The VC Development in Israel

As for Israel, it is often considered as the most successful case of the export of Silicon Valley-style venture capital practice. The close relationships between Israelis and Jewish individuals in the high-technology industry of the U. S. have enabled the development of the Israeli venture capital industry since the 1980s. It was until the creation of a government-funded Israeli venture capital fund, named Yozma, in 1993 that the venture capital industry in Israel took off. Yozma was very successful and was credited with triggering the creation of the domestic VC industry in Israel.

-10,000 20,000 30,000 40,000 50,000 60,000

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 NT$ million

Seed Early Stage Expansion Later Stage

In Israel, the government also plays an important role in encouraging the growth of venture capital. In 1991, there was only one venture capital fund, it was Athena Venture Partners Fund with size of US$ 29 million. Since 1995, the Israeli venture capital industry has raised and managed more than US$ 11 billion, and over 120 Israeli companies, mostly venture-backed, have been listed on NASDAQ(National Association of Securities Dealers Automated Quotations) with a combined market capitalization exceeding US$ 42 billion (Hasson, 2005). The Israeli government has also been generous in its fiscal incentives to start-ups and to foreign investment. Generous tax incentives and grants were offered to attract U. S. technology companies to locate R&D operations in Israel.⁴

Avnimelech (2008) states that Israeli government’s entrepreneurial innovation and technology policy (EITP) is triggering a VC industry. The promotion by the Israeli government promote of the start-ups seems to be crucial to the creation of a high-tech cluster and in sustaining it high impact and growth (Figure 2-10).

Source: Avnimelech (2008).

Figure 2-10: Israel’s EITP Profile: Policies and Impacts

4 Such a strategy was necessary in the early years of Israel’s venture capital industry. The strategy has worked;

at present, many of the world's leading companies, including Cisco. Intel, Motorola, Sony and Volvo, have significant operating and R&D presence in Israel (Koh and Wong, 2005).

Phase 1

• Diffusion of R&D and generation of innovation capabilities (1969-1984)

Phase 2

• Extensive start-up and VC experiments (1985-1992)

Phase 3

• Targeting VC and accerlerated growth of R&D /innovation activities and start-up intensive high-tech cluster (1993-2000)

Phase 4

• Congfronting with the crisis and system failure and experiment with sophisticated targeted related policy (2001-2005)

In 2010, Israeli VC funds were not able to attract new capital during the year. Capital raising trends in Israel tend to be in line with trends in the U. S., where a 50% reduction was seen from 2009 levels (Figure 2-11). Also, the VC investment correlation between Israel and the U. S. is significant.

Israeli entrepreneurs have a proven technological track record in network security and data communications, and the top-tier venture capital firms in Israel have been able to generate returns comparable to those found in Silicon Valley.

However, on the other hand, the Israeli VC was associated with the transformation of Israeli’s high-tech industry-from a military-dominated industry toward a start-up-intensive high-tech cluster. This case probably represented the most successful instance of diffusion of the Silicon Valley model of VC and star-up-intensive high-tech cluster beyond North America (Avnimelech, 2008).

In addition, some scholars claim that Israel, in select niches, has successfully completed new-product innovation projects and launched their products in large foreign markets, primarily the U. S. Product innovation based investment opportunities, with their technology risk, long R&D stages, greater service demands and historically poor performance in Taiwan’s environment have been unappealing to Taiwanese VCs who also lack experience in managing these investments effectively. The cost of this seemingly endless cycle is an innovation system with underdeveloped new-product innovation capabilities and players from government to industry to the VC community that are reluctant or unwilling to take the initiative necessary to develop and support these capabilities (Badino et al, 2006).

To be briefing, in Israel and Taiwan, there is a stronger entrepreneurship culture.

Moreover, R&D intensity is much higher, and there are stronger linkages with other technological hotspots such as Silicon Valley.

Source: NVCA(2012) and IVC Research Center.

Figure 2-11: Comparison of Israeli and American VC Fund Raised—2002~2011 2.4.3 The VC Development in Japan and Singapore

In Asia (Taiwan and Israel excluded), the major countries are reluctant to invest the start-ups and early stage, as well as the European VC. Therefore, Bruton et al. (2003) called the venture capital in East Asia as private equity financing. In the West, venture capitalists are engaged in early stage investments.

