- The Washington Times - Friday, June 7, 2002

"Venture capital" is a much-abused term that gets bandied about carelessly the world over. In China, a government-funded "venture capital" program collapsed in the 1980s when its real estate investments failed. In Congress, a House member recently called for "venture capital" to develop new deposits of natural gas. Neither of these projects would qualify for genuine venture capital, which is equity investment into, and the coaching of, young companies that have the potential for significant growth.

Because they systematically direct capital to the most promising fast-growing companies, venture capitalists contribute disproportionately to America's economic growth and technological leadership. According to a recent study commissioned by the National Venture Capital Association, companies originally funded by venture capital now generate annual revenue of $1.3 trillion and employ 7.6 million people. These companies now account for 13.1 percent of U.S. Gross Domestic Product.

Nearly every other nation would like to develop its own growth company creation process. But failures litter the landscape. Country after country has learned that it takes more than money and risk taking to generate globally competitive companies. Most of the so-called venture capital (VC)outside the United States is later-stage, private-equity investment. Two big problems for other countries have been a dearth of homegrown managers and inadequate incentives for successful VCs to operate abroad.

In Tokyo, an official of Japan's Ministry of Economy, Trade and Industry spoke for many countries when he told me, "We just don't have people in this county who can look at a pile of business plans and determine which of them has the best chance of success. We've tried doing that many times and it hasn't worked." The result is often a vicious spiral that feeds on itself. Entrepreneurs who are serious about launching new growth companies usually are forced to go to the United States to find risk capital and mentoring and that further impoverishes their country's entrepreneurial capacity.

The Japanese official was bemoaning the futility of trying to replicate the U.S. venture capital process from the demand side. But the good news is that American-style venture backed growth company creation is accessible from the supply side. Countries that have encouraged investment into venture capital firms have had much more success growing their own venture capital communities than those that focused only on garnering investment from VCs.

Most people don't realize that VCs need money, too. They can't invest in young companies until they've raised their own funding. Supplying some of the capital going into venture-capital firms is one of the best ways a country can develop its own venture capital capabilities. That capital can come from private investors, banks, institutions, pension funds, corporations, or even governments themselves.

In 1993, the government of Israel advanced $80 million to start 10 new Israeli venture firms. That capital allowed Israel's would-be VCs to partner with American VC firms to learn the venture-capital business as they jointly funded, staffed and mentored a series of start-up firms in Israel. After a few years, the Israeli VCs sold their stakes in their first round of start ups paid back their government and continued on their own. Just a few years later, in 2000, the new Israeli venture capital industry raised and invested more than $1 billion.

The government of Singapore took a different tack. Its first priority was return on investment. Back in the mid-1980s, Singapore began investing a portion of its treasury reserves into American venture capital. Their investments have done very well indeed. Over the last 20 years, investments into venture capital have earned outstanding returns. Over time several Singapore government organizations have become sophisticated and respected venture- capital limited partners. They have developed close relations with a number of the most successful American and European VC firms, persuading some to set up shop in Singapore. Now they are deliberately unlocking new sources of funding for VCs by linking Singapore's private-sector institutions and corporations to reputable VC funds globally.

So if Japan and other countries want to attract people who know how to identify and develop growth companies, one very promising approach is to encourage their investors, banks or corporations to begin supplying capital to venture capital firms that can teach those skills. Once investors develop some trusted venture advisers and earn good returns, they will be infinitely more willing to consider backing early stage growth companies in their own country, or providing the capital that would encourage overseas VCs to operate there.


Ken Hagerty is president of the non-profit Global Venture Investors Association.


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