The Future of Public Efforts to Boost Entrepreneurship and Venture Capital

Key highlights of the article “The Future of Public Efforts to Boost Entrepreneurship and Venture Capital” by Josh Lerner

APA Citation:

Lerner, J. (2010). The future of public efforts to boost entrepreneurship and venture capital. Small Business Economics, 35(3), 255–264. https://doi.org/10.1007/s11187-010-9298-z

In-text citation: (Lerner, 2010)

·         With populations of less than 5,000,000 people, both Jamaica and Singapore are small countries. The two countries were roughly equal in wealth when they gained independence: Jamaica's GDP (in 2006 US dollars) was $2,850 per person, slightly more than Singapore's $2,650. Singapore had risen to a per capita GDP of $31,400 (2006), whereas Jamaica's was barely $4,800, four decades later. What is the cause of such a large disparity in growth rates? Singapore actively invested in infrastructure, education, maintained a corruption-free economy, and established wealth funds to make a variety of investments.  It is hard not to give credit for its policies on entrepreneurship and the development of the entrepreneurial sector such as subsidies for companies that specialize in specific technology, and for leading biotechnology researchers to relocate their laboratories to Singapore.

·         Singapore's entrepreneurial programs have become increasingly vital in boosting growth. In the World Bank's 2008 review, Jamaica ranked extremely low on several key indicators. Two major obstacles to the growth of entrepreneurial businesses are: i) Jamaica was placed 170th out of 178 countries in terms of the difficulty of complying with tax legislation. The overall cost of complying with all tax rules is just over 50% of gross profits, implying that a large portion of entrepreneurs' revenue would be used to fulfill tax obligations. Singapore, on the other hand, was placed second in the world, with a load of only 23%. ii) When comparing the cost of registering property, Jamaica came in 108th out of 178 countries: the cost of registering property was 13.5 percent of the property's value. (In the United States, the ratio is 0.5 percent of the value). Most importantly, businesses that do not have a clear legal title to their property will be unable to borrow against it from a bank. This contrast once again implies that entrepreneurs have fewer resources for expanding their businesses.

·         The importance of technology advancement as a driver of economic progress is now universally acknowledged. Economists have shown a substantial link between technological advancement and economic development, both across countries and throughout time. Morris Abramowitz (1956), a pioneering study of technological development, developed this concept through his research. He realized that there are only two ways to increase the economy's output: (1) increasing the number of inputs into the productive process (for example, by allowing workers to work until the age of 67 rather than retiring at the age of 62), or (2) developing new ways to get more output from the same inputs.

·         Entrepreneurship and venture capital have been emphasized in academic research as important factors in encouraging innovation. These findings show that entrepreneurs and small businesses are critical in identifying where new technology might satisfy customers' demands and introducing items quickly. Venture capitalists and companies have developed techniques that are well suited to the difficult process of nurturing high-risk, high-reward fresh ideas. A vibrant entrepreneurial sector and venture capital industry, on the other hand, will be essential contributors to an inventive system.

·         Founders and venture capitalists benefit from the knowledge of their peers; for example, if entrepreneurs are already active in the market, investors, employees, intermediaries such as lawyers and data providers, and the wider capital markets are likely to be familiar with the venturing process and the strategies, financing, support, and exit mechanisms that it necessarily involves. The construction of the infrastructure for much of the contemporary venture capital sector began with the Small Business Investment Company (SBIC) program in the United States. Many of the industry's first venture capital funds and leading intermediaries—such as legal firms and data providers—began as SBIC-focused entities before progressively shifting their attention to independent venture capitalists.

