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Innovation Nations- A Look at the Global Expansion of Venture Capital

Venture capital has a long history in the United States. Along with MIT President Karl Compton, Ralph Flanders, Merrill Griswold, and Donald K. David, French-born Georges Doriot founded the venture capital firm American Research and Development Corporation (ARDC), which was incorporated under Massachusetts law on June 6, 1946. One of the most profound changes in the venture capital business during the past two decades has been its globalization. Today, venture capital flows to where it can multiply, regardless of its geography. Despite the recent rise of venture capital in other countries, the U.S. remains the most active investor in start-ups. Over the past decade, start-ups in the United States have raised $488 billion from venture capitalists, according to data from Thomson Reuters. That’s about 65 percent of all the money raised in the entire world from VCs. Start-ups in Canada raised the next-highest amount of money, collecting $39 billion, less than a tenth as much, yet still more than both China and India combined. Interestingly enough, 50% of venture capital in the United States is still raised in one state, California. The Bay Area itself raises almost 38% of the U.S. total. There are several strategies that a firm might consider when it decides to go global, depending on its preferences for risk, the makeup of its partnership or the nature of the country it aims to invest in. 1. Invest directly in a start-up. 2. Open a foreign office. 3. Invest in a partnership that becomes LP and assigns operating partners (other VCs). 4. Affiliate with knowledgeable locals. 5. Acquire a foreign firm. 6. Partner with the local government. Some firms prefer to keep their relations with foreign start-ups at arm's length. They fly to another country, pick a start-up in an industry they know with a management team they know and trust, wire funds and come home. Other firms prefer to open their own offices in a foreign country. This strategy may be particularly well suited to firms that are more confident with native language speakers and staff who have significant experience with the local culture, laws, rules and procedures. U.S. venture firms have had some success partnering with each other to form new firms focused on foreign countries. Others have worked to affiliate themselves with local investors. Both strategies work well if the U.S. firm is a competent fundraiser and can help the local firm connect with U.S.-based limited partners. Other venture capitalists would rather get into the foreign market faster and simply buy a successful foreign investment firm. Governments periodically try to stimulate innovation and create incentives to attract experts, though

these programs typically come with various strings attached. Thus, knowing how to invest abroad is

one thing; knowing where to invest is another. Many places have tried to replicate Silicon Valley's

unique confluence of innovation resources, but few have succeeded. The United States has

developed a very attractive environment for small companies that no other country has yet

replicated. People seem to be constantly asking: What makes Silicon Valley so successful at

commercializing innovation? Some attribute the area’s proximity to the best research and

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engineering centers such as Stanford and Cal Berkeley. Others say it has to do with the

geographically centralized venture capital industry, or even the concentration of large tech

corporations nearby; in other words, infrastructure. But where else might such an innovation

ecosystem emerge?

The number of start-ups financed and the total dollars financed in a given country might be the best

indicator of its ability to sustain further investment. Exhibit 8.1 shows which countries have had the

most active venture capital industries during the past decade. Of course each country or region has

advantages and disadvantages, some of which have opened opportunities while others have made

development more difficult. We’ll consider several of the areas of greatest interest. We believe that

some countries will eventually catch up to the United States, but start up formation and venture

capital financing is one of the few areas in business that the United States will continue to lead for

the foreseeable future. In fact, we believe that the U.S. will maintain that lead for at least another

generation (20-30 years or more), probably much longer.

Venture Capital Investment around

the World 2000–2010

Country Number of Start-ups

Investment ( $ Billion) Country

Number of Start-ups

Investment ( $ Billion)

United States 19,398 $488.1 Australia 809 $6.2

Canada 5,920 $39.0 Spain 716 $6.2

United Kingdom 3,234 $36.8 Sweden 892 $5.9

France 2,605 $23.5 Israel 522 $5.5

China 1,174 $18.5 Italy 433 $5.3

India 1,052 $15.9 Brazil 303 $4.7

Germany 1,692 $13.3 Hong Kong 179 $4.3

Netherlands 727 $10.0 Denmark 394 $4.2

South Korea 2,433 $9.5 Singapore 213 $3.4

Japan 451 $7.1 Rest of the world

4,599 $36.1

Source : Thomson Reuters

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China

China has the biggest venture capital industry outside the U.S. To compare the two, in 2011 U.S.

venture capitalists invested $26.5 billion in all deals. Out of that total, they funded 967 Internet deals

with $6.7 billion. By comparison, in 2011 Chinese VC’s invested $13 billion in all deals. Out of that

total, they funded 268 Internet deals with $3.2 billion. About 1/3 of all China’s VC investment is

made in Beijing and the majority of those investments are in the Technology, Media and

Telecommunications (TMT) sector. As vibrant as the China venture business has been, 2012 was a

different story. VC’s pulled back and only invested $3.7 billion in 202 deals, funding only 43 IT deals

with $563 million.

