Taiwan's Venture Capital: Policies And Impacts

Taiwan's Venture Capital: Policies and Impacts Lee-Rong Wang

Introduction Since the mid-1970s, Taiwan's labor-intensive industries have been losing their comparative advantage due to the domestic shortage of labor, environmental pollution problems, etc. The need to shift from traditional manufacturing industries to high technology (hi-tech) industries has therefore emerged. Among the various projects and policies designed to promote the development of hi-tech or strategic industries, Taiwan's government in 1980 established a Science-Based Industrial Park (SBIP) in Hsinchu in northwestern Taiwan to attract hi-tech enterprises to set up bases in Taiwan. However, the creation of such enterprises usually involves high risk which makes it difficult for these enterprises, despite their high potential for growth, to acquire financial support from traditional lending institutions. Venture or risk capital thus arose in Taiwan as a new source of industrial financing for hi-tech enterprises. A venture capital enterprise (VCE) often invests money solely on the basis of an entrepreneur's promising idea, a form of collateral that conventional bankers consider worthless. Typically, venture capital (VC) is aimed at new technologies or

1 innovative products in microelectronics, computers and biotechnology. The roots of VC industries are embedded in the United States, where the techniques and funding arrangements of VC, which have enabled hi-tech centers like Silicon Valley in California to flourish, first evolved. The foundation for the establishment of VC in Taiwan took place in the early 1980s with the creation of SBIP, the island's own Silicon Valley. In 1983, the Taiwanese government promulgated the Regulation Governing Venture Capital Investment Enterprises (RGVCIE) to promote VC and, with great anticipation, set up five goals for VC. Those goals are the provision of seed funds, management support for technological enterprises, guidance and assistance for the listing of the stock of technological enterprises on the stock exchange, the transfer of technology from industrialized countries, and the direction of long-term capital from other financial institutions to technological enterprises. The impacts and performance of Taiwan's VC in its twelve years of existence so far are thus worthy of exploration. Previous literature has focused on examining Taiwan VCEs' own investment strategies (Chen 1985, Hwang 1989) and organizational structure (Wu 1990). Lin (1995) investigated the return profile of Taiwan's VC and found that the VC investments made by four VCEs outperformed the local stock index. Ma and Wang (1990) assessed the performance of Taiwan's government in the promotion

2 of industrial R&D, but with very little discussion of VC. Thus, overall impacts and policies of Taiwan's VC have not been fully studied. This paper focuses on investigating Taiwan's policies toward VC and the overall impact of VC on Taiwan's economy. The origin and current status of Taiwan's VC policies are examined and are compared with VC policies in other areas, such as the United States and some other Asian countries. An investigation of the impact of Taiwan's VC on the rest of the Taiwanese economy is then conducted via three methods. The first is via a questionnaire sent to VC enterprises themselves and to technological companies, asking their opinions about VCEs' performance with respect to the five goals mentioned above. The second type of investigation is made through examination of objective macroeconomic statistics, such as VCEs' contribution to Taiwan's gross domestic product (GDP). The final method concentrates on examining VCEs' performance in the area of providing guidance for the initial public offerings(IPOs) of stocks of new hi-tech companies. The remainder of this paper is organized as follows. Section II compares policies relating to VC in Taiwan with those in other areas. The third section discusses the effect that domestic VC has had on the economy of Taiwan overall, using the three types of investigations outlined above. The fourth section explores possible future alternatives for Taiwan's VC policies, based on

3 the results of the above investigations and assessment of recent changes in the investment and international environments. Finally, conclusions are presented in the last section.

Policies Relating to VC in Taiwan and in Other Areas VC financing started and has been popular for more than 35 years in the United States. In brief, VCEs seek profits by investing in the early stages of a promising business venture and then divesting their interest when the business has become established in the marketplace. In its most highly developed form, VC is an amalgam of financial, managerial, and marketing know-how. Many companies welcome VC investment as a preparation for seeking a stock exchange listing because their VC investors can help them through the complex procedures and regulations involved. All the forms of assistance VCEs provide are known as "value added," and are coordinated in some degree with the five goals put forth by the ROC government as outlined above. These value added forms of assistance, when realized, not only serve to develop technological enterprises but also hasten the upgrading of Taiwan's domestic industries. The VC industry, therefore, attracted the attention of Taiwan's government. The development of VC efficiently utilizes the idle funds of Taiwan's private sector, and also avoids the industrial hollowing-out which some economists believe could result from the service-based industries' growing share of Taiwan's GNP.

