Published on April 13, 2008
Early Stage Funding: Creating a New Catalyst : Submitted By New Entrepreneur Forum and Technopreneurs Association of Malaysia September 2002 Early Stage Funding: Creating a New Catalyst Table of Contents : Table of Contents Introduction Scope of this Report Situational Analysis Issues Breakdown Implications Proposed Strategic Objectives Short Term Objections Medium Term Objections Long Term Objections Information on NEF and TeAM Conclusion Appendix ~ Description to the many stages of Technopreneur’s venture Introduction: Introduction The Government has set out a policy to achieve a Knowledge Society where the funding of high technology companies is critical in achieving such objective. A more critical issue is the fact that funding to early stage companies is rare. These issues have been identified as equally critical for both the Venture Capital and Technopreneur community As such the critical mass of Technopreneurs is lacking for Malaysia to realize its vision of a Knowledge Society. This paper outlines a framework to spark Early Stage Funding (ESF) Scope of this Report : This report will propose strategies to spark early stage funding. Definition of early stage funding (for purposes of this report is defined, as the following:- Pre-Idea Idea Seed The specific definition of the above is elaborated in the Appendix Scope of this Report Situational Analysis : Have we created world class Technopreneurs? New Competitors have emerged Success Stories Taiwan : ACER India : Hotmail Singapore : Creative Technology Where is Malaysia in developing Technopreneurs as compared to other neighboring countries? Situational Analysis Situational Analysis - cont. : Situational Analysis - cont. Traditionally, VCCs do not invest in Early Stage Funding 2 out of 10 ventures invested between 2000 to Q2 2002 by VCC were in Early Stage The majority of ventures in Malaysia are in Early Stage ~ approximately 70 to 80% Traditional funds for ESF such as Grants and Angels are not reaching ESF investments Grant funding to ESF is minimal due to the lack of private sector and commercialization linkage Majority of high net worth individuals (Angels) do not invest in Technology ventures, especially ESF. There exists an ESF failure in Malaysia Situational Analysis - cont. : VC Industry Source of funds for the VC industry has always been the Government. 41% of VC funds in Year 2000 is from the Government. Venture capital companies (VCC) in South East Asia invest only between 2% to 4% of the total funds disbursed in Early Stage investments. Situational Analysis - cont. Slide8: Even in the bigger economies in North Asia, the VCCs invests between 4% to 8% of the total funds disbursed in Early Stage companies. There is a wide gap between South East Asia and other North Asian countries. Slide9: Due to the nature of small investments in early stage ventures, measuring by percentage of fund size may be inherently misleading. An analysis of total number of ventures in Malaysia and the number of early stage investments would be a more accurate benchmark. A recent survey conducted by NEF and TeAM revealed that only 19% of ventures invested by VCCs from Year 2000 to Q3 2002 were in Early Stage (Idea and Seed). With the current infancy stage of the venture industry where approximately 80% of ventures are in the early stage, many ventures will not survive due to the lack of investment capital. Slide10: In the US and Australia, ESF Funding is also not the responsibility of VCCs In addition, the Year 1999 showed only 12% of US VCC funds investing in ESF while Australia recorded a 4% fund allocation to ESF (Source: Australia VC Annual Review, PriceWaterhouse Coopers and VentureOne) Source: Office of Tech., US Small Business Administration Sources RM70 billion funds in ESF (Year 2000/ US) Federal Labs 25% University and Colleges 33% Big Business 31% Non-Profit 6% Small Business 5% Slide11: Most VCCs in Asia are generally young (and the bulk of them are less than 10 years old). In the early years, the VCCs normally tend to focus on building profitable track record of investments and would try to minimize their exposure in the high risk investments. The lack of time, cost/ resources versus returns and inclination to nurture these companies is the primary reason why VCCs don’t invest in early stage ventures No fundamental expertise or activities in the VC industry to nurture and develop ventures, a critical component in early stage funding. Many VCCs investing in their ventures played a non-active role. “Here is a little known fact that in the US, angel investment (in Early stage funding) has always exceeded the amount of venture capital sums. For instance in 1997 and 1998, four times as much venture