HK

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HKS VENTURE CAPITAL SYSTEMAND THE
COMMERCIALIZATION OF NEW TECHNOLOGY

• Kevin Au
• Chinese University of Hong Kong
• Steven White
• China Europe International Business School

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Objectives

• describe and assess the performance of Hong
  Kongs venture capital system
• beyond the strict financial definition of venture
  capital (VC) to address the system of actors and
  institutions that finances the commercialization
  of new technology
• generate actionable recommendations to improve
  its efficiency and effectiveness in increasing
  the positive role of new technology in Hong Kong
  industry

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Agenda

• Startup process financing
• Venture capital system
• General situation of the HK VC industry
• Institutional framework for an evolutionary
  analysis
• VC Cycle, investment process, VC system
• West coast vs East coast VCs in the US
• Evolution of HKs VC industry
• Other key actors angels, stock market,
  institutional investors
• Inhibitors to VCs support to Commercialization
• Suggestions for the medium term

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Financing of New Firms
up to US0.1M
up to US1.0M
US1 - 3M
US3M and up
Expansion
Early stage
Start-up
Pre-start

• With great idea, you need finance for additional
  research or produce a prototypes

• With profits and well established business
  operation, funding is required for new product
  development and exploring new markets

• No sales yet, you need finance for working
  capital such as,
• salary, development testing

• Having a few sales, finance is required for
  marketing and operations, in order to make the
  business fly

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Cheaper sources of capital, such as bank
financing, are usually not available for most
early-stage ventures, which may be too small or
young to qualify for traditional loans
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Flow of Funds in a VC cycle
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Venture Capital Pool
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Number of VC Firms
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Investment Stage of VC Funds
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Disbursement of VC Funds Local or Overseas
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General situation of VC Industry

• have the largest pool of venture capital
• Most of them not interested in investing in
  early stage
• A lot of funds being parked in HK for investments
  outside Hong Kong
• Especially mainland China in recent years

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Venture Capital Process
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(No Transcript)
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West Coast vs East Coast VCs

• West coast VCs are dreamers and want to see how
  technology can change the world, whereas East
  Coast VCs only treat venture investment as
  another asset class.
• Udayan Gupta, Author of Done Deals

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Larry Sonsini, of the law firm Wilson, Sonsini,
Goodrich Rosati

• The West Coast model of venture capitalism has
  always been a very intense business partnership
  with the entrepreneurs.
• The providing of capital was one function of the
  venture capitalist. Being actively involved in
  developing the business model, managing the
  enterprise, and recruiting management
• They thought of more than investing money. They
  thought about mentoring, training, and providing
  business solutions. The goal was not only to make
  a successful investment but also to be a part of
  building a successful venture.

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Morton Collins, founder of DSV Partners in 1968

• The East Coast, the financial center of the
  world, has traditionally been fixated on
  financial engineering. There, with a priority
  placed on the structuring of deals, has often
  mattered less what a company did or what would be
  involved in ensuring its long-term success than
  whether the deal would provide tax benefits and
  financial returns.
• On the West Coast, by contrast, the driving
  spirit has been innovation in science and
  technology. Technologists and investors, many of
  whom are refugees from the East, have long
  gathered around the campuses of Stanford
  University and Cal Tech to create a new economy
  and a new entrepreneurial culture (p. 293).

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Reasons of the differences

• Early East Coast firms were set up as Small
  Business Investment Corporations
• Following governmental guidelines but not
  technology
• General partners are bankers and accountants, not
  operational managers
• New York Boston are financial centres, so lots
  of money from insurance firms and pension funds
• Expect regular disbursement low risk, not
  particularly fond of technology

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Evolution of HKs VC System

• Tying evolving institutions to VC development
• Four stages
• Prior to 1970s
• 1970s to mid 1990s
• Mid-1990s to 2001
• 2001 to present

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Prior to 1970s

• Traders mentality
• Favoring arbitrage
• Refugee mentality
• Short-term oriented
• Colonial government (British were guilty!!)
• Positive non-interventionism
• Supporting indirectly logistics, construction,
  trading and financial industries
• Successful lobbying from these industries