4 Furthermore, Taiwan's small- and medium-sized enterprises are famous for their entrepreneurship, which is also helpful for the development of VC. The island's first VC fund, Multiventure Capital Corporation, was established in November 1984 by the Acer Group, Taiwan's top computer company. Since then, Taiwan's real gross domestic product has grown by an average rate of nearly 10 percent a year. Among the many benefits of rapid growth is a plentiful supply of investment capital. Total VC under management in Taiwan by April 1993 was NT$ 12.18 billion, of which a total of NT$ 9.1 billion has been invested by 25 VCEs in 355 companies. The majority of the capital committed came from corporations (48 percent) and private individuals (16 percent). Insurance companies and pension funds, due to regulation restrictions, did not become involved in VC until the end of 1993. At that time, local sources accounted for over 86 percent of the total VC pool in Taiwan. In contrast to the United States, where VCEs are not offered any incentives by the government,1 Taiwan's government has been actively involved in promoting the VC industry. A VCE in Taiwan is defined as a company limited by shares which specializes in making direct investments in technological companies with the special approval of the Ministry of Finance.

1 The only exception is a class of companies called Small Business Investment Companies (SBICs), which are funded by a combination of privately raised capital and government loan funds. However, SBICs compose no more than 5% of total VC in the United States.

5 The minimum paid-in capital of a VCE is NT$ 200 million. With the passing of the RGVCIE, investors who want to operate under the regulation must invest in technological enterprises that qualify as what are defined in the RGVLIE as "strategic industry enterprises." In return, they receive tax incentives2 as set forth in January, 1991 in the Statute for Upgrading Industries (SUI). Recently, the government amended the VC regulation so that now VCEs can invest as much as 30 percent of their committed capital in traditional domestic manufacturing industries. The amendment stipulates, however, that such investments made in non-hi-tech projects do not qualify to receive the tax credits offered to hi-tech VC investments. Additionally, two funds-of- funds have been successfully co-established by the Chiao-Tung Bank, a government-owned development bank, and the Development Fund of the Executive Yuan. The shares from these two funds-of- funds as well as those from government-related institutions represent about 10 percent of total VC committed in Taiwan. Elsewhere in Asia, however, government involvement in fund raising is minor and has contributed less than 4 percent of the total VC in circulation. Japan, Hong Kong (combined with China), South Korea, Australia, Singapore, and Taiwan represent the six largest VC sources in Asia. Among them, the policies of the governments of Japan and Hong Kong have made no special

2 These tax incentives provided by the government of Taiwan are discussed in the following section.

6 contribution to VC development. As a result, Japanese VCEs focus on a wide range of industries, and the sectors receiving the most VC in Japan are consumer-related, financial services, other services, industrial and computer-related. The Hong Kong VC community is almost completely private. Invested capital there is mainly channelled to consumer-related and other manufacturing industries. It is thus notable that, although Japan and Hong Kong are the two largest VC sources in Asia, the VC industry in these two areas does not concentrate on hi-tech investments. On the other hand, the governments of South Korea, Singapore, and Taiwan have been actively involved in the VC industry, and have paid much more attention to developing domestic hi-tech industries via VC investments. The South Korean government is a major sponsor of VC in that country (Paik 1984) . For example, Korea-Technology Advanced Corporation (K- TAC) was established in 1974 to commercialize the R&D results of a government-funded institute, and three other corporations, the Korea Technology Development Corporation (KTDC), Korea Development Investment Corporation (KDIC), and Korea Technology Finance Corporation (KTFC), were set up in the early 1980s to promote the development of a technology-intensive industrial structure in South Korea and to provide enterprises with adequate financing facilities. In Singapore, two tax incentives to encourage the development of the local VC industry are available (Chia and Wong, 1989). To qualify for these

7 incentives, a company's investment program must show evidence of supporting local innovations and entrepreneurship, or of involving the transfer of technology from overseas investment projects, etc. To date, over 80 percent of the investments of VCEs in Korea have been dedicated to the early stages of business ventures. Almost half of the invested capital has gone into the industrial products sector, followed by the electronics-related sector. On the other hand, up to 1992, VC in Singapore was spread evenly among consumer-related (14.5 percent), computer- related (12.5 percent) and electronics-related (13.7 percent) sectors. In Taiwan, 70 percent of VC investments have been in computer-related and electronics sectors. The rest has been placed in communications, industrial products, and medical/biotechnology. The concentration by Taiwan's VC on technological rather than traditional industries, which is similar to that of Singapore and South Korea, can be explained by the tax incentives (discussed in the next section) which direct VC towards technological enterprise investments.

