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Deloitte Touche Tohmatsu (DTT)

The 2006 Global Venture Capital Survey was sponsored by the DTT TMT Industry Group and was conducted in association with Venture Capital Associations in the Americas, Asia Pacific and Europe, Middle East and Africa. There were 505 responses from venture capitalists with assets under management ranging from less than US$100 million to greater than US$1 billion. The survey questions were designed to show the degree to which venture capitalists are expanding their worldwide investment focus, identify territories they are targeting for expansion, and see how their business practices are changing in order to accommodate a more global approach to investing.

The new world order - A global Venture Capital (VC) network breaks the horizon

VCs all over the world are taking the idea of global investing more seriously than ever before. In querying VCs about their interest in expanding their global investment focus, more than half said they would expand their investment focus internationally within the next five years. This trend was similar in all geographies with the exception of the Middle East where only 33 per cent of respondents indicated they intend to expand their investment focus. Last year’s results reflected a similar interest in global expansion. Venture capital has flourished in the United States for almost 70 years as a means of raising private equity for early stage companies and is now taking hold all over the world. The industry has grown to maturity in Europe where the amount of venture capital investment increased from US$12.8 billion to US$15.8 billion from 2004 to 2005 according to data from the European Private Equity and Venture Capital Association (EVCA).

The United Kingdom, long considered to be the second most mature VC market outside the United States, continues to experience a venture capital boom. According to recent data from the British Venture Capital Association (BVCA), UK venture capital activity is close to the 2001 high levels, with US$2.8 billion invested in 2005 from US$2 billion in 2004.

Canada, like the United Kingdom, is also attracting increasing numbers of US and other foreign venture capitalists who have entered the market recently. In 2005, according to the Canadian Venture Capital Association, US$1.5 billion was invested in approximately 590 companies, which was on par with 2004 investing levels.

China, a market deemed by many as a market full of challenges and opportunities, is already home to some of the US venture industry’s most promising overseas strategic alliances: Legend Capital and Doll-DCM Capital4 as well as Tianjin Venture Capital Company with SAIF Partners. A Deloitte Touche Tohmatsu report on the China venture capital industry, for instance, pegged the investment level in China (adjusted for purchasing power) at approximately US$7 billion in 2004 and growing.

Representatives in the DTT member firm in Mumbai stated the number of start-ups being launched in India is on the rise. Meanwhile, high liquidity in the equity markets is providing a good exit outlet. As a result, private equity is beginning to rush into India. Private equity and VC firms invested about US$2.3 billion in Indian companies across 147 deals during 2005, according to a study by Venture Intelligence India. During 2005, private equity and VC firms obtained exit routes for their investments in 42 Indian companies, while 17 private equity and VC-backed companies raised about US$950 million via initial public offerings (IPOs) during the same period. Approximately US$2.5 billion is reported to have poured into India in the first quarter of 2006 alone, roughly the same amount of funding raised for all of 2005.

Israel continues to attract significant interest from the venture capital community. According to the Israel Venture Capital Association (IVA) US$1.3 billion was invested in 2005 compared with US$724 million in 2004. The IVA research also indicates VC firms in Israel raised US$1.2 billion in 2005 and projects they will raise at least $1 billion in 2006.

Though the bulk of investor funding may reside in the United States, the growing pool of entrepreneurial talent is boiling up beyond its border - talent that could blindside a more parochial US VC. For example, Skype, the European Voice-over-Internet Protocol (VoIP) phone company funded by Luxembourgbased Mangrove Capital, rattled more than a few cages in Silicon Valley when it emerged from obscurity to be acquired by eBay for 2.5 billion. Buoyed by Skype’s success and that of other non- U.S. technological concerns, governments around the globe have begun throwing public funds behind private dollars to help with the incubation of start-up firms and innovating technologies expressly for global competition.

Strategies for global investing

This year’s survey data strongly suggests there will be a growing international interdependence among VCs, resulting in unprecedented numbers of strategic alliances, global informal networks, and direct investment in foreign VC firms.

Instead of setting up offices in foreign markets - as most of this year’s survey respondents seemed reluctant to do - most are looking to expand through networking opportunities that will involve a heavy reliance on established local players. When asked how their business practices would change as a result of international expansion, over 80 per cent of the respondents said they expected partners to travel more. While partners may rack up frequent flier miles, respondent data suggested that few would be offered expatriate packages for relocation. Instead, responses suggested that VCs eyeing expansion planned to partner up with locally-based VCs and hire investment staff with expertise in targeted markets.

Strategic alliances with foreign-based firms, already a popular form of expansion among last year’s respondents, carried even more favor in 2006. Over 70 per cent of respondents identified strategic alliances as a key method for globalisation. The finding represents a market jump from last year when less than 60 percent of respondents identified strategic alliances as a key method for geographic expansion. These results reveal an attitude shift toward global interdependence among VCs. Interestingly, the trends indicated in the chart below are entirely consistent with the data when viewed on a regional or territory basis.

Following the flow - top markets where VCs want to go

Data responses differed when identifying the top territories where VCs intend to expand internationally. While US respondents identified China and India as their top two destinations, approximately 60 per cent of European and Asian respondents indicated a strong interest in investigating in territories located in their respective continent.

European respondents indicated an overwhelming interest in investing in Continental Europe. While the strongest interest remained in Western Europe, the data suggests that Central and Eastern Europe are generating significant interest as emerging entrepreneurial environments. European investors consider the Asia Pacific region primarily as a lower cost.

Respondents from the Asia Pacific region also indicated a desire to move to a more globally diverse investment strategy. The region showed a strong interest in other Asian territories, indicating lower cost locations and diversification of risk as important considerations for their Asian focus. The interest in the United States remained consistent with the results from the prior survey, with approximately 22 per cent of the respondents in both years indicating the United States as their top destination when investing outside their home territory due to higher quality deal flow and access to foreign markets justifying their U.S. focus.

US respondents remained consistent about the top markets they expect to target in the coming five years. Interest in China and India, which were the top two destinations for US respondents last year, showed an annual increase of ten and seven percent, respectively, with access to foreign markets, higher quality deal flow, and lower cost locations cited as the primary reasons. After the two Asian markets, US respondents fragmented across a number of geographies, including stalwart markets such as the United Kingdom and Canada.

Latin America captured little mindshare in the 2006 survey. This year, respondents indicated an overall decline in interest in Latin America as a source of private equity growth. Respondents ranked the region at the bottom of the heap in terms of interest. When queried about impediments to investing in South America and Mexico, respondents identified the region as one of the few places where political instability is a major factor.

Avenues to growth - clean technology, medical devices, and new materials on the rise

This year’s survey did not show that increased globalisation of the venture capital industry would result in a change of investment practices by industry sector. For the time being, it appears that the majority plan is to stay the course, focusing mostly on software investments followed by communications and networking technologies.

Conclusion

The data collected suggests that the intersection of mature and emerging VC markets is imminent, but not impulsive. Indeed many industry observers believe that the global investment activity is expanding slowly and VCs are moving cautiously as they explore the right business model, for a more global approach to finding opportunities and generating better returns for their investors.

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