3 Latin

A Historical Overview of Venture Capital in U.S. and its Past Performance Nousha Tajer Moshaei Azadeh Daniali Behrooz Ataee

What is Venture Capital ?  Venture capital is defined as “money made available for investment in innovative enterprises or research, especially in high technology, in which both the risk of loss and the potential for profit may be considerable. Also known as risk capital.”  Venture money is used to build a business in the expectation that value of the resulting business will be much grater than the initial investment.  An important source of equity capital for start-up companies.

Why use venture capital  Provides a solid, flexible, capital base to meet future growth and development of the start-up company.  Returns to the venture capitalist depend on the success and growth of the business, hence the entrepreneurs can relay on the vast business network of the VCs.  If the business runs into difficulty the VCs will work hard to ensure that the company is turned around.  VC funding is committed until exit (M&A, IPO, LBO, MBO – usually 3-5 years).

7 levels of research and planning for every startup • • • • • • •

Feasibility studies to determine whether a given venture should be started. The preparation of the business plan for the seed round, and subsequent rounds of investment and operation. Determining optimum debt and equity ratios, and developing a financial plan. The development of an operational plan to get the project up and running. Development of prospective funding sources for both debt and equity. Preparation of project evaluation for both pre- and postinvestment analysis. Planning investor and owner exit strategies through M&A, IPO’s, LBO, MBO, etc.

History of Venture Capital  In the fifteenth century, Christopher Columbus sought to travel westwards instead of eastwards from Europe and so planned to reach India. His farfetched idea did not find favor with the king of Portugal, who refused to finance him. Finally, Queen Isabella of Spain, decided to fund him and the voyages of Christopher Columbus are now empanelled in history.  In the 1920’s and 30’s, the wealthy families and individuals investors provided the start up money for companies that would later become famous. Eastern Airlines and Xerox are the most famous ventures they financed. Among the early VC funds set up was the one by the Rockfeller family which started a special fund called VENROCK in 1950, to finance new technology companies.  American Research and Development Corporation, formed in 1946. the founder of ARD was General Georges Doroit, a French-born military man who is considered “the father of venture capital”. In the 1950s, he taught at the Harvard Business School. ARD was the first firm, as opposed the private individuals, at MIT to finance the commercial promotion of advanced technology developed in the US Universities. ARD’s biggest success was investment in digital equipment corporation (DEC) in 1957.

History of Venture Capital in US 1946

Creation of American Research and Development (ARD) just after the second world war.

1958

A law was passed by congress which allowed small businesses to borrow from the federal government at below-market interest rates.

1960’s

A few wealthy individuals in California called “Angles” invested money in private companies.

1970’s

VC activity was depressed by a weak stock market, high taxation of capital gains and a global economic recession.

1979

Capital gains taxes were reduced from 49 percent to 28 percent, hence it encouraged investors making profits from investing in Venture Capital firms.

1981

The capital gains tax was further reduced from 28 percent to 20 percent.

1983

There were over 100 initial public offerings for the first time in U.S. some of 1983’s funding went to newly funded companies that are today’s largest and most prominent firms*.

Venture capital stages  Early Stage:  Seed Capital: primary for product development and market research. (seed investing)  Start-up capital: company has complete business plan, initial marketing begins.

 Expansion Stage: Company is ready for business, but no commercial sales yet.

 Later Stage: Invest in a company throughout the company’s life cycle: providing financing to help the company grow to a critical mass to attract public financing through stock offering.

