture
– Short-term oriented, low-tech
• VC and PE firms
– “we are out to make money”
• Focused late stage, large size, low risk ventures
– Lacking operational experience
• New ventures
– traditional owners expect control
– Younger generations
Inhibitors to VC’s…continued
• Stock market
– Welcome the listing of large firms
– Technology level of firms not a focus
• Banks & Endowment funds
– Lending by laterals
– Investment confined by the HK version of the
“prudent man” rule
• Angels & Angel Networks
– Lack knowledge in tech ventures
– Not organized to share risk and knowledge
Suggestions for the Medium term
1. Stimulate more VC funds with long-time
horizon and technology interest
•
Channel government reserve and pension
funds by lifting the “prudent man” rule
2. Develop professional qualifications for
investment advisors on VC/PE industries
3. Stimulate angel investment
 Training, guidebooks, & templates
 “Accredited investor” & possibly tax breaks
for investing in technology ventures
Suggestions…continues
4. Diversify the backgrounds of the general
partners
– VC firms hiring general & special partners are
more likely to receive endowment, pension &
government investments
5. Find new IPO exit for VC/PE invested in
technology firms
– setting up a new board with perhaps the main
board or the SME board in Shenzhen Stock
Exchange
“The society is innovative and
entrepreneurial. The Science Park is great
in innovation…But there is not a cohesive
financial arrangement, and entrepreneurs,
academics, politicians and civil servants
lack the appropriate skills to differentiate
good ventures from bad. They have to
mature in their decision-making to accept
risk and how return is generated.”
from a foreign, early-stage VC in HK
References
• Au, K., Baark, E., Chua, B. L., & Thomas, H. (2005). Innovation
policy and high growth startups. Hong Kong: CUHK Centre for
Entrepreneurship.
• Gupta, U. (2000). Done deals: Venture capitalists tell their stories.
Boston: Harvard Business School Press.
• Metrick, Andrew (2007) Venture Capital and the Finance of
Innovation. John Wiley & Sons, Inc., Hoboken, NJ
• Murmann, J. P. (2003). Knowledge and competitive advantage: The
coevolution of firms, technology, and national institutions.
Cambridge: Cambridge University Press.
• White, S., Gao, J., and Zhang, W. (2005). Financing new ventures in
China: System antecedents and institutionalization. Research
Policy, 34: 894-913.
Private Equity, VC & Hedge Funds