For the last 10 years China essentially closed its search, media and social network software market to

foreign companies with the result that Google, Facebook, Twitter, YouTube, Dropbox, and 30,000

other websites were not accessible from China. This left an open playing field for Chinese software

start-ups as they “copy” or “adapt, adopt and extend” existing U.S. business models. This closed

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but very large market means that greater than 90% of Chinese software startups focus exclusively on

the Chinese market. Chinese VC does not currently have a significant global infrastructure.

Nonetheless, we believe that companies like WeChat will push China into serious innovation mode.

To make this a complete transition, however, China’s innovation-driven economy will eventually

need intellectual property rights and anti-trust laws that are enforced. In addition, education seems

to still be one of China’s bottlenecks – rote lectures, passive learning, follow the process, exam-

based performance, etc.

Beijing Venture/Angel Ecosystem

Zhongguancun is the name of Beijing’s Silicon Valley, located in the northwest side of Beijing. Not

only does Zhongguancun have Chinese startups, but global technology companies (Nokia, Ericsson,

Motorola, Sony Ericsson, Microsoft, IBM, Oracle, BEA, Alcatel Lucent, and Google) all have

offices here or elsewhere in Beijing. While Beijing has VC’s and angel investors happy to write a

check, there aren’t as many angels/VCs in China versus US per capita. There’s a funding gap for

seed stage investments. The angel/seed network in Beijing is fragmented and mostly inexperienced

(as are a good number of the China VC’s). It’s still an immature market. Remember, auto sales in

China went from 1 million in 2001 to 14 million in 2011.

Liquidity

Unlike the U.S., there are almost no mergers or acquisitions in this market segment. According to

wildly successful entrepreneur Steve Blank, “It’s much easier to just steal their ideas and hire their

employees”. So, big companies rarely acquire startups. Liquidity for most Internet startups happens

via IPO’s. 70% of exits in China are via IPO (in the U.S. on NASDAQ or the NYSE or on

ChiNext, China’s equivalent of NASDAQ) compared to the 90% of exits in US via mergers or

acquisitions. Alibaba (commerce), Tencent (games/chat) and Baidu (search) all have market caps

over $40 billion.

Entrepreneurial Culture

Like most countries we looked at, China still has a pervasive fear of failure. The current cultural

pressure is to “work for a big company or the government.” Outward facing Universities are just

starting to appear, and while there’s a free flow of information inside China, it suffers from the

constraints of the Great Firewall. The second difference in ecosystems – the lack of freedom to

dissent – goes deeper to the difference between the two systems. As Steve Blank again so aptly puts

it, “In the U.S., entrepreneurs are encouraged to ‘Think Different’. Our touchstone for creativity is

the Apple ad that said, ‘Here’s to the crazy ones, the misfits, the rebels, the troublemakers, the ones

who see things differently — they’re not fond of rules. You can quote them, disagree with them,

glorify or vilify them, but the only thing you can’t do is ignore them because they change things….’

This spirit of rebellion against the status quo got us Steve Jobs. In China the same attitude is likely

to get you jail time. Unless you can speak truth to power, you’ll never have an innovation economy”.

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Therefore, we think that, just like about everything else, China will eventually probably catch us in

the entrepreneurial economy. Their progress thus far is astonishing and China’s numbers (people)

and speed are really incomprehensible. At some point, however, they will need to reconcile

intellectual property rights. More fundamentally, it seems that state controlled capitalism doesn’t jibe

with the wild creativity needed to generate breakthrough innovation. This is probably the point at

which individuality will have to clash with the forces of state power. Even if individuality wins, it will

probably come at a tremendous price. None of us knows how long that will take or indeed, if the

outcome will even be positive.

India

India’s growing markets, new innovations, abundance of computer savvy specialists and strong

communications sector have attracted venture capitalists for years. There are, however, numerous

issues to take into consideration such as the complex listing requirements of stock exchanges,

complex taxes and its infamous bureaucracy. In addition, the lack of crucial infrastructure remains a

real problem. Despite this, Indian start-up companies have raised nearly $16 billion of VC in the

past decade. Many U.S. investors were emboldened by the success of Info Edge, the company that

runs online job site Nauru. The start-up raised money from Kleiner Perkins and Sherpalo Ventures.

Info Edge went public on the Bombay Stock Exchange in October 2006 and closed its first day of

trading at nearly double its offering price. The venture capitalists’ stake was valued at $75 million.

During the past three years, over 49 different venture capital firms invested $850 million in 53 e-

commerce companies. For example, Snapdeal, the online retailer, raised $50 million from three

different firms, beginning in April with an investment by eBay. This has been the biggest

institutional funding in the sector this year, and Snapdeal will use part of the funds to further

develop technology for their business. Another sector that has obtained a great amount of funding is

the wind energy sector. $16 million was raised in the first quarter of this year, versus the $500,000

raised last quarter. E-commerce in India is continuing to grow at a fast pace, and by 2016, the

market is estimated to reach $13 billion.

