UC Berkeley Recent Work

UC Berkeley Recent Work Title Scattering Geese: The Venture Capital Industries of East Asia: A Report to the World Bank Permalink https://escholarship.org/uc/item/64j6d0zc Authors Kenney, Martin Han, Kyonghee Tanaka, Shoko Publication Date 2002-03-01 Supplemental Material https://escholarship.org/uc/item/64j6d0zc#supplemental eScholarship.org Powered by the California Digital Library University of California Scattering Geese: The Venture Capital Industries of East Asia* A Report to the World Bank BRIE Working Paper 146 September 17, 2002 By Martin Kenney Department of Human and Community Development University of California, Davis Davis, CA 95616 [email protected] Kyonghee Han Visiting Scholar Department of Human and Community Development University of California, Davis [email protected] and Research Fellow Institute for Social Development Studies Yonsei University, Seoul, Korea Shoko Tanaka 1312 Marina Circle Davis, CA 95616 Consultant [email protected] ãCopyright by the authors, 2002 * K. Han had primary responsibility for the section on Korea and S. Tanaka had primary responsibility for the section on Japan. M. Kenney bears responsibility for all errors and opinions expressed in this manuscript. Martin Kenney would like to thank Yili Liu and Tze-chien Kao for their assistance in understanding venture capital in Taiwan. At the beginning of the 21st Century, the importance of venture capital for the funding of new high-growth potential firms is universally recognized. Many defining firms of the last three decades including 3Com, Amgen, AMD, Compaq, Cisco, Federal Express, Genentech, Intel, Oracle, and Sun Microsystems were first funded by venture capitalists. Venture capital provides capital for financing some of the most dynamic, innovative firm clusters in the world. In the last two decades, venture capital investing has diffused internationally - - there are now 30 national venture capital associations. This report examines the development of the venture capital industry in China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Philippines, Singapore, Taiwan, and Vietnam.1 The diversity of East Asian nations in terms of their national systems of innovation, levels of entrepreneurship, political economic development, varying labor practices, corporate ownership regulations, educational achievement, and business cultures means that each country and its venture capital industry has a different evolutionary trajectory. This, quite naturally, means that current development and prospects for the future differ significantly from country-to-country. Moreover, the larger economies especially China and Japan have complex and even contradictory forces at work complicating any assessment of the continuing development and emerging role of venture capital. This report is divided into five major sections. The first section discusses the history, development, and operation of venture capital as an institution and its economic impacts. This is followed by a section that provides a checklist of the criteria of qualifications to be considered venture capital and the necessary conditions and preconditions to develop a dynamic venture capital industry. The third section is a general overview of venture capital in Asia. The fourth and longest section is a nation-by-nation discussion of venture capital in Asia. The final section summarizes the situation of venture capital in Asia and speculates on its further development. 1. Venture Capital as an Institution: History and Operation2 Prior to World War Two, the source of capital for entrepreneurs everywhere was either the government, 1In this report we treat Hong Kong and Taiwan separately from China because of their very different political and economic systems. 2 government-sponsored institutions meant to invest in such ventures, or informal investors (today, termed "angels") that usually had some prior relationship to the entrepreneur.3 In general, throughout history private banks, quite reasonably, have been unwilling to lend money to a newly established firm, because of the high risk and lack of collateral.4 After World War Two, in the U.S. a set of intermediaries emerged who specialized in investing in fledgling firms having the potential for extremely rapid growth. From its earliest beginnings on the U.S. East Coast, venture capital gradually expanded and became an increasingly professionalized institution. During this period, the locus of the venture capital industry shifted from New York and Boston on the East Coast to Silicon Valley on the West Coast (Florida and Kenney 1988a; 1988b; Gompers 1994). By the mid 1980s, the ideal-typical venture capital firm was based in Silicon Valley and invested largely in electronics with lesser sums devoted to biomedical technologies.5 Until the present, in addition to Silicon Valley, the two other major concentrations have been Boston and New York City. In both Europe and Asia, there are significant concentrations of venture capital in London, Israel, Hong Kong, Taiwan, and Tokyo. In the U.S., the government has played a role in the development of venture capital, though, for the most part, it was indirect. The indirect role, i.e., the general policies that also benefited the development of the venture capital industry, was probably the most significant. Some of the most important of these were: The U.S. government generally practiced sound monetary and fiscal policies ensuring relatively low inflation with a stable financial environment and currency. U.S. tax policy, though it evolved, has been favorable to capital gains, and a number of decreases in capital gains taxes may have had some positive effect on the availability of venture capital (Gompers 1994). With the exception of a short period in the 1970s, U.S. pension funds have been allowed to invest prudent amounts in venture capital funds. The NASDAQ stock market, which has been the exit strategy of choice for venture capitalists, was strictly regulated and characterized by increasing openness thus limiting 2 This section is adapted from Kenney and Burg (1999) and Dossani and Kenney (2001). 3 On angels, see Robinson and van Osnabrugge (2000). 4 Normally, banks charge interest. A practice that, to be successful, requires the repayment of the capital. Or, put differently, bankers cannot afford the loss of their capital when their return is only an interest payment. 5 There are, of course, important venture capital firms headquartered in other regions, and there is a diversity of venture capital specialists. For example, there are funds that specialize in retail ventures. Some of the largest venture capital funds such as Oak Investment Partners and New Enterprise Associates have partners devoted to retail ventures, though their main focus is IT. So, there is significant diversity in the venture capital industry (Gupta and Sapienza 1992). 3 investor's fears of fraud and deception. This created a general macroeconomic environment of transparency and predictability, reducing risks for investors. Put differently, environmental risks stemming from government action were minimized -- a sharp contrast to most developing nations. Another important policy has been a willingness to invest heavily and continuously in university research. This investment funded generations of graduate students in the sciences and engineering. From this research has come trained personnel and innovations; some of who formed firms that have been funded by venture capitalists. U.S. universities particularly, MIT, Stanford, and UC Berkeley played a particularly salient role (Kenney and von Burg 1999; Saxenian 1994). The most important direct U.S. government involvement in encouraging the growth of venture capital was the passage of the Small Business Investment Act of 1958 authorizing the formation of small business investment corporations (SBICs). This legislation created a vehicle for funding small firms of all types. The legislation was complicated, but for the development of venture capital the following features were most significant: It permitted individuals to form SBICs with private funds as paid-in capital and then they could borrow money on a two-to- one ratio initially up to $300,000, i.e., they could use up to $300,000 of SBA-guaranteed money for their investment of $150,000 in private capital. There were also tax and other benefits, such as income and a capital gains pass-through and the allowance of a carried interest as compensation. The SBIC program became one that many other nations either learned from or emulated. The SBIC program also provided a vehicle for banks to circumvent the Depression-Era laws prohibiting commercial banks from owning more than 5 percent of industrial firms. The banks' SBIC subsidiaries allowed them to acquire equity in small firms. This made even more capital available to fledgling firms, and was a significant source of capital in the 1960s and 1970s. The final investment format permitted SBICs to raise money in the public market. For the most part, these public SBICs failed and/or were liquidated by the mid 1970s. After the mid 1970s, with the exception of the bank SBICs, the SBIC program was no longer significant for the venture capital industry. 4 The SBIC program experienced serious problems from its inception. One problem was that as a government agency it was very bureaucratic having many rules and regulations that were constantly changing. Starting in 1965 Federal criminal prosecution was necessary to rectify the misappropriation of funds, incompetence, and fraud undertaken

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