 Japan

Japan was used to be the largest VC market in East Asia, however, it depressed dramatically. The investment made in 2009 fell by about 40% annually to Japanese Yen 37.8 billion (US$ 417 million), an even more marked sharp drop compared with 2007, when VCs invested about Japanese Yen 193 billion (US$ 2.1 billion), according to the Japan Venture Capital Association (JVCA).⁵

5 The amount was much lower than the US$ 2.7 billion investment in China VC. In addition, the venture capital over 472 deals from one year ago, Activities of venture capitalists have ebbed since their portfolio companies have been affected by the onset of the economic downturn, giving no option for investors to exit while they struggle with fundraising. As for new fund formation, only three venture funds raised 2.4 billion Japanese yen (US$ 26.5 million) in 2009, compare with nearly US$ 5.9 billion raised in China within the period.

2.8

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 US$ billion

US Israel (LHS)

In the1970’s, Japanese main financial institutions formed their risk averse subsidiaries.

Furthermore, hot markets in the1980s stimulated Japanese attention and accelerated forming new venture capital companies (Kirkulak, 2004). Basically, Japanese venture capital industry is one of the most established venture capital industries in the world. It started its venture capital industry about 30 years ago. To date, it still has many of the world’s largest private equity groups attached to NTT, Softbank and Honda. In Japan, it was the first VC boom from 1970 to 1973. In 1971, some members of Kyoto Economic Council visited Boston. After their coming back, they tried to set up the first Venture Capital Firm in Kyoto. So, the first VC firm named Kyoto Enterprise Development (KED) was set up in Kyoto in 1972. Between 1972 and 1974, eight private VC firms (VCFs) were formed by major banks and security firms (four were formed by banks and four were formed by security firms). The large part of the Japanese VC pool is controlled by firms associated with securities companies.

In 1983 the Japanese government deregulated the over-the-counter (OTC) market act.

This action made it easier for VCFs to make investments for new ventures managed toward IPO. So Japan stimulated a second VC boom. From 1980 to 1985, 68 VCFs were founded (Liang, 2008). However, the VC boom declined as a result of the recession caused by the rise of the yen in 1986 and 1987 after the Plaza Accord.

Traditionally Japanese venture capitalists invest in the later stage of a firm’s growth.

They rarely invest in new business. It is due to the major Japanese financial institution formed VC subsidiaries.⁶

Furthermore, regulations and government policies force Japanese VCs take small stakes in a large number of firms; limiting the potential for true venture type businesses. The regulations restrict venture capitalists to take risky positions. Therefore, the holdings of venture capitalists in portfolio firms are relatively low.

6 Accordingly, few Japanese VCFs are capable of finding entrepreneurs and investing in new companies. For

 Singapore

Recognizing the importance of VC in the growth process, the Singapore government has assiduously supported the development of the VC firms. Besides implementing regulatory and fiscal changes to attract top-tier international VC firms to establish a regional base in Singapore, the Government has also funded a number of new local and foreign VC funds based in Singapore. As Singapore restructures its economy in the midst of the current global economic downturn, VC will continue to play an important role in fostering entrepreneurship and economic growth. The Singapore government plays a key role in the development of the VC industry. First, there are several incentive schemes offered by the Singapore government to attract venture capital firms to locate in Singapore. These schemes include the Pioneer Service Incentive (Income Tax (Section 13H)) for new venture fund, the Venture Capital Incentive (section 97 of the Economic Expansion Incentives Act) for corporate investors, as well as subsidies for training of venture capital professionals (Koh and Koh, 2002).

Besides providing tax incentives to operate in Singapore, the government is a significant institutional investor in new venture capital funds. About 30% of the venture capital present in Singapore had its origins in government funding.

In Singapore, one of the first venture capital fund set up in Singapore was South East Asia Venture Investment (“SEAVI”) in 1983, with participation from the U.S venture capital firm Advent International. The first public investment in venture capital fund was in 1986 by the Economic Development Board of Singapore (EDB). Government agencies that have invested in venture capital as passive investors include Temasek Holdings,⁷ Government of Singapore Investment Corporation (GIC) and the Infocomm Development Authority (iDA).

7 Temasek Holdings is not a pure venture capital firm. According to the Temasek Review 2011, Temasek is an investment company and managed SUS dollar193 billion in portfolio at 31 March 2011. Its top five investments are mainly listed companies such as Bank of China, China Construction Bank, Standard Chartered PLC, Singapore Telecommunications Limited and Li & Fung Limited. Furthermore, the portfolio value in 2003 was SUS dollar 90 billion, compare to the VC capital under management in Singapore was 10.72 billion US dollars in the period.