money came from angels as oppose to venture funding” - Professor William Miller, Stanford University and Founding IAP Member during the Multimedia Business IAP Summit on 3rd of September 2002 Situational Analysis- cont: Situational Analysis- cont Grants Problems highlighted are as follows: - Difficulty in obtaining information about the availability of Grants and the stringent and market-driven application criteria. Lack of clarity regarding the level of funds and the associated terms. Too many different agencies to contact/approval process takes too long – discourages applicants No Central Resource to approach for advice. Projects funded by the Grant have little private sector linkage and thus have very little commercial value. Review Committee lacks detailed knowledge of the specific technology and future road map. More strategic direction is needed especially in wide clusters such as ICT Grants are not coordinated with private capital funding such as Incubation, VCs and Angel investments Source: Technopreneurs Association of Malaysia (TeAM); Fostering A Sustainable Environment For Technopreneurship In Malaysia ~ A Detailed Action Plan; 13th of December 2001. Findings from Industry dialogue Situational Analysis- cont: Situational Analysis- cont Available Grants for High Technology areas are as follows:- Situational Analysis- cont: Situational Analysis- cont Incubators Ample incubation space is available due to the over capacity in office rentable space The majority do have physical premises. Many also do not have the capability to provide value added support services Consolidation of the industry will occur due to the ‘dot-com crash’ and global recession. For example MTDC is currently evaluating exiting from the incubation business and JIC has seized operations Fundamentally there may be a handful of core players with the necessary capability to support and develop Technopreneur’s ventures. Due to their ability to develop Technopreneur’s ventures, these incubators will remain leaders in their respective fields No holistic matching of incubation with demand with corporations and the Government The majority are physical incubators with only a selected few having the support services such as advisory and technology support Situational Analysis- cont: Situational Analysis- cont Angel Funding Angel funding in Malaysia is very minimal The absence of angels investors causes the lack of successful technopreneurs willing to invest on future ventures Overall, angel type funding is crucial for Malaysian technopreneurs as even in the US, (the best funding model), not more than a quarter of VC funds have funded early stage ventures (Source: Dr. Colin Mayer (2001) – Information Economics and Policy – Volume 1) Despite the noble and innovative efforts of the Kuala Lumpur Angels Club (KLAC), there exists a market failure in Angel Investing in Malaysia Situational Analysis- cont: Situational Analysis- cont Technopreneur Community Majority of Technopreneurs are in the early stage where substantial numbers get eliminated due to lack of funding Valuation have become realistic and many have seized operations due to industry consolidation, global recession and the bursting of the Internet bubble Lack of broad based management expertise among Technopreneurs such as marketing, administration or corporate finance Lack of proven successful Technopreneurs Ample talent for Technopreneurship with considerable experience from abroad and local scene due to the the industry consolidation Potential entry of Technopreneurs from corporations and universities. Talent pool is relatively young (below 40 years old) “Reaching for the sky, without feet firmly on the ground” “Want money with no strings attached” Slide17: Idea/Concept Seed Start-up No. of ICT Companies Early Stage Idea/Concept Seed Start-up No. of ICT Companies Early Stage investment will allow increase in deal flows to Start-up stage where mostly VCCs invest. What we have a lot of Where the focus is now We need to build this to get a lot of this Situational Analysis- cont: Situational Analysis- cont The Gap of Discontent The Gap between Technopreneurs, VCs and Investors are widening. Issues – Technopreneurs Perspective: Issues – Technopreneurs Perspective Idea is generated Preparation of Business Plan Submission to VC for evaluation | valuation | Funding | Managing | Nurturing (if any) Receive funding Verbal presentation If Yes If No PROBLEM AREA Repercussions Low Investment rates of growth Not meeting half way Static between VC’s and Technopreneurs No growth for Technopreneurs and country Adverse social and economic impact Issues – VC’s Perspective: Issues – VC’s Perspective Idea is generated Preparation of Business Plan Submission to VC for