The Rise of Global Venture Capital Firms by lonyoo


									global perspective

           The Rise of
         Global Venture
          Capital Firms
             “Recent drops in stock market prices have
         induced fairer value in emerging markets even as
           the fundamentals show underlying strength.”
                                                                                                      alternative investments

                                                                G7 Versus BRICs & Frontier Economies
                                                               The world is undergoing an economic transformation as
                                                               there is a visible shift in focus towards the emerging econo-
                                                               mies of the BRICs comprising of Brazil, Russia, India and
                                                               China and FRONTIER economies which include some
                                                               budding economies of the former Soviet Union, Africa,
                                                               the Middle East and the least-developed parts of South
                                                               America and Asia.
                                                                  China will overtake Germany this year to become the
Bundeep Singh Rangar,                                          world’s third-largest economy after the U.S. and Japan, ac-
Chairman, IndusView Advisors Ltd                               cording to the Goldman Sachs BRIC report. Two years
                                                               ago, China soared past France, Britain and Italy to become
                                                               the world’s fourth-largest economy. China is closely fol-
                                                               lowed by India.
                                                                  From a Private Equity (PE) perspective, India and China,
                                                               the world’s two fastest growing economies, offer some
                                                               of the best opportunities for investment. By 2050, they
                                                               will be the two largest economies in the world. And the
Globalization and Venture Capital Firms                        rise of global companies from India and China such as
Venture Capital firms that traditionally invested in local Tata Group, with revenue of $62 billion and equivalent
companies are increasingly looking to invest overseas, as to about 5.6% of the India’s GDP; Infosys Technologies
global recession forces them to seek above-market returns Ltd, country’s second largest IT services company; Lenovo
in the emerging and frontier economies rather than West- Group Ltd, Beijing based fourth largest personal compu-
ern ones.                                                      ter manufacturer in the world and Haier Group, Qingdao,
   Silicon Valley’s “20 minute rule,” as described by the China headquartered world’s third largest home appliances
New York Times in October 2006, stated that a VC firm maker, suggest that the next billion-dollar companies are
invested within a 20-minute drive of the venture firm’s of- more likely to come from Asia than the Western world.
fices. Any start-up outside this driving range was unlikely By taking advantage of a rising tide within these emerging
to be funded.                                                  economies, investors and fund managers can reap tremen-
   California’s Sand Hill Road was built upon the 20-minute dous returns.
rule. Not surprisingly, nearly a third of all the U.S. VC         This search for ‘Super Returns’ has resulted in more
investments last year were made in                                                     than 450 VC and PE funds focusing
Silicon Valley, a 20-minute drive from                                                 on the emerging opportunities in the
                                                       From a pe
Sand Hill Road.                                                                        BRICs. The investor friendly Indian
   Now there is a new and more subtle           perspective, india                     economy has seen the maximum in-
trend at work in the world of venture             and china, offer                     terest with 160 firms, way ahead of
investing — a global trend, which has                                                  its competing economy, China, that
seen some of the U.S. private equity             some of the best                      has 115 firms. This competitive pic-
and Silicon Valley VC firms breaking             opportunities for                     ture becomes clearer as India grossed
away from being “purely local” to                                                      $19 billion in PE investments in 2007,
becoming “globally local.” They are
                                                      investment                       surpassing China that attracted about
establishing intelligent, local presences                                              $12 billion. The trend continued in to
in emerging economies. The driving force of this trend 2008 as well, as India grossed more than $10 billion invest-
is the viral growth of a “Global DNA”, which is rapidly ments, surpassing China that had PE investments of $9
infesting itself among the VC community. By doing so and billion. Venture capitalists invested $864 million during
capitalizing on differential growth rates, they are generating the year, up 3% from 2007, and $270 million in the fourth
extra-ordinary investment returns.                             quarter, a healthy growth rate of 90% for the same period
   This evolution of Venture Capital firms is a result of last year.
wide ranging macroeconomic trends. VC firms leading this          The Frontier Countries, a relatively new block of coun-
trend can be identified by the existence of six key building tries with the potential of high economic growth activity
blocks that comprise the DNA of a truly global VC.             with a combined market value of less than Exxon Mobil
                                                               Corporation, the world’s largest publicly listed oil & gas
                                                                                             January-April - 2009 Need the Dough?   49
global perspective