New Delhi and Bangalore are the top cities for startups in India. There is still, however, a significant

funding gap, with 74% less funding raised in Bangalore when compared to Silicon Valley. Internet

and mobile usage in India is also considerably lower than in the United States, with 39 million

subscribers compared to 208 million in the U.S. This has not stopped entrepreneurs and startups

from continuing to succeed, though. SlideShare, the document sharing service, was founded by

entrepreneurs from Bangalore. Last year, LinkedIn acquired the company for nearly $120 million.

Startup Festival India, an upcoming event that will celebrate and showcase Bangalore’s advances,

will include various startups, including 50 based in the city. This festival will be aimed at allowing

start-ups and entrepreneurs to exchange ideas and learn more about the various initiatives being

done to support them. Even though early stage investments in India are less frequent, the country

has seen an increase in the amount of angel funding received from entrepreneurs, executives in big

companies, and Indian expats. According to 500 Startups venture partner Pankaj Jain, this trend will

help jumpstart support for early stage start-ups.

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Israel

Israel’s entrepreneurs and technologists are world class, and its government has supported the

development of a vibrant venture capital community. Technology start-ups in Israel have benefited

from the country's investment into military technology and training. A large number of successful

technology start-ups can trace their roots back to Unit 8200 (Israel’s NSA), but the best known may

be digital security company Check Point Software. In addition, the government launched a

successful stimulus for technology investors during the first half of the 1990s called the Yozma

program. It acted as a fund-of-funds investor to support foreign firms interested in opening shop in

Israel. The government started by inviting foreign investors to establish venture funds based in

Israel that would invest solely in Israeli start-ups. It selected 10 firms it would support with public

money, offering to contribute up to 40 percent of each firm’s first Israel focused fund.

In the past decade, Israeli start-up companies have raised $5.5 billion from venture capitalists, yet

one thing that the country always seems to be missing is customers. This is because most of their

customers are typically in the EU and U.S. As a result, start-up executives will sometimes set up sales

and marketing in Silicon Valley or the EU to grow their top lines.

At first glance, Israeli VC investment has been down 30% since 2011, as revealed by PWC. Tech

start-ups in Israel raised $867 million in 2012. The MoneyTree Israel report indicates that only 51

Israeli tech companies were able to raise venture-capital funding in the first quarter of 2013.

According to Rubi Suliman, partner at PwC Israel, the growing presence of other investment players

in the marketplace enables a greater number of companies to raise funds from VC sources such as

private funds, incubators, accelerators and angels. In essence, this is good news. Thus, Israel’s

technology sector is maturing, continues to flourish and is considered to be the country’s top export.

One such startup that has become internationally recognized is Conduit, a billion dollar internet

firm, with a web-app marketplace used by over 120 countries. In 2012, Conduit was valued at $1.3

billion, and during the same year, JP Morgan bought a $100 million stake in the company.

PrimeSense, inventor of 3D gesture sensing technology, is used by Microsoft for Kinect. Not

surprisingly, PrimeSense was able to raise $20 million in venture funds last year. The U.S.’s VC firm

Silver Lake, also invested an undisclosed amount in the firm. Today, PrimeSense is used by over 20

million devices around the world. Finally, Newvem, an app which ensures that companies don’t

overpay for Amazon’s Web Services cloud, has raised over $4 million from Greylock Partners,

Innovation Endeavors, and Index Ventures.

According to serial-Israeli entrepreneur Amir Eldad, start-ups are excelling at technology, but

will not have access to global markets unless they work on customer-facing initiatives outside of the

country. For Israeli start-ups looking at prospects in Europe, some are considering the Netherlands

due to its ideal location, good infrastructure, and working capital. Ben Engel, senior Project Manager

of BOM Foreign Investments, located in the southern Brabant area of the Netherlands, is part of

the team working to finalize a program that will invest 125 million euros in foreign high tech

companies. This VC firm, sponsored by the Dutch government, works to attract businesses and

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startups to the area, with powerhouses such as Acer, Apple, Sony, IBM and Dell all having research

centers and offices set up there. Engel explains that while there are a few Israeli companies already

present in the country, he would like to see more, especially in the tech industry. BOM is ready and

willing to fund companies in both the startup and more advanced stages. The Investments Seminar

held in the Netherlands a few weeks ago proved to be a success. Organized in part by BOM, over

100 participants from different companies including start-ups attended. As a result, two or three

Israeli firms have already shown a solid interest in the program and are currently moving forward

with plans to establish themselves in the Brabant area in the upcoming years. According to Engel,

BOM will make investments of 2.5 million Euros in each company. This would also allow Israeli

firms that are looking into European markets to be in closer proximity to Germany, Belgium and

Holland.

