Investment Criteria of Singapore Venture Capitalists
Wee-Liang Tan, Senior Lecturer Dattatreya G. Allampalli., Research Associate, Ravinder Zutshi and Patrick T. Gibbons, Senior Lecturers Nanyang Business School Nanyang Technological University Nanyang Avenue Singapore 639798
Abstract
Venture capital industry in Singapore is of recent origin. However, funds under management in Singapore have grown from S$ 45 million in 1983 to S$ 7300 million in 1995. These developments together with the recent announcement of government’s vision of Singapore becoming a hub for venture capital in the region, provides an opportunity for an examination of the venture capital industry in Singapore. The venture capital industry originated in the western hemisphere, springing from the US, emerged as a response to the need of risk capital for high technology industries. Considering the nature of industrial developments in South East Asia, the authors anticipate that the investment criteria employed by VCFs in Singapore would differ in the light of the differences in culture and investment opportunities around Singapore. Although our study on sample of 31 venture capitalists from Singapore found more similarities than the differences in investment criteria when compared to US, Asia-Pacific, Europe and Canada, the mean scores of large number of investment criteria were higher than US, thus placing higher demands on entrepreneurs seeking venture capital.
Introduction
Scheela (1994) concluded that Singapore has great potential for the emergence of a venture capital industry based on Patricof’s (1984) four criteria for the emergence of significant venture capital activity. These criteria include: existence of a strong secondary market; a favourable tax structure; a flexible labour market; and an enterprising culture. Singapore meets these criteria and in addition to its role as a regional financial centre, has emerged as a venture capital hub in South East Asia. The rise of Singapore as a hub in South East Asia has been supported by two complementary developments. First, the Economic Development Board (EDB) of Singapore has embarked on a series of programmes to expand the venture capital industry in Singapore to complement Singapore’s role as a regional centre for finance, trade and industry. Second, the emergence of lower cost manufacturing centres in East Asia, in the rapidly growing second generation newly industrialised economies (NIEs), has placed competitive pressure on Singapore’s manufacturing industry. Singapore has therefore, moved up the technology ladder and promoted high value technology intensive industries. This move has spurred the development of an active venture capital industry. The existence of an active venture capital industry is critical to attract and promote new technology ventures. To catalyse the high-tech industry, EDB has itself entered the venture capital
industry with two funds, EDB Ventures and Singapore Bio-Innovations, which seek to invest in high technology companies. Whilst the industry has been developing and expanding, there is little information about the venture capitalists and their operations. There are few studies on the venture capitalists in Singapore and in Asia. In Singapore, Chia and Wong (1989) provide detailed case studies on three venture capital funds in Singapore. Through their in-depth analyses and interviews the researchers identified the initial investment objectives, philosophies, appraisal procedures and Investment criteria of the venture funds studied. Recently, Scheela (1994) using the case study methodology, also examined the investment approaches of five different venture capital funds in Singapore. Scheela (1994) found that the venture capital firms studied had strong international focus. In addition, he contrasted the management styles of the venture capital funds studied. In addition to this case study, the Economic Development Board (1995) conducts a survey of venture capital industry once in every two year. The 1995 survey (EDB) showed that the rate of increase in funds committed accelerated rapidly for two year-period 1993 and 1994 when compared with the two year-period between the years 1991 and 1992, with the amount of funds invested increasing by 300%. In the survey, it was reported that the bulk of funds was committed to South East Asia showing mounting evidence to the fact that there are investment opportunities in NIEs. Overall, although these studies are informative, the first while focusing on management styles is based on a small sample, and the other while comprehensive focuses directly on demographic data about the industry and does not address management styles employed. It is hoped that this paper will provide an insight into the current criteria used by the venture capital community in Asia as represented by the Singapore industry. This information would prove to be useful to the venture capitalists around the world, to entrepreneurs seeking capital around the globe, and to other academics. The study used MacMillan et al’s (1985) twenty-four different criteria, grouped under five broad classifications.
