1

OECD/ADBI 7th Round Table on Capital Market Reform in Asia

27-28 October 2005ADB Institute, Tokyo, Japan

SESSION 4: DEVELOPMENTS IN VENTURE CAPITAL AND PRIVATE EQUITY SINCE THE END

OF “TECH BUBBLE”

Mr. John K. ThompsonFinancial Counsellor, OECD

2

Developments in Venture Capital and Private Equity since

the end of “Tech Bubble”

Seventh Tokyo Round Table on Capital Markets Reform in Asia.October 28, 2005

John K. ThompsonFinancial Counsellor

Directorate for Financial and Enterprise Affairs, OECD

3

Sources of SME FinancingPositive

cash flow CollateralHigh

Return High Risk

Banks X X No

NBFIs X No

Govt.programmes

Usually Usually Sometimes

Equity X X

Internal Cashflow X

4

Hypothetical Life Cycle for New High-growth Companies

Phase 1: Pre-Venture Capital: Informal finance

Friends and FamilyBusiness Angels

Precondition: overall entrepreneurial environment, flows of potential high-growth projects, links between research and commerce

Phase 2: Formal Venture Capital

Appropriate legal structuresSources of funds (institutional investors, individuals, financialinstitutions, corporate sector, government)

Phase 3: Transition

M & AIPO Markets

Phase 4: Formal capital markets

5

Environment for Entrepreneurship

Cultural values

Education and training systemCorporate and bankruptcy law

Financial marketsTaxation policy

Social protectionScience/industry linkages

6

Entrepreneurial Activity in Selected OECD Countries.

0

2

4

6

8

10

12

United StatesKorea Australia Norway Canada Italy

United KingdomGermany Denmark Spain Finland Sweden Belgium France Ireland Japan

PercentStart-up activity: Percentage of adults engaged in the process of creating a business in the past 12 months

New firm activity: Percentage of adults owning (solely or partly) and managing an operating business that is less than 42 months old

7

Barriers to Entrepreneurship Vary Across OECD Countries

Based on 1998 Data

0.0

1.0

2.0

3.0

4.0

5.0

6.0

United

King

dom

Canad

aAus

tralia

Irelan

dNew

Zea

land

United

Stat

esDen

markNor

wayNeth

erlan

dsPor

tugal

Austri

aGree

ce

Spain

Sweden

Finlan

dGerm

any

Switzerl

and

Japa

nBelg

iumFran

ce

Italy

Barriers to competition

Regulatory and administrative opacity

Administrative burdens on startups

8

Informal Equity Investment

Former entrepreneursContribute capital and business skills“Hands on” participation, “coaching”Flexible participationLocally orientedOperate in both high growth companies and traditional SMEs“Business angels” and “business angel networks”An area for government support?

9

Venture Capital: Basic CharacteristicsOnly suitable for high-growth companiesPrivate equity (usually preferred shares)Players: entrepreneurs, venture capitals and investorsDeal flow: screening of projects and high rate of rejectionIntensive monitoring and coachingAsymmetric information, agency and monitoring problemsStaging of investmentImportance of exit

10

What kinds of firms are suitable for venture capital?

High risk, high returnNegative cash flow (burn ratio)Often technology related fields (ICT, biotech, etc.)Often in areas of concentration of technology related industryHigh share of tangible assets

11

Stages of Venture Capital Finance

Preparatory phases: origination, screening, due diligence and deal evaluationEarly stage– Seed– Start-up

Expansion (one or more rounds)MezzanineExit– Buy-out– Trade sale– IPO

12

Venture Capital Investmentas a share of GDP, averages 2000-2003

0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8

Slovak RepublicJapan (5)HungaryGreecePolandAustria

Czech RepublicSwitzerland

PortugalItaly

New Zealand (5)Germany

Euro areaIreland

BelgiumFrance

DenmarkSpain

NorwayAustralia (5)

EuropeEuropean Union

FinlandNetherlands

United KingdomSweden

Korea (3)OECD23 (4)OECD19 (2)

CanadaIceland

United StatesIsrael (1)

Per cent of GDP

Expansion Early stages

(1) 2000-2002. (2) Europe, Canada and United States. (3) 1998-2001. (4) Europe, Czech Republic, Hungary, Poland, Slovak Republic, Canada, and United States. (5) 1998-2001.Source: OECD, based on data from EVCA (Europe); NVCA (United States); CVCA (Canada); Asian Venture Capital Journal (The 2000 Guide to Venture Capital in Asia).