Russia

Russia is well respected for its technological prowess and potential to become a lucrative market for

new companies. The country's recent economic boom led the government to create a program to

stimulate start-up creation. It formed a fund-of-funds similar to Israel's Yozma program, but it

required foreign investors to partner with a Russian investment firm to qualify for the stimulus.

Although the energy sector in Russia accounts for nearly 30% of the GDP, only 1% is spent on

research and development. The OECD (Organization for Economic Development), has stressed

that Russia needs a thriving startup culture, especially in science and technology, in order to prosper.

Even though Russia possesses strong capabilities in the fields of technology, science and research, it

has been difficult for the country to obtain commercial success globally. That, however, is starting to

change, since the 2011 opening of the Skolkovo Innovation Center, based just outside of Moscow.

This planned high tech business area, co-chaired by former Intel CEO Craig Barrett, encourages

science and technology companies. Importantly, it has its own set of laws. With funding from the

non-profit Skolkovo Foundation, the nearly 1,000 acre city has border controls and various

incentives, including a 5-7 year tax holiday for start-ups. Additionally, special laws have been created

for entrepreneurs from other countries, allowing them to work at the center. The Center focuses on

IT, Biomedicine, Space and Nuclear Technologies, and Energy, among others. According to Forbes,

VC investments are greatest in the IT sector. In 2011, Russian IT start-up companies raised $237

million, with a total of 139 deals.

In order to further help boost start-ups in the country, Yandex, an Internet search and services

firm, has recently developed a new startup accelerator initiative, called the Tolstoy Summer Camp.

They will help early stage startups and entrepreneurs throughout the whole process; from idea to

launch. According to Yandex, the amount of venture capital on the Russian internet market

outweighs new ideas; however, this new seed accelerator is the optimal format for large internet

companies to successfully interact with many diverse individuals, as well as startups. Yandex will

launch their new program on July 1, 2013, and applicants around the world with Russian language

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skills can apply. In fact, Yandex will cover foreign entrepreneurs’ travel and accommodations

expenses if they have to relocate to Moscow.

EU

Europe is made up of many smaller markets, none of which has the critical mass to create a

consolidated pool of talent and investment money. Still, each country in Europe is free to pursue its

own development strategies, and governments are able to establish policies that promote specific

high-growth industries. The region still imports many of its entrepreneurial concepts from the

United States but is slowly developing its own batch of home-grown expertise. Europe remains the

overwhelming first choice of entry for US VC backed startups which are expanding globally.

Overall confidence in Investing in Europe

Respondent’s Country

2.00 2.17

2.38 2.31

3.90

2.05

2.92

2.25

3.44

1.86

3.41

2.17

2.58

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

Australia Brazil Canada China Germany India Israel Japan Netherlands Taiwan United

Kingdom

United

States Overall

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Germany

Over the past ten years, German start-up companies have raised nearly $13.5 billion from venture

capitalists, and Berlin has recently been deemed as the next startup capital of Europe. In fact, during

last five years, entrepreneurs from various parts of Germany, Europe and the U.K. have been

flocking to the capital city, enticed by its modern culture, relatively inexpensive rent, and well

organized environment for start-ups. Since 2008, about 1,500 companies in the technology sector

alone have started up in Berlin. Organizations such as the Make a Startup Angel Fund have done

tremendous work in the city and in different parts of Europe to create and strengthen ties between

start-ups and capital funding. Despite the fact that there is still a lack on the level of institutional

venture capital available in the city, major venture capital financers such as Earlybird, have recently

relocated from Hamburg to Berlin. Various start-ups such as Soundcloud have blossomed

tremendously over the last few years. The company, founded in 2008 by two Swedes, has over 20

million users and raised a $10 million funding round from Index Ventures in 2011. Today, the

company is valued at $200 million. Wooga (the biggest social-games developer in Europe), and

Jovoto have also blossomed over the last few years.

American investors have, and continue to, recognize the many opportunities of investing in

Berlin. Both Benchmark Capital and Accel, venture capital firms in California, have recently invested

in Research Gate, a network for scientists and researchers. Since 2008, over 3 million researchers

around the globe utilize the network. A wide array of established sectors including IT and

communications, renewable energy, optics and printed electronics have made the city one of the

most competitive in Europe. Unsurprisingly, in the 2010 AmCham Business Barometer, 80% of

surveyors selected Germany as their top European country for investments. In late 2011, Google

established a new Institute for Internet and Society branch in Berlin, with a budget of 4.5 million

euros for the first three years. Google, along with Microsoft, outlined their specific initiatives and

details of the programs they are making readily available for start-ups in Berlin at a recent Founders

Table event.

U.K.

Data released by VentureSource shows that in 2012, the United Kingdom received the greatest

amount of venture capital investment in all of Europe, totaling $2.2 billion, with 295 new deals.