%Distribution of Investment

U.S. Venture Capital Investment by Stage of Company Development

70% 60% 50% 40% 30% 20% 10% 0% 1997

1999

Early Stage

2002

Expansion

2004

Later Stage

The Economic Impact of Three Decades of U.S. Venture Capital Funding Cumulative VC Invested, 1970-2000 ($ billions)

Sales of VCBacked Firms, 2000 ($ billions)

Employment by VC-Backed Firms, 2000 (# of workers)

5-Yr Compound Annual VC Growth Rate, 1996-2001

108.8

207.6

1,415,748

24.3%

26

48.9

381,433

35.7%

Texas

17.2

158.2

676,158

29.8%

New York

16.1

65.9

369,314

33.1%

Colorado

9.9

14.6

62,971

32.1%

New Jersey

9.1

38.2

260,114

23.3%

Washington

7.4

75.4

263,585

20.9%

Virginia

7.2

35.7

207,777

14.5%

Pennsylvania

7.2

58

424,652

na

Georgia

6.4

62.8

338,188

34.5%

$ 273.3

$ 1,300

7,600,000

-

State California Massachusetts

U.S. Total

Year 2000 Venture Capital and Stock Market Capitalization, R&D, GDP GDP ($ Billions)

VC Investment ($ Billions)

Stock Market Capitalization ($ Billions)

R&D Spending ($ Billions)

VC as % of GDP

Market Capitalization as % of GDP

R&D Spending as % of GDP

United States

$9,152

$122.1

$16,635

$243.5

1.33%

181.8%

2.66%

United Kingdom

1,442

12.2

2,933

25.8

0.85

203.5

1.79

Germany

2,112

4.4

1,432

50.3

0.21

67.8

2.38

Canada

635

4.3

801

10.0

0.68

126.2

1.58

Israel

101

3.2

64

2.8

3.17

63.6

2.78

Italy

1,171

2.8

728

12.2

0.24

62.2

1.04

Hong Kong

159

2.2

609

0.35

1.38

383.3

0.22

Sweden

239

2.1

373

8.8

0.88

156.4

3.69

4,347

2.0

4,547

141.7

0.05

104.6

3.26

Singapore

85

1.2

198

1.6

1.41

233.7

1.85

India

447

0.5

148

2.3

0.11

33.1

0.51

Country

Japan

Venture Capital fund-raising worldwide

250 200 150 100 50 0

1989

1995

2000

$billion

2002

Venture Capital Fund-raising

$ Billions

250 200 150 100 50 0 1996

1998 Asia Pacific

2000 North America

2002 World

World Investment and Fund raising

North America Investment and fund raising

Cumulative Investment

Annual Venture Capital Investment in the U.S. 120 100 80 60 40 20 0 1990

1995

1998

2000

in billion $

2002

2003

Average Investment Per Company 12 10 8 6 4 2 0

1995

2000

2002

in million $

2004

Historical Trend Data-By Quarter 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 0

5

10 Qtr 1

15 Qtr 2

20 Qtr 3

25 Qtr 4

30 Billions $

U.S. Venture Capital Investment by Industry: 1998 - 2003 Industry

1998

2000

2002

2003

Computer Software & Services

21.6%

14.0%

17%

19.4%

Networking & Equipment

13.4%

46.4%

14.4%

7.9%

Biotechnology

5.2%

2.7%

12.1%

20.7%

Telecommunications

17.6%

17.1%

11.6%

11.7%

Consumer related

6.9%

1.6%

7.2%

3.3%

Semiconductor

4.2%

5.9%

6.9%

4.1%

Medical Devices & Equipment

12.8%

3.5%

6.6%

8.9%

-

-

5.6%

5.0%

Computer Hardware

3.1%

2.2%

3.8%

4.0%

Industrial / Energy

2.4%

1.4%

4.5%

3.8%

Other products

12.7%

5.1%

0.7%

11.2%

$18,705

$102,976

$21,400

$18,200

Media & Entertainment

Total ( $ Million)

