OECD/ADBI 7th Round Table on Capital Market Reform in Asia 27-28 October 2005 ADB Institute, Tokyo, Japan SESSION 4: DEVELOPMENTS IN VENTURE CAPITAL AND PRIVATE EQUITY SINCE THE END OF TECH BUBBLE Mr. John K. Thompson Financial Counsellor, OECD 1
Developments in Venture Capital and Private Equity since the end of Tech Bubble Seventh Tokyo Round Table on Capital Markets Reform in Asia. October 28, 2005 John K. Thompson Financial Counsellor Directorate for Financial and Enterprise Affairs, OECD 2
Sources of SME Financing Positive cash flow Collateral High Return High Risk Banks X X No NBFIs X No Govt. programmes Equity Internal Cash flow Usually Usually Sometimes X X X 3
Hypothetical Life Cycle for New Highgrowth Companies Phase 1: Pre-Venture Capital: Informal finance Friends and Family Business Angels Precondition: overall entrepreneurial environment, flows of potential highgrowth projects, links between research and commerce Phase 2: Formal Venture Capital Phase 3: Transition Appropriate legal structures Sources of funds (institutional investors, individuals, financial institutions, corporate sector, government) M & A IPO Markets Phase 4: Formal capital markets 4
Environment for Entrepreneurship Cultural values Education and training system Corporate and bankruptcy law Financial markets Taxation policy Social protection Science/industry linkages 5
Entrepreneurial Activity in Selected OECD Countries. Percent 12 Start-up activity: Percentage of adults engaged in the process of creating a business in the past 12 months New firm activity: Percentage of adults owning (solely or partly) and managing an operating business that is less than 42 months old 10 8 6 4 2 0 United States Korea Australia Norway Canada Italy Germany United Kingdom Denmark Spain Finland Sweden Belgium France Ireland Japan 6
Italy 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Barriers to Entrepreneurship Vary Across OECD Countries Based on 1998 Data Barriers to competition Regulatory and administrative opacity Administrative burdens on startups Canada Australia Ireland New Zealand United States Denmark Norway Netherlands Portugal Austria Greece Spain Sweden Finland Germany Switzerland Japan Belgium France United Kingdom 7
Informal Equity Investment Former entrepreneurs Contribute capital and business skills Hands on participation, coaching Flexible participation Locally oriented Operate in both high growth companies and traditional SMEs Business angels and business angel networks An area for government support? 8
Venture Capital: Basic Characteristics Only suitable for high-growth companies Private equity (usually preferred shares) Players: entrepreneurs, venture capitals and investors Deal flow: screening of projects and high rate of rejection Intensive monitoring and coaching Asymmetric information, agency and monitoring problems Staging of investment Importance of exit 9
What kinds of firms are suitable for venture capital? High risk, high return Negative cash flow (burn ratio) Often technology related fields (ICT, biotech, etc.) Often in areas of concentration of technology related industry High share of tangible assets 10
Stages of Venture Capital Finance Preparatory phases: origination, screening, due diligence and deal evaluation Early stage Seed Start-up Expansion (one or more rounds) Mezzanine Exit Buy-out Trade sale IPO 11
Venture Capital Investment as a share of GDP, averages 2000-2003 Israel (1) United States Iceland Canada OECD19 (2) OECD23 (4) Korea (3) Sweden United Kingdom Netherlands Finland European Union Europe Australia (5) Norway Spain Denmark France Belgium Ireland Euro area Germany New Zealand (5) Italy Portugal Switzerland Czech Republic Austria Poland Greece Hungary Japan (5) Slovak Republic Expansion Early stages 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 Per cent of GDP (1) 2000-2002. (2) Europe, Canada and United States. (3) 1998-2001. (4) Europe, Czech Republic, Hungary, Poland, Slovak Republic, Canada, and United States. (5) 1998-2001. Source: OECD, based on data from EVCA (Europe); NVCA (United States); CVCA (Canada); Asian Venture Capital Journal (The 2000 Guide to Venture Capital in Asia). 12
Venture Capital Investment in High-tech Industries in per cent of total venture capital investment, 2000-03. 100 80 60 40 20 0 Communications Information technology Health/biotechnology Spain Slovak Republic Portugal Netherlands Australia (2) United Kingdom Italy Japan (2) EU France Germany Sweden Korea (2) Switzerland Belgium Finland Greece Poland Iceland (1) Austria Hungary Czech Republic Per cent of total venture capital investment Norway New Zealand (2) OECD Denmark United States Canada Ireland (1) 2000-2002. (2) 1998-2001. Source: OECD, based on data from EVCA (Europe); NVCA (United States); CVCA (Canada); Asian Venture Capital Journal (The 2000 Guide to Venture Capital in Asia). 13