13

Venture Capital Investment in High-tech Industriesin per cent of total venture capital investment, 2000-03.

0

20

40

60

80

100

Spain

Slovak

Rep

ublic

Portu

gal

Nethe

rland

s

Austra

lia (2

)

United

King

dom

Italy

Japa

n (2

)EU

Franc

eGer

man

ySwed

enKor

ea (2

)

Switzer

land

Belgium

Finlan

dGre

ece

Poland

Icelan

d (1

)Aus

tria

Hunga

ry

Czech

Rep

ublic

Norway

New Z

ealan

d (2

)OECD

Denm

ark

United

Sta

tes

Canad

aIre

land

Per

cen

t of t

otal

ven

ture

cap

ital i

nves

tmen

t

Communications Information technology

Health/biotechnology

(1) 2000-2002. (2) 1998-2001. Source: OECD, based on data from EVCA (Europe); NVCA (United States); CVCA (Canada); Asian Venture Capital Journal (The 2000 Guide to Venture Capital in Asia).

14

Private Equity Fund StructuresCountry

(StructureTax

transparentfor domestic

investors

Ability to avoidpermanent

establishmentfor internationalinvestors fromtreaty or non

treaty countries

Ability toincorporate a

capitalinvestment/in

centive forfund

managers.

Ability toavoid paying

VAT onmanagement

charges

Abilityto avoidpaying

VAT oncarriedinterest

Freedomfrom unduerestrictions

oninvestments

Belgium X N/A XFinland X XFrance X XGermany XItaly X N/A XNetherlands XPortugal X N/A X XSpain X N/A XSweden XSwitzerland X N/A X X XUnitedKingdomUnitedStates

Source: European Venture Capital Association

Note: An X indicates a problem in the area concerned.

15

Who supplies fund for Venture Capital?

BanksInvestment banksPension fundsCollective Investment SchemesIndustryFoundations and EndowmentsHigh net worth individualsForeign investorsGovernment

16

Sources of Funds Raised for Venture CapitalAverages over 1999-200, per cent of total

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100

SVK

NOR

BEL

CAN

ISL

CHE

PRT

KOR

POL

JPN

GRC

IRL

SWE

FRA

ESP

HUN

NLD

DEU

DNK

ITA

USA

GBR

CZE

AUT

FIN

NZL

AUS

Banks and insurance companies Pension funds Corporate investors Other

Source: OECD, based on data from EVCA (Europe); NVCA (United States); CVCA (Canada); Asian Venture Capital Journal (The 2000 Guide to Venture Capital in Asia).

17

Performance of growth stock exchangesIndices, 02/01/1998 =100

0

100

200

300

400

500

600

700

800

900

Jan-

90

Jul-9

0

Jan-

91

Jul-9

1

Jan-

92

Jul-9

2

Jan-

93

Jul-9

3

Jan-

94

Jul-9

4

Jan-

95

Jul-9

5

Jan-

96

Jul-9

6

Jan-

97

Jul-9

7

Jan-

98

Jul-9

8

Jan-

99

Jul-9

9

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

NASDAQ COMPOSITE FTSE ALTERNATIVE INVEST.MKT (AIM)

NEMAX ALL SHARE NOUVEAU MARCHE

Source: Thomson Financial DataStream.

18

Current Trends in Venture Capital

Highly cyclical sectorInnovationFund raisingInflows into sectorRising valuationsMarket peaks

Earlier cycles1980-841995-2000

19

Is a New Cycle Beginning?