Research Methodology
A mail survey was employed to obtain the information required. The research instrument was developed to elicit information on the size of the venture capital firms, their investment priorities, time horizons and Investment criteria. The instrument included the Investment criteria used by MacMillian, I.C., Seigel, R. and SubbaNarasimha, P.N. (1985). These five categories Investment criteria have been used in other studies (hereinafter referred as “investment criteria”): entrepreneur’s personality, entrepreneur’s experience, characteristics of the product or service, characteristics of the market, and financial characteristics (Knight, 1986 & 1994; Ray, 1991; Elango, B., Fried, V.H., Hisrich, R.D., and Polonchek, A.,1995 ;). In addition to the criteria employed by earlier studies, for criteria on country risk and venture team were included (hereinafter referred to as “additional criteria”). Venture team characteristics were included as it were part of the original research carried out by MacMillan (1986) but not reported in the subsequent research studies by Knight(1986) and Ray (1991). Country risk as an additional set of criteria was felt to be relevant in the light of Singapore’s venture capital industry being a hub for regional economies (Allampalli, Gibbons, Tan & Zutshi, 1996). The scale used for evaluation criteria is a four point Likert-like scale : 1) Irrelevant 2) Desirable 3) Important and 4) Essential. Prior to distributing the survey, the chief executives of the venture capital funds in Singapore listed in the EDB Directory of venture capital were contacted and informed about the
objectives of the survey. The questionnaire was then sent directly to the chief executive officer of each venture capital fund, as it was expected that these individuals would be the most knowledgeable about their company’s investment criteria and strategies. From a total population of fifty-eight venture capital funds in the Directory, thirty-one responded yielding a response rate of 53%, which is quite high. Of more importance, the total amount of funds under management by the venture capital funds surveyed amounted to $3 billion, which represents 56.4% of the S$ 5.32 billion, the total funds under management at the beginning of 1995, as estimated by the EDB. Thence the responses are quite representative of the population.
Findings
Demographics In Singapore, there are 58 venture capital funds listed in the Venture Capital Directory (EDB, 1995). Venture capital funds under management has grown to S$ 7300 million in January 1996 from S$ 5320 million in 1995 after a modest start of $ 45 million in 1983. The average amount of funds managed by the respondents to our survey was approximately $110m. However there was a wide dispersion in the amount of funds invested. Singapore firms in our sample ranged in size from the smallest of S$ 0.2 million to the largest at S$ 700 million, and the median size of fund is S$ 90 million. The venture capital funds in our sample were classified utilising the criteria used by Elango, et al (1995) in categorising the venture capital funds by size. In their sample of 149 US venture capital firms (belonging to Silicon Valley, Northern and Southern California, New York and Texas), Elango et al (1995) found that the average size venture capital fund was US $ 278.9 million, US $50.9 million and US $12.3 million for Large, medium and small venture capital fund respectively. The classification of the venture capital funds by size is shown in Table 1 (next page). Table 1 Grouping of venture capital funds in Singapore(in S $ millions)
1
Singapore Mean (SGD) 12.05 54.53 230.80
2
United States Mean (USD) 12.345 50.962 278.91
Grouping of Venture Capital Funds Number Small (< 25 million) Medium (>=25 but < 100 million) Large (> 100 million) 8 11 11 Number 40 58 45
It can be seen from the Table 1 that the mean size of venture capital funds in various groupings for Singapore and United States also shows a close resemblance. The size of the venture capital funds involved in the venture capital industry in Singapore is not significantly different from US in decimal terms. Moreover, the proportions of firms across the three categories are similar.
1 2
Singapore - 30 reported out of 31 United States - 143 reported out of 149 venture capital funds.