The Impact of VC on Taiwan's Economy In this section, three methods are adopted in order to investigate the overall impact of the VC industry on Taiwan's economy.

Survey Results from Technological Enterprises

8 As mentioned above, our investigation was conducted via three channels. The first set of material was collected in the middle of 1993 by issuing two types of questionnaires. One type of questionnaire was sent to the twenty-five VCEs registered in Taiwan as of the middle of 1993, i.e., the time of this investigation. On the other hand, another type of questionnaire was sent to 151 portfolio (venture capital-backed) and 133 non- portfolio companies.3 The main results based on the two types of questionnaires are presented as follows. To understand why portfolio companies initially accept VC investment, our questionnaire itemized thirteen possible reasons and asked portfolio companies to order these according to priority. The result shows that "to increase capital supply" and "to raise the company's prestige and credibility" are the two most important reasons. As mentioned in the first section, VCEs in Taiwan were set up with the special approval of the government and must invest no less than 70 percent of their total capital in technological enterprises. As a result, VCEs generally obtained more favorable assessments than ordinary

3 Each portfolio enterprise (including those having more than one VCE investor) received only one questionnaire. Foreign portfolio companies, which are less related to Taiwan's domestic economy, were excluded. Notwithstanding this, the role of technology transfer, by which foreign portfolio companies influence Taiwan's economy, will be discussed in this subsection section. The sample of non-portfolio companies was randomly picked from among companies that have never received investments from VCEs, but that mostly, except for a small number of traditional manufacturing enterprises, conform to the Taiwanese government's definition of "technological enterprises" as given in Article 4 of the RGVCIE.

9 investment companies from portfolio companies. In addition, "to obtain advice on the company's momentous decisions" and "to get aid in making the IPOs of the company's stocks" obtained the same score, indicating that they share the third priority equally. Furthermore, the levels of satisfaction achieved by the portfolio companies with respect to several of their goals were also measured. Only two items, "to obtain advice on the company's momentous decisions" and "to get aid in making the IPOs of the company's stocks," achieved above average satisfaction levels. Other items, which were all related to technology, such as "assistance in searching for the market trend of products," and "aid in technology transfer," obtained the lowest levels of satisfaction. This reflects a general phenomenon in Taiwan and in other areas, that the background of most directors of VCEs is in finance and management rather than technology and science. Some survey respondents from portfolio companies complain that venture capitalists are concerned with profits, yet lack an understanding of the concept of risk. Others comment that venture capitalists are so shortsighted that they provide little of the long-run investment that technological companies need. The above phenomena can be explained by two characteristics of Taiwan's VC industry. One is an inefficient environment for the exit of VC from their investments and the other is a stockholder structure of Taiwan's

10 VCEs wherein more than 95 percent of stockholders are individuals or corporate juridical persons. The inefficient VC exit environment in Taiwan is due partly to the inactive over-the-counter (OTC) market and the third category listing specifically for hi-tech enterprises on the Taiwan Stock Exchange. These hamper the marketing of new hi-tech companies' stock to the public. On the other hand, according to the SUI mentioned above, only a company limited by shares is qualified to receive tax incentives for investment in Taiwan. As a result, limited-partner type VCEs, which constitute more than 75 percent of the VCEs in the United States, are not found in Taiwan. In the United States, a partner-type of VC fund is generally managed for seven to ten years, after which partners can take back their share of the profits and their initial investment capital. The exit process for a partner-type VC fund such as that common in the U.S. is therefore faster than for Taiwan's company-limited type of VC fund, which emphasizes the establishment and continued stable operation of a company. The ideal type of VC stockholder is one with long-term capital, such as that from pension funds or capital from insurance companies, since long-term capital is consistent with the VCEs' long-term investments in hi-tech companies. It usually takes about four years or more for a hi-tech company to get a good return. However, in Taiwan, pension funds are not well developed, and restrictions on the investment of insurance