·         Governmental programs contributed significantly to the exponential rise of practically every other major venture industry throughout the world. The Israeli government launched Yozma Venture Capital Ltd., a US $100 million fund owned entirely by the government, in June 1992. According to one study, 60 percent of entrepreneurs in previous programs were successful in fulfilling their technical goals but failed because they were unable to market their products or raise funding for further development. Yozma's main purpose was to attract the investing skills and network of foreign venture investors to Israel. As a consequence, Yozma deliberately discouraged Israeli investors from participating in its ventures. Rather, the emphasis was on attracting foreign venture capitalists to invest in Israeli entrepreneurs. The government matched investors' funds, typically $8 million of a $20 million fund, accounting for 40% of foreign venture capital. The venture fund was given the right to buy back the government stake within the first 5 years for the initial value plus a preset interest rate of roughly 5–7%. Thus, the incentives of Yozma meant that the government provided an added incentive to the venture fund. The program has succeeded in attracting foreign investors, mostly from the United States, Western Europe, and Japan, took advantage of the offer. Eventually, ten initial Yozma groups were in charge of $2.9 billion in Israeli funds a decade after the initiative began.

·         A similar approach was followed by the government of New Zealand for New Zealand Venture Investment Fund (NZVIF) in late 1999 where private venture capital could buy out the NZVIF investment based on capital plus interest only. Encouraging venture capital was a critical aspect for New Zealand so the government sought to accelerate the growth of the New Zealand venture capital market through co-investment with private investors. In addition to the financial incentives, foreign investors would get a 10-year fund life, limited partnerships modeled, and ‘‘flow-through’’ tax status.

·         The Israeli Yozma program and the New Zealand Venture Investment Fund, both of which were successful, differed in their details: the former was targeted at recruiting foreign venture capitalists, while the latter supported locally based, early-stage funds. They did, however, have one thing in common: they both employed matching funds to determine where public subsidies should go.

·         Entrepreneurship and venture capital are establishing themselves as global businesses. This development has two significant implications. First, authorities must recognize that, no matter how keen they are to stimulate activity in their own backyard, businesses must have a global footprint to be successful. Attempts to force businesses to hire and manufacture locally are likely to fail. Second, it is essential to include as many international investors as possible.

·         If the government is going to promote entrepreneurship, it needs to have some entrepreneurial qualities of its own. Recognize that "agency problems" exist everywhere and take actions to reduce their risk. Agency difficulties should be minimized as much as feasible when establishing public programs to support venture capital and entrepreneurship.

·         Entrepreneurial education is a crucial step. Entrepreneurs in many new venture markets may have a lot of confidence, but little grasp of what top-tier private investors, possible strategic partners, and investment bankers are looking for. The greater the amount of work that can be done to close these gaps, the better.

Key highlights of the article “The Development of Venture Capital Industry and the Role of Government in Korea: Venture Boom vs. Post-boom” by Suil Lee

APA Citation:

Lee, S. (2008). The development of Venture Capital Industry and the role of government in Korea: Venture Boom vs. post-boom. KDI Journal of Economic Policy, 30(1), 211–246. https://doi.org/10.23895/kdijep.2008.30.1.211

In-text citation: (Lee, 2008)

·         This paper examines the role of the Korean government in the venture capital business, focusing on fund-raising and venture investing. The research is done separately for the venture boom and post-boom periods, using data from the Korean Venture Capital Association (KVCA). The government played a substantial role in the fund-raising stage in both the venture boom and post-boom periods, according to empirical findings. However, when it comes to the investment stage, the empirical findings show that the government did not play the expected roles. During the venture boom period, the government failed to encourage investments in outside funds in which the government had a larger share toward early-staged enterprises and direct common stock investments. The empirical findings also demonstrate that during the post-boom period, not the venture boom period, the government did not properly enhance venture capital investments in high-tech industries.

·         Korea's venture capital industry enjoyed a boom from 1998 to 2000, but it quickly shrank after that, with the bubble abruptly ending. Since 2003, when the bubble burst, the industry has been steadily recovering. Since the mid-1990s, the Korean government has made significant efforts to expand the venture capital business as a crucial source of innovative finance. By actively making major cash commitments, the government has played a vital role in the fund-raising effort. It also aided the exit of venture capital investments by establishing the KOSDAQ stock market in 1996, which opened a window of IPO for venture capital-backed enterprises.

·         Compared to the U.S., for instance, the venture capital investments in the U.S. amount to $25.5 billion in 2006, which accounts for 0.19 percent of the U.S. GDP, whereas the amount of venture capital investment in Korea is just $0.75 billion in 2006, accounting 0.095 percent of the GDP of which the government remained the largest investor of outside funds. One of the key reasons is that venture capital firms' organizational structures were not approved in the form of a limited liability company until 2005.

