Copyright 2000: Council on Foreign Relations & Westview Press
INTERNATIONAL VENTURE CAPITAL:
The Role of Start-Up Financing in the United States, Europe, and Asia
Jeffrey D. Nuechterlein
Introduction
This article describes and analyzes the role of venture capital as a key source of financing for start-up companies in the United States, Europe, and Asia. Venture capitalists provide equity financing to private companies with rapid-growth potential for a variety of purposes, including product development, production, marketing, sales, and expansion. In essence, venture capital is high-risk, high-reward finance designed for young companies that have different asset structures, cash flows, and growth rates than mature companies. Companies backed by venture capital historically have produced a disproportionate share of new jobs, particularly well-paid and highly-skilled jobs. Moreover, U.S. venture capital-backed companies generate about three times more export sales per dollar of equity than more established companies and are a key source of research and development spending and applied technological innovation. Consequently, governments are increasingly aware that venture capital is an important source of economic growth and a means of developing targeted sectors of the economy.
U.S. venture capitalists pioneered and continue to dominate the venture capital business. In 1998, U.S. venture capitalists again raised and had more capital under management than venture capitalists in any other region of the world. While European and Asian venture capitalists have an increasing amount of capital under management, much of this capital is dedicated to buyouts of established companies, as opposed to start-up and expansion financing. In addition, most venture capital investments in Europe and Asia are in safer, more mature, and less dynamic companies than venture-financed firms in the United States. In fact, most European and Asian countries have had relatively little success in early-stage venture capital. The U.S. lead in venture financing for start-up companies partly explains the U.S. dominance in developing many new technologies, including software (nine of the top ten companies are American) and the Internet.
Background
Venture capital is defined herein as early and expansion-stage financing, as opposed to financing for buyouts (the outright purchase of a company, usually with borrowed funds) and workouts (the turnaround of a troubled company). Venture capitalists provide equity financing rather than loans to young companies in exchange for ownership of part of the company. As a result, entrepreneurs avoid interest payments and can more quickly achieve profitability. Entrepreneurs seeking venture financing typically prepare a business plan that provides a description of the product and the market, financial statements and projections, as well as the background of key managers and directors. Venture capitalists assess the quality of the management team and the competitive position and financial prospects of the company. On average, venture capitalists invest in only about 1% of the opportunities presented. Once they invest, venture capitalists actively work with the company's management by contributing their business experience and industry knowledge gained from helping other young companies.[1]
During the first few years, before significant revenues are generated, about two-thirds of the average venture capital-backed company's total equity is supplied by venture financing. The average U.S. venture-backed company raises about $16 million of venture capital during its first five years.[2] Start-ups typically use initial financings to develop a prototype and fund marketing and sales. Later financings allow companies to grow more quickly than proceeds from sales alone would allow. At this point, the company could be ready to go public, putting financing in the market's hands and allowing venture capitalists to realize a return on their investment.
In the United States, however, it is as common for a venture capitalist to sell a start-up to another firm as to offer it to the public through an initial public offering. For example, 101 venture-backed firms were sold to other companies in 1996, 152 were sold in 1997, and 190 were sold in 1998. By contrast, 275 venture-backed firms went public in 1996, 136 went public in 1997, and 77 went public in 1998.[3] In Europe, which lacks a liquid, transnational stock market on a par with the U.S. National Association of Securities Dealers Automated Quotation (NASDAQ) market and which has an underdeveloped equity culture, venture-backed companies are more likely to be acquired by another company than sold to the public through an initial public offering. The time period from start-up to an initial public offering varies considerably from country to country. In the United States, the average time is about five years, whereas in Japan the average has been about 30 years because of regulations that make it difficult for young companies to list on the Tokyo Stock Exchange.[4]
In addition to the institutional venture capital market analyzed in this article, there are approximately 250,000 so-called "angel" investors (generally wealthy individuals) in the United States who invest about $20 billion in 30,000 companies annually. Angel investors generally operate as individual investors, but some angels meet informally in groups to consider investments. The best known group of angel investors is the Band of Angels, comprised of more than 100 Silicon Valley high-tech executives who meet monthly to hear business presentations and make investments. The Band of Angels invested $45 million in 86 companies between 1995 and 1998 with a rate of return of 30 percent.[5]
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Venture Capital in the United States
U.S. venture capitalists pioneered the venture capital business immediately after World War II, roughly three decades before venture capital grew to a significant size in any other country. Milestones in the development of venture capital in the United States include the formation in 1946 of American Research and Development (ARD) -- the first publicly traded company specializing in equity investing in start-up companies -- which had some spectacular early successes, particularly on the $70,000 it invested in 1957 for a 77% equity stake in the Digital Equipment Corporation that produced a 5000-fold return over 14 years.[6] The founders of ARD believed that scientists at the Massachusetts Institute of Technology and elsewhere who had developed promising new technologies during the war years needed financing and hands-on assistance to successfully commercialize their research.
In 1958, Congress -- reacting in part to a 1957 Federal Reserve Bank study that revealed a lack of equity capital for new companies -- enacted the Small Business Investment Company (SBIC) Act. SBICs are private corporations licensed by the Small Business Administration (SBA) to provide venture capital to new companies. SBICs can lever their private capital with loans from, or guaranteed by, the SBA; the additional funds made available through SBA guarantees may equal 2 to 3 times the invested private capital. By 1963, the 692 SBICs licensed by the SBA managed $464 million of private capital and included 47 publicly owned SBICs that raised $350 million through public offerings. By comparison, ARD raised only $7.4 million in its first 13 years.[7] In the 1960s and 1970s, SBICs accounted for as much as one-third of venture financing, but by 1990 accounted for less than 5% of such financing.
After years of mismanagement and abuse, culminating in numerous SBICs going bankrupt between 1986 and 1992, Congress restructured the SBIC program by enacting the Small Business Equity Enhancement Act of 1992 and its 1994 implementing legislation. In addition to correcting a number of structural problems in the program, the 1992 Act enables SBICs to defer paying the accrued costs on their debenture leverage until the SBICs realize sufficient capital gains and income to achieve cumulative profitability. As a result of this legislation, the licensing of new SBICs has increased dramatically. Between 1994 and 1998, 138 new SBICs were licensed with initial private capital of $1.8 billion. Combined with additions to the private capital of existing SBICs, this resulted in a doubling of private capital in the program from $2.3 billion in 1993 to $5.8 billion in 1998. In 1997, SBICs accounted for 45% of the total number of venture financings and 20% of the total dollar volume of venture financings in the United States. By mid-1998, there were 242 active regular SBICs and 78 Specialized SBICs (which finance businesses owned by socially or economically disadvantaged persons). Of the regular SBICs, 83 are owned by banks, which are limited by banking regulations in their ability to make large equity investments except through an SBIC subsidiary. Bank-owned SBICs represent 63% of the private capital in the program and generally do not use SBA-guaranteed leverage. Companies that trace their initial financings to SBICs include America Online, Apple, Federal Express, and Intel.[8]
In addition to the creation of the SBIC program, the late 1950s and the 1960s also saw the establishment of the first venture capital limited partnerships where professional venture capital managers acting as general partners invest funds on behalf of limited partners, which are commonly institutional investors like pension funds.[9] Limited partners are so-called because their liability extends only to the capital they contribute. Limited partnerships typically have a 10 year life, during which the limited partners forgo nearly all control over the management of the partnership. Limited partnerships now manage about 80% of all private equity investments.[10]
U.S. venture capital funds grew markedly in the 1980s, in part because of six key legislative acts between 1978 and 1981: the Revenue Act of 1978, which reduced the capital gains tax rate from 49.5% to 28%; the 1981 Economic Recovery Tax Act, which further reduced the capital gains rate to 20%; 1979 and 1980 legislation that allows pension funds to invest in private equity; the 1980 Small Business Investment Incentive Act, which reduced the regulatory burden on venture capitalists; and the 1981 Incentive Stock Option Act, which allows holders of stock options to defer tax liability to the date when the stocks are sold rather than the date when the options are exercised. The U.S. venture capital industry also profited enormously from the boom in personal computers in the 1980s. Between 1980 and 1990, the value of the personal computer industry grew from virtually zero to $100 billion, the largest legal accumulation of wealth in history. More than 70% of these firms were venture-backed.[11] Cisco, Compaq, Cray, Genentech, Lotus, Microsoft, Netscape, Starbucks, and Sun Microsystems are some of the well-known U.S. companies nurtured by venture capital.
