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  • Time for a venture capital comeback


Athar Osama says that while attempts to transplant US-style venture capitalism to the developing world may still be doomed to failure, carefully designed programmes stand a fair chance of success.

Once touted as a fast-track solution for economic development, initiatives to boost venture capital projects in developing countries suffered in the 1990s when a US report suggested they may not work in emerging markets.

It is time to re-assess the evidence. Examples from India and Israel suggest that venture capital in developing countries has been more successful than it is generally perceived to be. More often than not, however, it is marred by misguided strategies and misplaced expectations rather than any inherent defect in it as an instrument for development.

The US venture capital industry was born in the mid 1940s around the Massachusetts Institute for Technology. It was then hailed as the engine of growth behind the success of Silicon Valley. Through much of the 1970s and 1980s, venture capital — funds made available to entrepreneurs — became one of the most well established buzzwords of the international development community.

Following the US example, many governments around the world attempted to export venture capital through policy interventions of various kinds. These ranged from creating public venture capital funds to providing a favourable policy environment. Multilateral agencies also tried to trigger indigenous venture capital industries in many developing and former socialist economies. But all this work met with mixed results. 

A damning report

In 1996, a report by the US Agency for International Development (USAID) painted a bleak picture of venture capital as an instrument applied to poor settings and has shaped debate on the issue ever since. Entitled 'The Venture Capital Mirage: assessing USAID experience with equity investment', the report has come to represent conventional wisdom on the issue.

It looked at 13 of USAID's venture capital investments and found that ten had failed to meet the desired outcomes. Three were not even implemented. It attributed these failures to a lack of readiness of the financial markets in developing countries to host an instrument as sophisticated as venture capital.

But a closer examination of the USAID-funded projects reveals serious design flaws that are more likely responsible for their premature demise.

In one instance, following its traditional fund disbursement guidelines, USAID provided the money for a venture fund and then began looking for an appropriate person to manage it. This process, carried out in the reverse order to the traditional venture capital setting, has inherent problems that could easily cripple the operations of a fund itself.

Less-experienced fund managers were recruited in the rush to get the project off the ground, and whose ability was not linked to the size of the fund. In the traditional venture capital setting, the fund is raised by the fund manager themself, so the size of fund raised is proportional to their ability. Furthermore, this design is a moral hazard, because the fund manager does not have any of their own money invested in the fund. In the traditional setting, their would first invest their own money in the fund to signal commitment to it, thus aligning their interests with those of the limited partners.

In another instance, USAID showed utter disregard to the local socio-economic environment as it attempted to literally replicate a US institution in the host country with unfeasible and unsustainable organisational structures.

Clearly, the failure of USAID's venture capital investments has more to do with its own inability to understand the instrument than the failure of the instrument itself to deliver in developing country and emerging market environments.

Success stories

Some recent evidence from difficult economic environments across the world show how carefully designed venture capital programmes that adapt the important features of the instrument to their unique socio-economic settings stand a fair chance of success.

The International Finance Corporation (IFC) invested US$196 million in 49 venture capital funds in developing countries and emerging markets between 1977 and 1995. Over the years funding increased considerably, and from 1990-1995 it was 12 times higher than during the previous 13 years.

While the overall results of the IFC's investments were somewhat mixed, the later investments are doing much better than the earlier ones, and one gets a sense of guarded optimism from the literature. These venture capital funds seem to be spawning a small but growing private venture capital industry in many of the target countries.

Another example of a successful public venture capital initiative is Israel's Yozma Program (which means 'initiative' in Hebrew). Launched in 1997, the Israeli government provided venture capital funds to match private investment. Yozma was hugely successful within a short time and after four years was successfully privatised. The Israeli venture capital industry grew from US$30 million in 1986 to US$6 billion in 2000.

The Indian venture capital industry showed a much slower but sustained growth pattern. India benefited from four venture capital programmes funded by the World Bank in the 1980s. While these programs were only moderately successful, they created the expertise for an entire cadre of individuals who had learnt the art of venture investment through trial and error.

These people created a second series of successful venture capital funds. Today India boasts a vibrant venture capital sector that ably supports the growth of its IT and biotechnology industries.

While attempts to literally transplant US-style venture capitalism may still be doomed to failure, evidence from across the developing world paints a more optimistic picture and calls for a re-examination of conventional wisdom.

Athar Osama is a senior executive at ANGLE Technology Group in the United States and specialises in technology-based economic development issues such as science and technology policy, venture capital, and entrepreneurship. He can be reached at [email protected]

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