Investment Criteria Used By Venture Capitalists In Singapore Mean response for each set of the investment criteria is shown in Tables 2-6. Findings from Knight’s (1994) on United States, Europe and Asia-Pacific and Canada, have been included in Tables 2 to 6 for comparison of investment criteria on a cross-cultural basis. However, it must be noted that the findings in Knight (1994) were from studies conducted at different periods of time and there may be some changes in the means of the responses as Knight discovered with respect to his Canadian samples (1994). Of the five categories of investment criteria, entrepreneurs’ personality, experience, characteristics of product or service, characteristics of market, and financial characteristics, it appears that financial characteristics are not regarded as important as the other categories. The mean scores for this category (Table 6) are generally lower than those for the other categories. The ranking of the mean scores for the twenty-four investment criteria used in earlier studies are indicated in square brackets in Tables 2-6. The means scores from the earlier studies were also ranked and their rankings similarly indicated. It must be observed that the Singapore venture capitalists only include one aspect of the market and another on the financial aspect in the top ten criteria as ranked by the means. The other market and financial aspects are low in the ranking. The top five investment criteria in Singapore are drawn from the first two groups of criteria on the entrepreneur. The entrepreneur’s familiarity with the venture’s target market (Table 3) and capability of sustained intense effort (Table 2) are the top two criteria with his ability to evaluate and react well to risk, and his past leadership ability are tied in the third position. The list is completed by the entrepreneur’s relevant track record. It is interesting to note that the top five criteria centre on the entrepreneur. This finding is similar to the situation in Europe but differs from the relative importance of the investment criteria in the US, the Asia-Pacific and Canadian samples. In the US study, the entrepreneur features in the top five criteria. However, the criterion ranked third is a financial characteristic - that the return must be equal to at least ten times the investment within a period of ten years. In the case of the Asia-Pacific sample, one aspect of the intended market was the fourth most important criterion; namely, the target market enjoys a significant growth rate. Finally, the Canadian venture capitalists indicate a product characteristic in the top five (in the fourth place) - the product has been developed as a functioning prototype. Knight in his study (1994) noted that the US venture capitalists appeared to be more demanding overall in their investment criteria. When the Singapore results for the same criteria are compared with the other countries, it appears that Singapore venture capitalists may be even more demanding than the US ones as in eleven of the twenty-four investment criteria indicated with an asterisk in Tables 2 - 6, Singapore venture capitalists have higher mean scores than the US. However, without the data from the earlier studies it was not possible to statistically compare the means.
Discussion
The investment criteria employed in Singapore appear to focus on the entrepreneur as the rankings of the mean scores indicates. the market, product and financial criteria appear to be lower on the rankings of the mean scores.
There has been a change in the criteria over time between the study of Ray in 1991 and ours in 1996. ray in 1991 found the top five investment criteria in his study of five venture capital firms to comprise a mix of entrepreneur and market criteria. Where as our study revealed a mix of criteria focusing on the entrepreneur in the top five. Such a change was found by Knight(1994) in his two Canadian samples, one taken in 1988 (31 VCFs) and the other 1993 (47 VCFs). This change points to a limitation of cross-cultural comparison where time lag may exits between samples. Investment Criteria on entrepreneur’s personality and entrepreneurs experience In evaluating the ‘entrepreneur’s personality’ and ‘entrepreneurs experience’, the results show remarkable similarity in investment criteria between Singapore, Asia -Pacific, Europe and US. A strong similarity is reflected by the rating which falls between ‘important’ and ‘essential’ for the first 2 criteria on both groups. Venture capital community across the globe feels that entrepreneur behind the venture is the important and essential consideration for investment decisions. Investment Criteria on Product, market and financial Strong similarities can be found in the evaluation of product characteristics, market and financial criteria across the East, West and European community of venture capitalists. The degree of importance of these criteria falls between important and essential for the first two criteria on product, market and financial characteristics with some noticeable differences. Evaluation of these characteristics stems from the common understanding of the evaluation of feasibility of investments. Commonality of investment criteria among venture capitalists across the globe on products, market and financial reflects their common concern for reasonable reward for risks, liquidity and safety of their investments. It was found that the investment criteria employed in Singapore are similar to those found in earlier studies in the US, Europe, Canada and the Asia-Pacific. Whilst the industry is at an earlier stage of development and there is a difference in culture, there appears to be consistency in the criteria applied across the various countries. There are a number of possible explanations for the similarity. First, US Venture capitalist’s early success in posting extra-ordinary returns of the 1980s returns of 40 % to 80% and some as high as 318% (Huntsman & Hoban, 1980) has led to acceptance of venture capital as a form investment that can catapult the economy around the world. As a developing industry, the Singapore venture capitalists have adopted criteria employed by the venture capitalists in other countries. Second, the influence of US extend to many countries as they have joint venture partnerships which might be based not only common understanding of objectives besides common ground for investment criteria as well. Singapore sample includes foreign owned venture capital funds like OCBC Wears Walden, Hambrecht & Quist, etc. and it would not be out of ordinary to expect them to apply investment criteria from their head office. There would be cross-fertilisation of ideas as the managers from the various funds interact in Singapore, where most of the managers are members of the Venture Capital Association. Third, as the size of funds managed by the venture capital funds in Singapore are similar to the size-structure reported in his study by Elango et al , it perhaps should not be surprise to learn that the investment criteria of Singapore VCFs are similar to the US. Thus such a strong similarity in emphasis on the entrepreneurs personality and experience is not surprising.