        Table 1: Some of the Large PE Deals

         Acquirer                                             Target                   Sector        Stake %   Value $
         Providence Equity Partners                 Aditya Birla Telecom, a sub-      Telecom        20.00%    640.00
                                                       sidiary of Idea Cellular
         Symphony Capital                               DLF Assets Pvt. Ltd.        Real Estate &     N.A.     450.00
                                                    (Property fund of DLF Ltd.)     Infrastructure
         Orient Global Tamarind                           Cairn India Ltd          Power & Energy    2.60%     278.69
         Fund Pte Ltd
         DE Shaw                                       Mack Star Marketing          Real Estate &     N.A.     250.00
         Kohlberg Kravis Roberts & Bharti Infratel (wholly owned                       Telecom       2.00%     250.00
         Company                   subsidiary of Bharti Airtel Ltd)

                                                        will collectively see private equity investments in excess of
        company at $500 billion and population equal to that of
                                                        $50 billion over the next few years. In fact, a few of the
        India, signifies the next investment destination for inves-
        tors.                                           top VC firms have already begun to take advantage of such
                                                        investment opportunities.
           These countries can offer great returns, owing to sys-
                                                           Draper Fisher Jurvetson, one of Silicon Valley’s VC
        temic inefficiencies that can be tamed and thus bring about
                                                        firms with portfolio companies that include ‘big hits’ in the
        overall economic development. Frontier markets are where
                                                        United States such as Overture Services Inc, an Internet
        emerging markets were a couple of decades back, but have
        evolved over the years. The effects of globalization seen in
                                                        search engine company acquired by Yahoo!, and Hotmail,
                                                        a free webmail service by Microsoft Corp. has seen ex-
        the rising incomes signals the potential private consump-
                                                        ceptional returns on investments coming from Europe
        tion led growth, which helps diversify risks, ensuring safe
        returns.                                        and China. Sype’s $4.1 billion exit to eBay in 2004 gave
                                                        DFJ a 35x return, and the leading Chinese search engine
           Taking a broader view of this transformation – GDP
                                                        Baidu’s IPO, in 2005, provided a 31x return on a $12.5
        in the developing world will grow eight times its current
                                                        million investment.
        value of $8 trillion, and will grow three times faster than
                                                           In 2001, the U.S. based VC firm Warburg Pincus
        the GDP of the developed world from the current year to
                                                        faced a “moment of truth” and realized that expansion
        2050. This presents an immense investment opportunity for
                                                        beyond the U.S. was critical to its survival. By the end
        venture capitalists. Estimates suggest that India and China
                                                        2001—well before the first version of Goldman’s BRIC
                                                              report came out—Warburg had opened offices in
        Table 2: Others in the Line                           Hong Kong, invested in India’s top mobile operator
                           Destination India                  Bharti Airtel Ltd and, a year later, in India’s biggest
                                                              Business Process Outsourcing company WNS Ltd.
         VC firm                    Funds being Last Fund
                                                              Bharti gave Warburg a 5.5x return on its $300 million
                                   Raised ($mln) ($mln)
                                                              investment in 2005 and WNS gave it a 13x return on
         Matrix Partners                 300       150        its $40 million investment in 2006.
         IDG Ventures                    300       150           Sequoia Capital, one of Silicon Valley’s technol-
         Clearstone                      200       210        ogy-focused VC firms, with investments in Apple Inc,
         Nexus India Capital             220       100        Yahoo, YouTube and Google, is an excellent example
         Helion Ventures                 210       140        of a fast-follower within this trend towards global
                                                              investment. In 2001, Sequoia was reluctant to expand
         Walden International            150         -
                                                              even to the U.S. East Coast. In 2006, it went across
         Accel India Venture Fund         60         -
                                                              the world and set up an office in India by buying local
         Seed Fund                      50-60        -        VC firm WestBridge Capital Partners.
        50   Need the Dough? January-April - 2009
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   These examples underline the need to ‘look beyond the     these VCs out of their traditional markets – the developed
