4
Capital Markets and Investment

The availability of seed, angel, and venture capital is a key factor in the creation and growth of businesses involved in the development of innovative technologies. In the United States and other developed countries, early stage investors in particular have played an important role in nurturing firms that have new and innovative products and services to offer. As companies grow, debt capital becomes more important, especially for investment in research and development. Thus, in assessing the potential for the development of innovative capacity in China and India, it is important to take into account the condition of capital markets in those countries. David Morgenthaler led a discussion of this topic by a panel that included Martin Kenney of the faculty of the University of California at Davis, Oded Shenkar of Ohio State University, Lee Ting of W.R. Hambrecht and Lenovo Group Ltd., and Sandra Lawson of Goldman Sachs.

VENTURE CAPITAL IN CHINA AND INDIA

Venture capital (VC) industries in India and China are quite immature and were led initially by international development agencies and government agencies, observed Martin Kenney. The first significant interest in indigenous technology-based firms came in the dot-com boom in the late 1990s. China took off rapidly, with excellent NASDAQ public offerings and acquisitions by established firms beginning in 2003. India has seen successful U.S. stock market exits for private equity. India also has the advantage of a vibrant stock market. China has experienced many more venture capital investments than India, focused on the domestic market. Venture capital in India has both global and domestic market investments.

TABLE 1 Total Venture Capital Investment ($ Billions) in Five Key Global Nations/Regions, 2002-2006.

Year

China

India

Israel

Silicon Valley

Boston

2002

0.4

0.2

1.3

7.6

3

2003

2.4

 

1

6.8

3.1

2004

0.6

0.3

1.4

8.3

2.9

2005

1.2

 

1.3

8.5

3.1

2006

1.9

0.5

1.4

9

3.1

SOURCE: Adapted from Global Venture Capital Insights Report (2007) Ernst & Young

A look at regional VC investments (Table 1) reveals the predicted concentrations--in Beijing and Shanghai in China and in Bangalore, Mumbai, and Chennai in India. One in three Indian VC firms had significant U.S. VC involvement. Many elite Silicon Valley VC firms are operating in China, such as Sequoia Capital International Funds. American venture capitalists are growing more comfortable with doing business in both countries and are learning the differences in their intellectual property systems. India’s IP system poses fewer impediments (Figure 5).

Multinational VC firms are playing an important role in both countries although generally not on the frontier of technology, where U.S. VC firms are dominant. Exceptions are firms such as Softbank, 3i, and Jafco. Corporate VC funds, especially Intel Capital and Nokia, are also active. In China VC investments are generally larger, more mature, and geared mostly to supplying needs in the domestic market. In India, they are concentrated in



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4 Capital Markets and Investment market. Venture capital in India has both global The availability of seed, angel, and venture and domestic market investments. capital is a key factor in the creation and growth of businesses involved in the development of innovative technologies. In the United States TABLE 1 Total Venture Capital Investment ($ and other developed countries, early stage Billions) in Five Key Global Nations/Regions, investors in particular have played an important 2002-2006. role in nurturing firms that have new and innovative products and services to offer. As Year China India Israel Silicon Boston companies grow, debt capital becomes more Valley important, especially for investment in research 0.4 0.2 1.3 7.6 3 2002 and development. Thus, in assessing the 2.4 1 6.8 3.1 2003 potential for the development of innovative 0.6 0.3 1.4 8.3 2.9 2004 capacity in China and India, it is important to 1.2 1.3 8.5 3.1 2005 take into account the condition of capital 1.9 0.5 1.4 9 3.1 2006 markets in those countries. David Morgenthaler SOURCE: Adapted from Global Venture led a discussion of this topic by a panel that Capital Insights Report (2007) Ernst & Young included Martin Kenney of the faculty of the University of California at Davis, Oded Shenkar A look at regional VC investments (Table 1) of Ohio State University, Lee Ting of W.R. reveals the predicted concentrations--in Beijing Hambrecht and Lenovo Group Ltd., and Sandra and Shanghai in China and in Bangalore, Lawson of Goldman Sachs. Mumbai, and Chennai in India. One in three Indian VC firms had significant U.S. VC involvement. Many elite Silicon Valley VC VENTURE CAPITAL IN CHINA AND firms are operating in China, such as Sequoia INDIA Capital International Funds. American venture capitalists are growing more comfortable with Venture capital (VC) industries in India and doing business in both countries and are learning China are quite immature and were led initially the differences in their intellectual property by international development agencies and systems. India’s IP system poses fewer government agencies, observed Martin Kenney. impediments (Figure 5). The first significant interest in indigenous Multinational VC firms are playing an technology-based firms came in the dot-com important role in both countries although boom in the late 1990s. China took off rapidly, generally not on the frontier of technology, with excellent NASDAQ public offerings and where U.S. VC firms are dominant. Exceptions acquisitions by established firms beginning in are firms such as Softbank, 3i, and Jafco. 2003. India has seen successful U.S. stock Corporate VC funds, especially Intel Capital and market exits for private equity. India also has Nokia, are also active. In China VC investments the advantage of a vibrant stock market. China are generally larger, more mature, and geared has experienced many more venture capital mostly to supplying needs in the domestic investments than India, focused on the domestic market. In India, they are concentrated in 17