evaluation | valuation | Funding | Managing | Nurturing (if any) Receive funding Verbal presentation If Yes If No PROBLEM AREA knowledge pride risk profile expectation Experiences Industry knowledge High risk takers Does not understand what risk is Does not understand what is required by investors Reaching for the sky, feet not on the ground Want money with no strings attached Does not want to be told what to do Does not want to learn Low knowledge on Business BUT at times high knowledge in Technical issues Repercussions Bad business plan Does not understand what is needed Cannot justify idea Cannot explain the idea clearly Sometimes technically inclined but not in other fields Low investment take up rate from investors Get frustrated and give up Issues – Investor’s Perspective: Issues – Investor’s Perspective Investors investment decision Preparation of Investment Charter Do Investors invest in VCs rather than more traditional avenues/ What is my risk profile? Invest in traditional means Review of Investment choices If Yes If No PROBLEM AREA knowledge risk profile expectation Low risk takers Comfortable profits from investments with low risks Low knowledge on Technology Repercussions Lack of VC funds Early stage investments are not funded due to the perceived high risks \ Risk adverse is transferred to VCs Form a VCC and/ or appoint VCM Breakdown - Knowledge: Breakdown - Knowledge Many Technopreneurs, many ideas BUT cannot translate into readable business plan Quality of deals not meeting VCs standards Poor business writing skills Break in chain – marketing and sales strategy VCs – no technical expertise, does not appreciate technology Breakdown – Risk Profile: Breakdown – Risk Profile VCs Risk Averse consequently no funds for seed capital Bonded with high ROI to shareholders and Risk Adverse investors Lack of profitable exit strategies for early stage involvement Business Model structure: Do not encourage to invest Technopreneurs Risk taker – Selected few beliefs in ‘do or die’ situation To avoid the “Fake Technopreneurs” A need to have better selection of Technopreneurs Wanting capital with no strings attached Expensive Lifestyle - Many still wants it Breakdown - Expectations: Breakdown - Expectations VC vs. Technopreneur The gap is broader and nobody addresses it Critical need for Government bodies (MAVCAP, MDC, MIMOS etc). to address these issues What exactly are VCs looking for in the investee companies? Breakdown - Market Failure: Breakdown - Market Failure No right risk and reward scenario Investment in Early stage companies takes high risk with high cost with very little reward Due to the following: - Low survivability due to saturated/ highly competitive demand in local market to sustain early stage technology ventures Demand for technologies is low - Mindset and Culture No exit avenues prior to flotation Implications: Implications Government Unable to achieve K-economy targets Misdirection in funds (VC, Loans and Grants) No innovation Technopreneurs Business ideas distorted ~ Do not meet VCs’ standards Funding issues remain unresolved Winding up because unable to sustain Losing competitiveness as compared to foreigners Quality of Technopreneurs is low Proposed Strategic Objectives: Proposed Strategic Objectives Holistic Approach Funding Quadrant Technopreneurs Quadrant Venture Capital Institutional Investors Government Investors Angels Grants Project Financing Loan Incubators Source of Technopreneurs = University and Corporates Technopreneur community Proposed Strategic Objectives - cont.: Proposed Strategic Objectives - cont. Strategic Thrusts Direct capital into Early Stage ventures Enhance the info-structure of all communities Improve the quality of Technopreneurs and their ventures Improve the source of Technopreneurs Improve the sustainability of Technopreneurs Seeding Angel Community Development Slide29: 2H 2002 2003 2004 1H 2005 2H 2006 Short Term Mid Term Long Term Thrust 1: The creation of an Incubation Industry Thrust 2: Strategic changes in VC Industry Thrust 3: Strategic changes in Grant Disbursement Thrust 4:Tax Incentive to Angel investors Thrust 1: Implementation of the Technopreneurs Development Grant Thrust 2: Changes in University Commercialization Plans Thrust 3: Changes in Project Financing Loans Thrust 4:Test bedding and Commercialization by Corporations and Government Thrust 5: The Case of Instigation Thrust 5: The Technopreneurs On-Line Database (TOD) Proposed Strategic Objectives - cont. : Proposed Strategic Objectives - cont. Short Term (By the end of 2003) Getting capital to Early Stage Technopreneurs Thrust 1: The creation of an Incubation Industry Thrust 2: Strategic changes in VC Industry Thrust 3: Strategic changes in Grant