traditional stomping grounds’ and adopt global investment    economies of the U.S. and Europe.
strategies in the backdrop of the world economy reaching        There is an increased interest in global investing and
a point of inflection.                                       the venture capital industry is gradually becoming a global
                                                             industry. Last year, 58% of VCs are invested outside of
Globalization of VCs – Target Asia                           their home country, compared with 51% previous year,
The initiative taken by a few firms is now shaping up into a according to the annual survey conducted by Deloitte Tou-
new trend in the Venture Capital industry. Venture capital- che Tohmatsu, a global audit, tax, consulting and financial
ists (VCs) raising new funds dedicated to the Indian market services firm.
are confident of the market and are betting incremental         The survey focused on innovativeness of countries in six
funds to be invested here despite the much talked about technology sectors – telecommunications, semiconductors
global slowdown impacting availability of capital.           including electronics, software, biopharmaceuticals, medical
   For instance, Matrix Partners India, part of Matrix devices and equipment and alternative/clean energy. The
Partners U.S., expanded its consumer services fund to ap- VCs were asked to identify the countries that they con-
proximately $450 million from $150 million. The venture sidered the most innovative in these areas and categorize
and growth capital investment firm will now make larger them as primary countries that had the best technology in
growth capital investments up to $30 million in consumer a particular sector and then a secondary country.
services businesses, apart from continuing smaller venture      While the survey gives a thumbs-up to the U.S., which
capital investments in early stage companies. Its portfolio continues to be the leader in each technology arena, but
companies include Asklaila, Itzcash, Seventymm and Yo! in case of the choice of strong secondary leaders glo-
China, among others.                                         bally there are intriguing up-and-coming stories that vary
   Clearstone Venture Advisors, a global venture capital by technology sector. The survey affirmed that India is a
fund with over $650 million of committed capital for in- hotbed for software development. As a choice for primary
vestment globally, plans to close its fourth fund soon. The leader in software, India ranked second, but far behind
fund, which could be over $200 million, will also have a the U.S. However, as a secondary leader, India was ranked
larger share of investments in India. The company had first by a wide margin. In fact, India is the only developing
raised $210 million for its third fund, of which 20% to country that held a leading role in innovation among the
25% was dedicated for investments in India.                  six areas of technology ranked in the survey.
   IDG Ventures, a global network of venture capital funds      More than half of the U.S. VC firms intend to invest
with approximately $3.7 billion under management has a globally, 30% of the firms intend to invest in China and
$150 million early-stage technology venture capital fund 25% of firms intend to invest in India, according to an
in India and is planning a fund raising                                            earlier survey conducted by Deloitte
of about $300 million for India. IDG
                                             vcs are increasingly Touche Tohmatsu in 2006.
Ventures has so far invested in eight                                                 The growing focus of these firms
companies in India. IDG Venture’s                    looking at                    on their global investment strategies
portfolio in India includes 3D Solid                investment                     further comes to light as 70% of them
Compression, Kreeda, Aujas Net-                                                    plan to develop strategic alliances with
works, Manthan Systems, ConnectM,           opportunities within foreign firms. Almost 90% required
Perfint and iViz. The company was             those fast-growing                   their partners to travel more. Nearly
looking at the option of investing upto                                            80% plan to co-invest with local inves-
$5 million in companies in Internet
                                                         brics                     tors. And more than 60% of the VCs
and mobile payment space in India.                                                 said they planned to hire “local fund
   Walden International, headquartered in San Francisco, managers” over the next five years.
with a committed capital of about $1.9 billion, had an-         Non-U.S. VCs have similar interests for expansion, as
nounced its plans to raise a $500 million global fund for 58% of them intend to invest globally according to the
2009 to step up its investment in China and India. Over survey.
the next year, the global VC fund will invest close to $150     The key implication: VCs both within and beyond the
million (around Rs 650 crore) in India.                      U.S. are increasingly looking at investment opportunities
                                                             within those fast-growing BRICs.
Innovation: The Key                                             These results indicate that VC firms are beginning to
The hot-bed of innovation and point of origin of the next acknowledge the importance of looking beyond their own
generation of disruptive technologies is what is moving borders to identify and take advantage of the most power-
                                                                                            January-April - 2009 Need the Dough?   51
global perspective