Surge in activity in 2004 early 2005

In US, both venture capital and buy-outs

Globalization of the industry; India and China emerge

In Europe, strong buy-out activity, but ventutrecapital lags – especially early stages

20

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

2000 2001 2002 2003 2004

Ann

ual C

omm

itted

Cap

ital (

US

D $

M)

North AmericaEuropeAsia/Australia

Global VC Fundraising Capital Raised by VC Funds; 2000-2004

21

Global Venture Investment Activity2000-2004

0

20

40

60

80

100

120

2000 2001 2002 2003 2004

(USD $Bil)

North AmericaEuropeAsia

22

US IPO’s by number of issues

0

50

100

150

200

250

2001 2002 2003 2004

Non-VC backedVC Backed

23

$0

$100

$200

$300

$400

$500

$600

$700

$800

2001

2002

2003

2004

($

Billi

ons)

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

# of

Dea

ls

$ Proceeds # IPOs

US M&ABy number of Deals & Rank Value2001-2004

24

European versus US private equity cumulative IRR

Since Inception by Calendar Year (Inception to December 31, 2004)(1)

-5

0

5

10

15

20

25

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Net

IRR

Sin

ce In

cept

ion

(pct

)US Europe

1) US Funds formed 1969-2004, European Funds formed 1980-2004Source: Thomson Financial

25

European versus US private equity cumulative IRR

From Inception to December 31, 2004(1)

1) US Funds formed 1969-2004, European Funds formed 1980-2004Source: Thomson Financial

Stage No. Pooled Upper Quartile Median DPI RVPI TVPI Early/Seed VC 545 20 16.2 2.7 1.29 0.54 1.83

Seed VC 65 10.2 13.3 4.0 1.08 0.39 1.48

Balanced VC 426 13.6 15.6 5.4 1.03 0.50 1.53

Later Stage VC 182 13.8 15.2 5.4 1.04 0.44 1.49

Total US Venture 1153 15.9 15.9 4.4 1.12 0.50 1.63 Development VC 173 8.2 7.4 0.0 0.74 0.68 1.42

Early VC 252 0.2 4.2 -3.1 0.40 0.60 1.01

Balanced VC 146 7.9 10.7 0.0 0.66 0.59 1.26

Total European Venture 571 6.0 6.7 -0.4 0.60 0.62 1.21

Small Buyouts 186 25.0 18.6 7.9 1.32 0.40 1.73

Medium Buyouts 105 16.4 16.1 6.8 1.07 0.42 1.49

Large Buyouts 82 17.4 18.8 7.0 1.01 0.59 1.59

Mega Buyouts 101 8.6 14.7 5.8 0.64 0.66 1.30

Total US Buyouts 474 13.1 17.8 7.0 0.81 0.60 1.41

Small Buyouts 218 11.2 15.8 7.6 0.92 0.51 1.42

Medium Buyouts 36 17.7 22.2 9.0 1.16 0.54 1.70

Large Buyouts 28 20.4 18.6 7.0 1.09 0.55 1.64

Mega Buyouts 25 6.4 12.8 1.8 0.38 0.81 1.19

Total European Buyouts 307 12.3 16.5 6.9 0.70 0.67 1.37

26

Venture capital: United States vs. Europe

Source: Thomson Financial, VentureSource/Ernst & Young

0

5,000

10,000

15,000

20,000

25,000

30,000

1Q99

2Q99

3Q99

4Q99

1Q00

2Q00

3Q00

4Q00

1Q01

2Q01

3Q01

4Q01

1Q02

2Q02

3Q02

4Q02

1Q03

2Q03

3Q03

4Q03

1Q04

2Q04

3Q04

4Q04

1Q05

Ven

ture

Am

ount

Inve

sted

, Eur

ope

& U

S

0

200

400

600

800

1000

1200

1400

1600

Num

ber

of V

entu

re D

eals

, Eur

ope

& U

S

Amount: Europe Amount: US Number: Europe Number: US

27

US Venture FundsAnnualized Net Cumulative IRR by Vintage Year

As of December 31, 2004

-40

-20

0

20

40

60

80

100

1969

-75

1976

-79

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

An

nu

aliz

ed C

um

ula

tive

IRR