U.S. venture capitalists raise about three times more venture funding each year than those in any other country. In 1997, U.S. venture capitalists raised more than $10 billion (up from $4.4 billion in 1995 and $7.5 billion in 1996), largely from pension funds (55%), corporations (13%), and endowments and foundations (10%) flush with capital from the doubling of the S&P 500 over the last three years.[12] U.S. venture capitalists raised an additional $25 billion in 1998 (largely from pension funds - 60%) and $9.5 billion during the first six months of 1999.[13] Investors have increased their allocations to venture capital in part because of historical figures showing average annual returns of approximately 20% for venture capital investments compared to 11% for the S&P 500.[14] As a result of 1998's inflow, net capital under management by U.S. venture capital firms increased to about $75 billion, up from $3 billion in 1980. Moreover, the internal rate of return of venture capital investments historically is considerably higher in the United States (approximately 20%) than elsewhere in the world (e.g. Britain and France where returns have averaged about 10%).[15]
U.S. venture capitalists invested a record $14 billion in nearly 3000 companies in 1998, compared to $12 billion in 1997, $10 billion in 1996, and $8 billion in 1995. The average size of each financing in 1998 was $5 million. There was more venture capital invested in California ($5.8 billion), Massachusetts ($1.7 billion), and Texas ($800 million) than in all of Europe.[16] Venture capital investments in the United States, unlike in Europe and Asia, are highly concentrated in technology. In 1997, U.S. software companies captured 22% of the total invested, networking/communications companies 19%, Internet companies 18% (up from just 2% in 1994), healthcare services 9%, biotechnology 8%, and medical devices 6%. Retailing and consumer products companies combined accounted for only 8.8% of the total.[17] U.S. venture capitalists invested an additional $11.4 billion during the first six months of 1999. During the second quarter of 1999 alone, U.S. venture capitalists invested $6.8 billion; 56% of that amount went to Internet companies.[18]
The United States has the world's most successful venture capital industry in large part because of a strong entrepreneurial culture that allows managers to take substantial ownership positions in their companies. U.S. managers are much more likely than their European and Asian counterparts to join a rapidly-growing start-up that cannot afford to pay large salaries but can attract top talent by offering equity ownership through generous stock option grants.[19] European and Asian managers, on the other hand, generally prefer the security of large corporations and are unlikely to have equity interests in their companies. In fact, many European and Asian countries have severely restricted or prohibited the use of stock options. The United States also has the most competitive market in the world, which produces excellent managers and gives U.S. companies a significant advantage in increasingly competitive international markets. In addition, the United States, unlike many European and Asian countries, has well-developed and liquid stock markets, which are critical for a vibrant venture capital sector because venture investors and entrepreneurs must have an exit mechanism for realizing capital gains. The U.S. venture capital industry also benefits from ready access to institutional financing, a relatively flexible labor market that allows companies to hire and fire workers more easily than can European and Asian companies, bankruptcy laws that do not prohibit failed entrepreneurs from starting another company, a tax system that generally allows entrepreneurs to retain a higher percentage of profits than their European and Asian counterparts, strong intellectual property rights protection, the world's preeminent business schools,[20] and a merit-oriented business culture that directs capital to good ideas usually without regard to the entrepreneur's pedigree.
U.S. entrepreneurs also have benefited enormously from relatively close links among universities, government laboratories, and private companies. The transfer of research and development and technology innovations from research universities (e.g. Stanford and MIT) and government laboratories (e.g. Oak Ridge in Tennessee)[21] to the private sector has led to clusters of entrepreneurial companies and venture capitalists in areas like Silicon Valley in Northern California, the Route 128 corridor in Boston, Northern Virginia, the Research Triangle Park in Raleigh-Durham, North Carolina, and Austin, Texas where much of the development of the semiconductor, software, computer, biotech, and Internet industries has occurred. While there are some examples of universities in other countries transferring technology research to the private sector (e.g. the relationship between Cambridge University and the 1,000 high-technology companies in Silicon Fen in England), there generally is little cooperation between universities and the private sector in Europe and Asia. Unlike U.S. universities, most European and Asian universities do not encourage the commercialization of research, focus more on theory and less on applied innovation, and rarely recruit from the private sector to fill academic positions.[22]
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Venture Capital in Europe
Venture capital did not become a significant source of financing in Europe until the 1980s. In the last few years, however, the amount of venture capital under management has grown steadily. By 1997, the approximately 500 European venture capital firms had made cumulative investments of about $30 billion in 20,000 companies.[23] The level of venture capital financing in Europe, however, would need to be three or four times its current level for venture capital as a percentage of the region's GDP to match the equivalent ratio in the United States. Baan, British Biotech, Business Objects, Filofax, Parker Pen, and Zodiac are some of the well-known European companies nurtured by venture capital.
For a number of reasons, however, the greater use of venture capital in Europe over the last few years has not resulted in the same kind of dynamic start-ups that venture capitalists in the United States have helped nurture. First, much of what is classified as venture capital in Europe (and Asia) is dedicated to buyouts and workouts, as opposed to start-up and expansion financing. More than half of Europe's $11.5 billion in venture financing in 1997 went to management buyouts as opposed to start-up or expansion funding.[24] Less than 10% of Europe's venture financing is invested in start-ups, compared to about 37% in the United States, in large part because investments in European start-ups have produced low rates of return.[25] In 1997, European venture capitalists invested about $840 million in early stage companies whereas U.S. venture capitalists invested $2.5 billion in such companies.[26] Second, venture capitalists in Europe tend to fund safer, more mature, and less dynamic companies than venture capitalists in the United States. In 1995 and 1996, European venture capitalists allocated only about 2% of their investments to biotechnology firms and less than 20% to various technology sectors, including communications, computer, and electronics firms.[27] In 1996, U.S. venture capitalists invested 12 times more funds in technology companies than their European counterparts.[28] In fact, a larger percentage of venture financing in Europe goes to consumer-related industries than to technology companies. In Europe as a whole, less than 10% of venture financing is invested in technology companies. By comparison, in 1997, U.S. venture capitalists invested more than 70% of their funds in technology-based companies and only 9% in retailing and consumer products companies.
Compared to their U.S. counterparts, most European institutional investors (outside of Britain and the Netherlands) are more wary of equity investments in start-up firms and prefer the relative safety of fixed income investments. In addition, while the United States has allowed pension funds to invest in private equity since 1979, some European and Asian countries prohibit pension funds from participating in the private equity market. Consequently, pension funds supply more than 50% of venture capital raised in the United States compared to 25% in Europe (up from 16% in 1993) and 5% in Japan. Because many European countries allow banks to lend money and make equity investments in the same company, banks are still the leading source (26%) of venture capital funding in Europe.[29] In the United States, banks account for a much smaller percentage of venture capital financing because U.S. banking laws (e.g. the Glass-Steagall Act) impose more restrictions on banks making equity investments in companies in their loan portfolios. Banks, particularly in Europe, however, are much more likely than venture capitalists to invest in relatively safe investments and normally do not bring the type of expertise needed to nurture young entrepreneurial companies.
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Germany
In Germany, the commercial banks, insurance companies, and venture capital firms that invest in start-ups historically have had limited success. The total amount of venture capital that has been invested in Germany is about $4 billion, roughly equivalent to the amount of venture capital invested in the United States in the second quarter of 1998 alone.[30] About $300 million (7%) of this total is invested in start-ups and less than 15% is invested in high-technology companies (although the amount of venture capital provided to technology start-ups is growing rapidly).[31] German banks provide 58% of all venture financing and favor large investments in expansion stage companies.[32] Techno Venture Management, established in 1984 as an offshoot of Siemens, is Germany's oldest venture capital firm, while Deutsche Bank's venture capital arm is Germany's largest provider of venture financing.
The primary problems facing German entrepreneurs have been excessive government regulation, relatively high capital gains taxes, high labor costs, inflexible labor laws (supported by powerful labor unions) that limit the ability to hire and fire employees and a general political concern with protecting workers from layoffs, inadequate exit mechanisms for investors, a lack of management talent to nurture early stage companies, a dearth of employees willing to leave the safety of well-paid jobs with large German companies to join a start-up (in part because of the stigma associated with failure in Germany), and an underdeveloped entrepreneurial culture. In part because of these problems, as well as the German preference for bonds over stocks, Germany has less than half the number of quoted companies as Great Britain. Numerous German entrepreneurs have moved their high-tech ventures to the United States to escape Germany's taxation system and to be closer to potential investors and partners.
The German government and business sector have recognized the importance of encouraging entrepreneurial activity and recently have taken steps to bolster support for start-ups. For example, Deutsche B?rse, which runs the Frankfurt securities exchanges, established the Neuer Markt in March 1997 to assist young companies in raising capital and to provide venture capitalists with an effective exit route. By August 1999, nearly 150 companies had listed on the exchange.[33] (By comparison, U.S. stock exchanges list approximately 1500 high-technology companies with a market capitalization twice that of all non-U.S. high-technology companies combined.) In addition, Deutsche Ausgleichsbank, a government-owned bank that is one of the largest start-up financiers in Germany, sponsors the Technology Participation Society that helps finance young technology companies. The German government's BioRegio initiative, begun in 1995, appropriated $90 million to three winning areas (Munich, Rheinland, and Rhein-Neckar-Dreieck) to help develop a more robust biotechnology industry. German banks and investors have agreed to invest an additional $900 million in the initiative over the next five years.[34] On the local level, the Bavarian government has begun funding scientific research to aid the region's growing information technology and biotech sectors.[35] SAP, the German enterprise software maker that is the world's fourth largest software company, is developing a German venture capital arm and recently established four professorships in entrepreneurial studies at German universities. In part because of these developments, Germany's venture capital sector is growing rapidly.