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18 THE DRAGON AND THE ELEPHANT 30% 25% 25% China 20% 14% 14% 15% 13% 13% 12% 11% 11% 11% 10% 10% 10% 10% 9% 10% 8% 7% 6% 5% 5% 0% Difficulty in Lack of quality Lack of Lack of talented Intellectual Regulatory achieving deals that fit experienced local portfolio property laws environment succesful exits investm ent investors m anagers profiles APAC Europe U.S. 30% 25% India 20% 15% 12% 10% 10% 10% 9% 10% 8% 8% 7% 6% 6% 6% 5% 5% 4% 4% 4% 5% 3% 1% 0% Difficulty in Lack of quality Lack of Lack of talented Intellectual Regulatory achieving deals that fit experienced local portfolio property laws environment succesful exits investment investors managers profiles FIGURE 5 Major impediments to VC investment in China and India. Respondent groups are Europe, United States, and Asia Pacific (APAC). SOURCE: Adapted from Global Trends in Venture Capital (2007) Deloitte & NVCA

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CAPITAL MARKETS AND INVESTMENT 19 services and more oriented to the global market. CHINA’S VENTURE CAPITAL MARKETS It is possible that Indian venture capital could be Lee Ting, a U.S.-based private equity more significant for global technology firms in investor who is also an official of the Lenovo five years, according to Kenney. Group, offered a practitioner’s perspective on China’s private equity markets. Ten years ago, he observed, U.S. private equity firms were not THE LINK BETWEEN EDUCATION AND active in China; now we find all the large VC CAPITAL MARKETS firms with a presence and investments in China. What are the similarities and differences Oded Shenkar explored the linkage between between the U.S. and China situations? In both, education and capital markets in China. Mattel a private equity firm searches for companies Corporation’s recent admission that U.S.-based with high value positions in a large market. design work, not China-based manufacturing, Differences include the additional complexities was to blame for their faulty toys was telling. in China, including a legal structure requiring a How long will it be before Chinese greater reliance on legal services, greater manufacturers take on the design process regulatory risk, and personal trust issues. How themselves? The answer has huge financial do you trust local management with venture implications, as design determines a large share money? An ability to identify the right person of the value captured in exports. for a transaction is extremely important in China overtook the world in volume of IT China. The China market is still evolving. It exports but the largest share of those exports still lacks transparency, which China’s regulatory belongs to foreign enterprises working in China. agencies are working to improve. And the In 2005, MNCs were responsible for 58 percent market suffers from the liquidity problems of an of China’s exports. The standard critique of inefficient market. Still, the prospect is for more Chinese innovation is that it has a long history opportunities to invest, more successful exits for of inventions but has not maintained flexibility investors, and hence more multinational VC for adapting its formulas. This critique dates involvement. back at least to de Tocqueville in the early 1800s. Shenkar listed several challenges to successful innovation in China. The strategy of DEBT MARKETS acquiring innovation, illustrated by the Lenovo Sandra Lawson of Goldman Sachs echoed acquisition of the personal computer division of Kenney’s points on the long-term picture, but IBM, has clear benefits for the mid-term. The observed that while China outpaces India in strategy of attracting Chinese graduates back foreign direct investment (FDI), India’s foreign from abroad is also very likely to pay off. But investment upturn is likely to continue (Figure 6). government spending per student in China has not risen, and this points to difficulty in fostering indigenous innovation. Most Chinese China India universities are not on par with high-quality 5 universities internationally; learning in China 4 still depends mainly on repetition and 3 memorization. There are weaknesses in both educational theory and practice in China. 2 Another challenge to foreign companies 1 below the top rung in China is the vulnerability 0 of their intellectual property to exploitation by 97 98 99 00 01 02 03 04 05 06 Chinese competitors. Even in a knowledge FIGURE 6 Foreign direct investment as a economy, Shenkar concluded, it is possible to yearly percentage of GDP. SOURCE: Lawson grow and profit by imitating without innovation.

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20 THE DRAGON AND THE ELEPHANT Across Asia, debt markets play a limited role in economic growth. They are small and 2000 dominated by governmental or quasi- 1750 governmental debt. A more robust corporate 1500 India China debt market is essential for economic growth 1250 1000 and is the backbone for R&D investment. It 750 enables companies and lenders to take more risk. 500 At this point, however, the corporate debt 250 market has little liquidity. 0 In both countries there are problems with 97 99 01 03 05 07 respect to supply, demand, and marketplace FIGURE 7 Domestic support underpins equity infrastructure. In India, for example, there is markets, as of September 2007 (USD Billions). little transparency. Companies disclose debts SOURCE: Lawson only to a few investors. Markets in mutual funds and pension funds are exceedingly weak. A good deal of investment could go there, but There is a need for larger investors to get things investors are restricted on where they can invest. moving in that direction. Building a debt market For the most part investment is channeled to now can fuel the growth of medium-size government debt. Investors have little ability to corporations over the long term. price risk, and they face unwelcome tax and Asked about the significance of the money accounting rules. Thus, debt markets represent a flows associated with China’s real estate boom, chicken-and-egg situation. It is a supply issue the panel said that the boom underscores the but also a problem of market infrastructure. If need for leaders to create a greater range of the infrastructure problem is addressed, both investment opportunities. Rising real estate demand and supply will accelerate. India’s prices do not create value per se and the bursting Knowledge Commission is creating awareness of the real estate bubble can have disastrous of what is needed to grow innovation there, but consequences for the economy as a whole. But the choices are politically difficult. real estate transactions do help grow a middle In Lawson’s opinion, both China and India class, which in turn has broader positive effects. have strong prospects for growth of debt markets A growing mortgage market helps spread (Figure 7). In the slightly longer term by 2016, growth by creating demand for furnishings and China’s domestic debt market could grow to the related products. size of today’s U.S. market for Treasuries.