Friday, May 26, 2006

Barriers to Venture Capital

Venture Capital is a powerful and effective way for doing big and interesting things in cutting-edge technologies. VC enables entrepreneurs to pursue their dreams by providing funds for their projects in exchange for a share of the business they are creating. VC have enabled many success stories in Silicon Valley (eg, Sun, Google, Cisco) as well as in other parts of the world.

A VC investment is not a loan. If you are an investor, risks in funding a VC project are very high. If the venture fails - happens 90% of the time - you lose your investment. But gains are also high, with 100x returns not uncommo in a successful venture.

The other day I was talking to someone from the British govt who has worked in Bd for several years on promoting different types of businesses. When I found out that he had an investment banking background, I asked him what were the barriers to creating a Venture Capital friendly environment here.

He mentioned two top items: no "exit strategy", and the lack of minority rights.

"Exit strategy" is how a VC investor realizes their gains in a successful venture. In the West, when a VC-funded company turns into a successful business, it is either floated (IPO) in the share market (in which case the investor makes a ton of money from selling their share of the company), or it is sold to a bigger company (in which case usually the investor's share also becomes a lot of money.) In Bangladesh, this person pointed out, neither is a viable option. The stock market is not vibrant, and there is no practice of buying out companies.

Minority rights was unfamiliar to me. So he explained it. VC investors are usually minority shareholders in a company (ie, they own < 50%). In the West, with this much ownership, they still have lots of rights and power within the company. However, in Bd, in a company boardroom, the majority shareholder has much greater power over the rights of the minority shareholder.

I plan to dig in more. I have heard lots of businessmen in Bd are sitting on tons of money, and we need to enable them to profitably put this equity back into the economy. A VC culture would be a boon to our IT business and help create an economy based on higher value goods and services.

2 comments:

Salam Dhaka said...

Ihtisham bhai,

This is an area of interest to me too. I agree with your freinds comment - "No exit strategy". Unless we can present a good exit strategy, people will not make an equity investment and IT will remain a family business.

Anonymous said...

Aside from a variety of government initiatives, there are currently two private VC firms in Bangladesh--Venture Investment Partners Bangladesh and Asian Tiger Capital Partners. Both are run by returned expats who have significant IB experience in the US.

Lack of an exit strategy and poor minority rights certainly are a hindrance to the development of the VC sector, which is integral to proper SME growth in the country. For this reason, government institutions such as the Bangladesh Bank, Board of Investment, and the SME Foundation need to be actively involved in promoting them. VC firms are not even considered financial institutions under current law.

At the same time though, there are ways of tweaking the western VC model to match the unique circumstances of Bangladesh. For example, VIPB's website says they follow a quasi-equity model, which is partially equity and partially loan, minimizing the firm's risk and overcoming problems with minority rights. As for the exit strategy, the government's EEF venture capital fund requires its investees to purchase back the fund's equity share within eight years of the initial investment. The assumption is that the entrepreneurs have made enough money or have enough collateral to access traditional credit markets to finance this purchase after 8 years. Of course, this modified exit strategy only works with small-growth SMEs, not the Silicon Valley miracles where the market value of the equity share far exceeds the company's actual capitalization.