Country (Structure Private Equity Fund Structures Tax transparent for domestic investors Ability to avoid permanent establishment for international investors from treaty or non treaty countries Ability to incorporate a capital investment/in centive for fund managers. Ability to avoid paying VAT on management charges Ability to avoid paying VAT on carried interest Freedom from undue restrictions on investments Belgium X N/A X Finland X X France X X Germany X Italy X N/A X Netherlands X Portugal X N/A X X Spain X N/A X Sweden X Switzerland X N/A X X X United Kingdom United States Source: European Venture Capital Association Note: An X indicates a problem in the area concerned. 14
Who supplies fund for Venture Capital? Banks Investment banks Pension funds Collective Investment Schemes Industry Foundations and Endowments High net worth individuals Foreign investors Government 15
Sources of Funds Raised for Venture Capital Averages over 1999-200, per cent of total Banks and insurance companies Pension funds Corporate investors Other AUS NZL FIN AUT CZE GBR USA ITA DNK DEU NLD HUN ESP FRA SWE IRL GRC JPN POL KOR PRT CHE ISL CAN BEL NOR SVK 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100 Source: OECD, based on data from EVCA (Europe); NVCA (United States); CVCA (Canada); Asian Venture Capital Journal (The 2000 Guide to Venture Capital in Asia). 16
Performance of growth stock exchanges Indices, 02/01/1998 =100 NASDAQ COMPOSITE FTSE ALTERNATIVE INVEST.MKT (AIM) NEMAX ALL SHARE NOUVEAU MARCHE 900 800 700 600 500 400 300 200 100 0 Jan-90 Jul-90 Jan-91 Jul-91 Jan-92 Jul-92 Jan-93 Jul-93 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Source: Thomson Financial DataStream. 17
Current Trends in Venture Capital Highly cyclical sector Innovation Fund raising Inflows into sector Rising valuations Market peaks Earlier cycles 1980-84 1995-2000 18
Is a New Cycle Beginning? Surge in activity in 2004 early 2005 In US, both venture capital and buy-outs Globalization of the industry; India and China emerge In Europe, strong buy-out activity, but ventutre capital lags especially early stages 19
Global VC Fundraising Capital Raised by VC Funds; 2000-2004 Annual Committed Capital (USD $M) 100,000 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 North America Europe Asia/Australia 2000 2001 2002 2003 2004 20
Global Venture Investment Activity 2000-2004 120 100 80 (USD $Bil) 60 40 20 North America Europe Asia 0 2000 2001 2002 2003 2004 21
US IPO s by number of issues 250 200 150 100 50 Non-VC backed VC Backed 0 2001 2002 2003 2004 22
US M&A By number of Deals & Rank Value 2001-2004 $800 9,000 $700 8,000 $600 7,000 $500 6,000 ($ Billions) $400 $300 5,000 4,000 3,000 # of Deals $200 2,000 $100 1,000 $0 0 2001 2002 2003 2004 $ Proceeds # IPOs 23
European versus US private equity cumulative IRR Since Inception by Calendar Year (Inception to December 31, 2004) (1) US Europe 25 20 Net IRR Since Inception (pct) 15 10 5 0-5 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 1) US Funds formed 1969-2004, European Funds formed 1980-2004 Source: Thomson Financial 24
European versus US private equity cumulative IRR From Inception to December 31, 2004 (1) Stage No. Pooled Upper Quartile Median DPI RVPI TVPI Early/Seed VC 545 20 16.2 2.7 1.29 0.54 1.83 Seed VC 65 10.2 13.3 4.0 1.08 0.39 1.48 Balanced VC 426 13.6 15.6 5.4 1.03 0.50 1.53 Later Stage VC 182 13.8 15.2 5.4 1.04 0.44 1.49 Total US Venture 1153 15.9 15.9 4.4 1.12 0.50 1.63 Development VC 173 8.2 7.4 0.0 0.74 0.68 1.42 Early VC 252 0.2 4.2-3.1 0.40 0.60 1.01 Balanced VC 146 7.9 10.7 0.0 0.66 0.59 1.26 Total European Venture 571 6.0 6.7-0.4 0.60 0.62 1.21 Small Buyouts 186 25.0 18.6 7.9 1.32 0.40 1.73 Medium Buyouts 105 16.4 16.1 6.8 1.07 0.42 1.49 Large Buyouts 82 17.4 18.8 7.0 1.01 0.59 1.59 Mega Buyouts 101 8.6 14.7 5.8 0.64 0.66 1.30 Total US Buyouts 474 13.1 17.8 7.0 0.81 0.60 1.41 Small Buyouts 218 11.2 15.8 7.6 0.92 0.51 1.42 Medium Buyouts 36 17.7 22.2 9.0 1.16 0.54 1.70 Large Buyouts 28 20.4 18.6 7.0 1.09 0.55 1.64 Mega Buyouts 25 6.4 12.8 1.8 0.38 0.81 1.19 Total European Buyouts 307 12.3 16.5 6.9 0.70 0.67 1.37 1) US Funds formed 1969-2004, European Funds formed 1980-2004 Source: Thomson Financial 25
Venture capital: United States vs. Europe Amount: Europe Amount: US Number: Europe Number: US 30,000 1600 25,000 20,000 15,000 10,000 5,000 1400 1200 1000 800 600 400 200 Venture Amount Invested, Europe & US Number of Venture Deals, Europe & US 0 0 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 Source: Thomson Financial, VentureSource/Ernst & Young 26
2004 US Venture Funds Annualized Net Cumulative IRR by Vintage Year As of December 31, 2004 100 80 60 40 20 0-20 -40 27 1969-75 1976-79 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Annualized Cumulative IRR