Venture Capital

COVER S T O R Y

For small and medium-sized enterprises looking for an alternative source of financing, venture capital (VC) is an option worth exploring. A solid capital base to aid in the company’s future growth and development plans, no fixed repayment of loans and a mentor to provide practical advice and expertise – these are only some of the benefits VC can bring. In an exclusive interview, Mr William Liu, President of Green Dot Capital Pte Ltd, provides a basic understanding of how VC works. Productivity Digest brings you the details.

Venture Capital –

An Alternative Source of Finance for SMEs by Jaime Koh

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PRODUCTIVITY DIGEST NOVEMBER 2003

PD: What is venture capital? How does it serve as an alternative source of finance for SMEs? Mr Liu: Venture Capital (VC) is actually a class of asset. The people who carry out this type of investments are known as venture capitalists. A form of investment capital, VC is often regarded as risk capital. But there is an expected rate of return attached to it. It is also considered as a subset of private equity as the capital is raised from private sources. VC provides a solid capital base to aid in small and medium-sized enterprises’ (SMEs) future growth and development plans. It is good for cash flow, as capital repayment, dividend and interest costs (if relevant) are tailored to the company’s needs depending on what it can afford. A venture capitalist will be committed to the investee company until it exits. Notably, a venture capitalist’s primary concern is to invest for returns. To realise his investment, he will exit eventually when either the company pursues amerger/ acquisition with another company or an Initial Public Offer (IPO). In the former, a VC can sell his stake in the investee company to the acquiring company or alternatively he may obtain shares from the combined company. Whereas in an IPO, he sells his stake (in the form of shares) to the public after the listing, thus obtaining proceeds from the sale. PD: What are the benefits of VC, as compared to other forms of financing? Mr Liu: Let us consider a bank loan. Usually the bank will ask for a collateral or guarantee. And the repayment of the loan (plus interest) is on a regular basis. As far as the bank is concerned, the loan must be guaranteed. They want to make sure they get back the full amount and interest, if not, they lose money. On the other hand, VC offers SMEs flexibility, in that the company can decide what to do with the funds. And, they do not need to repay the loan as the VC funds are invested as private equity. All the SME has to do is give away company shares to the venture capitalist (usually a minority stake in the company, about 20% to 50% of total company’s shares). If the business fails, the venture capitalist will rank alongside other shareholders, after the banks and other lenders, and stand to lose their investment. On the other hand, for bank loans, the bank generally has first call on

the company’s assets if the business fails. Venture capitalists are true business partners, sharing the company’s risks and rewards. They offer practical advice and expertise (if required) to assist in the company’s business success, whereas for banks, assistance could vary considerably. Besides, a lot of the venture capitalists have domain knowledge in the field of work of the SMEs. And they can put their knowledge to good use in the SMEs. For example, with our expertise in information technology (IT), Green Dot Capital can share its experience and impart relevant practical knowledge on management to its investee companies. Venture capitalists also invest in other companies, which could be similar or are in related fields. Thus, they can help bring strategic partners or potential customers to the companies. PD: What are the potential sources of VC? Mr Liu: Apart from traditional VCs, sources can come from corporations, pension funds, security houses or investment banks. Investment banks are slightly different from commercial banks in that they primarily finance companies and projects, not loans. Not forgetting angel investors too; they are usually rich individuals who give seed money or investment capital to start-ups. PD: Are there any capital assistance schemes available to help SMEs? Mr Liu: Startup EnterprisE Development Scheme (SEEDS), which is Economic Development Board’s (EDB) funding scheme to nurture entrepreneurship, provides seed funding for local start-ups in both the high-tech and non high-tech business. As of February 2003, 65 companies have obtained SEEDS funding. The total amount raised is $39.8 million ($16.4 million from EDB). 50% of SEEDS enterprises have launched their products and/or services, while 80% are developing patents or Intellectual Property Rights (IPR). Both EDB and the third party investor own shares in the start-ups according to their investment amounts. Other incentive schemes include the Venture InfoTech Support Scheme (VISS) where a $50 million matching fund by EDB is provided for start-ups. For every $2 of private equity raised, $1 from the VISS fund is given. There is also the $1 million Fund for National University of Singapore (NUS) Start-ups, which is offered by NUS