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France
France has some of the right elements for a strong venture capital industry, including a strong technology base, an entrepreneurial culture exemplified by a large number of small companies,[36] and a new small company stock market (Le Nouveau Marché).[37] Total venture investments in France, however, are small. In 1996, French venture capitalists invested only about $500 million, less than $200 million of which went to start-ups.[38] In 1997, French venture capitalists invested only about $100 million in start-ups.[39]
The primary problems facing the French venture capital industry are relatively poor performance records, the absence of sizable pension funds,[40] the inability of France's financial system to channel significant funds into private equity, relatively high capital gains taxes, a dearth of skilled management teams willing to join start-ups, and a highly regulated labor market weighed down with social charges.[41] In part because of these problems, nearly 50 French companies recently have moved or committed to move to Great Britain, which has a more welcoming business climate.[42]
Great Britain
Great Britain has made the most progress among European countries in stimulating venture capital investments, in part because of government reforms in the 1980s and 1990s that reduced high tax rates, promoted more flexible labor markets, and streamlined burdensome regulations that had disproportionately disadvantaged small companies. In addition, Britain has the most liquid stock markets in Europe. In 1995, the London Stock Exchange established the Alternative Investment Market in London, which is designed specifically for small growth companies; by 1999, more than 300 companies had listed on the exchange.[43] In 1999, the London Stock Exchange launched Techmark, a new market designed specifically for high-tech companies.
Unlike France and Germany, British pension funds are the dominant source (32.8%) of venture financing, whereas insurance companies and corporations provide 20.6% and 16.0%, respectively.[44] In 1996, Britain, with less than half the population, attracted twice as much venture capital as France and Germany combined; Britain accounted for 44% of total European investment whereas France and Germany accounted for 12% and 10%, respectively.[45] In 1997, British venture capital firms invested about $265 million in 219 early stage companies (whereas U.S. venture capitalists invested $2.5 billion in more than 700 early stage companies).[46] British venture capitalists invest about 5% of their funds in start-ups and about 16% in technology companies.[47] Although small by U.S. standards, Britain is the second-largest high-technology venture capital market in the world after the United States. Britain also has Europe's largest biotechnology industry, with more than 180 companies, about twice the size of the biotech sectors in France and Germany.[48] More than any other country in Europe or Asia, Britain offers an experienced array of entrepreneurial managers who are available for new start-ups as their older venture-backed companies mature.[49]
One of the centers of Britain's technology venture boom is Cambridge Science Park ("Silicon Fen") in and around Cambridge, which is home to about 1,000 high-technology companies that employ 30,000 people and produce more than $3 billion in annual revenues.[50] In 1997, Microsoft established an $80 million research laboratory in Cambridge to take advantage of Cambridge University's strengths in the sciences and its long history of collaborating with industry. Microsoft's links with Cambridge are particularly close - the head of the University's computer laboratory also heads the Microsoft facility. (The Gates Foundation also donated $20 million to the University's computer science department and Microsoft committed $8 million -- plus an additional $8 million for possible co-investments -- to a Cambridge and London-based venture capital fund managed by Amadeus Capital Partners.)[51] Cambridge University recently established a management school, after years of ambivalence about business as an academic discipline, and has announced that it will establish a school of entrepreneurship modeled on the entrepreneurship program at the Massachusetts Institute of Technology.
A second concentration of venture-backed companies in Britain is in Oxford and the Thames Valley (the M4 corridor), west of London. The Oxford Science Park (established in 1991, 21 years after Cambridge's) and the Oxfordshire region generally are home to 730 high-technology companies that employ about 26,400 people. In addition, 8 of the top 10 U.S. information technology companies have their British or European headquarters in the Thames Valley and the other two, Apple and Sun Microsystems, are on the outskirts of the region. Numerous other electronics, telecommunications, and biotechnology companies also are based in the Valley. For many years, a large percentage of Oxford University academics were hostile to the commercialization of research and, like many Cambridge academics, questioned whether business should be part of the academic curriculum. Nevertheless, Oxford established a graduate business school in the 1980s and, after a fierce debate, recently established an undergraduate business school. In addition, Oxford formed Isis Innovation in 1988 to help the University's 2500 funded researchers and 2000 doctoral candidates in science and medicine commercialize their research. Since its inception, Isis Innovation has filed 200 patents, completed 50 licensing deals, and attracted venture capital to help establish several biotechnology companies that employ intellectual property developed in University laboratories.[52]
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European Small-Company Stock Markets
Many European countries have an imbalance between venture capital investments and divestments, indicating that while there is a large supply of venture capital, the exit mechanisms for these investments have been insufficient. Efficient exit mechanisms are critical for a vibrant venture capital sector because venture investors and entrepreneurs must have a mechanism for realizing capital gains. One reason for the imbalance in Europe is that, until 1996, European venture capitalists were hampered by the lack of a liquid, transnational stock market designed for start-up firms on a par with the U.S. NASDAQ market. Although a number of European countries (Belgium, Britain, Denmark, France, Germany, Ireland, Italy, and the Netherlands) established stock markets in the 1980s and 1990s that are designed to broaden the supply of capital to small companies that do not meet the requirements of the primary markets, these small-company markets have not lived up to expectations for a number of reasons. First, unlike in the United States and Japan, the European small-company markets are under the same management as the primary markets. In general, managers of the European markets are more interested in promoting the primary markets than the secondary markets. Second, European companies generally seek to move their listings to the primary markets as soon as possible (unlike in the United States where many large companies -- e.g. Cisco, Dell, Intel, and Microsoft -- have retained their listings on NASDAQ). Third, European institutional investors are less likely to have significant holdings of small-capitalization stocks than U.S. institutional investors, which has depressed the liquidity of the small-company markets. While some European venture-backed companies are listed on NASDAQ, such cross-border offerings represent only a small percentage of European small companies. For all these reasons, a venture-backed company in Europe is much more likely to be acquired by another company than sold to the public through an initial public offering (the preferred exit mechanism in the United States and Japan).
In September 1996, Europe created the European Association of Securities Dealers Automated Quotation (EASDAQ) market, which is intended to make it much easier for European entrepreneurs and venture capitalists to offer start-up companies to the public. EASDAQ, modeled on NASDAQ, seeks to bring together high-growth companies, their investors, and financial intermediaries into one highly liquid, well-regulated, pan-European stock market. Companies listed on EASDAQ have direct access to, and an increased profile with, a wider range of capital sources than can be found in any one national stock market in Europe. Based in Brussels, EASDAQ operates across 14 European countries and is independent of all other European stock markets. EASDAQ is off to a slow start -- by August 1999, it had attracted only 49 companies with a combined market capitalization of $21 billion.[53]
EASDAQ's competition in the effort to create a European version of NASDAQ is the EURO.NM market, also created in 1996 to allow cross-border trading by the five small company markets in Amsterdam, Brussels, Frankfurt, Milan, and Paris. The small company markets in Denmark, Italy, Sweden, and Switzerland are scheduled to join the EURO.NM market in 1999. EURO.NM has more than 150 listed companies with a combined market capitalization of more than $30 billion.[54] The companies listed on EASDAQ, however, are generally larger and face tougher listing and disclosure requirements and the exchange has a fast-track trading link with NASDAQ, all of which appeals to institutional investors. In choosing whether to list on EASDAQ or EURO.NM, nationality continues to plays a role, which illustrates one of the key issues that must be overcome before Europe succeeds in creating a single stock market to complement a single European currency.[55]
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Venture Capital in Asia
The amount of venture financing in Asia has grown steadily in the 1980s and 1990s. By late 1997, Asia's 800 venture capital firms (up from 50 in 1989) had $38 billion under management (up from $21 billion in 1991). Asian venture capitalists invested $5.5 billion in 1996; of that total, Japanese venture capitalists invested about $1.4 billion. By comparison, U.S. venture capitalists invested nearly $4 billion in Silicon Valley alone in 1997. Historically, Japan has been the most popular destination for venture capital with about two-thirds of the total. Excluding Japan, Korea (17%), Hong Kong (11%), and Singapore (8%) are the largest recipients of venture financing. Funds are distributed across the spectrum with industrial products (17%), consumer-related products (16%), and other manufacturing industries (15%) attracting the most capital. In 1996, more than 18,000 Asian companies had venture capital backing.[56]
As is the case in Europe, however, much of what is classified as venture capital in Asia is either long-term debt or is dedicated to later-stage financing, as opposed to start-up financing. About 70% of Asia's venture capital goes to later-stage financing, while only 21% is invested in start-ups.[57] The latter number is misleading, however, because the start-up category in Asia includes new ventures incorporating long-standing state or family-run businesses. By comparison, about 37% of all venture financing in the United States is dedicated to actual start-ups. Asian venture capitalists are more likely to invest in older, maturer companies than U.S. venture capitalists. For example, more than 60% of venture investments made by Nippon Investment & Finance Company, an established venture capital company, are made in companies 10 years or older.[58]
Unlike the United States, three of the largest sources of venture capital in Asia are corporations (41%), banks (16%), and government agencies (7%).[59] Non-Asians are among the largest venture investors in the region -- about 25% of all venture capital invested in Asia is sourced from outside the region. Excluding Japan (which historically has not readily welcomed foreign venture capital), about 50% of Asian venture capital is raised locally, 35% is raised outside Asia, and 15% is raised in other Asian countries.[60] U.S. venture capitalists, and the pension and other large funds that back them, are among the largest investors backing Asian entrepreneurs. U.S. investors have been attracted to Asia because of the high growth rates across the region in the 1990s and because returns on investment in the U.S. private equity market are coming under pressure as competition for deals among U.S. venture capitalists drives up valuations.[61]
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Japan
In Japan, the largest sources of venture capital are corporations (46%), banks (30%), and insurance companies (10%).[62] Japanese venture capital firms allocate a much smaller share of funds to technology companies (35%) than do U.S. venture capitalists (70%). Japan's largest venture capital firm is the Japan Associated Finance Company (JAFCO), a publicly-traded company founded in 1973 and associated with the Nomura Securities house. JAFCO has made more than 1800 investments worldwide and its portfolio companies represent about 30% of the initial public offerings in Japan. It has offices throughout Japan, as well as in eight other Asian countries, Britain, and the United States.[63]
Most Japanese venture capital firms are subsidiaries of large corporations. For example, in 1996, Toyota Motor Corporation created one of Japan's largest venture capital funds (nearly $400 million) to finance companies inside and outside the Toyota keiretsu. Like most Japanese corporations, Toyota's primary goal for its venture capital unit is not capital gains, but rather the development of new technologies.[64] In 1996, Nippon Telephone and Telegraph, Nippon Life Insurance, Sanyo, and several other large corporations created Nippon Venture Capital Company; to date, it has invested $64 million in 122 companies inside and outside of Japan.[65] Several other Japanese corporations recently established venture capital arms, including Mitsui and Mitsubishi.