11 companies' capital in VC funds has only just been lifted. As a consequence, the main source of Taiwan's VC so far is from corporations, which are more concerned about making profits in a short period of time and therefore are not patient with long- term investments. However, some exceptions may exist in the cases of VC entrepreneur shareholders who intend very much to run hi-tech business via the experience with VC investments and are thus patient with long-term investments. In the United States and Europe, pension funds, insurance companies, and banks contribute more than half of all VC funds. These two characteristics outlined above result in heavy pressure on Taiwan's VC fund managers to exit, and to focus on short-term returns. The other part of the first questionnaire is concerned with how well the VCEs fulfilled the goals of the government as set out at the beginning of this paper. The evaluation by portfolio and non-portfolio companies reveals that VCEs performed best in the three goals related to finance: "provision of funds," "guidance for the listing of the stocks," and "direction of long-term capital of other financial institutions to technological enterprises," in that order. The other two goals, "providing management support" and "transferring high technology from industrialized countries," obtained the two lowest scores. The finding that VCEs performed poorly in technology transfer may have something to do with the fact that only one

12 third of all Taiwanese VCEs' investments were in foreign technological enterprises. Additionally, since most of Taiwan's VCEs have only minor shares in foreign VC funds, it is very hard for them to acquire important information about technology transfer, as they could by, for example, holding seats on a company's board of directors. Furthermore, Taiwanese VC investments in foreign countries frequently fail due to language problems and geographic distance. However, we still find some cases of technology transfer which are helpful for the development of hi-tech industries in Taiwan. Such cases of technology transfer fall into the following categories: first, those in which the foreign enterprise is directed to establish a manufacturing facility in Taiwan, and transfers in technology -- after a Taiwanese VCE has invested abroad in that foreign enterprise; second, cases in which Taiwanese VCEs search for new sources of technology and transfer in new technology via cooperation with Taiwan's domestic enterprises; and third, cases in which VCEs introduce domestic enterprises to opportunities to invest in or to merge with international enterprises to raise the prestige of Taiwan's enterprises. The number of cases so far, given by VCEs, for each of the above three categories is 17, 16, and 14 cases, respectively. The frequency of occurrence of the above described cases of technology transfer is perhaps not very impressive. However, of the technological enterprises that are involved in these cases,

13 around 70 percent verified that VCEs have played a momentous or critical role in the process of technology transfer. In addition, some shareholders of VCEs which were initially involved only in traditional industries have also become involved in these cases. This proves that the spillover effect of technology transfer by VCEs has spread throughout many industries. This role of VCEs as catalyzers is still an important part of VCEs' contribution to Taiwan's industrial upgrading.

Macroeconomic Contributions Two quantitative indicators are used here to investigate the contribution of VCEs to Taiwan's macroeconomy. These indicators are, first, a ratio of the sum of the production value of VCEs and portfolio enterprises (after adjustment) to gross domestic production (GDP); and, second, an output/input ratio for calculating the GDP-generating effect of tax incentives. To obtain the first ratio, we procured the data for income after taxes, which accords with the value-added (or final product) concept of GDP. In addition, the percentage of total shares belonging to VCEs within each portfolio company was used to represent the degree to which VCEs contribute to the respective portfolio company. An average of 13.8 percent contribution by VCEs to total portfolio companies was finally procured, and this was adopted to adjust the summation of the incomes after taxes of all portfolio companies. Next, the

14 incomes after taxes of all VCEs and portfolio companies (after the adjustment) together was then taken to represent the total contribution of VCEs in GDP. This total GDP contribution of VCEs is 0.42, 1.017, and 0.847 billion NT dollars for the years 1990, 1991, and 1992, respectively. The ratio of the above amounts to total GDP ranges between 0.01 and 0.02 percent from 1990 to 1992. These ratios are quite small, mainly due to the limited volume of VCEs in Taiwan. We did not compare the above numerical results with those in other geographical areas due to the limitations of data4 and the different timespans of VC histories in different areas. Our second measure of VCEs' macroeconomic contribution is a ratio of the total contribution of VCEs to Taiwan's GDP to the amount of related tax incentives. We refer to the above ratio as the "output/input ratio" hereafter. The main tax incentives received by VCEs in Taiwan in the past have been a 20 percent investment credit for VCE shareholders, as well as an 100 percent tax exemption for the capital gains for VCEs. Some other minor tax incentives, such as a one- to four-year tax holiday for dividends secured from investments abroad (before 1991), and loss reserves for investments abroad (begun from 1991), are not included in this

4 In the U.S., for example, it is very hard to find value-added data such as income before taxes for each portfolio company. The data we could find, such as sales and employment, are double-counted data and are not comparable with what we used here.