Although this was a 5% decrease from 2011, certain sectors such as the IT industry experienced

significant growth, receiving nearly $250 million in investments. During 2012, almost $960 million

were invested into technology start-ups in the U.K., reaching a 10-year high. This number is

expected to increase in 2013. The majority of investments are being made in internet, mobile and

digital media firms, as well as in new clean tech businesses.

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One area in particular that is thriving with technology startups is the Silicon Roundabout (U.K.’s

Silicon Valley), or Tech City known by some. Located in east London, it is a base for over 600

companies concentrated on a beltway. Earlier this year, the British government invested $80 million

to continue the area’s development. The consumer services sector in Europe also saw a 13%

increase on investments, with a staggering $2.1 billion of funding. More than half of this went to

social media, online shopping companies, and entertainment.

Ireland

Approximately 189 Irish companies in the technology sector raised close to $400 million in venture

capital funding last year. The amount of VC capital funding is expected to increase, with the

continued success of startups like Trustev, a security-tech company. Earlier this month at the Tech

All Star Awards held in London, Trustev won the prize for best startup in Europe. This company

has developed social fingerprinting technology, offering real time online verification. As a result, the

possibility of identity or credit card fraud is reduced..

There has been, and continues to be, an increased focus on IT and biotechnology companies.

Medical device firms also obtained an increase in funding, with over $76 million, and software

companies received around $100 million. Ireland continues to be a favorite spot for global

technology firm market entry. The government provides a vast array of programs which incentivize

large operational and job placement there.

Norway

Norway is one of the richest countries per capita, with an estimated $55,300 GDP per capita. The

country boasts a large amount of VC funds, with thriving sectors in IT, oil, gas, and renewable

energy. In 2012, Norwegian companies received nearly $1.3 billion from VC funding, with ten

different firms in the energy sector receiving a record $950 million in investments. There also

continues to be an increased focus on bio-technology; a firm received $1 million of VC last year.

Fjord IT is a recent Norwegian startup that offers Green Data Power to various cloud, service and

data centers in Europe. The company has opened up its first data space center in Oslo, and is

planning on developing another one late this summer. Fjord IT has created a cooling technology

that is fueled by hydropower, resulting in a lower carbon footprint. As a result, this startup’s IT

services are very appealing to environmentally-conscious businesses around the world. Fjord IT has

raised $2.5 million in VC from investors in Europe and Hong Kong. The total amount of VC

funding Norway received in 2012 was a 20% increase from the previous year.

Latin America

As reported in 2013 Latin American Private Equity and Venture Capital Association (LAVCA)

Industry Data (in collaboration with The Economist Intelligence Unit), last year a record $7.9 billion

was deployed in new investments across Latin America. Overall Latin America continues its steady

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path of growth and positive reform, a positive signal for PE/VC firms eager to invest in the region.

Last year, nearly $8 billion was committed to more than 200 deals in Latin America—with over half

of these deals in the information technology (IT) sector. Startups in IT included e-commerce, data

storage, mobile platforms, outsourcing, and infrastructure. The number of IT deals climbed from

only 18 in 2008 to 104 in 2012.

Chile

According to The Chilean Economic Development Agency (CORFO), the 2013 LAVCA Scorecard

report showed that Chile ranked first in Latin America for the 8th straight year, followed by Brazil,

Mexico and Colombia. This annual Scorecard measures conditions relating to countries’ venture

capital industries and policies, such as tax treatment, relevant laws and regulations, minority

shareholders’ rights, capital markets development and corporate governance requirements.

Chile received high marks for its “strong entrepreneurial environment,” citing CORFO’s financial

support of start-ups as a critical factor. CORFO’s Start-Up Chile and Venture Capital programs

were also mentioned as examples of the “active government support of SMEs and start-ups” in

Chile. CORFO Executive Vice President Hernán Cheyre has referred to Start-Up Chile as an

emblematic program that has “contributed positioning Chile as a regional hub of entrepreneurship

and innovation”. Chile continues to lead on indicators that are generally weak across the rest of

Latin America, specifically intellectual property protection, judicial transparency and the perception

of corruption, and posted an increased score on accounting standards that put the country’s overall

score on par with benchmark nations Taiwan and Spain.

Out of a potential 100 points measuring 13 criteria, Chile for the first time received the same

number of points as Spain at 76. Brazil, Mexico and Colombia received the next highest scores, with

72, 67 and 61 points, respectively.

Chile has one of the lowest costs of starting a business the region due to improvements

implemented in recent years. This marks a significant change from previous years, which is also

evident in the 2012 World Bank Doing Business Guide, where Chile’s ranking on this factor jumped

from 62nd to 27th.

According to Ernst & Young, foreign capital is forecast to boost investment Chile’s growth in the

short term, while low inflation should sustain the real purchasing power of consumers. This,

combined with ongoing employment growth, should mean that private consumption stays robust.

