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Abstract Thoughts
GROWING VENTURE CAPITALISM AND SMES IN EMERGING MARKETS
“Building a Thriving Venture Ecosystem: Essentials Fostering Entrepreneurship in Egypt”
Published by Endeavor Egypt and Kauffman Fellows Program, November 2009
Analysis by Sarah Marquer
A November 2009 report published jointly by Endeavor Egypt and the Kauffman Fellows Program and titled “Building a Thriving Venture Ecosystem: Essentials Fostering Entrepreneurship in Egypt” examines how venture capitalists can best develop entrepreneurs in countries and markets that are developing or emerging.
The report identifies entrepreneurs as individuals who embody innovation, who are very business-oriented, and perceive and create new business opportunities. It also argues that these same individuals encounter substantial obstacles to success due to a lack of infrastructure, services and support for small and medium enterprises (SMEs) in emerging countries.
“Findings from the ‘Egypt Entrepreneurship Report 2008’ indicate that Egypt ranks 11th of the 43 countries participating in the Global Entrepreneurship Monitor in terms of Total Entrepreneurial Activity rate. One of the key recommendations the report makes is the need to ‘develop a stronger financial-support environment to enhance the creation and development of entrepreneurial startups and growth ventures.’”
The report continues its exploration of how venture capitalists can effectively develop SMEs and entrepreneurs in developing countries for the benefit of all concerned. It lists nine guidelines to which venture capitalists should adhere in order to maximize the potential of SMEs and entrepreneurs.
“People, rather than just technology or capital, should be perceived as the most important intellectual property in an innovative business environment.”
In order for developing countries to harness entrepreneurial potential, according to the report, all of the region’s assets must be able to be pulled together very fast. The report points out that of all these assets, people are the most valuable; the individual is the force responsible for pooling a region’s assets, as well as making business networks innovative and competitive vis-à-vis other countries.
“Risks are necessary in the business of technology commercialization; it requires interaction and networking – it is a ‘body contact’ sport; very hands-on, not something you can do in the abstract. This personal element is much overlooked in centrally planned efforts to drive business innovation and economic growth, and one of the reasons these efforts have failed largely.”
In order to encourage innovation and give entrepreneurs their best shot at success, they must be allowed and even encouraged to take risks. The report states that those who have tried and failed tend to learn from their mistakes, and those lessons can prove to be significant factors on the road to future success.
“As such, in order to create a context for business success and economic growth, you want to create environments that 1) allow you to pull together resources and 2) allow people to fail, but to keep coming back to try again with new ideas.”
The report uses two metaphors to demonstrate the kind of environments in which businesses can grow: the plantation and the rainforest. Traditional growth is likened to that of the plantation, where crops are planted and yield a certain quantity at the end of the growing season. Growth is determined by set conditions. On the other hand, there is the growth model similar to that of the rainforest ecosystem, in which companies that are successful have almost completely expired several times. They are highly competitive, innovative and capable of adapting to their changing surroundings. Thus, SMEs and entrepreneurs from developing countries must receive assistance and opportunities to acquire the skills necessary to adapt to a constantly changing environment – for example, private sector involvement, multiple forms of investment, and integrated regional and community infrastructure. Such support goes a long way toward encouraging the persistence that can result in achieving success even after encountering failure.
“This is a new definition of ROI; success that is measured according to ‘Return on Involvement,’ not Return on Investment... based on initially forming [a] relationship and subsequently forming the transaction – versus the transaction coming first, possibly followed by a relationship. Working under this mindset gives the investor the opportunity to form new relations, to be exposed to new ideas, talent and alternative perspectives, to identify new ways to engage, to learn from others, and to make an efficient use of one’s time.”
The primary catalyst for returns, argues the report, is the commitment of time first, then capital. Venture capitalists should think in terms of time rather than money and be open to new ideas and talents so as to allow SMEs and entrepreneurs to “think big.” The bigger the thinking, the bigger the payoff.
“Thus the ability for people to trust one another, because reputations matter, becomes another critical element to building an entrepreneurial ecosystem.”
Similarly, relationships between venture capitalists and entrepreneurs must be based on mutual trust. In order for a network of SMEs to get off the ground, those who participate in the building of startups must operate in an environment where they trust one another.
“In terms of nurturing startup companies, angel investors are probably more important than mature venture capital firms.”
The report claims that angel investors – accredited investors who typically provide capital to startup companies in their early stages of growth using their own funds, unlike larger, pooled sums of money used by venture capitalists – are vital to getting SMEs off the ground.
“The difference between venture capital and ordinary capital is that venture capital is rooted in trust-based relationships, with high transparency and integrity in motivations. It is about the relationship first and the transaction second, which is very different from ordinary capital. When a transaction comes first and the sole focus of a business relationship is getting returns, an ordinary investor might try to squeeze the startup company for what it is worth.”
Two kinds of capital are discussed in the report: venture capital and ordinary capital. The former builds upon the earlier points of the report, namely that trust-based relationships and commitment of time over money exist within the relationship between venture capitalists and SMEs. While ensuring a return on investment is a major concern, the report cites focusing on the transaction first and the relationship second as detrimental to both the relationship and the success of the SME, and therefore the potential return.
“The guiding principle here is: Play a fair deal from the beginning, and it will stay fair until the end.”
The report states that the most qualified and successful venture capitalists are those individuals who were once SME owners and entrepreneurs themselves. In general, they understand that trust, time and fair deals must exist within all venture capitalist-SME relationships in order for both sides to win. Success can’t be maximized unless both players in the relationship are on an equal footing. Moreover, as long as venture capitalists play fair, additional opportunities will appear thanks to the reputation they have earned. In short, playing fair means one can play the game for the long term.
“A quick formalization of a relationship is the beginning of a failed startup company.”
As mentioned earlier in the report, committing time to an investment is necessary. Unions between startups and investors must be for the long term. Partnerships must be well thought out in order to be of the most benefit for both parties.
“Having access to a broad set of networks... can be a great source for building relations for strategic acquisitions and liquidity.”
The report concludes with a brief commentary concerning emerging markets and liquidity. It argues that liquidity is a difficult asset to acquire in emerging markets because public markets are limited. However, it points to the example of one of the world’s largest economies – the United States – and how 90 percent of exits by venture capitalists occur not through initial public offerings, but as a result of strategic private acquisitions. If emerging markets are to follow that example, they will need established networks of venture capitalists with reputations for being committed for the long haul, fairness and encouraging innovation.
This report is available from Endeavor Egypt. Website: www.endeavoreg.org; E-mail: [email protected]
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