15 paper due to the limitations of available tax data.5 The amounts subject to the investment credit grew steadily from 1989 to 1991, due to the boom in Taiwan's stock market since 1988. The amount of VC funds in Taiwan has also risen sharply since then -- the total paid-in capital of all VCEs increased from 3.3 billion NT dollars in 1988 to 11.06 billion NT dollars in 1991, rising more than 2 billion NT dollars each year. However, since 1991, newly raised VC funds are not eligible for the investment credit until they have been held by the stockholders of the VCE for more than two years. Additionally, beginning from 1991, the amount of investment credit allowed has to be weighted by the proportion of technological products within each respective portfolio company's total range of products. The amount of total investment credit dropped in 1992, probably partly due to these new rules for calculating investment credit. Furthermore, the increase in newly raised VC funds has been slower in recent years since 1992, and the huge amount of VC funds raised during the boom years of 1988-1991 has been almost completely invested.6 As a consequence, the total amount of investment tax credit has decreased. Tax losses from the two main incentives given to VCEs amounted to 43.50, 70.43, and 48.30 million NT dollars in the three years from 1990 to

5 The tax data are not categorized in such detail as to allow us to distinguish VCEs from other industries.

6 It generally takes about one to four years to completely invest the VC funds which have been raised.

16 1992. Furthermore, we calculated the so-called "output/input ratio" as being 9.66, 14.44, and 17.67 for the same three years. Thus, the multiplier effect of Taiwan's stimulation of the VC industry has been ten-fold or above in recent years. The above research does not consider tax revenues such as income taxes from the shareholders of VCEs, from the VCEs themselves, and from portfolio enterprises, or stock exchange taxes, or any kind of tax losses as discussed above. As a result, the contribution of Taiwan's VCEs to the macroeconomy was probably not overestimated.

VCEs Performance in Taking Companies Public The achievements of VCEs in directing technological enterprises about how to go public with their stock are considerable. Selling off ownership in a new enterprise by listed the company's stock on the main board of the stock exchange remains the primary exit route for many of Taiwan's venture capitalists. The government has introduced more lenient listed requirements by creating a new category, the third one, listed on the Taiwan Stock Exchange to facilitate capital flows, especially to high- tech portfolio investments. Nevertheless, very few of the third category companies have been listed of late. An OTC market was also opened in 1988. However, it has not caught on, and its inactivity has reduced the number of attempts at VC liquidation through that route. In addition to going public, exits by VCEs are also made by

17 selling shares of portfolio companies to other parties in private transactions, called trade sales. Trade sales and public offerings have constituted 47 and 42 percent, respectively, of the exits of Taiwan's VC up until now. As to the rest of the exits, write-offs resulting from investment failure contribute the most, around 11 percent of all exits currently. In Taiwan, it is difficult to figure out from the existing studies7 the exact frequency of occurrence of management buy-backs, mergers and acquisitions (M&A), redemptions of special stocks, etc. However, it is believed that these financial instruments are rarely adopted in general, due to the less-developed financial markets in Taiwan, and some common attitudes of Chinese people, such as an unwillingness to have their company merged or to allow their own enterprise to pass into other hands. In contrast, the composition of VCE exits in Europe, in 1993, is as follows: trade sales, public offerings, write-offs, and others (M&A, etc.) accounted for 45, 23, 18, and 14 percent of exits, respectively. Obviously, the last category, which involves more advanced financial tools, had much higher frequency in Europe than in Taiwan. And, public offerings contributed a much larger share in Taiwan (42 percent) than in Europe (23 percent). The success of Taiwan's VCEs in directing technological enterprises to go public is therefore verified to some extent. The above comparison, nevertheless, is weakened by