Several government agencies, such as the EDB have also taken an active role to set up technology and biotechnology venture capital funds and directly managed them.

As in other parts of Asia, venture capital firms in Singapore focus more on late-stage expansion financing and investment in mature companies, rather than early-stage financing in startups. Very few venture capital funds invested in start-ups unless there are significant compensatory government incentives to do so (Koh and Wong, 2005). Meanwhile, Singapore’s venture capital industry is much less domestically invested.⁸

Due to the availability of various tax incentive schemes, Singapore attracted many foreign venture capital firms to use it as their regional base for investment in the Asian-Pacific region. Singapore's efficient legal, financial and urban infrastructure has always been a draw in encouraging multinational companies to establish their regional headquarters facilities in the country. They have invested in opportunities in China, India, Middle East, Japan, United States and Europe (Koh and Koh, 2002).

2.5 Summary

Unlike the U. S., the Europe and Asian venture capitalists do not take parts in start-ups so aggressively. They find these investments risky therefore most of VC investments are involved in later stages, except Israel and Taiwan before 2001.

In terms of development, the Asian private equity-venture capital industry is still relatively less developed compared with the United States and Europe. Generally, with a longer history of venture capital, the venture capital industry in Europe and the United States have well-developed mechanisms for monitoring and managing risks, as well as exercising governance. In Asia, the regulatory framework for the venture capital industry still lags

8 In 2000, close to 74% of Taiwan’s venture capital funds are invested domestically, compared with about15-30% in the case of Singapore (Koh and Wong, 2005). In 2003, the VC investment in Singapore was

behind although governments have recently stepped up efforts to create the appropriate set of incentives and legislation to promote and regulate the venture capital industry.

Venture capitalists in Taiwan and Israel invest more in riskier early-stage investments, due to the connection with the Silicon Valley. Compared with Israel and Taiwan, the development of the venture capital industry in Asian region such as Hong Kong and Singapore are best considered as supply-pushed (i.e. driven by the government), rather than demand-pulled (i.e. driven by the demand for capital financing by startups and entrepreneurs).

C ^hapter 3 The Venture Capital Industry in China

In this chapter, it is expected to discuss the legal environment and regulation development as a main part of the sector. We will review the historical development of the VC industry in China and then focus on its current status base on the legalization procedure.

From the part, we expect to catch a broad view on the China VC industry for further studying.

3.1 The VC Market in China

China’s venture capital system has emerged over the last two decades in the context of China’s dramatic transition from central planning to more market-based coordination of economic activity. In 2011, the venture capital industry in China was rapidly growing with an estimated total of RMB 240.66 billion of funds in the country, another US$ 4.07 billion was raised worldwide to invest in China, according to Zero2IPO.

3.1.1 The Transition in Economic System

Previous research about VC and entrepreneurship in China often assumes that due to China’s transitional nature, there is a conflict between two institutional systems, socialism and capitalism (Bruton and Ahlstrom, 2003), and this conflict causes such confusion that entrepreneurial firms often cannot capitalize on some business opportunities. Fuller (2010) therefore argues that instead of inherent conflict between these two institutional systems, there is actually institutional separation although not on the neat socialist and capitalist divide envisioned in these earlier works. Instead of socialist and capitalist systems at loggerheads over the same institutional terrain, today there are two partially overlapping but mainly separate institutional systems, the one in which pervasive government influence shapes the marketplace and the one where foreign institutions, accessed via various offshore financial

arrangements and brought onshore via foreign direct investment (FDI). Thus, the government interference in the economy that many correctly noted in previous studies (Peng and Luo, 2000) is still there and still often unpredictable (Peng, 2001).⁹

The different learned experience gained from operating in different environments explains why the foreign firms avoid investing in technology-generating activities in China whereas the ethnic Chinese firms are willing to do so despite China’s notorious weak intellectual property rights regime. The political factors influencing the distribution of finance in China explain the behavior and essential failure of the local state-run venture capital firms. These findings demonstrate that several distinct, separate and non-clashing institutional arrangements are concurrently operating within China and shaping the behavior of venture capital firms there.

3.1.2 The VC Participants in China

Due to the political system, the VC source of Chinese is different from that of Japanese.

