Last month’s announcement that Intel will take active role in the growth of the information and communication technology (ICT) in the Middle East with the establishment of a $50 million venture capital fund to invest in technology companies developing innovative hardware, software and services in the region covering the Middle East and Turkey, represents a significant milestone in helping create sustainable growth, development and competitiveness of the region. This fund will be in addition to an independent $100 million venture capital investment company to invest in technology companies located in, or having a connection with, Saudi Arabia, which is to be established by Intel Capital and the Saudi Arabian General Investment Authority (SAGIA).
Increased access to venture capital helps stimulate enterprise creation and entrepreneurship, one of the main drivers of growth and productivity in any nation. Recent studies indicate that countries have had varied success in venture capital. On the supply side, this may be due to a lack of funds, risk-averse attitudes, and the absence of an equity investment culture. On the demand side, there may not be a sufficient pool of entrepreneurs and investment-ready small firms. In order to develop the venture capital industry, countries need to first determine where financing gaps exist and assess all possible supply and demand factors which may be contributing to market failure in terms of access to venture capital.
Countries differ markedly in venture capital as a share of GDP and the portion going to start-ups. The United States has the oldest and one of the largest venture capital markets in the world. Not only does the United States have an entrepreneurial and risk-taking culture, small firms have benefited from a continuum of venture finance provided by public equity schemes, business angels, and private funds.
Studies on OECD countries have provided insights into effective policy approaches in the venture capital area, although these will need to be tailored to specific national economic and financial contexts. Entrepreneurship policies which are complementary to venture capital initiatives are essential to assuring sufficient demand for financing. A broader support structure is needed to ensure that small innovative firms have access to the talent necessary for technology or product development, skilled labor, knowledge, marketing capability and strategic insights about emerging business opportunities and trends.
Countries also differ greatly with regard to the sources of venture capital funds. While institutional investors, in particular pension funds, play a key role in the leading OECD capital markets, their role is fairly limited in others. According to OECD venture capital database 2003, countries with significant share of pension funds are the United States, Australia, and New Zealand (over 40 percent). But, due to regulatory restrictions as well as conservative investment attitudes, these pension funds and insurance companies play a minor role in venture capital markets in many OECD countries. In some countries where bank financing is dominant, or with bank-based financial systems, such as Austria, Germany and Italy, around 50 percent of venture capital raised came from banks between 1999 and 2002. But the asset and liability structure of banks is not as suited to undertaking long-term venture capital investments, which they generally conduct through specialized subsidiaries. Thus, more institutional investor involvement is expected as venture capital markets in Middle East countries mature.
When considering a venture capital strategy in emerging markets, such as the Middle East, countries should ask a fundamental question: Is a government equity program essential to leverage private sources of venture funding? If yes, what type of program is suitable?
In many OECD countries, the primary sources of venture capital is the government. In countries such as Korea, Norway and Portugal, the relative contribution of government has been significant. Studies indicate that in almost all OECD countries, venture capital investment started as a publicly-financed activity. Government equity funds have been widely used to pump-prime private venture capital and reduce imbalances in the allocation of funds across different financing stages, sectors and regions. Particularly at the beginning, the risk profile of seed and start-up firms is generally too high to attract sufficient private equity capital, hence the need for risk-sharing between the public and private sectors. In some countries, the government played dominant role for a long period of time, e.g. the small Business Investment Company (SBIC) program in the United States. These schemes not only channeled substantial amounts of venture capital to emerging companies, but helped to train managers who later launched their own funds stimulating growth in venture markets and instilling a venture culture.
Studies also indicate that not all public initiatives are well-targeted, and some have outlived their original purpose and usefulness. Over time, public programs tend to converge toward the same market segments as the private sector rather than addressing gaps in the provision of risk capital. Thus, the type and extend of the government’s role in terms of equity funding should be evaluated on a continuing basis.
Several countries now have privately-managed funds which use public funds to leverage private venture capital, such as the case of the Early Growth Fund in the United Kingdom. To enlarge the pool of high quality deals, countries are also strengthening public/private partnerships, such as case of the University Challenge Fund in the United Kingdom, which provides seed financing to facilitate the transfer of know-how and technology from universities into commercial applications.
Thus, governments play a key role on issues affecting entrepreneurship and small business, as innovator of new ideas, new policies, new interventions in the market. Governments can play the role of an engine for change within government making sure that government’s investment in the small entrepreneurial sector brings about growth in the economy.
(Dr. Adnan Soufi is a professor of business administration at King Abdul Aziz University, former dean of its Faculty of Economics and Administration, and currently is on sabbatical at Oxford University, as senior associate member at St. Antony’s College. He can be reached at: [email protected])