Disbursement Thrust 4:Tax Incentive to Angel investors Enhancing Info-structure to all communities Thrust 5: The Technopreneurs On-Line Database (TOD) Proposed Strategic Objectives - cont. : Proposed Strategic Objectives - cont. Medium Term (By the end of 2005) Improve the quality of Deals and Technopreneurs Thrust 1: Implementation of the Technopreneurs Development Grant Improve the source of Technopreneurs Thrust 2: Changes in University Commercialization Plans Improve the sustainability of Technopreneurs Thrust 3: Changes in Project Financing Loans Thrust 4:Test-bedding and Commercialization by Corporations and Government Seeding “Angel” community development Thrust 5: The Case of Instigation Proposed Strategic Objectives - cont.: Proposed Strategic Objectives - cont. Long Term (2006 and onwards) Create winning Angels from successful Technopreneurs/Viable industry funded mechanism for early stage funding Create a sustainable Incubation Industry led by the Private Sector Incubators with specialized domain expertise Track record from Incubators An Environment of early exit Continuous community-driven programs to develop Technopreneurs Short Term Objectives (By the end of 2003): Short Term Objectives (By the end of 2003) Thrust 1:The Creation of an Incubation Industry Current number of True Incubators are minimal. To create the demand for Incubation arising from the following needs:- The need to nurture, mentor and develop via “Best Practices” ventures in the early stage Increasing the success rates of ventures in the early stage as to provide quality and quantity of deal flows Increasing the quality of deal flows to Venture capital companies Short Term Objectives (By the end of 2003) - cont. : Short Term Objectives (By the end of 2003) - cont. Thrust 1:The Creation of an Incubation Industry - cont. The creation of Boutique Incubators (BI) led by capable and experienced Technopreneurs with low overhead costs. 12 boutique incubators funded and supported by the Government BI’s will be managed by experienced Technopreneurs drawn from the current supply of experienced talent abroad and locally/ with domain expertise Investments to concentrate in early stage funding of approximately RM500,000 to RM1 million BIs will have the necessary Domain Expertise and will invest in the respective industry The need for viable Business Model. International experience shows that Incubators are a social need and government-supported business model is crucial to the industry’s success Short Term Objectives (By the end of 2003) - cont.: Thrust 1:The Creation of an Incubation Industry - cont. Focus Incubation Funds Strategic funds to be set by the Government to be managed by BIs of RM300 million to be divided among the 12 BIs A Business model will have to be formulated between BIs and the Government The nature of the funds is developmental in objective, so as to create the critical mass of local Technopreneurs. Short Term Objectives (By the end of 2003) - cont. Short Term Objectives (By the end of 2003) - cont.: Short Term Objectives (By the end of 2003) - cont. Thrust 2: Strategic Changes in the VC Industry Explicit policy to direct at least 30% of total funds to be invested in Early stage as defined here as Pre-idea, Idea and Seed level companies Disbursed via Incubators Heavier penalty (including withdrawal of funds) to Govt funded VCs who failed to disburse funds within stipulated period Revamp and more active roles by Govt in monitoring VCs activities – set priority in local companies rather than foreign companies The smart partnership between VCs and BIs and where VCs will collaborate with BIs to source, invest, advise and develop early stage ventures Short Term Objectives (By the end of 2003) - cont.: Short Term Objectives (By the end of 2003) - cont. Thrust 2: Strategic Changes in the VC Industry - cont. Developmental driven financial package to Early stage funding, valuation and criteria Government guided Win - Win Business Model The fee structure and business model must be viable to sustain Incubation activities Full mandate by BIs to invest in early stage companies with domain expertise and meeting minimal standards Supported by the Government Hybrid Model Sharing fee structure with VCs Fees to BI as part of investment amount Government supported Management fees Short Term Objectives (By the end of 2003) - cont.: Short Term Objectives (By the end of 2003) - cont. Thrust 3: Strategic Changes in the Grant Disbursement Revamp needed in the structure and disbursement of existing Grants Government grants should be reviewed and relevance to K-economy efforts should be continuously assessed. Grants should move from a purely R&D and social focus, to a “developmental focus”. Disbursement period should