In the medium term, EY expects growth to be underpinned by strong emerging market demand for

Chile’s exports, particularly copper, as well as the stable macroeconomic environment – which

should help boost investment, productive capacity and living standards. But energy infrastructure

bottlenecks could constrain economic growth in the long run, while the reliance on copper leaves

the economy exposed to commodity price volatility in the near term.

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Brazil, Colombia, Peru and others

As it has in past years, Brazil led the region in receiving investments with 72 percent of the total

amount invested and 62 percent of the total number of deals. There are also many positive

developments in Mexico, but Brazil will still likely be the main destination for investments.

According to Patrice Etlin, Advent International’s managing partner based in São Paulo and

LAVCA’s chairman, “It will be a very strong year for Brazil, particularly if valuations start to get

more reasonable with a deteriorating macroeconomic condition”.

In Brazil, where a new reporting code aimed at fund transparency went into effect, scores remained

stable. Both Mexico and Colombia improved their scores as a result of gains on the indicators for

entrepreneurship. Peru also saw an important gain in the 2013 Scorecard, with a reform approved

last year that lifts restrictions on local pension funds investing in private equity in Peru and

internationally. The new regulation reflects a return to a more proactive stance among Peruvian

regulators on this issue, and increases the country’s overall score by two points.

In Central America and the Caribbean scores were generally unchanged, though investor interest in

the smaller opportunities presented by these markets continues to grow, prompting local

governments to consider improvements in their regulatory environment. The Dominican Republic,

where a new administration is tackling corruption, increased its score by three points.

Argentina presents the sole obstacle to progress, as the economy continues to deteriorate, and public

policy presents a hostile environment for foreign investors. The country hosts a vibrant start up

community, but even Argentine entrepreneurs are beginning to look elsewhere for funding and

partnerships.

Mexico

According to the Latin America Venture Capital Association (LAVCA), Mexican startups raised

$469 million dollars in 25 projects in 2011 through venture capital funds, compared to $211 million

dollars raised through 19 deals in 2010. For 2012, LAVCA estimates that VC firms will invest

around $1 billion in more than 30 deals. With the support of institutions and private funds, some

estimate Mexico’s VC industry to reach $100 USD billion dollars invested by 2018.

Mexico has a vibrant entrepreneurial economy, but its entrepreneurs, for the most part, establish

micro and small businesses through self-financing and debt. As a result, those businesses have little

growth potential. In order for Mexico to tap into the potential of its entrepreneurial economy to

create high growth companies, it will be necessary to increase the availability of equity capital. The

Mexican government and multilateral agencies have begun to support venture investment in Mexico.

Private investors have been attracted to Mexico as well, and have established a few private funds for

investment in the country. There are still, however, a number of barriers that inhibit further

development of the venture capital industry. Still, there is vast room for growth in the Mexican

venture capital industry. VC firms in Mexico only deployed funds representing 0.02 percent of the

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country’s GDP, compared to Brazil, the leader in Latin America, where funds represent 0.22 percent

of the country’s GDP.

As we’ve shown, the emergence of a large entrepreneurial community is essential for the

development and growth of any country. For there to be a sizable number of new enterprises and

for these to grow and thrive; they need funding, and this funding usually comes from venture capital

In the U.S., large, venture-backed companies — Amazon, Apple, Cisco, Google, Medtronic — are

major parts of the economic landscape. A recent study by the National Venture Capital Association

and HIS Global Insight estimates that 11% of U.S. jobs were created by VC-backed companies.

In Latin America, on the other hand, the VC industry is still nascent. At a recent meeting at the at

the Multilateral Investment Fund (the investment and granting arm of the Inter-American

Development Bank), Josh Lerner of Harvard Business School said the Latin America VC industry

still has to go through the growing pains that Silicon Valley did 40 or 50 years ago during its

embryonic days.

The growing pains of the VC industry in Mexico are in two dimensions: on the fundraising side and

on the investment side.

Fundraising side

VC fund managers in Mexico are still learning how to achieve trust with investors, the limited

partners (LPs). It takes transparency to achieve this objective, but too much transparency can

sometimes get in the way of effective fund management activities — as VCs spend too much time

keeping their LPs informed and not enough focusing on their investments. Many LPs are also still

learning how best to be effective investors by providing support and demanding accountability,

without micromanaging.

Mexico is also still struggling to build a large enough base of local investors to sustain its VC

industry. Despite several tremendously successful Mexican venture capital investments — such as

microlender Compartamos, where early investors made a 250x gain — most local investors are still

reluctant to invest in early-stage ventures. And many of the family offices and institutional investors

that are willing to make risky investments are hesitant to do so through VC funds — they continue

to prefer to invest directly. This is partly because direct investing has become an attractive activity

for family heirs. The challenge is that few of them have the relevant experience to do it well.

