Building a VC industry, the Israel example

I recently participated in a conversation with one of the original architects of the Yozma initiative, which helped build the VC industry in Israel.

Here are some bullet points from that conversation:
• In the early 1990s, Israel’s government committed $100M as an LP across 10 venture funds
• The goal was to entice foreign VC funds to Israel to invest in companies and train local VC managers (funds were from US, Europe and Asia)
• The funds had the option to buy out the Israeli share within 5 years at a low rate (there was a pre-set formula, it turned out to be ~7%)
• 8 of the 10 funds were doing so well, they exercised the option
• The foreign funds had to have a local partner; the Yozma administrators had a veto over the who would be the local partner
• In only one instance did Yozma reject a candidate; in all other instances Yozma supported whichever local partner the foreign fund found
• Low taxes on foreign investors, no capital gains tax

The result was:
• Foreign funds came in with expertise to train and mentor the next generation of VC managers (this is by far the most important result)
• With the buy-out option, funds had the potential for additional upside at low risk (there were no guarantees for downside)
• In five years, the government got back $140M from their $100M investment
• Spawned about 70 new VC companies in Israel (which has since been pared down to about 35)

What also made Yozma a success was that there was a steady pipeline of companies ready to be funded, mostly coming out of the defense industry. Also, because Israel is such a small market and has hostile neighbors, companies have to think global from day one (as opposed to regional or local). This “global from day one” is also part of the philosophy that made Indian ITS companies so successful.

Damn the Aid

I was recently directed to what is probably the most damning opinion on foreign aid I’ve come across in a while (hat tip Jodi and Tracy.)

Here’s the bottom line:
Over the past 60 years at least $1 trillion of development-related aid has been transferred from rich countries to Africa. Yet real per-capita income today is lower than it was in the 1970s, and more than 50% of the population -- over 350 million people -- live on less than a dollar a day, a figure that has nearly doubled in two decades.

The point the author makes is that Africa (and I would add other developing nations) needs investment and not aid. When you accept investment, be it equity or debt, there is significant responsibility attached to provide a return. In other words, you need to make the money work so you can pay back your investors.

Hopefully the money you make with the investment is more than what you need to pay back. If so, you have economic growth and that is good.

It’s not a perfect system, but it seems to work in places like India, SE Asia and more recently in Latin America (the Economist gushed on Brazil in its cover story a few weeks back.)

I’ve touched on this point before, but my view is that the world is awash with capital trying to find its way into places like Africa. Yes, I know there is a credit crunch going on but I think the view still holds.

African countries could start by issuing bonds to raise cash. To be sure, the traditional capital markets of the U.S. and Europe remain challenging. However, African countries could explore opportunities to raise capital in more non-traditional markets such as the Middle East and China (whose foreign exchange reserves are more than $4 trillion). Moreover, the current market malaise provides an opening for African countries to focus on acquiring credit ratings (a prerequisite to accessing the bond markets), and preparing themselves for the time when the capital markets return to some semblance of normalcy.

I would also add multilateral institutions and development banks as potential partners. Yes they have been part of the problem in the past, endlessly financing non-returning projects. But there are factions within these organizations that are now demanding a return and reform for their development financing dollars, and that is a good thing.

Corporations are eager to invest in developing country as well. The problem is there aren’t any good projects to invest in. There is a lot of money sitting on the sidelines waiting for the right time to enter Africa (I’m talking about investment in things other than resource extraction).

So what is everyone waiting for? Institutional reform for one (or even institutional creation in some instances)

Governments need to attract more foreign direct investment by creating attractive tax structures and reducing the red tape and complex regulations for businesses. African nations should also focus on increasing trade; China is one promising partner. And Western countries can help by cutting off the cycle of giving something for nothing. It's time for a change.

I would disagree with the point on China. Yes, China is pouring money into Africa but it is doing so to buy up resources and it is hard to see China making the demands for reform an outside investor has to make on Africa. Recent news from Dubai may make the Middle East a less active investor as well.



Why Foreign Aid Is Hurting Africa - WSJ.com

BRIC? BIIC?