        ful investment opportunities. But to ensure success with            For instance, take the experience of Global Silicon in the
        such international investments, VCs must have more than          U.K. Established in 1999 as a university spin-off, it devel-
        just a set of globally-appropriate tactics. They must possess,   oped a suite of Digital Signal Processing (DSP) technolo-
        at their core, the “Global DNA.”                                 gies focused on the consumer audio market. The VCs in
                                                                         U.K. pumped in $18 million in the company unaware that
        Building Blocks of the Global DNA                                a Chinese firm with comparable technology was develop-
        This Global DNA is what it takes to make a smart global          ing a cheaper product. The U.K. Company quickly became
        investor. To see success with the adoption of the Glo-           unprofitable and had to sell off its assets and intellectual
        bal DNA involves seamless correlation between the six            property to the Chinese competitor.
        key building blocks, thus ensuring realization of super             Think of what the outcome would have been. If the
        returns.                                                         U.K. VCs had some local intelligence on the ground in
           There are six key building blocks of the Global DNA:          China, the outcome of their investment would have been
        1) Establish a global presence with local fund managers;         quite different.
        2) Apply global experience across different local mar-              Not having local intelligence affects small and large
        kets;                                                            companies alike. When Titan, the watch-making unit of
        3) Combine the best-practices of the West with the eco-          Tata Group ventured into Europe in 1995 without a local
        nomic growth potential of the East;                              partner, it lost $18 million before deciding to scale back in
        4) Leverage differences in business cycles to make the most      Europe. If Titan had local intelligence and local partners, it
        of investment opportunities                                      could quite possibly have had a very different outcome.
        5) Identify how costs in one market can create value in
        another; and                                                2. Global Experience, Local Advantage
        6) Use global investments to create a larger number of      Being prudent while investing is wise. VCs can, and should,
        exit opportunities.                                         learn from the successes and failures of investing in one
                                                                    geography and apply it in another. There is no need to re-
        1. Be Global: Invest Local                                  invent the wheel, or worse, repeat the same mistakes.
        To thrive in this New World Economy, investing smartly is      The investment made by Warburg Pincus in Bharti Tele-
        the core to success, with globally deployable capital.      Ventures of $300 million is an example of cross-border
           What that means, is the need to have local intelligence, smartness. Warburg invested in Bharti only after learn-
        local networks and local insight. This involves application ing from its investments in telecom companies in the U.S.
        of smart market principles within a local context –- and such as Avaya, Espirit Telecom and Neustar and witnessing
        on a global basis. We have to be as intelligent as we were the growth of the mobile phone industry in the Western
        in our “20-minute drive zone”—in a                                               World.
        new “20-hour flight zone.”                                                         By learning from similar imple-
                                                     the backing of a vc
           To be global and yet invest local                                             mentations in the West and adopt-
        means that a VC firm must have local with global networks ing industry best practices, Warburg
        fund managers, who understand lo- and relationships has anticipated an opportunity in the In-
        cal markets and inherent complexities,                                           dian telecom sector while the industry
        across the world in the same incentive      helped the company was still in a “regulatory mess,” and so
        pool. They must operate in both the amalgamate the best secured an early stake in a company,
        West and the emerging East to take                                               which quickly emerged as India’s larg-
        advantage of the changing macro-
                                                    of the east and West est mobile phone operator.
        economic environment.
           These fund managers must regularly talk to each other 3. Combine the West and the East
        so that local investment decisions are made by applying As part of their global investment strategies, VCs with the
        the collective global knowledge and experience of Gen- strength of their local intelligence across the developed
        eral Partners. By doing so, they get a distinct comparative economies of the G7 as well as the two fast-growing BRIC
        advantage over traditional and purely local VCs who only economies, China and India should be able to leverage the
        cater to a local market. When managers in both emerging best of the East and the West, together.
        and developed economies communicate with one another           The West offers capital, technology innovation, intel-
        and draw from each other’s experience, they can make lectual property protection and mature markets with high
        better investment decisions. Absence of this local intel- purchasing power. The East, on the other hand, offers a
        ligence can be fatal.                                       high-growth market, low cost manufacturing, a large skilled
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  Chart 1: Relative Size of G7 and E7 Economies
  at Market Exchange Rates (MER) and Purchasing Power Parity (PPP)


