Heinrich Liechtenstein

International allocation determinants for institutional investments in venture capital and private equity limited partnerships

We examine the determinants of institutional investors when deciding about international capital allocation in venture capital and private equity limited partnerships through a questionnaire addressed to limited partners world-wide. The respondents provide information about their criteria for international asset allocation. The protection of property rights is the dominant concern, followed by the need to find local quality general partners, and the quality of management and skills of local entrepreneurs. Furthermore, the expected deal flow plays an important role in the allocation process, while investors fear bribery and corruption. Public funding and subsidies are not important for the international allocation process. Hence, private money does not follow public money. Additionally, IPO activity and the size of local public equity markets are not as relevant as proposed by other researchers. Our results can support policymakers to increase the attractiveness of their countries for institutional investors to receive more risk capital for innovation, entrepreneurship, employment and growth.

The First Step of the Capital Flow from Institutions to Entrepreneurs: the Criteria for Sorting Venture Capital Funds

We contribute to the knowledge of the capital flow from institutional investors via venture capital (VC) funds as intermediaries to their final destination, entrepreneurial ventures. To this end, we conduct a world†wide survey among limited partners to determine the importance of several criteria when they select VC funds. We find the top criteria to be the expected deal flow and access to transactions, a VC funds historic track record, his local market experience, the match of the experience of team members with the proposed investment strategy, the teams reputation, and the mechanisms proposed to align interest between the investors and the VC funds. A principal component analysis reveals three latent drivers in the selection process: ‘Local Expertise and Incentive Structure’, ‘Investment Strategy and Expected Implementation’, and ‘Prestige/Standing vs. Cost’. It becomes evident that limited partners search for teams which are able to implement a certain strategy at a given cost. Thereby, they focus on an incentive structure that limits agency costs.

Limited Partners' Perceptions of the Central Eastern European Venture Capital and Private Equity Market

Growth expectations and institutional settings in Central Eastern Europe are assumed to be favorable for the establishment of a vibrant Venture Capital and Private Equity market. Despite this, there is a lack of risk capital. We examine the obstacles to institutional investments in the region through a questionnaire addressed to (potential) Limited Partners world-wide. The respondents provide information about their perceptions of the region. The protection of property rights is the dominant concern, followed by social criteria, such as the belief in the management quality of local people, and the lacking size and liquidity of the Central Eastern European capital markets. However, Limited Partners regard the growth expectations as attractive, and those with exposure in Central Eastern Europe are satisfied with the historical risk and return ratio, they have a good knowledge of the region, are attracted by other emerging regions, and they appreciate the regions entrepreneurial opportunities and the local General Partners. Overall, the region is ranked very favorable compared to other emerging regions, and especially with respect to its economic and entrepreneurial activity.

Do Business Angels Alter the Risk-Return Equation in Early Stage Investments?: Business Angels as Seen by Venture Capitalistsin the German Speaking Countries

Venture capitalists in the German-speaking countries do not value the contribution of business angels in co-invested deals. Business angels do not reduce the risk perceived by venture capitalists in early stage deals even if the business angels have what venture capitalists regard as an ideal profile. Venture capitalists also refute that deals with business angels typically generate higher internal rates of return than deals without business angels. The results of this study can be particularly important for the delicate transition process in the venture financing from business angels to venture capitalists.

The First Step of the Capital Flow from Institutions to Entrepreneurs: The Criteria for Sorting Venture Capital Funds

We contribute to the knowledge about the capital flow from institutional investors via Venture Capital (VC) funds as intermediaries to their final destination, entrepreneurial ventures. Therefore, we run a world-wide survey among 1,079 institutional investors to determine the importance of several criteria when they select VC funds. The expected deal flow and access to transactions, a VC funds historic track record, his local market experience, the match of the experience of team members with the proposed investment strategy, the teams reputation, and the mechanisms proposed to align interest between the institutional investors and the VC funds are the top criteria. The level of fees payable to the funds is not an important selection criterion. The VC relationship is based on a complex structure of (several) principals and agents, and functional only, if the interests of all participants are aligned. Fees are an important element of this alignment. Overall, the sorting criteria of institutional investors are very similar to what we know about the criteria applied by VC funds themselves, when selecting entrepreneurial ventures: The institutions have to mitigate the same kind of agency conflicts that VC funds and entrepreneurs are exposed to.

Assessing Country Attractiveness in the Venture Capital and Private Equity Landscape in Emerging Markets

In our research project “The Global Venture Capital and Private Equity Country Attractiveness Index�? we tackle the question where institutional investors should best allocate their venture capital (VC) and private equity (PE) exposure. In this project, we have calculated an index in its third edition in 2012 which benchmarks 116 (thereof 83 emerging) countries across the world with respect to their attractiveness for international VC and PE investment. In this book chapter, we comment on this index with respect to emerging market VC and PE. The emerging market attractiveness ranking is led by China, followed by Malaysia, South Africa, Chile, Saudi Arabia, Poland, and India. Despite this overall ranking, we also discuss the success factors of the countries that remarkably improved their investment conditions over the last five years, namely Tunisia, Morocco, Saudi Arabia, and Egypt. We detect, that all Northern African, and almost all Middle Eastern countries covered by our index strongly increased their attractiveness for investors. Our index can help to support investors’ allocation decisions on the enlarging map of potential target countries. However, several emerging markets are probably not yet sufficiently mature for VC/PE investments and too early entry might not be a beneficial allocation strategy.

Putting Everything Together

We would like to end this book with an example of a highly successful strategic investor, going back to the 1970s and lasting about 25 years. While we live in a very different global environment today, this example is used to illustrate that the guiding strategic principles are timeless, having been used for over 3000 years.

The Empowered Investor: A New Paradigm of Investing

The literature on strategy deals with dozens of different principles. Some are general, like the advice to “build on strengths”, and others apply to only a specific field such as strategic management. In this book, we have chosen to concentrate on key principles that are crucial for wealth creation. We aim to empower the investor in developing and successfully implementing his or her unique investment strategy using a new strategic framework presented in this chapter.

Putting the Process of Strategic Investing into Practice

Recapping our key findings, we emphasize that: 1. Wealth cannot be created by following traditional investment advice. If you invest according to the traditional diversification concepts and capital market theory promoted by the finance industry, you may be able to preserve wealth or, in the best case, generate marginal returns. 2. To create wealth an investor must apply strategic concepts to develop an investment strategy that: • builds on investor strengths and core competencies • exploits opportunities • uses networks • incorporates an investment approach that differentiates the investor from others • prevents threats and handles risks appropriately • observes trends and cycles and invests accordingly • is executed with high efficiency The strategic investor must build strengths and core competencies, and use available resources (personal time, finances, IT, and so on) in a concentrated manner. 3. It is advisable to develop the strategy through a formal process, as illustrated in Figure 8.1.

What Should an Effective Investment Strategy Contain

Our practical experience shows that a strategy should be kept as simple as possible while still including the following items: 1. The vision of the investor 2. The core competences the investor intends to build 3. The structure of the investment portfolio 4. Handling threats and risks 5. The networks the investor intends to build and use 6. Guidelines for cash and liquidity 7. Priorities for allocating the investor’s resources 8. The legal and tax structure.