Better incentives need to be established to attract local family offices or institutional investors to VC

investment. How? In Brazil, the government made investment through VC funds tax-free — and

the country now has approximately 130 funds. In Israel, the government put money into VC funds

alongside local investors without demanding a return, thus allowing the private investors to leverage

their returns, thus helping to launch a thriving VC and entrepreneurial scene. In Mexico, the

government has created funds of funds to invest in VC, which has helped. The government,

however, has also been investing directly in companies — making the government a competitor of

VC funds and disrupting the sector's market dynamics.

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Investment side

Entrepreneurship in Mexico continues to be exceptionally difficult. To manage sector ecosystem

risk, you need to be local. Today the two biggest hurdles in its way are lack of access to capital and

difficulty in dealing with the industry ecosystem risk. To solve the bottleneck, Mexico needs more

money to flow to funds, and more fund managers with business track records who can guarantee

execution. One without the other won't be enough. The challenge is that senior experienced

operational talent in Mexico is not interested in bearing the risk and hardship of working in the still-

struggling VC industry. Government will have to create incentives for experienced professionals to

enter the field. Another issue in Mexico is that few VC funds want to make early-stage investments.

Andres Moreno of Open English shared the story of his company’s fundraising efforts, starting with

a round of convertible notes that took over a year to raise $400,000. The second round of VC

funding took 60 days to raise $43 million, and the next 45 days to raise $65 million. He stressed that

firms such as Kazsek that have invested in Open English are now looking at other deals with Latin

American companies for the first time. So, strong support to the early stage infrastructure and

current angel investing networks is again a big factor.

The U.S.-Latin America Relationship

Investors bringing capital to Latin America often tie funding to a U.S. connection. Serious

entrepreneurial firms will establish an office in California because investors prefer to be close to the

companies they are funding. If there is interest in scaling the service or technology to the United

States, or other experience with the U.S. market, this process becomes easier.

Medina Capital, for example, does not invest in Latin America unless there is a U.S. connection.

They invest exclusively in technology infrastructure such as networks, big data, and cyber security,

and seek companies to mentor and develop in order to bring into the U.S. market. He added that

U.S. companies also have a strong advantage in valuations. A U.S.-domiciled company will have a

significantly higher valuation than the same company with the same product based in Chile or

Argentina.

Still, the reception of Latin American entrepreneurs has changed in Silicon Valley. The region is

gaining attention for its emerging economies, where greater access to credit brings consumer

demand for technology-related services. Ambrose added that Brazil has dominated regional venture

capital investments because firms such as Accel Partners, Tiger Global, and Flybridge recognize

these opportunities. Much like in China, investors saw a market with 200 million consumers eager to

buy over the internet.

Outside of Brazil, companies need to look at either pan-regional enterprises or development for the

U.S. market in order to show the scale needed to attract later-stage investment. Successful deals

often involve the intersection of international and local entrepreneurs.

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New Ideas, Strong Talent

The people of Latin America are hugely innovative. They’ve had to be in order to survive consistent

economic and political challenges. As a result, there are fresh ideas in Latin America that can be

brought to the U.S. market. Mobile banking is one example, where the technology and platforms

have been developed abroad by companies such as YellowPepper, and now function in the United

States as demand increases for similar services. Another example is a company in Colombia that

operates in the cyber security space, protecting banks from fraud. Latin America has a lot of

experience in anti-fraud and the product set developed by this company was much more powerful

than anything seen in the United States.

Juan Pablo Cappello of Idea.me noted that this trends runs against the grain of mainstream thinking,

which portrays Latin America as a market filled with copycats as opposed to new ideas. Ambrose

added that contrary to popular wisdom in Silicon Valley, there is an incredible pool of talent for

creative professionals and developers, particularly in Argentina and Colombia.

Open English has established service hubs in the region around the best talent. The company found

skilled developers at the best cost in Argentina and set up an office there. They established three call

centers in Colombia, where there were sales and service professionals best-suited for the company.

But the enterprise is headquartered is in Miami, where Moreno said it has access to well-trained

professionals with experience at larger firms working across Latin America. Miami also has the

advantage of being in the United States, which is useful for raising capital.

The Importance of Regulation

As it should be, YellowPepper’s analysis of new markets is driven by regulations. For example,

YellowPepper entered the Mexican market because of a positive regulatory environment, but has not

yet entered Brazil. Investors feel confident in Chile because they are aware of the rules. The legal

framework is less friendly to investment in other markets and should be reformed. Otherwise, why

would a U.S. investor to go Latin America?

Korea

Based on statistics from the Korean Venture Capital Association, VC firms raised $191 million in

the first quarter of 2013, about $2 million more than the amount raised in the first quarter of 2012.

The amount of Korean startups has also increased, doubling to nearly 29,000 in 2012, from just

15,400 in 2008. KakaoTalk is one example of a Korean startup that has grown into a huge mobile

platform. Just six months after its launch by Kakao Corp., the mobile app had one million users.