PRODUCTIVITY DIGEST NOVEMBER 2003

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COVER S T O R Y Your Gateway to Business Financing Entrepreneurs with good deals can turn to the Deal Flow Connection to help them navigate the complex world of business financing and link them to various sources of funds. Through the Deal Flow Connection, money meets business. Deal Flow Connection brings together three essential parts – the money, the deal and the intermediaries or matchmakers. Assistance is available through: • •

An online portal to match-make entrepreneurs and intermediaries at http://www.dealflow.org.sg and provide access to finance-related news and information Finance First Stop at SMECB (SME Corporate Board Pte Ltd) – a helpdesk providing information and referral services on finance-related issues

To date, close to 50 intermediaries have signed up under Deal Flow Connection and more than 250 deals have been facilitated.

Centre for Entrepreneurship and Singapore Technologies. Its objective is to promote innovation and technology spin-offs. In addition, in the Annual Singapore Technologies $500K@Work! Competition (where the winning team cash prize is $30,000 plus), there is up to $470,000 funding of new ventures. The criterion is that at least one core team member should be from Singapore Technologies. PD: Are there any drawbacks to the use of VC for SMEs? Mr Liu: The only concern of the SME is the sharing of ownership of the company. If the venture capitalist has a substantial stake in the company (say 10-20%), he would pay a lot of interest in the business. He will want to see reports of how the SME achieves its milestones and will sit in at board meetings. Usually, the venture capitalist will set milestones/targets for the company to achieve. It is good in a way that the venture capitalist would monitor and keep a close supervision on the company. I would not think of that as a drawback, just something that the SME might be concerned about, particularly if the company does not meet its business milestones, then the owners could be further diluted in share holdings and control. PD: What are the key factors that investors look for in a company? Mr Liu: Investors generally look out for good management. Companies must also have a good business plan. And, it should not just be a concept plan; the plan should reflect sound business judgement. They must ensure that the business is an on-going concern. A good business plan will show how the company is going to grow. Another factor is the management team’s ability to adapt and scale up the business. The business environment changes rapidly and it is vital that SMEs adapt in the face of many challenges. How the company scales up its growth and how it manages its costs are things to look out for.

Green Dot Capital Pte Ltd Green Dot Capital Pte Ltd is a subsidiary of Singapore Technologies Group, whose mission is to grow and invest in electronic and mobile business technologies that drive the new economy. Its vision is to be the region’s leading InfoComm investing, operating and development company with a steady focus on growth, profitability and leadership. Its portfolio of investments include five VC funds (two of which are Constellation Ventures and Draper Fisher Jurvetson ePlanet Ventures, a fund to identify global technology investment opportunities); Neopets.com, one of the most popular websites on the Internet with a community of over 40 million virtual pet owners world-wide and Enworkz, which helps utilities companies improve the profitability of electricity generation, distribution and retailing.

Investors are also interested to know if there is a very large market opportunity for the company and if there are strong barriers to entry. If the SME is in the IT business, venture capitalists will want to know if they own any patents/rights or if there is value in the company’s Intellectual Property (IP). This is important in determining if the company has a better competitive edge over others, thus raising the barriers to entry. Lastly, investors are also concerned with how they should exit the company. A company where the venture capitalist’s exit strategy can be clearly defined is a plus. PD: What is your advice for SMEs who are keen to make use of VC? Mr Liu: Choose a venture capitalist that understands your business. And it is important to keep an open mind. If you go in with a pre-conceived idea of what you must own or your thinking is too rigid, that makes it difficult for your business to succeed. In the end SMEs must be clear what is their bottom line, what it is prepared to give up for the funding partnership eg the minimum shareholding stake they will want to maintain in their company and what this means in governance and management terms. Pd

Reprinted with permision from the November 2003 issue of Productivity Digest. The Productivity Digest is published by SPRING Singapore (Standards, Productivity and Innovation Board). All rights reserved. For more information, visit www.spring.gov.sg/pd or email [email protected].

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PRODUCTIVITY DIGEST NOVEMBER 2003