The Japanese government, like many governments in Asia, continues to work closely with the private sector to formulate business strategy. Japan's reaction to the growth of the Internet is illustrative. Although U.S. government researchers created the Internet in the 1960s to enable scientists around the country to communicate with each other, U.S. entrepreneurs -- and the venture capitalists that have rushed to fund them -- are responsible for the tremendous growth in Internet services over the last few years. What has most impressed Japan's Ministry of International Trade and Industry (MITI), however, is the U.S. government's initial role in creating the Internet. Consequently, the Japanese government's emphasis has been on funding a government-industry partnership to integrate the operations of Japanese manufacturing facilities worldwide, an initiative that MITI says it eventually will turn over to the private sector.
Although Japan has the largest venture capital market in Asia, a venture capital industry has never developed in Japan on a par with the United States for numerous reasons. First, Japan's Ministry of Finance long has maintained tight regulation of financial markets, which limits the ability of Japanese entrepreneurs to obtain capital, and has prohibited Japanese pension funds from investing in venture capital funds. Second, Japanese banks are reluctant to lend to new businesses, in part because bank lending generally is contingent on ownership of land as collateral and few entrepreneurs can afford Japan's high-priced real estate. Third, Japanese entrepreneurs confront a high tax rate that can take 50% of taxable income. Fourth, Japan's culture has hindered the development of an entrepreneurial sector backed by venture capital. It is often said that the nail that sticks out gets hammered down in Japan.
The Japanese emphasis on order, conformity, and seniority contrasts with the U.S. tradition of supporting individualism and limited government power. Japan has spent years nurturing and protecting big manufacturing exporters rather than emulating the entrepreneurial spirit that has driven the high-technology boom in Silicon Valley. Although Japan has had some entrepreneurial heroes - like Soichiro Honda, who created Honda Motor Company, and Akio Morita, who co-founded Sony Corporation - most emerged in the years just after WW II. The current environment is not designed to foster entrepreneurial activity. Because most Japanese favor lifetime employment at major companies like Sony or a major bank and view jobs at start-ups as second rate, it is difficult for entrepreneurs to attract good management. Americans, on the other hand, are more willing to accept risk and tolerate career shifts. The result is that the United States, with about twice the population of Japan, produces more than seven times as many new companies each year as Japan.[66]
The Japanese government, however, recently has taken a number of significant steps to increase support for Japanese entrepreneurs. For example, in 1991, Japan established JASDAQ, a stock market designed for start-up firms that is modeled on NASDAQ.[67] In 1995, Japan approved the use of stock options and, in 1997, amended tax laws to make options more attractive to employees at Japanese start-ups.[68] U.S. start-ups, which often have limited cash flow and are forced to pay low salaries to employees, have used stock options for years to attract and retain talented managers, software engineers, and scientists.
In addition, MITI recently created a program that provides grants of up to $500,000 to start-ups and another program that provides loan guarantees.[69] In the last several years, most other Japanese government ministries, as well as local and regional governments, have also adopted programs to encourage Japanese entrepreneurs, including setting up venture business incubator programs that bring capital, facilities, and entrepreneurs together. The Japanese venture incubators are modeled in part on the 300 venture incubators that U.S. states have established with mixed success. Moreover, MITI recently rescinded the law prohibiting Japanese venture capitalists from serving on and appointing others to the boards of their portfolio companies. MITI and the Finance Ministry also are drafting a limited liability law (similar to that which exists in the United States) that would enable pension funds and other institutional investors to invest in venture capital funds by providing some protection from poor investments.
Recognizing the important role that university research has had in advancing U.S. entrepreneurial activity, the Japanese Ministry of Education and Science and the Ministry of International Trade and Industry recently began funding more than 20 so-called venture business laboratories in Japan's largest universities through the Original Industrial Technology R&D Promotion Program, which is designed to promote original research and development that will seed new industries and train new researchers. Significantly, MITI broke with its long-standing practice of unilaterally identifying important new technologies for research and development and now openly solicits proposals for university research projects and encourages researchers to compete for funding.[70]
Despite these efforts by the Japanese government, venture capital activity recently has been declining in Japan. The Japanese recession and the instability of the financial system have led to the failure of numerous venture-backed businesses. Unlike the United States, where venture capitalists increased investments from $8 billion in 1995 to $10 billion in 1996, Japanese venture investments were flat, $1.4 billion in both years.[71]
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China
Although Japan accounts for the majority of venture capital activity in Asia, venture investments have been increasing in a number of other Asian nations. For example, a number of Chinese, Asian, and U.S. venture funds have been investing in China over the last several years, primarily in provinces on the coast and near Hong Kong. China has some of the right elements for a strong venture capital industry, including an entrepreneurial culture (exemplified by Chinese living not just in China, but in Taiwan, Indonesia, and numerous other Asian countries),[72] as well as an educational system that directs large numbers of Chinese students to programs in engineering and business at Chinese and U.S. universities.
Nevertheless, venture investors face an array of obstacles in China, in large part because of decades of communist policies that have curtailed entrepreneurial activity. A key difficulty is finding experienced managers to run entrepreneurial companies in a country that only recently began adopting capitalism. In addition, the relationship between venture capitalists and companies is often different in China than in the United States and Europe; Chinese entrepreneurs welcome investment but may chafe at the degree of influence that venture capitalists want over the company's activities. Moreover, China does not have accounting and reporting standards, credit ratings, or a legal system on a par with the United States, and China's two major stock markets in Shanghai and Shenzhen -- like most exchanges in Asia -- are primitive. Consequently, venture capital returns in China are generally in the single digits.[73]
Taiwan
Elsewhere in Asia, the Taiwanese government established a national laboratory -- the Industrial Technology Research Institute (ITRI) -- in the mid-1970s in order to focus Taiwan's attention on critical technology markets. It has actively embraced venture capital since 1983, when it formally began encouraging formation of a venture capital industry by easing government restrictions and providing financial backing for venture funds. Taiwan's government has financed and recruited managers for scores of young companies. For example, in 1986, ITRI supplied about 50% of the start-up capital, lined up other investors, and recruited Morris Chang, a 25 year veteran of Texas Instruments, to establish the Taiwan Semiconductor Manufacturing Corporation, now one of the world's largest producers of semiconductors. Numerous other Taiwanese citizens, educated in the United States and trained at U.S. companies, have returned home to run Taiwanese technology companies.[74]
Although the Taiwanese government provides start-up capital and offers young companies subsidized land-lease rates and generous tax credits, it does not, unlike most of its Asian counterparts, offer much help after companies are up and running. In fact, one key to Taiwan's success is that uncompetitive companies are not shielded from market forces and are allowed to fail. Unlike Japan, declaring bankruptcy in Taiwan does not carry an overwhelming stigma; many failed entrepreneurs immediately start new companies.
In addition to the Taiwanese government's support, major Taiwanese companies have provided venture financing to Taiwanese start-ups for years. Acer, the world's third largest personal computer manufacturer, has announced that it will provide venture financing to create 100 Taiwanese software companies by 2010.[75] An increasing number of Taiwan's approximately 100 venture capital firms are establishing branch offices in Silicon Valley, in part to prospect for cutting-edge technologies that can be commercialized by Taiwanese companies. One of Taiwan's largest venture capital firm's is Crimson Asia Capital Holdings, which raised a $400 million fund in 1997. In large part because of the strong entrepreneurial mindset of Taiwan's 22 million people, Taiwan has the highest concentration of small to medium-sized technology companies in Asia, whereas the Japanese and South Korean economies are dominated by large conglomerates.[76] Taiwanese workers are much more likely than their Japanese or Korean counterparts to take a low-salaried position with a start-up in exchange for payment in stock (options are still illegal) and the hope of gaining wealth through a successful initial public offering. Since the beginning of 1997, 32 of the 82 companies that have gone public on Taiwan's over-the-counter market have been technology-based.[77]
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South Korea
Unlike Taiwan, South Korea's government has long maintained high barriers to entry and exit and shielded uncompetitive companies from market forces by offering generous government loans and allowing creative accounting. The lack of exposure to constantly changing markets has plagued the country's chaebol conglomerates. Nevertheless, the South Korea government recognized the role that U.S. venture capital plays in spawning high-technology companies. Consequently, the government set up Korea's first four venture capital firms between 1974 and 1984 in an attempt to help commercialize technologies developed by state-financed research institutes. Although the first venture capital firms met with mixed success, there were 60 independent venture capital firms in South Korea by the early 1990s. Between 1987 and 1997, South Korea venture capitalists invested about $1 billion in 1,891 firms, three-quarters of which were electronics and communications companies. In early 1998, the government announced that it would appropriate $620 million to help finance 2,000 venture-backed firms. In addition, a recently enacted law grants tax concessions to venture investors, lifts the usual ceiling on foreign investment, and, for the first time, allows the country's pension funds to invest in venture capital.