Today, over 90 million people around the world use KakaoTalk, and the app has recently gained

tremendous popularity in Vietnam and Indonesia. The company has raised over $100 million of VC

funding, the latest from Tencent and WeMade.

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Korea’s continuous growth can be attributed to a variety of factors. With exceptionally high

standards for education, the country has a diversified economy and a mature, yet still rapidly

growing middle-class consumer base. It has world-class manufacturing sectors in telecom,

shipbuilding, electronics and automobiles. The Korean government is also promoting major

expansions in new sectors, such as clean tech and green energy. In addition, the government has

recently pledged nearly $3 billion in funding for venture companies, specifically for those in the

technology sector. Therefore, the country’s growth outlook is hugely positive.

Japan

Japan is the third largest economy in the world, with market-leading technology in a variety of

sectors. Over the past decade, Japanese startups have raised a little over $7 billion. In 2012, the

country’s stock market increased by 23%, experiencing the biggest gain in seven years. One sector in

particular that is gaining momentum is e-commerce. Locondo, a successful shoes and fashion e-

commerce service startup, has over 300,000 registered members. The company recently raised $6.3

million of VC funding from Excite Japan (one of the country’s leading web portals), Lead Capital

Management, and Itochu Technology Ventures. Locondo’s partnership with Excite Japan, which

boasts 50 million monthly visitors to its portal site, will enable the e-commerce company to increase

its user base.

Two Tokyo-based startups have recently raised a significant amount of VC. Freak Out, which

provides a real time advertising platform for smartphones, received close to $5.5 million of funding

form YJ Capital. Founded in 2012, YJ Capital is the VC arm of Yahoo Japan Corporation.

Accounting SaaS Japan is another thriving startup, providing solutions to Japanese accounting firms.

The company has recently raised $6.6 million of VC from SalesForce.com, GREE Ventures, and

Mobile Internet Capital. A growing number of Japanese companies are seeking to expand their

businesses globally, and will thus require more funds and support from VC investors. Based on its

enormous technology and capital base, we think Japan’s role in Venture Capital has tremendous

opportunity in Japan right now.

Conclusion

Venture Capital financing is one of the few areas in business that the United States will continue to

lead for the foreseeable future. In fact, we believe that the U.S. will maintain that lead for at least

another generation (20-30 years or more). The United States is among the top countries in terms of

technology talent. In addition, the country has been at the startup game longer and more intensely

than anyone else. It has built up an enormous base of technical knowledge, startup business

formation knowledge and a thriving base of wealthy entrepreneurial “alumni” as well as

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knowledgeable and relatively enthusiastic institutional investors or Limited Partners and investors at

every stage of start-up funding. But although the U.S. commands a huge lead in the VC space, it

does not own the concept of innovation. Many of the IT, internet, media and telecom innovations

from the U.S., are ironically, speeding that globalization process up.

Within the next 20 years or so, I believe we could see China surpass the United States in terms of

deals done and total investment volume, just as it will surpass the United States in total GDP. Until

China, however, embraces the concept of intellectual property protection, it won’t lead in terms of

innovation. More fundamentally, it seems that state controlled capitalism doesn’t jibe with the wild

creativity needed to generate breakthrough innovation. This is probably the point at which

individuality will have to clash with the forces of state power. Although we don’t know how long

that “pause” will last, individuality should eventually win out. When that happens, China’s numbers

will win out as well. China’s ability to produce at a world-class level in a very short period of time is

simply astonishing.

I also think Latin America has enormous potential. They currently badly lack startup formation

knowledge, experience and capital, particularly at the seed levels. But, I would argue that the people

there are naturally very creative and that this may be enough to push the region to achieve great

things in the future. It’s funny; a week ago I would have thought that the region’s government

corruption and poor infrastructure would minimize its potential, like it has done with everything

else. The recent demonstrations in Brazil and the fact that the Mexican government is actually

challenging monopolies give me real hope that the majority of the people realize that their

bureaucracy is the problem and is the biggest factor holding them back. The middle class is finally

getting large enough to “scale”. It will take time to get results, but if Latin America can affect

meaningful change to existing archaic business laws, institutionalized corruption and poor physical

infrastructure, the sky’s the limit. The same could be said for India.

Finally, there remains enormous potential growth in places like DAS (Germany, Austria, and

Switzerland), the UK and Ireland, Korea and Japan. All of these countries have well-established

technology and capital infrastructures. In general, they don’t have the entrepreneurial mindset or

tradition of the United States, but are realizing that they must acquire it if they want to begin

breaking the cycle of low-growth in their respective regions. The good news is that the wind is at

their backs. The rise of alternative forms of startup funding will only enhance the ever-accelerating

effects that technological innovation has on globalization.