$ billion





             G7 GDP   2005 MER                2050 MER                   2005 PPP                      2050 PPP
             E7 GDP

  workforce and globally ambitious entrepreneurs. One of       was the driving force with a share of 65% of the sales in
  the important components of the Global DNA is con-           the region at 75 million for the second quarter, according
  necting the spheres of East and West to generate the best    to Gartner, Inc., an information technology research and
  investment opportunities.                                    advisory firm headquartered in Stamford, Connecticut.
    Investment by the U.S. based private equity firm Carlyle   Taming these differences in business cycles to create invest-
  Group, in AuthenTec, world’s leading provider of finger-     able opportunities is a critical building block of the DNA
  print authentication sensors and solutions shows how this    of a truly global VC.
  Global DNA can be put to work. AuthenTec has its sales          Take the example of OnMobile Global Ltd, a California-
  and marketing in the U.S., design centers in Finland and     based Company that develops proprietary software for
  France and a manufacturing base in China.                    wireless devices. Infosys Technologies Ltd, India’s second
    The backing of a VC with global networks and relation-     largest IT services company, incubated it and Boston-
  ships has helped the Company amalgamate the best of          based Argo Global Capital led its $12 million first round
  the East and West. Perhaps Carlyle’s Managing Director       in 2000.
  Robert Grady describes Authentec best as “a small com-          When the U.S. telecom market experienced a downturn
  pany in central Florida 100% integrated into the global      in 2001, the company shifted to India, moving its opera-
  supply chain.”                                               tions there a year later.
                                                                  That coincided with the growth in India’s telecom in-
  4. Global VCs: Ride the Waves                                dustry where the Company was ideally positioned. The
  Different regions of the world have different business cy-   Company today is one of the leading Value Added Service
  cles. While one industry might be experiencing a downturn    provider in the Indian mobile market and received another
  in one economy, it could be riding a boom in another.        $28 million in funding from Goldman Sachs, Deutsche
  Worldwide sales of mobile phones reached close to 305        Bank and Polygon Investment in 2006.
  million units in the second quarter of 2008. More than          VC’s should “ride the waves” as a concerted strategy.
  half of these handsets were sold in Asia-Pacific region      That can only happen if they have local fund managers in
  that clocked sales of 115 million mobile handsets. India     different geographies who talk to each other and spot the
                                                                                            January-April - 2009 Need the Dough?   53
global perspective