Despite the progress that South Korea has made in fostering a venture capital industry, Korea's high-technology firms have proved much less innovative than Taiwan's, in part because of the oppressive presence of the chaebol, which dominate most sectors of the economy. In addition, although the number of venture capital firms is increasing, their profitability is decreasing, in part because of a lack of managerial experience in running entrepreneurial companies. Moreover, South Korea has yet to develop much of a shareholder culture. On average, South Korea's venture-backed companies take 10 years to list on the Korea Security Dealers Association Automated Quotation (KOSDAQ), the country's small-company equivalent to the U.S. NASDAQ market. (One third of the companies listed on KOSDAQ are venture-backed.) Most companies also seek the added credibility that comes with leaving the KOSDAQ for the larger Korea Stock Exchange. Consequently, KOSDAQ lacks liquidity, which makes it difficult for venture capitalists to sell their stake in portfolio companies that trade on the smaller market.[78]
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Government & Venture Capital
Governments are increasingly aware that venture capital investing is critical to the health of their economies. Venture-backed companies historically have produced a disproportionate share of new jobs, particularly well-paid and highly-skilled jobs, and are a key source of research and development spending. For example, from 1991 through 1995, U.S. venture-backed companies created new jobs at a rate of about 34% annually while Fortune 500 companies reduced jobs at a rate of about 4% annually. During the same time period, venture-backed companies' revenues increased 38% while Fortune 500 companies' revenues increased only 3.5%. U.S. venture-backed companies also have increased their annual research and development budgets at about three times the rate of Fortune 500 companies and are an important source of applied technological innovation. In addition, U.S. venture capital-backed companies generate about three times more export sales per dollar of equity than more established corporations.[79] Moreover, venture capitalists have helped create entirely new industries by financing companies like biotechnology pioneer Genentech and overnight shipping provider Federal Express.
Similarly, European venture-backed companies outperform the 500 largest European companies in a number of categories. From 1991 through 1995, venture-backed companies created new jobs at a rate of about 15% annually, compared to 2% for the top 500 European companies. During the same time period, venture-backed companies' revenues increased 35%, while the top 500 companies' revenues increased by only 14%. In 1995, research and development expenditures by European venture-backed companies represented 8.6% of total sales compared to 1.3% for the top European companies.[80] In Britain, the number of people employed in venture-backed companies has increased by 15% annually, compared to a national growth rate of less than 1%. More than 1 million people in Britain are employed by companies currently using venture capital. In addition, venture-backed companies in Britain increased their sales by 34% annually, 5 times faster than FTSE 100 companies.[81] In countries like France, Germany, Italy, and Spain, which have unemployment rates ranging from 11% to 19% and which need more new companies that can compete globally and contribute to Europe's economic revival, venture financing can play an enormously positive role.
The staggering difference in job growth between the United States and Europe is at least partly caused by much higher levels of venture financing in the United States during the last 25 years. Between 1970 and 1995, the European Union, which has one-third more people than the United States, added only 8.5 million jobs or 6% of the work force, whereas the United States increased its work force by 46 million or 65%.[82] Since 1993, the United States has created more than 13 million new jobs net, whereas the nations of Europe have lost 1 million jobs.[83] The EU's unemployment rate is more than double the U.S. rate. One of the EU's primary problems is that while large companies are cutting jobs, there is relatively little new business formation. Between 1992 and 1996, 3,000 U.S. companies went public raising more than $150 billion, whereas only 150 EU companies went public between 1990 and 1996.[84] The European Commission recognizes the importance of venture capital to Europe's economy and, in May 1998, called for an "action plan" to remove various barriers to venture financing, including a review of national tax systems.
Governments can encourage venture investing by offering legal, fiscal, and financial support that benefits venture capitalists and entrepreneurs. In fact, government incentives often have been crucial to attracting venture capital to risky, cutting-edge start-ups that may result in job and wealth creation that otherwise would not occur.
For example, although an increasingly large percentage of venture financing comes from tax-exempt investors like pension funds, the capital gains tax rate is an important factor determining the overall level of venture financing. In the United States, for example, venture financing increased significantly after the government lowered the capital gains tax rate from 49% to 28% in 1978 and to 20% in 1981. By comparison, capital gains tax rates in Europe and Asia can reach 60% and higher. U.S. tax law also permits owners of closely held companies to make so-called "sub-S" elections and to issue section 1244 stock, provisions that allow for favorable tax treatment of losses.
The taxation of stock options also has an important effect on entrepreneurs. Start-ups, which cannot afford to pay large salaries, often offer stock options to attract skilled managers. Securities laws governing the issuance of options and fiscal laws governing the level of taxation determine whether managers will be willing to leave the security of larger companies to risk working for a start-ups. In the United States, wealth accumulated from stock options is taxed as a capital gain when the stock is sold, whereas in many European countries (including France and Germany) options are taxed as regular income when granted, even though the employee may not be able to cash in the options for several years.[85]
State governments also can use tax incentives to target certain points in the investment cycle (i.e. start-ups) or encourage venture investing by certain types of investors. For example, Louisiana, Missouri, and New York have enacted legislation allowing Certified Capital Companies (CAPCO), which are venture capital funds that invest at least 60% of their capital in private, in-state companies. They are funded primarily by insurance companies, which are given tax credits as an incentive to become limited partners. Several other states have CAPCO bills under consideration.[86] Such incentive programs are particularly helpful to entrepreneurs in states (e.g. Missouri) that traditionally have not received large amounts of venture capital.[87]
Governments also can target certain types of venture financing by offering loan guarantees, project finance, and insurance to investors. For example, the Overseas Private Investment Corporation (OPIC) has offered financial support to U.S. investors who are developing and expanding business operations in certain emerging markets that have the effect of creating U.S. jobs and increasing U.S. exports. This OPIC program is designed, among other things, to support U.S. foreign policy objectives, assist in the economic development of emerging countries, and support the transfer of ownership of businesses from state to private hands. By 1998, 26 U.S. investment funds had been approved for OPIC loan guarantees for their investment activities in emerging markets ranging from Latin America to Asia to the Newly Independent States. OPIC has committed $2.2 billion in loans, or two-thirds of its $3.26 billion funds program. For example, OPIC currently is providing a guarantee of $100 million to an investment fund managed by Olympus Capital Asia that is investing in Bangladesh, India, Indonesia, Laos, the Philippines, South Korea, Sri Lanka, Thailand, and Vietnam. Under this public-private partnership, OPIC guarantees $100 million of financing that is used to support a $50 million equity fund, providing a total of $150 million available for investment. If the investments fail and OPIC must pay on its guarantee, OPIC could lose up to $100 million.[88]
In some cases, U.S. government agencies directly fund entrepreneurs. For example, the U.S. Department of Agriculture's Alternative Agricultural Research and Commercialization Corporation has provided $33 million in venture capital financing over the last five years to companies to help commercialize bio-based industrial products from agricultural and forestry materials and animal byproducts.[89] Governments also can fund research and development consortiums like the Semiconductor Manufacturing Technology Initiative (SEMATECH), a U.S. government-industry R&D project designed to advance semiconductor equipment manufacturing techniques, and ESPRIT and JESSI, EU efforts to stimulate transnational research and development efforts in information technology. In addition, governments can allow venture capitalists the right to acquire the government's share of an investment at reduced rates if the investment succeeds. If improperly administered, however, public venture financing can have the detrimental effect of displacing or retarding the development of private venture capital and can cause economic distortions by creating unfair competition or by sustaining unprofitable projects.
Governments also can assist entrepreneurs and venture capitalists by establishing adequate infrastructure, such as strong intellectual property rights protection. For many entrepreneurs, intellectual property rights are their only assets. Consequently, it is essential that patents and copyrights be processed efficiently and that there is adequate enforcement. The United States provides the strongest patent protection in the world and has taken the lead in the World Trade Organization in encouraging other countries to adopt similar protection. In Europe and Asia, however, intellectual property often is not adequately protected. For example, in Europe, there are three patent systems -- national, European, and Community -- that can conflict with each other and with international obligations. Currently, however, no European court has jurisdiction over patents. The European patent system is the most effective system in Europe, but the lengthy patent protection process costs $120,000 compared to $13,000 in the United States.[90] In Japan, patents are narrower in scope than in most other developed economies, which allows competitors more latitude in inventing around existing patents. In China, the enforcement of intellectual property rights is often completely inadequate.
Governments also can support entrepreneurial companies by helping to create efficient exit mechanisms, such as stock markets for young companies, which are critical for a vibrant venture capital sector because they increase liquidity and allow for realization of capital gains. In addition, governments can establish regulatory systems to ensure that new drugs and biotech products are given a timely review.