Nouriel Roubini questions whether Russia is solid enough to be a BRIC. I have to admit, I've had the same reservation (not that anyone noticed/cared.)

He makes an case for a number of other countries that should be included in the most famous acronym in the emerging markets; Turkey, Mexico and so on. All good choices, Turkey especially.

He also makes this point:
Indonesia, moreover, has shown resilience not only economically, but also as a nation. In spite of its diverse ethnic makeup and far-flung island territory, the country has made a quick transition from military dictatorship and has recovered from myriad challenges and setbacks, including the 1997 Asian financial crisis, the tsunami in 2004, the emergence of radical Islam, and domestic unrest. While Indonesia’s per capita GDP remains low, it is a country’s potential that matters in economic affairs, and here Indonesia shines.

I couldn't agree more.

Venture capital in America: The brightest and the rest | The Economist

Few thoughts here based on the Economist story:

Is it really “Too much money has been chasing too few great start-ups” as written in the subhead or is the problem as indicated further down the story“…much of the money has ended up in me-too companies that will not become the shining stars venture funds so badly need. All that cash has also inflated valuations of fledgling businesses, making it harder for VC funds to turn a profit on them.”

To modify the sub-head, I’m inclined to think that it is too much money chasing the same types of companies; everyone simultaneously going after Web 2.0, cleantech or whatever is sexy at the time. Potentially great companies that are not a flavor-du-jour are left behind while Paris Hilton companies (trendy but vapid) are actively sought after. (Is she still trendy… I’m so out of touch!)

Also, this is focused on the US. I think there are great VC opportunities abroad. The challenge here (as highlighted before) isn’t the lack of money or the lack of good business ideas, it is the lack of highly experienced VCs who can play the mentoring role to help local entrepreneur with great technologies build great companies.


Venture capital in America: The brightest and the rest | The Economist

Reaching out to emerging markets

Fantastic piece inthe Globe on Canada’s need to expand its economic and commercial horizons beyond the US. This has been a refrain for some time now but the writer nicely summarizes the key points. As I deal in emerging markets investments for a large US firm this topic is of particular interest to me. At conferences and in conversations, Canada is noticeable absent from the emerging markets dialog.

Canada does not have a holistic strategy on how to engage emerging markets. I use the word “holistic” because it needs to include Canada’s foreign policy and international trade interests. It seems to me that there is a separation of church and state in Canada around foreign policy and trade. In our economically interconnected world, this separation is not a sophisticated strategy. With a relatively strong banking sector, Canada has the unique opportunity to use its national balance sheet to create economic and policy linkages in the emerging markets.

Don’t forget, the emerging markets are going through a recession because the West, a main customer, is going through a recession. But there isn’t a fundamental crisis of finance in the emerging markets as there is in the West (an ironic twist of fate, one could say.) So the emerging markets remain open to do business with whoever still has capital.

Despite current challenges, Canada still has capital, but it is not seizing the opportunity to use it and expand its economic and political influence.

Some thoughts on what the writer said:
By 2050, China and India are set to be the No. 1 and No. 3 economies in the world by GDP, and together will be larger than the G7 combined.

Yes, but the US is still #2, so let’s not get too ahead of ourselves. And if we look at GDP per capita, the US will remain number 1 for a very long time.

Moreover, the emerging patterns of global trade, travel and investment are increasingly multidirectional - from China to Africa, Brazil to India and no longer guaranteed to flow through the once dominant hubs of Europe and the United States.

Great point. All Western countries, not just Canada, need to better understand this trend.

Our competitors are cued up with active strategies and we risk losing out if we do not act quickly and with focus.

The US and Europe have diverse strategies that engage the emerging markets with a combination of aid, expertise, commercial contacts, loans, equity investments, technology sharing, JVs, the list goes on and on. It involves national governments and companies together creating linkages in the emerging markets and using a portfolio of investments, loans and grants to win influence and business. Canada doesn’t seem to get this.