        global crests of industry cycles, thus reinforcing the case     least-developed parts of South America and Asia.
        for VCs to possess the Global DNA.                                 Recent drops in stock market prices have induced fair-
                                                                        er value in emerging markets even as the fundamentals
        5. Cost in One Market, Value in Another                         show underlying strength. Latin America is predicted
        Global VCs can also identify and unlock hidden value.           to deliver 4.1% GDP growth in 2009, North-East Asia
        What’s a cost in one economy can be the creation of new         7.9%; South-East Asia 5.8% and Eastern Europe 5.9%,
        value in another.                                               according to analysts.
           Warburg Pincus’ one of the most profitable investments          An updated report on Emerging Economies by the
        in India’s largest Business Process Outsourcing group, WNS      U.K. accounting firm PricewaterhouseCoopers sug-
        Holdings highlights the presence of the Global DNA. War-        gests:
        burg Pincus is one of the prominent investors in India.         • The ‘E7’ emerging economies: the ‘BRIC’ economies
           WNS started as a captive outsourcing unit for British           of China, India, Brazil and Russia, plus Mexico, Indo-
        Airways Plc, an initiative to lower its own operating costs.       nesia and Turkey will by 2050 be around 50% larger
        Warburg, however, recognized the value of the company              than the current G7 (the U.S., Japan, Germany, the
        as India’s Business Process Outsourcing industry grew              U.K., France, Italy and Canada)
        globally and invested $40 million in 2002 for a 65% stake.      • China will overtake the U.S. by 2025 as the world’s
        That investment gave Warburg about 13X return, an ex-              largest economy
        cellent example of cost in one economy leading to value         • India is assessed as having the potential to nearly catch
        in another.                                                        up with the U.S. by 2050
                                                                        • Brazil is expected to overtake Japan by 2050 to move
        6. Exits – Global Options                                          into fourth place.
        The last strand of the Global DNA for VCs is to create a        • Russia, Mexico and Indonesia all have the potential to
        diversified portfolio dispersed across geographies which           have economies larger than those of Germany, France
        gives them increased number of exit options.                       or the U.K., by 2050
           Till recently the U.S. private equity investors have long    • The Turkish economy could be of similar size to the
        been able to generate healthy returns due from exits in            Italian economy by 2050.
        large, robust and liquid U.S. capital markets. That is gradu-
        ally changing, with the changing world economic scenario.          The Frontier Countries on track of reforms and trans-
        Efficient investment strategies are those that involve de-      parency offer varied investment options, which have given
        veloping a portfolio that minimizes risks, which can be         them growth well above 5% compared to the rest of the
        ensured with distributed exposures across geographies           world growing at around half of that.
                                                                           Goldman Sachs has identified 11 countries with BRIC-
        Some Indicators Of Decoupling                                   like possibilities. By the year 2050 the combined econo-
        The trend of venturing beyond borders has its roots in          mies of the “Next 11” could reach two-thirds the size
        the rapidly globalizing emerging economies growing at           of the G-7 nations.
        about 8% overshadowing the developed economies at just
        2% accompanied by the current recessionary trends.              Rewriting the Rules
           The emerging markets, particularly in Asia, are less         The world seems to be shrinking as ambitious Venture
        dependent on developed markets. Growth deceleration             Capitalists (VCs) shed the myopic view of the national
        was much less marked in emerging markets in the first           borders or distances, in search of profitable business
        half of 2008 than in developed markets, according to            ideas that yield above average returns.
        Morgan Stanley, the U.S. based global financial services           Aptly referred to as Globalization, the phenomenon
        firm. It forecast developed market growth to slow to 1%         is compelling the VC industry to revisit the ‘un-written’
        in 2009 from 2.5% in 2007 while emerging markets to             rule-book that governed the investment criteria for the
        slow to 6.6% only from 7.8% for the same period.                investors.
           The emerging markets continue to retain their strength,         Private equity managers in search of investment oppor-
        with strong cash reserves of about $5 trillion, amidst          tunities that yield above average returns look for market
        greater decoupling from Western economies and contin-           inefficiencies. Possessing the Global DNA helps identify
        ued domestic consumer spending. This is underpinned             arbitrage opportunities with a single window view of the
        by strong GDP growth for emerging and FRONTIER                  entire world economy. The Global DNA enables VCs to
        Countries, which include some budding economies of              identify such arbitrage opportunities, and capture super
        the former Soviet Union, Africa, the Middle East and the        returns.                                               l
        54   Need the Dough? January-April - 2009
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January-April - 2009 Need the Dough?   55

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