Bankruptcy laws also have an important effect on entrepreneurs. The U.S. bankruptcy law is designed to give those who suffer bankruptcy an opportunity for a fresh start and quickly channels resources away from companies that are not competitive. In some cases, managing a company that goes bankrupt is viewed as a useful apprenticeship for starting another company.[91] Declaring bankruptcy in many European and Asian countries, on the other hand, carries a stigma that frequently destroys an entrepreneur's future.[92] In addition, some Asian countries either have inadequate bankruptcy laws or no law at all.
Throughout much of Europe and Asia, pension funds are prohibited from investing in venture capital, denying entrepreneurs a significant source of financing. The United States and Britain, on the other hand, allow pension fund portfolio managers to diversify into venture capital. In the United States, "prudent man" guidelines first allowed pension funds to invest in venture capital in 1979. Although only a small percentage of U.S. pension fund assets are invested in venture capital, the amount invested is substantial and has greatly benefited U.S. entrepreneurs.[93]
Although the United States is widely recognized as the world's most entrepreneurial economy, U.S. companies face a number of legal and regulatory impediments. For example, U.S. companies are much more likely to be sued than their European and Asian counterparts and many small U.S. companies, which lack the resources of larger companies, often settle rather than incur the high and growing costs of litigation. Fear of lawsuits also has affected the freedom of small U.S. companies to hire and fire employees; employment practices liability insurance has become a $100 million a year business.[94] In addition, U.S. companies face increasing health care costs and a wide array of federal, state, and local government regulations, not to mention a convoluted U.S. tax code. Nevertheless, it is virtually impossible to find a U.S. entrepreneur who would rather incorporate abroad.
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Conclusion
The United States will continue setting the standard in the venture capital business for many years to come. No other country offers entrepreneurs as welcoming an environment to do business. U.S. start-ups enjoy ready access to institutional financing, the world's most liquid stock markets, a flexible labor market, a large pool of experienced managers trained in the world's preeminent business schools, strong intellectual property rights protection, a favorable capital gains tax, a bankruptcy law that does not permanently stigmatize those who fail, and a regulatory environment that allows managers to take substantial ownership positions in their companies through stock options.
In Europe, Britain will continue to outpace France, Germany, and other Continental economies in entrepreneurial activity. Prime Minister Tony Blair has embraced most of the economic reforms put in place by Margaret Thatcher and John Major in the 1980s and early 1990s that reduced high tax rates, promoted more flexible labor markets, and streamlined government regulations. The Blair government also has supported a number of new initiatives designed to encourage entrepreneurial activity, including a proposal to teach entrepreneurship in schools.[95] In France and Germany, on the other hand, the new social democratic governments led by French Prime Minister Lionel Jospin and German Chancellor Gerhard Schr?der have put on hold many of the efforts by their predecessors to reduce high capital gains taxes, reform excessive and rigid regulatory environments, and restructure highly regulated labor markets and welfare systems. In fact, the Jospin government submitted an expansionary budget for 1999 with a heavy emphasis on social spending and has proposed reducing the workweek to 35 hours,[96] and the Schr?der government has proposed reversing Helmut Kohl's modest labor market reforms.
In Asia, Taiwan's entrepreneurial culture and vibrant small company sector have helped the island weather the Asian economic storm better than most. One of the keys to Taiwan's success is that, unlike Japan and South Korea, where government ministers identify and fund high-technology initiatives (and shield uncompetitive enterprises), Taiwanese companies have largely made their own way without government interference. Although Japan would benefit from emulating Taiwan's entrepreneurial environment, Prime Minister Keizo Obuchi, like his predecessors, appears to lack the will or ability to reform a regulatory system that puts start-ups at a disadvantage. China's potential is enormous, particularly given the entrepreneurial vigor of the Chinese people, but it will be some time before China's government moves to a market economy and reverses decades of communist policies that have stunted entrepreneurial activity. In sum, European and Asian governments will need to remove myriad regulatory impediments to entrepreneurs to foster venture capital activity on a par with the United States.
References
[1] See generally B. Zider, "How Venture Capital Works," Harvard Bus. Rev., Nov.-Dec. 1998, pp. 131-39.
[2] Coopers & Lybrand, "Economic Impact of Venture Capital Study," 1997, p. 1.
[3] VentureOne, "1998 Investment Highlights,"http://www.v1.com/; National Venture Capital Association, "1997 Annual Report," pp. 54-55.
[4] N. Weinberg, "Small is Ugly: Problems Small Businesses Face in Japan," Forbes, Dec. 18, 1995.
[5] M. Gannon, "Financing in Purgatory," Venture Capital Journal, May 1999, pp. 40-42; C. Darwall & M. Roberts, "The Band of Angels," Harvard Business School, case note (1998); M. Perkins, "Angels on High," Red Herring, June 1997 (supplement); SBA Report on the Angel Capital Electronic Network (ACE-Net) (1996), www.sba.gov/advo/acenet.
[6] S. Abbott & M. Hay, Investing for the Future: New Firm Funding in Germany, Japan, the UK and the USA, Pitman Publishing, 1995, pp. 5-6.
[7] G. Fenn, et. al., "The Economics of the Private Equity Market," Board of Governors of the Federal Reserve System, Dec. 1995, p. 8.
[8] See SBA, "Small Business Investment Company Program,"www.sba.gov/inv.
[9] Among the first venture capital limited partnerships were Draper, Gaither & Anderson (1958), Davis & Rock (1961), and Greylock (1965). G. Fenn, "The Economics of the Private Equity Market," pp. 1-2, 9.
[10] Technology companies like AT&T, Intel, Lucent, Microsoft, and Xerox also are large providers of venture capital. Intel has one of Silicon Valley's largest venture funds; it has invested $300 million in more than 100 companies and recently raised a $300 million fund. Intel targets start-ups that are developing new applications for faster Intel semiconductors. "Intel Wraps up $300 Million Fund," Venture Capital Journal, July 1999, p. 5. In addition to its direct investments, Microsoft is investing $5 million to $10 million in several venture capital funds, partly to track new technologies and partly to help potential partners grow. Large technology companies also are an important birthing ground for new companies. For example, Lucent formed a new ventures group in 1997 to nurture an assortment of products that are not focused on Lucent's core telecommunications business. See C. Deutsch, "When a Big Company Hatches a Lot of Little Ideas," New York Times, Sept. 23, 1998, p. D4. In 1989, Xerox created an in-house venture financing arm that incubates and capitalizes on Xerox's non-core research and development discoveries.
[11] "Venture Capitalists: A Really Big Adventure," The Economist, Jan. 25, 1997, p. 20.
[12] Coopers & Lybrand, "Money Tree Report - 1997 Results," p. 1.
[13] Joshua Prager, "Venture Capitalists Pour Record Amount into Start-Ups," Wall Street Journal, Aug. 3, 1999, p. B2; J Reyes, "Returns Slump, Commitments Soar," Venture Capital Journal, July 1999, p. 44.
[14] The S&P 500's average annual nominal rate of return is 11% for the period from 1926 to October 1998. Venture capital returns over the last several years have been unusually high. For the year ending December 31, 1997, U.S. venture capital funds formed from 1969 to 1997 returned 28.7% to their investors after management fees and carried interest, compared to a 41.7% return in 1996 and 48.5% in 1995. J. Reyes, "Venture Capital Performance Takes a Breather," Venture Capital Journal, July 1998, pp. 44-46. In 1998, returns slipped to 17.2%. J. Reyes, "Returns Slip," Venture Capital Journal, July 1999, p. 44.
[15] European Venture Capital Association, "Europe Private Equity Update," Jan. 1998, www.evca.com; "European Performance Surveyed - A Tentative First Step," Venture Capital Journal, Feb. 1997, p. 30.
[16] PricewaterhouseCoopers, "Money Tree Report - 1998 Results," pp. 104.
[17] Coopers & Lybrand, "Money Tree Report - 1997 Results," pp. 2-3; Price Waterhouse, "National Venture Capital Survey - Full Year 1997," pp. 1-2. See also www.v1.com/venturedata/stats. Figures detailing the level of venture investing in the U.S., Europe, and Asia include venture investments made from abroad.
[18] VentureOne, "Q2 1999 Investment Highlights," www.v1.com.
[19] See generally B. Gross, "The New Math of Ownership," Harvard Bus. Rev., Nov.-Dec. 1998, pp. 68-74.
[20] Academic programs in entrepreneurship studies have expanded rapidly in the United States in the last 20 years. In 1980, there were 18 entrepreneurship chairs at U.S. business schools; today, there are more than 200. In 1990, only about two dozen U.S. business schools offered course work in entrepreneurship; today, about 120 business schools offer entrepreneurship studies as a major. E. Bronner, "Students at B-Schools Flock to the E-Courses," New York Times, Sept. 23, 1998, p. D6. Despite its success at the graduate business school level, the United States lags behind many other developed countries in math and science performance in K-12 education.
[21] The Oak Ridge National Laboratories, which enriched uranium for the first nuclear weapons, has helped form Technology 2020, a nonprofit incubator designed to foster high-technology ventures. Similarly, Sandia National Laboratories in Albuquerque has spawned 60 new companies and Rocky Flats outside Denver has nurtured companies that are working on products as diverse as optical communications and a vaccine to combat AIDS. See C. Wohlwend, "Bomb's Birthplace Gets Down to Business," New York Times, Sept. 23, 1998, p. D3.