·         During the period 1998-2000, the venture capital industry in Korea has seen a boom, with 98 new venture capital firms and 281 overseas funds launched. The government's policy to grow the venture capital industry such as the development of the KOSDAQ market as an exit window for emerging businesses' IPOs significantly contributed to the boom. However, the venture boom ended when the IT boom disappeared in 2000.

·         After the burst of the boom, the main trend in the venture capital industry in Korea was to attract outside funds, consequently, the amount of outside funds per firm has increased almost four times in five years. In 2000, the total size of inside funds amounted to $4.2 billion which accounted for almost 70 percent of the total venture capital raised and the size of outside funds was just $1.9 billion which accounted for 31 percent of the total venture capital. Interestingly in 2005, the size of inside funds has shrunk, and the size of outside funds increased rapidly to $4.6 billion which accounts for more than 70 percent of the total venture capital.

·         Between 2001 and 2005, the government was the largest investor, delivering on average 27.1 percent of committed capital to each outside fund. In comparison to the United States, this fund-raising structure is unique. Private and public pension funds, financial/insurance corporations, endowments, and foundations are the largest venture capital investors in the United States, accounting for at least 80% of venture capital raised. Like Malaysia, a characteristic of the Korean venture capital market is that foreign funds typically have a five-year life term. On the other hand, the life spans of venture capital funds in the U.S. are primarily 10 years or more. In terms of the exit mechanism, the Korean venture capital business differs from that of the United States. M&A is a dominating exit window in the United States, whereas it accounts for fewer than 5% of total exits in Korea, reflecting the country's underdeveloped M&A sector.

·         During the venture boom, the government invested approximately $0.3 billion, accounting for 16.9% of total outside funds. Individual investors gave 17.2 percent of the capital raised during the same period, while general corporations provided 30.1 percent. After the boom, the government extended its participation dramatically in response to a sharp drop in venture capital commitments from the private sector. The government contributed $0.7 billion to 173 of the 309 outside funds established during the post-boom period. This amount accounted for 24.4 percent of the capital raised within the same period, making the government the largest outside fund investor. According to data, from 1998, the government has supplied a large amount of funding to venture capital firms for their venture investments, and this direct role of the government appears to have expanded following the venture boom. During the post-boom period, the government was also successful in luring private investments.

·         Regardless of government participation, the amount of private capital committed to outside funds surged dramatically between 1998 and 2000, resulting in a 'boom.' Considering the facets of 'boom,' it may be inaccurate to read the co-movement between government capital commitments and private investor capital commitments during the venture boom period as a causation link. Instead, during the venture time, a large portion of the co-movement observed will be due to a simple correlation between the two variables. During this time, each $1 of government commitment induced a maximum commitment of $0.926 from the private sector.

·         When the government owns holdings in outside funds, data reveals that the ratio of common stock investment is lower. However, after the venture boom, these unanticipated patterns vanished. These findings could indicate that the government did not play the expected role, but rather acted in the opposite direction, and that policy on those factors has improved since the boom ended. In terms of investment ratios in high-tech and high-and medium-tech industries, the situation is the opposite of what has previously been observed. These findings could also indicate that the government isn't doing its job in directing venture capital to high- and medium-tech firms.

·         In the post-boom period, as the government's proportion of GDP increased, the ratio of investment in high-tech industries declined. These estimates can be viewed as more evidence for the idea that the government has failed to direct venture capital investments to enterprises that the government has targeted. The main reason for those policy failures is that the government has pursued two opposing goals: establishing a venture capital business and avoiding the risk of losing money. Taking the risk of losing money is viewed as a necessary foundation when dealing with venture capital. Instead, if the government wishes to continue to play a role in mobilizing outside funds for private venture capital firms, it should focus on identifying qualified venture capital firms, monitoring their investing activities, and assessing their performance.