Venture Capital Funding in Information Technology

90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1998

2000 % of total

2002

High-technology investment trends

Top 20 countries based on high-tech investment

Venture Capital Fund-raising sources 1979-2000 Sources of Funds

1979

1983

1987

1991

1995

1999

2001

Private Pension Funds

31%

26%

27%

25%

38%

9%

42%

Public Pension Funds

a

5%

12%

17%

a

9%

a

Corporations

17%

12%

10%

4%

2%

16%

4%

Individuals

23%

21%

12%

12%

17%

19%

8%

Endowments

10%

8%

10%

24%

22%

15%

23%

Insurance Companies & Banks

4%

12%

15%

6%

18%

11%

23%

Foreign Investors & others

15%

16%

14%

12%

3%

22%

na

Independent Venture Partnerships as a share of total Venture Capital pool

na

68%

78%

80%

na

na

na

Law Origin vs. VC Performance

Country

Legal Origin Nation’s Commercial Code

Venture Capital Investment

Stock Market Capitalization

R&D Spending

As % of GDP

Ranking

As % of GDP

Ranking

As % of GDP

Ranking

Israel

English common law

3.17%

1

63.6%

16

2.78%

4

Singapore

English common law

1.41

2

233.7

3

1.85

11

Hong Kong

English common law

1.38

3

383.3

1

0.22

20

United States

English common law

1.33

4

181.8

5

2.66

5

Sweden

Scandinavian law / Civil

0.88

5

156.4

7

3.69

1

France

French civil law

0.34

10

103.0

11

2.21

8

Switzerland

German law / Civil

0.23

14

268.0

2

3.12

3

Japan

German law / Civil

0.05

20

104.6

10

3.26

2

Average, English common law countries

1.14%

-

166.4%

-

1.60%

-

Average, all civil law countries

0.31%

-

105.0%

-

2.10%

-

Top 20 countries – based on investment

Top 20 countries – based on growth 1998-2002

Top 20 VC countries (Total VC Investment)

Annual Rate of Return to Investors in U.S VC Funds, (1974-1999)

160 140 120 100 80 60 40 20 0 -20

1974

1976

1978

1980

1982

1984

1986

1988

1990

% Return

1992

1994

1996

1998

1999

The pricing of Venture Capital Investment

FV=A(1+r)n FV= Future Value A= Initial Investment Amount r= required return n= investment horizon, (years)

% Equity = FV/ Exp MV %Equity= % of equity that Venture Capitalist will receive FV= Future Value Exp MV=Expected Market Valuation

Asia Pacific Region Venture Capital Investment

12 10 8 6 4 2 0

1995

2000 $billion

2002

Asia Pacific Investment and Fund raising trends

Asia Pacific

Reasons for low VC investment in Asia



Lack of the basic legal and accounting infrastructure



Lack of an efficient IPO market

Characteristics of a successful VC industry

 A tradition of entrepreneurship & risk-taking.  A well- established legal system, with good investor protection.  A supportive, but non-interventionist, government.  A stable regulatory system, that doesn’t penalize start-ups.  A free (and mobile) labor market, rich in engineering talent.  A non-punitive taxation regime that allows use of stock options.  A strong R&D culture especially in Universities or national labs.  A vibrant IPO market, though this could be a result, rather than a precursor of a strong VC industry.  A risk-tolerant pension system.

Why Use Venture Capital in Iran  Iranians contribute more than $6 billion per year to high technology industries in United States ~ 25% of Iran’s Oil Revenue  In 2003, all 15 Sharif University PhD students who participated in Engineering School Doctoral Exam at Stanford University passed the exam. No other university in the world could claim such achievement.  No.1 student in the exam was from Sharif University, Abtin Keshavarzian.  75% of population below 30 years of age (~ 55,000,000 people)  15.7% official unemployment rate (~25% if taxi agency drivers are included)  1.6 million official number of collage students.

This mental power of expatriates should be absorbed back into Iran’s industry and academia.

What we can do for developing a VC industry in Iran? 1.

IP protection strategy

2.

Transfer of investment practices know how

3.

Establishment of an investment bank support unit

4.

Creation of financially streamlined corporate structure

5.

Creation of synergic new business models

6.

Creation of win-win business development practices

Data Sources • “Synergetic Combination of Idea, Capital, and Management”, by Behrooz Ataee, in the First IDRO Conference of Human Resources Development, October 2526, 2003 • The Pricewaterhouse Coopers/Venture Economics / National Venture Capital Association MoneyTree Survey www.pwcmoneytree.com • “Toward A Global Model of Venture Capital” by William L.Megginson, University of Oklahoma