[22] C. Goldberg, "Across the U.S., Universities are Fueling High-Tech Booms," New York Times, Oct. 8, 1999, p. A1.
[23] European Venture Capital Association, "White Paper on Priorities for Private Equity," 1998. In 1997, European venture capitalists invested about $5 billion. European Venture Capital Association, "1998 Yearbook," pp. 84-85, 89. See also K. Campbell, "Europe Hits Venture Capital Record," Financial Times, June 5, 1997, p. 20.
[24] European Venture Capital Association, "1998 Yearbook," pp. 87, 105.
[25] Id. at pp. 57, 105. One study found that European early-stage venture funds raised between 1980 and 1992 produced returns of only 5.7% per annum to the end of 1996. Id. at p. 57 (citing the "1997 Investment Benchmarks Report: International Private Equity"). See also "Europe's Great Experiment," The Economist, June 13, 1998, p. 67; "Behind America's Small-Business Success Story," The Economist, Dec. 13, 1997, p. 51; "Fresh Interest in Technology Funds," Financial Times, Oct. 10, 1997.
[26] European Venture Capital Association, "1998 Yearbook," p. 29; Price Waterhouse, "National Venture Capital Survey (1997)," p. 11.
[27] K. Campbell, "Europe Hits Venture Capital Record," Financial Times, June 5, 1997; "Venture Capitalists: Europe's Tentative Ventures," The Economist, Jan. 25, 1997, p. 21.
[28] "Fresh Interest in Technology Funds," Financial Times, Oct. 10, 1997.
[29] The other main sources of venture capital funding in Europe are insurance companies (16.4%) and corporations (11.3%). European Venture Capital Association, "1998 Yearbook," p. 88. See also S. Abbott & M. Hay, Investing for the Future: New Firm Funding in Germany, Japan, the UK and the USA, Pitman Publishing, 1995, p. 18.
[30] Steinmetz, "Venture Capitalists Find Opportunities in German Stocks," Wall Street Journal, Mar. 20, 1998; K. Campbell, "Europe Hits Venture Capital Record," Financial Times, June 5, 1997, p. 20; PricewaterhouseCoopers, "Money Tree Survey - Q2 1998," p. 1.
[31] Campbell, "Germany Surges Ahead in Venture Capital," Financial Times, May 28, 1998, p. 18; W. Kuemmerle, "Survey of Private Equity in Germany," Harvard Business School Working Paper, 1998; Fisher, "German Banking and Finance: Seed Finance Feels the Cold," Financial Times, May 29, 1996.
[32] Pension funds and insurance companies provide 11.7% and 11.3% of all venture financing, respectively. European Venture Capital Association, "1998 Yearbook," pp. 95, 112.
[33] Deutsche B?rse, www.neuer-markt.de; "Neuer Markt: Runaway Success Story," Financial Times, June 24, 1998, p. IV. Despite the establishment of the Neuer Markt, German venture capitalists still are twice as likely to sell a portfolio company to another company as to offer it to the public through an initial public offering.
[34] See "Europe's Great Experiment," The Economist, June 13, 1998, p. 67.
[35] The German government's support for start-ups is so extensive that a company receiving $10 million in venture capital can also apply for $10 million in loans from the federal government and $10 million in loans from the local government. In addition, venture capitalists can apply for a public guarantee covering half their initial investment. The result is that some German property developers have become venture capitalists. See "Europe's Great Experiment," The Economist, June 13, 1998, p. 68.
[36] The largest concentration of high-technology companies in France is in Sophia Antipolis, a science park on the C?te d'Azur, which has 1,050 companies with 16,000 employees. See B. Groom, "Oxford Closes High-Technology Gap on Cambridge," Financial Times, June 30, 1998, p. 10.
[37] Le Nouveau Marché,www.nouveau-marche.fr.
[38] "France Sees Swing Back to Early-Stage," Venture Capital Journal, Sept. 1997, p. 25.
[39] European Venture Capital Association, "1998 Yearbook," p. 141; K. Campbell, "Germany Surges Ahead in Venture Capital," Financial Times, May 28, 1998.
[40] Banks and corporations provide 34.9% and 16.6% of venture financing in France, respectively, whereas insurance companies and pension funds provide 3.4% and 2.6%, respectively. European Venture Capital Association, "1998 Yearbook," p. 142.
[41] Public spending as a proportion of gross domestic product is 54.1% in France compared to an average of 38.3% for the G7 countries. See R. Graham, "Dose of Realism for France," Financial Times, Aug. 17, 1998, p. 11.
[42] See W. Hoge, "Ah, Britain! The Light at the End of the Tunnel," New York Times, Mar. 9, 1998, p. A4; "Tale of Two Job Markets: Why England Works, France Doesn't," Wall Street Journal, Aug. 7, 1997, p. A10.
[43] London Stock Exchange, www.londonstockex.co.uk; British Venture Capital Association, "Report on Investment Activity (1997)," pp. 24-25. In 1997, 217 British companies went public, compared to 82 French companies and 35 German companies. European Venture Capital Association, "1998 Yearbook," p. 34.
[44] European Venture Capital Association, "1998 Yearbook," p. 207.
[45] British Venture Capital Association, "Report on Investment Activity (1997)," p. 26; www.bvca.co.uk.
[46] British Venture Capital Association, "Report on Investment Activity (1997)," p. 5; Price Waterhouse, "National Venture Capital Survey (1997)," p. 11.
[47] British Venture Capital Association, "Report on Investment Activity (1997)," p. 11; "New Funds Focus on IT Companies," Financial Times, Oct. 10, 1997. The largest and most established venture capital company in Britain (and in Europe) is 3i. Created more than 50 years ago by the Bank of England and the major British banks to serve the long-term investment needs of industry, 3i has 28 offices throughout Europe and has invested about $16 billion in more than 13,000 businesses. 3i is listed on the London Stock Exchange and is a FTSE 100 company. See "3i in Europe," www.3i.com.
[48] In terms of total revenue, Europe's biotech sector is about one-seventh the size of the U.S. biotech sector. See "The Cloning of U.S. Success," Financial Times, May 15, 1997, p. 15.
[49] Global Entrepreneurship Monitor, "1999 UK Executive Report" (1999), pp. 1-26.
[50] By comparison, Silicon Valley's high-tech workforce numbers 480,000 and its exports are 20 times larger than Silicon Fen's. B. Groom, "Cambridge Overview," Financial Times, July 16, 1998, p. VII. See generally M. Peel, "Cambridge: "Helping to Change the World," Financial Times, July 16, 1998, p. IX.
[51] See N. Itoi, "Two-Timing," The Red Herring, May 1998, p. 28; Y. Ibrahim, "In Old England, A Silicon Fen," New York Times, Jan. 4, 1998, sec. 3, p. 1. Gordon Moore, co-founder of Intel, recently committed $12.5 million to Cambridge to establish Europe's most advanced science and technology library. See S. Targett, "Intel Founder Gives $12m to University," Financial Times, Oct. 1, 1998, p. 11. The total amount of venture capital under management in Cambridge is about $250 million. B. Groom, "Cambridge to Receive $80m Venture Capital," Financial Times, Aug. 29-30, 1998, p. 5.
[52] Isis Innovation, www.isis-innovation.com; B. Groom, "Oxford Closes High-Technology Gap on Cambridge," Financial Times, June 30, 1998, p. 10.
[53] See EASDAQ, www.easdaq.be.
[54] See EURO.NM, www.euro-nm.com.
[55] V. Boland, "Gloves Come Off in Battle for Europe's Answer to NASDAQ," Financial Times, June 22, 1998, p. 28. See generally A. Swardson, "Discord in Europe's Unity: Plan to Link London, Frankfurt Exchanges Sows Strife," Washington Post, Oct. 13, 1998, p. C1. As of August 1999, U.S. equities accounted for 53.5% of the total capitalization of world stock markets, Britain 10.6%, Japan 10.9%, Germany 3.8%, France 3.5%, and the rest of the world 17.7%. Goldman Sachs, "Viewpoint Supplement," U.S. Research, Aug. 3, 1999, p. 12.
[56] "1996/97: The Year in Review," Asia Venture Capital Journal, Dec. 1997, www.asiaventure.com.
[57] Id.
[58] S. Sugawara, "Upstarts and Start-Ups; Japanese Entrepreneurs Gain Attention and Incentives," Washington Post, July 28, 1996.
[59] "1996/97: The Year in Review," Asia Venture Capital Journal, Dec. 1997, www.asiaventure.com.
[60] Id.
[61] Similarly, Japanese companies -- seeking high-technology R&D and partners to facilitate their overseas expansion -- have invested substantial amounts of venture capital abroad, particularly in the United States and, to a lesser extent, in Europe. This investment includes both direct investment in portfolio companies and indirect investment through U.S. venture capital firms. For most venture capital firms associated with Japanese corporations, exposure to new technologies takes precedence over financial returns.
[62] "JAFCO's Dai Ichi Looks to the Long Term," Asia Venture Capital Journal, Dec. 1997, www.asiaventure.com.