Further research work needs to be conducted to examine whether the investment criteria differ between venture capitalist’s who focus in the regional markets versus those whose focus is Singapore. yet another aspect that has to be examined is venture capitalist’s strategies may be found in their management of the investments and their degree of involvement in investee companies.
Conclusion
The venture capital industry is still at the stage of development seeking to fulfil the role set by the policy makers who desire to see Singapore become the hub for venture capital in the region. The study showed that the primary focus of the venture capitalists in Singapore is on the entrepreneur. Apart from some differences in the mean scores of the investment criteria, the Singapore venture capitalists appear to apply investment criteria similar to those of other countries/regions comprising in this study. Going by the higher mean scores on the eleven of the twenty-four investment criteria, Singapore venture capitalists are more demanding than the US. However, without the data from the earlier studies it was not possible to statistically compare the means.
References
Allampalli, D. G., Gibbons, P.T., Tan Wee-Liang; & Ravi Zutshi, (1996) “A Profile of Venture Capital Firms in Singapore” Paper presented at 7th ENDEC World Conference, Singapore. Chia, Robert and Wong, K.C. (1989) Venture Capital in the Asia Pacific Region, Toppan, Singapore. Economic Development Board, (1995) “Singapore Venture Capital Directory”. Economic Development Board (1995) “ Survey on VCFs in Singapore” Press report. dated 28 December 1995. Elango, B., Fried, V.H., Hisrich, R.D., and Polonchek, A. (1995), “How Venture Capital Firms Differ”, Journal of Business Venturing, 10, pp 157-179. Huntsman, B. and Hoban, J.P., (1980), “Investments in new enterprise: Some empirical observations on risk return, and market structure. Financial Management , 9, pp 44-51 Knight, R.M., (1988), "Criteria Used by Venture Capitalists "Journal of small business and entrepreneurship”, Vol. 1, No. 1 Knight, R.M., (1994), "Criteria Used by Venture Capitalists: A Cross Cultural Analysis" International Small Business Journal, Vol. 13, No. 1. MacMillian, I.C., Seigel, I.R. and SubbaNarasimha, P.N., "Criteria Used By Venture Capitalists to Evaluate New Venture Proposals, Journal of Business Venturing, Vol. 1, pp 119-128 Patricof, A. (1989), “The Internationalisation of Venture Capital”, Journal of Business Venturing, vol., pp 227-230. Ray, Dennis., (1991), “Venture capital and Entrepreneurial Development in Singapore” International Small Business Journal, Vol. 10, No. 1. pp 11-26 Scheela, W.J. (1994), “The Increasing Importance of Venture Capital in Singapore”, Journal of Asian Business, 10 (3), pp.73-86.
Table 2
ENTREPRENEUR’S PERSONALITY ( Mean Scores ) CRITERIA Singapore (31) Asia Pacific ( 53 ) 3.74[1] 3.45[3] 2.77[10] 2.77[11] 2.19[17] US ( 100 ) Europe (195) Canada ( 81 )
Entrepreneurs personality must be: 1. Capable of sustained intense effort. 2. Able to evaluate and react to risk well. 3. Articulate in discussing venture. 4. Attends to detail. 5. Has a personality compatible with mine.