·         Although these are not clear confirmations of the concept, venture capital firms managed outside funds prudently to invite the government to the fund-raising process in stages. For venture capital businesses' venture investments, the government has supplied a large amount of funding. After the venture boom, the government's direct engagement in the fund-raising stage was enlarged, making it the largest stakeholder in outside funds. In both times, the regression analyses show that the government's capital commitment was a successful tool for attracting private investments.

Key highlights of the article “The Effects of Government-Sponsored Venture

Capital: International Evidence” by James A. Brander, Qianqian Du and Thomas Hellmann

APA Citation:

Brander, J. A., Du, Q., & Hellmann, T. (2014). The effects of government-sponsored venture capital: International evidence*. Review of Finance, 19(2), 571–618. https://doi.org/10.1093/rof/rfu009

In-text citation: (Brander et al., 2014)

·         This article examines at businesses that are funded by government-sponsored venture capitalists (GVCs). We discovered that firms backed by both GVCs, and private venture capitalists (PVCs) receive significantly more investment than those backed solely by PVCs, and significantly more than those backed solely by GVCs. Mixed GVC and PVC funding also has a positive correlation with successful exits, as assessed by initial public offers (IPOs) and acquisitions, which is mostly due to the additional investment. We find a positive and highly significant correlation between GVC investment and total investment. Only 4% of companies have a successful IPO, compared to 19% who have a successful exit.

·         We assembled a sample of 20,446 firms (located in twenty-five countries) that got VC funding between 2000 and 2008 using data from Thomson One (formerly named VentureXpert) and the Asian Venture Capital Journal and tracked whether successful entry occurred through 2012.

·         Venture capital (VC) has attracted the interest of governments all around the world. This interest arises in part from the crucial role that venture capitalists have played in the establishment of some of the world's most innovative businesses. VC, in general, gives significant support to entrepreneurial firms that are major sources of innovation, employment, and productivity growth in many countries. Entrepreneurial firms are key providers of innovation, employment, and productivity growth in many countries. Furthermore, there are market failures related with innovation and entrepreneurial finance—market failings that could justify government intervention in VC markets on economic grounds.

·         According to our statistics, governments own or fund VC companies that invest over $4 billion per year in privately held businesses around the world. Government-sponsored VC funding was received by more than a quarter of all VC-funded businesses. However, there is significant opposition, or at the very least skepticism, to the role of government in VC finance, as expressed, for example, in Cohen and Noll (1991) and Lerner (2009). Critics question whether governments can improve on private sector VC activity, and many believe that government involvement in VC markets will be marred by political influences, rent-seeking, and general bureaucratic inefficiencies.

·         In Europe, we find that pure GVC businesses have a greater rate of successful exit than in the United States. Surprisingly, while there is a negative correlation between pure GVC funding and exit success in the United States, there is evidence of a positive correlation in Europe.

·         We also discovered that pure GVC investments perform better in civil law countries than in common law countries, and that they perform better in countries with less developed VC markets. In more developed VC markets, businesses that are only supported by GVCs obtain significantly less financing and perform significantly worse. In civil law countries, 37.30 percent of all businesses receive GVC finance, compared to 15.77 percent in common law countries. In civil law regimes, mixed finance has a higher positive effect on both investment and exit than in common law regimes. Pure GVC investment, on the other hand, has a lower detrimental impact under civil law regimes. As a result, GVC activity is not only more widespread, but it also performs better in civil law countries. In terms of both additionality and exits, GVC has a higher positive effect in more innovative countries.

·         GVCs are further divided into two types: government-owned venture capitalists (GOVCs) and government-supported venture capitalists (GSVCs). The latter are venture capital firms that are normally privately owned but get significant government funding, tax credits, or other subsidies. According to our statistics, GSVCs funded 86 percent of all GVC-backed businesses. Surprisingly, the additionality and performance benefits of mixed GVC and PVC funding for GOVCs are substantially smaller than for GSVCs.

·         Table I shows the number of firms funded by VC by country for each of the twenty-five countries in our data set. Approximately half of all VC-backed businesses are based in the United States. GVC support was found in more than 50% of the recognized businesses in South Korea and Canada. Involvement in the GVC was also relatively high in France and Germany. The United States had a lower (but still significant) amount of GVC support, at around 17%.