The structural advantage is we have a good story for the times. Canada's relative financial stability amidst crisis, our advanced resource markets, quiet excellence in many of the emerging 21st-century technology areas, from clean tech to agriculture, in addition to the advantage that comes from our diversity, make for a compelling story that, if marketed well, will find ready global audiences.

Agreed

Being a destination and source of trade with India is essential - but better still, we need to be part of India's strategy for Brazil. Innovative trade and corporate strategies should be focused on building these trade triangles.

Genius.. This man for PM.

An effective diversification strategy requires focusing even greater corporate and public diplomatic resources on three key markets: Latin America, China and India.

What can I add?

To send the right signal to corporate India, Canadian business needs to take the lead and support the call for a "comprehensive economic partnership agreement" - a pathway to free trade. We should start simply by focusing on free trade in services and leave the other more contentious issue like agriculture off the table.

I agree in theory, but wonder if this will work in practice. Can Canadian businesses take the lead in building these sorts of economic partnerships? Perhaps, unfortunately, business waits too long and government must lead. That seems like a more Canadian way.

We are late to the party in these emerging markets. To jump ahead in the queue, Canada needs to get ahead of its peers with a co-ordinated public diplomacy strategy enabling us to tell a compelling 21st-century Canadian story, streamlining the cacophony of messages from our various levels of governments.

…and business communities.

Conceding risk capital in Canada

Another story about a Canadian researcher being lost to the US due to budget cuts.

This shouldn't be dismissed as another example of Canada's "brain drain." Sure, Canada and many other countries will always lose talent to the US because it is a bigger market, more things are happening, and there will always be more opportunity.

But there is no reason why this trend should be exacerbated by budget cuts. Quite the opposite, money should be spent in order to stem this tide as much as possible. This isn’t a cost, it is an investment in the future (yes, I know this is clichéd)

There are two clear negative repercussions to losing R&D talent:

1) It will be more difficult to attract foreign investment, especially VC money, to fuel innovative industries. People invest risk capital in countries where they see new products and services being developed. A leading indicator for this is the relative health of the local R&D community. A non-existent community means no innovations, which mean no outside risk capital coming into Canada.

2) It threatens Canada's future as a hub for innovation. If Canada wants to diversify its economy away from just commodities, then it needs to make this sort of long term investments. The hope of Canada becoming a center for any sort of innovation will be dimmed without active R&D investing, which will lead to the commercialization of products and the creation of industries later down the line.

What is the point of creating an "urban paradise" if no one is around to enjoy it?

The new normal - The McKinsey Quarterly - The new normal - Strategy - Strategic Thinking

Quick look at the “new normal” by McKinsey. Not a lot of detail here but in the spirit of the article, here are a couple of my “new normal” predictions;

1) The economy will be more slow burn. With (somewhat) higher savings rates and (somewhat) lower consumption, the economy will be on a slower, but hopefully more sustainable and less bubbly) path

2) I don’t want to overstate the higher savings/lower consumption in the US. Yes, there will be some changes in consumption patterns but it won’t be extreme. The US is not going to turn into Asia-type supersavers and consumer credit will trickle back to fuel consumption.

3) Western/Ango-Saxon/whatever you want to call it capitalism won’t die. It won’t even be on life support. Yes, it may evolve somewhat. Yes, there may be more regulations. But the core principles will remain

4) I hope I can say the same for globalization. I don’t think there is great long-term threat to globalization but there may be bumps


The new normal - The McKinsey Quarterly - The new normal - Strategy - Strategic Thinking

Investment in addition to aid

I’m not sure I agree with much of this WSJ article, but hidden within this anti-IDB opinion is I think a valuable point, that creating an environment to attract investment, not just aid, is key for a country’s development.

Those developing countries that are the most attractive for investment are those with a stable local market, an educated population, and those that facilitate a way to both protect and safely deploy capital.

Developing countries (especially those that don’t happen to be China or India) need to demonstrate to international investors that the government is on their side when it comes to protecting capital.