[] denotes overall rank on 24 criteria on Singapore or respective country/region’s sample. () Sample size
3.58[2] *3.52[3] 2.61[14] 2.81[12] 2.26[19]
3.60[1] 3.34[5] 3.11[9] 2.82[12] 2.99[11]
3.55[2] 3.57[1] 2.77[10] 2.60[13] 2.10[17]
3.56[2] 3.31[3] 2.74[7] 2.68[8] 1.99[17]
* Rank of Singapore VCFs higher than US
Table 3
ENTREPRENEUR’S EXPERIENCE [ Mean Scores ) CRITERIA Singapore ( 31 ) Asia Pacific ( 53 ) 3.57[2] 2.98[5] 2.92[7] 2.22[16] 1.72[21] US (100) Europe (195) Canada ( 81 )
Entrepreneurs experience must be: 1. Be thoroughly familiar with the market targeted by venture. 2. Demonstrated Leadership ability in past 3. Has a track record relevant to venture. 4. Was referred to me by a trustworthy source. 5. I am already familiar with the entrepreneur's reputation.
3.61[1] *3.52[4] *3.39[5] *2.52[15] *2.30[18]
3.58[2] 3.41[4] 3.24[7] 2.03[20] 1.83[21]
3.54[3] 3.18[4] 3.03[5] 2.01[19] 1.55[22]
3.68[1] 3.01[5] 2.68[9] 2.10[16] 1.50[23]
[] denotes overall rank on 24 criteria on Singapore or respective country/region’s sample () Sample size
* Rank of Singapore VCFs higher than US
Table 4
CHARACTERISTICS OF PRODUCT OR SERVICE ( Mean Scores ) CRITERIA Singapore ( 31 ) Asia Pacific ( 53 ) US (100) Europe (195) Canada ( 81 )
Characteristics of products or service must be : 1. The product is proprietary or can otherwise be protected. 2. The product enjoys demonstrated market acceptance. 3. The product has been developed to the point of a functioning prototype 4. Product may be described as "high tech."
2.94[9] *3.10[7]
2.64[13] 2.81[9]
3.11[10] 2.45[13]
2.74[11] 2.85[9]
2.28[15] 2.66[10]
*2.94[10]
2.92[8]
2.38[15]
2.97[7]
3.05[4]
1.87[22]
1.42[23]
2.30[19]
1.45[23]
1.25[24]
[] denotes overall rank on 24 criteria on Singapore or respective country/region’s sample () Sample size
* Rank of Singapore VCFs higher than US
Table 5
CHARACTERISTICS OF MARKET ( Mean Scores ) CRITERIA Singapore ( 31 ) *3.35[6] *2.68[13] Asia Pacific ( 53 ) 3.15[4] 2.52[14] US (100) 3.34[6] 2.43[14] Europe (195) 3.00[6] 2.36[14] Canada ( 81 ) 2.86[6] 2.37[14]
1. The target market enjoys a significant growth rate. 2. The venture will stimulate an existing market. 3. The venture is in an industry with which I am familiar. 4. There is little threat of competition during the first three years. 5. The venture will create a new market.
*2.39[17]
2.10[20]
2.36[17]
2.14[16]
1.81[20]
*2.52[16]
2.42[15]
2.37[16]
2.23[15]
2.40[12]
*2.23[20]
2.17[18]
1.82[22]
1.75[20]
1.63[21]
[] denotes overall rank on 24 criteria on Singapore or respective country/region’s sample. () Sample size
* Rank of Singapore VCFs higher than US
Table 6
CHARACTERISTICS - FINANCIAL ( Mean Scores ) CRITERIA Singapore ( 31 ) 2.84[8] Asia Pacific ( 53 ) 2.94[6] US (100) 3.43[3] Europe (195) 2.86[8] Canada ( 81 ) 2.56[11]
1. I require a return equal to at least 10 times my investment with-in 10 years. 2. I require an investment that can be easily made liquid (e.g.. taken public acquired). 3. I require a return equal to at least 10 times my investment within at least 5 years. 4. I will not be expected to make subsequent investments. 5. I will not participate in latter rounds of investment (requires my participation in the initial round of investment).
3.00[11]
2.67[12]
3.17[8]
2.72[12]
2.39[13]
2.16[21]
2.12[19]
2.34[18]
2.1[18]
1.99[18]
*1.77[23] *1.68[24]
1.72[22] 1.24[24]
1.34[23] 1.20[24]
1.57[21] 1.4[24]
1.92[19] 1.56[22]
[] denotes overall rank on 24 criteria on Singapore or respective country/region’s sample. () Sample size
* Rank of Singapore VCFs higher than US