Table 1: VC Activities by Country

·         We can see that around 19% of the businesses in the sample had a successful exit. Breaking down this, we find that 20% of pure PVC-funded firms had a successful exit, whereas 24% of mixed GVC and PVC-funded enterprises had a successful exit, and just 15% of pure GVC-funded enterprises had a successful exit. The majority work in industries that are classified as "high tech," although about 25% work in other fields. However, many of those, such as alternative energy, also rely considerably on advanced technology.

Key highlights of the article “Venture Capital in Malaysia: The Role of the Government” by Grahame Boocock

APA Citation:

Boocock, G. (1995). Venture Capital in Malaysia: The role of the government. Development Policy Review, 13(4), 371–390. https://doi.org/10.1111/j.1467-7679.1995.tb00099.x

In-text citation: (Boocock, 1995)

·         Senior executives from ten venture funds were interviewed using a semi-structured set of questions. Only 14 venture capital funds are active in Malaysia, hence this article represents the views of the vast majority of the venture capital community.

·         Small and medium-sized enterprises (SMEs) have the potential to play a critical role in ensuring that the economy grows in a balanced manner. The growth of a small business sector can facilitate a country move from developing to developed; Japan's and other Asia's newly industrialized countries' experience suggests that a modern SME sector is a crucial phenomenon for sustained and rapid development. In Malaysia, the importance of SMEs has been increasingly recognized; indeed, by the late 1980s, the sector had begun to receive favorable treatment in comparison to major corporations.

·         The availability of funds for SMEs has been a source of significant concern. Access to money (rather than the cost of financing) has long been recognized as a fundamental issue. While the breadth of available funding sources has clearly expanded over the last two decades, the financial system remains fundamentally debt-based. High debt levels are not typically ideal for high-risk businesses that have the potential for quick expansion. In these situations, venture capital can help to bridge a significant gap in the financial intermediation process. Because venture fund managers look for and foster high-growth companies that are commonly turned down for funding from traditional sources, venture money may be a powerful driver for entrepreneurship and economic growth.

·         In the private sector, commercial banks and other financial institutions have been aggressively seeking loan opportunities in the small business sector. By the end of 1992, the value of credit facilities extended to small scale enterprises by the core banking system - commercial banks and finance companies - had reached RM 9.8 billion. SMEs can also get money from a variety of other sources, including as publicly-backed development financing institutions and private leasing and factoring firms. Outside the core banking system, outstanding credit facilities to small businesses are estimated to be about RM 9-10 billion.

·         Venture capital is frequently connected with stock or equity-linked financing mechanisms. These are risky investments. As a result, compared to banks and other financing providers, venture fund managers have a far more direct role in the company. In return, they get a piece of the success of the firms they invest in when the shares are eventually sold, such as when the investee company gets a stock market quote.

·         Venture capital was intimately associated with the early-stage financing of enterprises dealing with advanced technology in the United States during its early years of development. The economic significance of innovative technology-based businesses has been recognized; they contribute significantly to research and development efficiency, economic growth, and employment. High-tech SMEs, on the other hand, pose even bigger risks to financiers than traditional SMEs, because they, for example, require significant upfront investment and face uncertain market acceptance of their products.

·         The Malaysian government has repeatedly declared its desire for a robust venture capital industry. In official circles, venture capital appears to be firmly associated with the funding and fostering of high-tech companies. The government has taken a variety of steps to foster the growth of these businesses. For example, the country's first Technology Park was constructed near Kuala Lumpur in 1988, major tax benefits are available for high-tech enterprises, and the sixth Five-Year Plan established a National Action Plan for Industrial Technology Development. In addition, the government has created particular incentives for venture funds that invest in specific sorts of businesses. A venture capital company (VCC) must invest at least 70% of its fund in 'venture companies' (VCs) to be eligible for help. The Ministry of Finance defines venture capitalists as "businesses engaged in high-risk ventures or ventures in new technology in relation to a product or activity that the Minister of Finance believes will benefit Malaysia's economic or technological development.