People and institutions that put money in emerging markets are not risk-takers, they are in fact very risk-averse (or at least, the smart ones are.) So if these risk-averse investors find a developing country where they see a reasonably safe way to deploy and grow their capital---allowing them to put money in and take it out, to find and invest in promising enterprises, to work with trustworthy local partners—then the country will not only benefit from the money that comes in, but also from the talent and know-how that often accompanies these types of investment.



Latin America Needs Economic Liberalization and Property Rights, Not Foreign Aid - WSJ.com

The recession's Churchillian moment?

To quote Churchill

"Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning."

Or, in econospeak:

"I don't think that this is the beginning of a recovery. It's the beginning of a much slower pace of decline," said Ethan Harris, an economist with Barclays in New York. "You've got to walk before you run."

U.S. economy shows signs of crawling out of hole | Reuters

As Obama bestrides the world stage, Canada has nothing to say

Great OpEd on Canada's absent foreign policy.

Here’s a key point:
On the military side, we continue to pull more than our weight in Afghanistan. But who believes Canada will contribute significantly to shaping the future of that benighted country, or its relations with Pakistan - or Pakistan's relations with India, even though millions of South Asians have flocked to our shores?

I take this point even outside of the Afghanistan context. Canada’s immigrant population is a huge and valuable resource. We should be tapping newly arrived and first generation immigrant Canadians to help the country forge stronger political, economic, trade and security ties with their home countries.

And I think the article lets Canadian foreign policy off a little easy. Sure, the musical chairs that is the government has put a strain on trying to develop a coherent long-term foreign policy; but I think the problem is deeper than that. I think there is a fundamental lack of vision on what a Canadian foreign policy should look like.

In a globalized world (and the nature of global intertwined economy could not be more clear as it is now) foreign policy is not just a tool of diplomacy and security. Foreign policy plays a key role in trade and economic growth. A new vision is needed to bring Canada our of its Lester Pearson “we’re the world’s peacekeepers” view on our foreign policy (which was never true anyway) to a more sophisticated vision that encapsulates the complex relation between economics, technology and security.

Brazil: The anti-globalist?

NYTimes has a profile on Brazil today. Probably the most interesting part of the story is about Brazil's self-sufficiency.

Here's the money quote:
“What makes Brazil more resilient is that the rest of the world matters less,” said Don Hanna, the head of emerging market economics at Citibank.

As I've looked at Brazil that has been the one thing that has impressed me the most. The country really has been able to build and grow domestic industries and feed its own growth through internal consumption.

Of course, Brazil hasn't had the GDP growth numbers that other large, more "globalized" emerging markets have demonstrated; Brazil's GDP growth has been in the 4-5% range vs. India's 7% range and China's +9-10% range.

But what it lacks in GDP growth, it makes up in resiliency. It is still a tough story to tell because despite the great social advances as of late in Brazil, it is hard to see how 5% growth will really make a dent in the huge social inequalities in the country.

Adding the "World" in worldwide web

It is clichéd by now to say that as soon as your company is on the web, it is global. But that is not so as witnessed by the experiences of some major web companies.

The globalization paradox that I love talking about is that in order to be global, you really need to be intensely local. Big web companies are realizing this are starting to localize their offering and event their trademarked look and feel.

Here's a great money quote:
"Creating a national company is like rocket science," said John Strand of Strand Consulting in Denmark. "But creating an international company is like proton physics."



An un-American feel aids expanding US Web firms - Yahoo! News

The World Is Upside Down

NAN, that's a new acronym for me. It means (apparently) newly acquisitive nations and refers to companies from Brazil, Mexico, India and China going on a global buying spree usually snatching up US or European (or Canadian) assets.)

A lot of the action is in commodities, oil and gas, and manufacturing. Those markets are where all the money is currently flowing (well, maybe not manufacturing) so it is not surprising.

The most interesting story mentioned here Grupo Mexico battling with Vedanta Resources for Asarco; a Mexican company fighting with an Indian company to buy an American copper company.

With China being an increasingly larger consumer of commodities, the battle over American assets won't be to better serve the American market, but to make more of an in-road in the Chinese one.

Some may be inclined to think this represents the end of the US market as the world's most influential one, I don't think I would agree with that proposition. However, it does indicate that we are entering an increasingly multipolar era where global companies and "must-win" markets originate from every corner of the globe.