The main source in China is from the government, while the financial system finances the venture capital to be extremely limited. The experience in the United States suggests that, as an economic policy, allowing pension funds to invest in venture capital could be a great success. Therefore, in the source of funds, China should let individual fund and the commercial fund enter the venture capital market, break the sole funds source pattern.

Moreover, in the investment stage, the capital should invest into the seed and early stage of emerging and high tech enterprises. Today, there are four distinct types of VC firms in China,

 Foreign Firms;

 Government Firms (university firms included);

 Corporate Firms; and

9 However, today this pervasive government role in the economy is in one of the two institutional systems that potentially impact firms’ behavior. China’s transition has led not to a full-fledged market economy but to two divergent outcomes.

 Chinese-foreign Equity Joint-venture Firms.

Each of the different types of venture capital firms has experienced some successes and some difficulties, though foreign venture capital firms are most active. Each of the different types of venture capital firms has experienced some successes and some difficulties, though foreign venture capital firms are most active (Ahlstrom et al., 2007). The VC industry in China saw meteoric growth through the decade, first led by American and other foreign private equity firms, with domestic firms entering the scene in late 2006 and rapidly catching up. The American private equity firms are pioneers and industry leaders in the world. There players brought fresh and bold ideas into the fledging and tightly controlled capital markets in China (Zhang, 2011).

From Figure 3-1, we see the RMB funds become the main power of venture capital market in China. The raising and investment of RMB Funds increased rapidly, about 70%

newly raised funds in the total number were raised in RMB. Obviously, RMB began to dominate the absolute advantage in the number. although the foreign capital was still the main part in the volume, the foreign venture capital institutions have established RMB funds one after another with the gradual maturity of venture capital market. In terms of the structure of ownership, the local VC firms keep on growing and occupy around 40% of the investment amount (Figure 3-2). Both trends show that the Chinese venture capitalists are getting mature after 30 years development in China. The money inner China is not only sufficient for VC development, but also looks for investment opportunities outside.

It is mainly because that China government allows foreign private equity and venture capital firms to raise funds that are structured as limited partnerships (LP, it will be discussed in later content). It enables RMB funds to become the fund platform of choice for China's private equity market. These funds raise capital mainly from institutional investors such as government and corporate pension funds, insurance companies, and endowments, as well as

from high net worth private investors to play as the LP.¹⁰ Even Zhang (2012) argues that China still needs alternative mechanisms for simulating fund raising from the pension funds and the independent status of venture capitalists.

Furthermore, in July 2011, the China Securities Regulatory Commission (CSRC) issued the Regulatory Guidelines for Securities Firms’ Direct Investment Business (the Regulatory Guidelines), one of the highlights in the Regulatory Guidelines is that brokers’ direct investment subsidiaries are allowed to set up direct investment funds to raise capital by private placement, instead of only being allowed to participate in the direct investment business with their own funds. Since the issuance of the Regulatory Guidelines, brokers’

direct investment subsidiaries are not only expected to bring in LP to raise more funds, but also take a role as a general partner(GP) to gain ‘management fee + commission’ earnings.¹¹ The RMB fund therefore grows so tremendously in 2011.

 Foreign Firms

The most important and active venture capital firms in China were foreign venture capital firms in the past (the top active foreign firms please see the Table A-4 in Appendix).

The first international venture capital firms entered China in the early 1980s. The impetus for the development of the Chinese venture capital industry was government policy; in China the government still has a dominant role in the economy.

China moved toward allowing LP fund structure in the private equity market since 2009.

Today, even the new raised fund is mainly in RMB, the foreign LPs still control more than RMB 613 billion of capital, compare to the RMB 142 billion under local LPs, according to Zero2IPO Research.

10 The National Social Security Fund plays an crucial role on it, the accumulated investment in 2011 was RMB 19.5 billion, and expected to increase to 50.0 billion in 2013, according to the Fund disclosed.

11 KPMG, Mainland China Securities Survey 2011; on 11 September 2007, the CSRC gave brokers the green light to launch their direct investment business. So far, 31 brokers have been granted permission for direct investment, 25 of whom commenced business via their subsidiaries in 2010. They disclosed a total of 147

11 KPMG, Mainland China Securities Survey 2011; on 11 September 2007, the CSRC gave brokers the green light to launch their direct investment business. So far, 31 brokers have been granted permission for direct investment, 25 of whom commenced business via their subsidiaries in 2010. They disclosed a total of 147