·         Official guidelines in South Korea state that new venture funds should prioritize supporting start-ups over more lucrative portfolio investments (Kiernan, 1994). Venture funds in Singapore are allowed to write off the entire capital loss from the sale of shares in approved companies from their revenue. In Malaysia losses on the sale of shares can be offset up to a maximum of 25% of allowable expenses.

·         The 'everything under one roof' (single tier) or 'fund plus management company' (second tier) techniques are used by venture capital firms all around the world (Ibanez, 1989). The venture fund is established as a limited partnership under the second approach, with investors contributing funds. The fund's management is delegated to a management firm, which is organized as a general partnership. Only if the country's tax regulations are tailored to avoid double taxation on limited and general partners is the limited partnership strategy appealing (Ray, 1993). The limited and general partners should only be taxed when income or capital gains are disbursed, as the fund is not typically responsible for taxation on its income or chargeable gains.

·         The Singapore government recognized that venture capital may be a significant instrument for facilitating knowledge transfer through financing SMEs. The primary incentive for venture capital funds is the grant of pioneer status to local venture capital funds, which includes a 10-year tax exemption based on the limited partnership model. In Malaysia, the situation is less clear. Venture capital firms can set up as investment holding corporations, which are exempt from capital gains taxes. When a venture fund actively sells its shares in investee companies, however, it is considered an investment trading company for tax purposes. As a result, 30 percent of profits are paid in taxes.

·         Malaysia's government has attempted to integrate its industrial strategy with ethno-political policies. In 1971, the government implemented the 20-year New Economic Policy (NEP) in response to major race rioting. The NEP's main goal was to promote Malays and other indigenous peoples' ('Bumiputeras') participation in the Chinese-dominated economy by increasing Bumiputera ownership of assets, including corporate shares, to 30%. The NEP was successful in increasing Bumiputera ownership from 2.4 percent in 1971 to 20.3 percent in 1990. According to the Ministry of International Trade and Industry's (MITI) standards, any firm with net assets of more than RM2.5 million must give up 30% of its shares to Bumiputera partners. If a KLSE listing is desired, a minimum of 15% of the company's shares must be offered in an Initial Public Offering (IPO), with the remaining 30% going to Bumiputera partners nominated by the MITI.

·         There are few options for venture capitalists to exit their investments. The Malaysian Companies Act, for example, prohibits companies from repurchasing their own shares, despite the fact that the venture fund can sell its shares to individual entrepreneurs. In Malaysia, the links between venture capital and high-tech development are currently quite poor. A lot of fund managers mentioned that they have funds available, but that they are having difficulty identifying suitable investment possibilities.

·         Despite the fact that many Malaysian managers are still salary-driven and unwilling to sacrifice their jobs for uncertain independence, a culture of entrepreneurship is emerging. Individuals with knowledge, experience, and a network of contacts are becoming more willing to start their own businesses. Local enterprises have been permitted to function as subcontractors as a result of the influx of foreign investment; these SMEs have then extended their customer base and seen significant growth. The air freight industry is a good example. Government-sponsored vendor development programs focused at enhancing import substitution are bolstering this trend. There was widespread agreement that buyouts could play a larger part in Malaysian venture funds' portfolios. The Malaysian government is actively pursuing its privatization agenda, and buy-out opportunities should exist in a variety of industries.

·         Individuals' savings, large local companies, multinationals, financial institutions, and foreign venture capital funds must all be encouraged to invest in venture funds within the general tax framework. The limited partnership concept has gained a lot of traction around the world. Even if the general tax environment is favorable, the government will need to take further steps to encourage venture capitalists to invest in new technology. For instance, particular incentives could be granted to allow venture funds to write off losses from high-tech investments; another option would be to encourage government backed money to support high-risk projects alongside private sector funds.

·         A lack of adequate information networks can lead to market inefficiencies. SMEs must be informed about the benefits that venture capitalists can provide to their investee companies. While variables such as tax incentives and divestiture options are significant, government must play a critical role in fostering an environment that encourages entrepreneurs and private enterprise. Malaysian venture capitalists viewed this characteristic as crucial when predicting a bright future for their industry.