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1970s to mid 1990s

• Background
• British trading firms dominated
• Booming stock market
• First VC firm Inter-Asia Venture Management
• transfer strategy
• 1981 ARRAL Partners
• succeeded against skepticism
• Listed HK Teawood in NASDAQ, 1984
• 1988 US150M APAC Fund launched
• Grew industrial firms benefited in the China and
  Asia boom
• Invested almost all in late stage ventures
• 1987 HK Venture Capital Association founded

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Mid-1990s to 2001

• 1994 US1.7B Asia Infra-Structure Fund by AIG
• Tech Boom then Bust
• Entering many new VC firms, local overseas
• Large PEs after the Asia Crisis
• Government VC Applied Research Fund
• Corporate VCs
• Short-term risk averse didnt know technology

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2001 to present

• Dismal investment
• New firms had little technology
• New VCs had little operational background
• Lacking qualified startup management teams
• Overdue government intervention
• Not all was lost
• Some success
• New opportunities threats
• Rapid development of China HKs economy and
  financial markets

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Summary

• Lots of money but not channeled to tech ventures
• there is not a cohesive financial arrangement,
  and entrepreneurs, academics, politicians and
  civil servants lack the appropriate skills to
  differentiate good ventures from bad. They have
  to mature in their decision-making to accept risk
  and how return is generated.
• By the time Chinas stock markets become mature
  and the RMB circulates more widely, Hong Kong as
  a base for venture funds will be lost forever.

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Key actors and resource flows
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VC-Backed IPO 2000-07
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Inhibitors to VCs Supporting the
Commercialization of New Tech

• Government Culture
• Short-term oriented, low-tech
• VC and PE firms
• we are out to make money
• Focused late stage, large size, low risk ventures
• Lacking operational experience
• New ventures
• traditional owners expect control
• Younger generations

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Inhibitors to VCscontinued

• Stock market
• Welcome the listing of large firms
• Technology level of firms not a focus
• Banks Endowment funds
• Lending by laterals
• Investment confined by the HK version of the
  prudent man rule
• Angels Angel Networks
• Lack knowledge in tech ventures
• Not organized to share risk and knowledge

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Suggestions for the Medium term

• 1. Stimulate more VC funds with long-time horizon
  and technology interest
• Channel government reserve and pension funds by
  lifting the prudent man rule
• 2. Develop professional qualifications for
  investment advisors on VC/PE industries
• Stimulate angel investment
• Training, guidebooks, templates
• Accredited investor possibly tax breaks for
  investing in technology ventures

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Suggestionscontinues

• 4. Diversify the backgrounds of the general
  partners
• VC firms hiring general special partners are
  more likely to receive endowment, pension
  government investments
• 5. Find new IPO exit for VC/PE invested in
  technology firms
• setting up a new board with perhaps the main
  board or the SME board in Shenzhen Stock Exchange

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• The society is innovative and entrepreneurial.
  The Science Park is great in innovationBut there
  is not a cohesive financial arrangement, and
  entrepreneurs, academics, politicians and civil
  servants lack the appropriate skills to
  differentiate good ventures from bad. They have
  to mature in their decision-making to accept risk
  and how return is generated.
• from a foreign, early-stage VC in HK

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References

• Au, K., Baark, E., Chua, B. L., Thomas, H.
  (2005). Innovation policy and high growth
  startups. Hong Kong CUHK Centre for
  Entrepreneurship.
• Gupta, U. (2000). Done deals Venture capitalists
  tell their stories. Boston Harvard Business
  School Press.
• Metrick, Andrew (2007) Venture Capital and the
  Finance of Innovation. John Wiley Sons, Inc.,
  Hoboken, NJ
• Murmann, J. P. (2003). Knowledge and competitive
  advantage The coevolution of firms, technology,
  and national institutions. Cambridge Cambridge
  University Press.
• White, S., Gao, J., and Zhang, W. (2005).
  Financing new ventures in China System
  antecedents and institutionalization. Research
  Policy, 34 894-913.

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Private Equity, VC Hedge Funds