7 The composition of the exits of Taiwan's VC is investigated regularly by the Taipei Venture Capital Association.

18 being based on different timespans. Unfortunately, the available data for the United States cannot be matched entirely to Taiwan's data either. The number of public offerings of venture-backed companies in Taiwan has been 1.2 per year, on average, from 1984 to 1993, whereas for the United States the number is 43.3 per year, on average, from 1978 to 1987 (Barry and Vetsuypens, 1990). We divided the above number by the relative scale of the VC industries in the two countries, as represented by the total amount of VC under management.8 Thus, the relative frequency of directing a portfolio company to go public was represented by the ratio of the number of public offerings, on average, to the scale of the VC industry. The results were 0.149 in the United States and 0.24 in Taiwan, respectively. Thus, Taiwan's VC industry again performed well, as shown, in the aspect of directing technological companies to go public, when compared with even the United States, which is the birthplace of the whole concept of VC. Notice that the above calculation, which is again based on different time periods, may be biased against the United Sates, for which the available data is for earlier periods of time. However, if we consider the timespans of VC histories in the two countries, i.e., that Taiwan has a shorter history of VC, the ratios above can still be usefully adopted as a reference.

8 Total VC under management was 29 billion US dollars in the U.S. up to 1987, and 0.5 billion US dollars in Taiwan up to 1993.

19 Possible Alternatives for Taiwan's Current VC Policies The role of government in developing a nation's VC and hi-tech industries is briefly discussed in the previous section-- where we note that the active involvement of the governments of South Korea, Singapore, and Taiwan have directed VC towards technological enterprise investments. In the United States, however, most VCEs also invest in hi-tech enterprises without the promotion of the government. Although several changes to government regulations in the Unites States, such as the provision of government loans to the SBICs as mentioned, the variation of the tax rates on capital gains, and the decision to allow investment by pension funds in VC, have made some impacts on U.S. VC, these changes were not made primarily for VCEs. Considering the different roles governments play towards VC around the world, and the cultural differences east and west, it is difficult to say what the best policy toward VC is. Taiwan's VC policies are a combination of special approval combined with tax incentives and strict restrictions -- the latter mainly applied to the allocation of

VC funds not yet invested.9 Furthermore, the maximum percentage of total investments one VCE can make in a single enterprise is

9 VC funds not yet invested cannot be loaned out, or used to buy stocks listed on the stock exchange, or be invested in real estate. Instead, these idle funds can only be deposited in banks, be invested in government bonds, bonds of financial institutions, or money market orders.

20 restricted to 20 percent of the total paid-in capital of that VCE. This policy assures diversification of portfolio risks. According to the survey results discussed in the last section, more than one-third of all VCEs in Taiwan express their desire to have these incentives and restrictions abolished in the long run. Only one-fifth of Taiwan's VCEs think that it is essential to keep these regulations in the long run. However, for the near future (say, the next five years), most VCEs (50 percent) in Taiwan still prefer maintaining the above regulations. In other words, VCEs, so far, are still willing to be restricted to some extent in their operation in order to acquire tax incentives and the prestige and credibility that comes with the special approval of the government. In the long run, Taiwan's VCEs have established their credibility, and thus desire more freedom in fund allocation and portfolio management. As a consequence, VCEs would rather give up tax incentives in the long run in exchange for greater autonomy in business operations. In fact, several foreign VCEs, which operate without being a VCE as defined and regulated in Taiwan, have already set up branches or offices in Taiwan, such as Prudential Asia, Techno- Ventures (Hong Kong), and Transpac Capital. Their investments in Taiwan are liberally spread among traditional manufacturing, service-related, and technological industries. In addition, many domestic ordinary investment companies in Taiwan also manage

21 similar VC businesses, but do not apply for VCE status and thus are not regulated by the RGVCIE. According to Wang (1994), however, the performance of Taiwan's VCEs, measured by either net sales or income before taxes, is, on average, worse than that of domestic ordinary investment companies.10 The result is more or less related to the restrictions on fund allocation and portfolio management mentioned above applied to VCEs under the regulations of the RGVCIE. Taking into account the above results and recent changes in the international and investment environment, which are described below, VC policies in Taiwan may need revision in the future. Technology transfer into Taiwan has heretofore been highly emphasized by the government in Taiwan. However, in the future, technology transfer out will probably be started, in accordance with a more internationalized investment environment and increased opportunities for strategic alliances between transnational enterprises and domestic enterprises in Taiwan. A more liberal operation environment for VC in Taiwan would be more suitable and also more helpful for Taiwan's continued growth and development. For example, due to the high growth rate and ideal

10 Due to limitations of data, Wang (1994) did not adopt the indicator of the internal rate of return, which is used mostly in the United States and Europe when measuring the rate of return of a VCE. For a VCE, the internal rate of return can better reflect its financial performance because of the unrealized part of the portfolio that usually is realized much more slowly on a VCE's long term investments in hi-tech enterprises.