Op-Ed Columnist - The World Is Upside Down - Op-Ed - NYTimes.com

An Alarm Is Blaring: Time to Buy - New York Times

This strikes me as an articulation of the "buy low, sell high" mantra... and right now things seem to be low.

An Alarm Is Blaring: Time to Buy - New York Times

The importance of separating globalization from politics

I don't really want to get into politics on this blog, but Nicholas Kristof makes some excellent points in his oped Better Roses Than Cocaine.

While I am an admirer of both Hillary Clinton and Barack Obama, I have been quite disappointed with their take on globalization (for the record I consider myself, among other things, both pro-trade and liberal).

At the core of the world's troubles is a question of economic security; you are more likely to be tempted by radical ideologies if you don't have it. In effect, when you have nothing to lose you become fertile ground for anti-social behavior.

Obviously, a lack of economic security isn't the only cause of radical ideologies, and there are many examples of those who are economically secure acting in anti-social ways. (I'm currently reading Confessions of an Economic Hit Man which provides enough examples)

All that said, global stability is obviously good for everyone, but it is especially good for the US as many of the world's problems often come washing upon its shores. Promoting economic security around the world is a far more effective way of, to paraphrase, fighting problems abroad so they don't have to be fought here.

The issue is neatly summed up here:

As she clips flowers in a vast greenhouse, Ms. Reynosa knows that her future depends on access to the American market. She agrees that Colombia has human-rights problems, but she argues passionately that the free-trade agreement is the way to register continued improvements. More trade will mean more jobs and more security and human rights, she argues.

Brazil tops MSCI

Brazil is now the largest stock market on the MSCI emerging markets index, and as a long-time investor in the Brazilian equity market I have to say this news has brightened up an otherwise less than stellar day.

So, why is Brazil doing so well? The FT has some thoughts here (watch the video too).

While I buy the argument that the commodities is fueling the bull run, I don't have much support for the "decoupling argument" -- that perturbations in the US market have less and less impact on the emerging markets. (How can the world markets be simultaneously "globalized" and "decoupled"?)

That said, Brazil's insular nature seems to have at least buffered Brazil from what is going on in the global markets. Credit within Brazil remains strong, although IPOs have dropped. The FT also notes that Brazil responded favorably to the Fed's drop in interest rates (how does that play into the decoupling theory?)

Brazil is doing uniquely well as a commodity exporter based of off the huge recent discoveries by Petrobras and the positive impact that news had on its stock price.

U.S. Import Prices Soar, Boosted by Chinese Goods - WSJ.com

Increasing global demand pushes prices up, and a dropping US dollar makes more expensive goods seems even more expensive.

This shouldn't surprise anyone

U.S. Import Prices Soar, Boosted by Chinese Goods - WSJ.com

Update: More on China and inflation.

The global/local paradox

It is not just markets that are globalizing, but companies are as well.

Being a globalized company means more than just having a single corporate HQ and selling abroad. It is the globalization of the HQ itself, with different senior corporate functions being located in many parts of the world.

In doing do, the company in effect becomes a local one. The global company mimics the behavior of an indigenous company because key corporate decisions are made within the country's boarders.... even though those decisions have global impact.

A company truly becomes global when it mimics a local company in as many different countries as it can.

Canadians: Think Globally, Act Locally

I've been reading a lot recently about how culture and general timidity have prevented leading Canadian companies from expanding globally.

The flip-side seems to be a lack of Canadians willing to invest locally.

It seems VC money is flowing in Canada, but it is from foreign sources. Now, I have no problems with the global flow of capital, in fact, I actively support that. A country such as Canada should be welcoming of VC money from the US and elsewhere. But here's the money quote:

So while the news of VC investments is good, "we need strong Canadian investors if we want strong Canadian companies," says Rick Nathan, president, CVCA and managing director of Kensington Capital Partners.

So true.

Here's the real threat to US competitiveness

If you're really worried about US competitiveness, you should be more concerned about drops in research than about globalization.