[63] See JAFCO, www.jafco.com. JAFCO America has $265 million under management and has made more than 100 investments, including investments in 30 companies that have gone public
[64] "Toyota Offers to Support Outside Venture Companies," Asia Pulse, June 13, 1997.
[65] "NVCC: Japan's Rising Venture Capitalist," Asia Venture Capital Journal, Nov. 1997, www.asiaventure.com.
[66] See N. Weinberg, "Small is Ugly: Problems Small Businesses Face in Japan," Forbes, Dec. 18, 1995. A survey conducted by the Organization for Economic Cooperation and Development found that entrepreneurs have a much higher status in the United States and Britain than in Japan, France, or Germany. See "Entrepreneurs to Order," The Economist, March 14, 1998, p. 61.
[67] Historically, the most practical exit route for venture investments in Japan is an initial public offering; the merger and acquisition market has been relatively inactive.
[68] "Japan Tries to Encourage Entrepreneurs and VCs," Venture Capital Journal, Nov. 1997, p. 38. As a result, more than 160 Japanese companies, including Sony, have adopted stock option plans (although most of the plans account for only a small fraction of a worker's earnings). D. Johnston, "American-Style Pay Moves Abroad: Importance of Stock Options Expands in a Global Economy," New York Times, Sept. 3, 1998, p. C1.
[69] See S. Sugawara, "Upstarts and Start-Ups; Japanese Entrepreneurs Gain Attention and Incentives," Washington Post, July 28, 1996.
[70] See D. Normile, "Japan Hopes to Cash in on Industry-University Ties," Science, Nov. 29, 1996.
[71] "1996/97: The Year in Review," Asia Venture Capital Journal, Dec. 1997; www.asiaventure.com.
[72] In 1997, ethnic Chinese accounted for less than 4% of Indonesia's population, but controlled more than two-thirds of its economy. J. Laing, "No Relief," Barron's, July 27, 1998, p. 18. The four Chinese states - China, Taiwan, Hong Kong, and Singapore - have often fared better in terms of stock market and currency performance than other Asian countries. See "An Army of Ants," The Economist, Nov. 7, 1998, p. 9 (Taiwan Survey).
[73] D. Lau, "Behind the Great Wall: China Opens its Doors to Domestic and Foreign Venture Capital Funds," Venture Capital Journal, July 1999, pp. 48-50.
[74] In addition to the thousands of Taiwanese studying in U.S. universities, Taiwan's universities produce nearly 50,000 new engineers a year, more than a quarter of all graduates. "Silicon Valley (East)," The Economist, Nov. 7, 1998, pp. 14-16 (Taiwan Survey).
[75] L. Tyson, "The High Priest of Taiwanese High-Tech," Financial Times, May 18, 1998, p. 9.
[76] Small to medium-sized enterprises make up 98.5% of Taiwan's companies, 75-80% of all employment, and 47% of the total economy. There is one company for every 18 people in Taiwan, the highest density in the world. "An Army of Ants," The Economist, Nov. 7, 1998, pp. 8-9 (Taiwan Survey). The Hsinchu Science Park near Taipei is the center of the world's third largest high-technology industry, accounting for a third of Taiwan's manufacturing exports and a huge share of the world's computer production. See "Silicon Valley (East)," The Economist, Nov. 7, 1998, p. 14 (Taiwan Survey). Similarly, Hong Kong, Malaysia, and Singapore are investing billions of dollars to build industrial parks to attract and retain high-tech companies. M. Landler, "Mapping Out Silicon Valley East," New York Times, April 5, 1999, p. C1.
[77] See "Made in Taiwan: Entrepreneurs," USA Today, June 23, 1998, p. 1B; "The Guide to Venture Capital in Asia," Asia Venture Capital Journal, 1998. In addition to the main stock exchange and the over-the-counter market, Taiwan has a gray market comprised of a network of local brokers who are market makers for promising new companies, primarily in the high-technology sector. Although liquidity is generally low, the gray market enables start-ups to more easily raise capital and helps position start-ups for listing on the other two exchanges.
[78] "South Korean Firms: Wild Careers," The Economist, Feb. 14, 1998, p. 67. Although the United States, Europe, and Asia produce the vast majority of technology start-ups, there are several other centers of high-tech innovation. For example, Bangalore, India is home to the Indian Institute of Science and about 250 software and networking companies, including Texas Instruments and Infosys. Israel's venture capitalists have raised about $2 billion since 1991 and invested $567 million in 250 companies in 1998. Tel Aviv is home to about 1000 high-tech firms. See generally PricewaterhouseCoopers, "Money Tree Report - 1998 Results," pp. 7-8; D. Claymon, "Israel," Red Herring, Oct. 1998, pp. 30-34; A. Machlis, "Watershed for Israeli High-Tech Funds," Financial Times, Sept. 15, 1998, p. 24; "Venture Capital in India," The Economist, Jan. 18, 1997, p. 70.
[79] Coopers & Lybrand, "Economic Impact of Venture Capital," 1997, p. 1.
[80] Coopers & Lybrand, "The Economic Impact of Venture Capital in Europe," 1998.
[81] British Venture Capital Association, "Report on Investment Activity," 1997, p. 3.
[82] P. Lynch, "The Upsizing of America," Wall Street Journal, Sept. 20, 1996.
[83] Goldman, Sachs & Co., "Investment Strategy - 1999: Issues and Outlook."
[84] P. Lynch, "The Upsizing of America," Wall Street Journal, Sept. 20, 1996.
[85] To curtail the drain of executive talent to their U.S. rivals, European and Asian companies have begun lobbying their governments to modify tax and securities laws and accounting practices that discourage stock options. D. Johnston, "American-Style Pay Moves Abroad: Importance of Stock Options Expands in a Global Economy," New York Times, Sept. 3, 1998, p. C1. Tax legislation can affect venture investments in many other ways. For example, in July 1998, the U.S. Congress passed a bill that will reduce taxes for individuals who invest in small companies through venture capital funds. At issue is the tax treatment of investments in companies with less than $50 million in assets that are sold at a profit, with part or all of the gains reinvested in another small company. Currently, solo private investors can defer capital gains taxes on many such investments. The tax code, however, has not clearly allowed individuals investing in venture capital funds to enjoy the same tax benefits. Under the new legislation, individuals who invest in venture capital funds will enjoy the same tax treatment. See G. Anders & J. Schlesinger, "IRS Bill Clears Senate, Aids Venture Capitalists," Wall Street Journal, July 10, 1998, p. A2.
[86] S. Fineberg, "CAPCOs Come of Age," Venture Capital Journal, Nov. 1997, pp. 44-46.
[87] State-funded venture capital efforts have a mixed record. For example, Iowa recently abolished Iowa Seed Capital Corporation, which invested $14 million in 72 companies in an effort to help diversify the state's economy. Poor investments led to large losses that exhausted legislators' support for the program. See generally "California Considers State Venture Fund," Venture Capital Journal, July 1998, p. 6.
[88] See generally S. Fineberg, "The Battle of OPIC," Venture Capital Journal, March 1998, pp. 41-43.
[89] AARC Corp., "Source Book," 1998, www.usda.gov/aarc.
[90] European Commission, "Background Report - Innovation for Growth and Development in Europe," Apr. 21, 1997.
[91] See generally J. Maloney, "Failure May Not Be So Bad After All," New York Times, Sept. 23, 1998, p. D12; "America Goes Bust," The Economist, July 4, 1998, p. 78.
[92] See S. Sugawara, "Shame of Bankruptcy: Suicide and Hiding Rise in Japan," International Herald Tribune, Aug. 21, 1998, p. 13. Bankruptcy laws in Japan and South Korea are much tougher on existing management than the U.S. bankruptcy law. In Japan and Korea, when a company files for bankruptcy, management is dismissed, the court appoints trustee management, and there is no automatic protection from creditors. Consequently, there is little incentive to declare bankruptcy and many crippled companies continue operations. Even when companies do declare bankruptcy, many Asian countries do not have adequate procedures to protect creditors and distribute a bankrupt company's remaining assets. See S. WuDunn, "Bankruptcy the Asian Way," New York Times, Sept. 8, 1998, p. C1.
[93] Some European and Asian governments also limit pension funds and insurance companies from cross-border investments, thereby requiring that all or a proportion of assets be invested in a country's capital markets.
[94] On occasion, the U.S. government has acted to curtail abusive litigation that adversely affects entrepreneurial activity. For example, on August 13, 1998, President Clinton signed into law the Biomaterials Access Assurance Act of 1998, which is designed to protect the suppliers of raw materials to medical device companies from frivolous product liability lawsuits. Similarly, the Private Securities Litigation Reform Act of 1995 was designed to curb meritless securities lawsuits that frequently are filed against high-technology companies.
[95] See "Britain: Entrepreneurs to Order," The Economist, March 14, 1998, p. 61. See generally "Growth Agenda for Small Firms," Financial Times, Oct. 29, 1998, p. 11. This is the first time since 1929 that the three largest European states - Britain, France, and Germany - are simultaneously headed by left-of-center governments. Prime Minister Blair, however, stands decidedly to the right of the French prime minister and the German chancellor on economic policy and places more trust in the market.
[96] See A. Swardson, "A Job in France? No Sweat: Laws Banning Overwork Trim Executives' Hours," Washington Post, Dec. 9, 1998, p. A27.
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