22 conditions for investment in Taiwan, as well as to the opening of the huge market in mainland China, more and more transnational enterprises are choosing Taiwan as their regional operations center in hopes of extending their development into mainland China. Furthermore, given the similarities of language and culture in the two areas, Taiwan's advantages in the commercialization of hi-tech products and its abundant capital are complementary to the advantage of mainland China in low-cost hi-tech research and manufacturing. In the future, the role of VCEs as catalyzers in the process of possible technology transfers between Taiwan and mainland China is therefore expected to come into play. Therefore, the current restrictions on VCEs' operation and the emphasis on transferring in technology have to be changed to allow more flexibility. More flexibility usually brings more challenges. Other challenges Taiwan's VCEs will face in the future include the reimposition of income taxes on stock transactions (i.e. capital gains taxes) and the possibility that pension funds can be used as sources of VC. The first, although it increases tax justice, removes one of the great advantages of making VC investments in Taiwan. For investment companies like VCEs, capital gains constitute most of their profits. In addition, the Ministry of Finance in Taiwan, to encourage the development of the stock market, plans to levy capital gains taxes on private trade sales in a way which is relatively disadvantageous, compared to the

23 taxes on sales from public offerings. This will further discourage VCEs, which seek profits by investing in the early stages of a business venture, and will thus obstruct the development of technological industries in Taiwan. As to the entry of pension funds to the VC market, the attitude of Taiwan's government toward the management of these huge pension funds will probably have a strong influence on VCEs, even those VCEs with very high returns. Pension funds are usually conservatively managed, whereas VC investments involve high risk --at least in the mind of many government officials who oversee pension fund management. As a result, it has been very hard to convince these officials to permit VC investment as one of the possible channels of pension fund management. However, because Taiwan's government is now very concerned about hi-tech development, VCEs will probably take advantage of this opportunity and be able to use the great amounts of money available in pension funds as their most important source of capital in the future.

Concluding Remarks This paper has investigated Taiwan's VC policies and the impacts of Taiwan's VC on its economy. We find that the government of Taiwan, like those of Singapore and South Korea, has been actively involved in encouraging domestic VC. The effects of the government's VC

24 policies in Taiwan are apparent not only in the multiplier effect, mentioned below, but also in the composition of VC investments, which have come to focus much more on technology- intensive industries than have those in Japan or Hong Kong, where governments have made no special contributions to VC development. In the long run, however, considering that VCEs have established their credibility in Taiwan and the tax incentives have coexisted with numerous restrictions on VCEs' portfolio management, our survey reveals that Taiwan's VCEs would rather give up tax incentives (in exchange, of course, for relaxation of restrictions at the same time) to obtain more freedom in their business operations. Less regulation of Taiwan's VC would be more suitable under an increasingly liberalized and internationalized environment and would be helpful for Taiwan's continued growth and development. With regard to the impacts of Taiwan's VC, according to evaluations from technological enterprises themselves, Taiwan's VCEs performed better in the area of providing financial services than they did in the support of management and technology transfer. Financial services provided by Taiwan's VCEs include provision of seed funds, guidance for the initial listing and sale of the stocks of technological enterprises, and direction of the long-term capital of other financial institutions to technological enterprises. Furthermore, the

25 finding that VCEs performed worst in the area of technology transfer, among the five goals Taiwan's government set up when it started to promote VC (outlined in the introduction of this paper), may have something to do with the minor number of shares Taiwanese VCEs hold in foreign enterprises or in VC funds, and the high rate of failure in Taiwanese VCEs' investments in foreign VC funds (mostly focused on those in industrialized countries). However, we still find some successful cases of technology transfer, and around 70 percent of the technological enterprises involved verified that VCEs played a momentous role in the process of technology transfer for them. On the other hand, an output/input ratio, representing the GDP-generating effect of the tax incentives, showed that the multiplier effect of Taiwan's stimulation of VC has been ten- fold or above in recent years. Finally, we find that, compared with VC in the United States or Europe, Taiwan's VC performed better in its role of directing new technological companies through the process of going public. The timespans available for comparison, however, were not the same in these three geographic areas. In the future, therefore, studies again making these comparisons, but using data based on the same time periods, are in order.

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