be shortened to below 6 months from complete application. Matching Grant Existing Grant should be established to match investments automatically (without any further assessments) investments by Angels, BIs and VCs into early stage companies Short Term Objectives (By the end of 2003) - cont.: Short Term Objectives (By the end of 2003) - cont. Thrust 4:Tax Incentive to Angel investors 100% tax deduction on investments made by Angels to Early Stage Companies With the ability to carry forward on outstanding balance to future incomes. Short Term Objectives (By the end of 2003) - cont.: Short Term Objectives (By the end of 2003) - cont. Thrust 5: The Technopreneurs On-Line Database (TOD) to meet the following objective: - To register an inventory of Technopreneurs in Malaysia with their skills and ventures; To promote collaborative Technopreneurship where a symbiotic program is instilled to assist a technopreneur from the skills, knowledge and experience from another technopreneur; To effectively monitor and manage Technopreneurs and their ventures An online application for the relevant grants that assist the growth of ventures A source to seek VCs, angels, Incubators and other funders A source for market and business development collaboration, including foreign linkage. A Technopreneur registered at the site must have one or more ventures or may be working on a few ventures, which may be eligible for the Technopreneur Development Grant (TDG/ Medium Term Objective) The Government is to provide a Grant in the development of TOD Medium Objectives (By the end of 2005): Medium Objectives (By the end of 2005) Thrust 1: Implementation of the Technopreneurs Development Grant To concentrate on Pre-Idea and Idea stage or any stage prior to first round financing from VCs For Market research, business plan, recruitment of suitable key personnel for core management team, identification of strategies and strong partners for strategic alliances and initial “Proof of Concept” Applicable also for due diligence cost incurred in relation to investments by Angels, BIs and VCCs. Maximum of RM150,000 per Technopreneur Applicable to Technopreneurs registered with TOD Medium Objectives (By the end of 2005) - cont. : Medium Objectives (By the end of 2005) - cont. Thrust 2: Changes in University Commercialization Plans Patent and licensing Business Model review between University staff and the University Utilize research centers set up by Universities Transform ideas to saleable products Provide channel of marketing and packaging for the ideas Inject more business input from Private Sector Cost savings in R&D equipment Medium Objectives (By the end of 2005) - cont. : Medium Objectives (By the end of 2005) - cont. Thrust 3: Changes in Project Financing Loans The current climate for early stage companies is difficult to secure project financing loans The current initiative by Malaysia Debt ventures to finance ICT related projects is exemplary and should be replicated for Projects of RM1 million and below Sources of loans now originate with development banks and commercial banks which do not have the skill sets to evaluate high technology companies It is recommended to collaborate and form smart partnership with BIs and specialized consultancy companies to evaluate and analyze loan applications submitted to development and commercial banks Medium Objectives (By the end of 2005) - cont. : Medium Objectives (By the end of 2005) - cont. Thrust 4:Test bedding and Commercialization by Corporations and Government Strategic Demand creation Work with corporations/ government to test bed and refine commercialization of products and services by Incubated Technopreneur companies/SIRIM Benefits Enhance skill sets and innovation by Incubatees Widen marketing and client base of Incubatees Reduce foreign technology reliance by Corporations and the Government Reduce cost of technology usage by Corporations and the Government Slide45: Technopreneur Barrier Attempts to go for projects but comes across a big barrier Reasons for barrier: Not known Dependency by clients of foreign technology Perception of high risk and instability Lack of development innovative companies Bad perception of small technology providers Slow growth for SMI’s Left to compete for a smaller pie among other SMI’s REPERCUSSIONS Technopreneurs Online Database Corporations and Government can access TOD to source for technologies Medium Objectives (By the end of 2005) - cont. : Medium Objectives (By the end of 2005) - cont. Thrust 5: The Case of Instigation It’s a “mind-set” problem The need to instigate “Angel” success where others can follow in the success stories Create the success stories to encourage early stage investments from the disclosure of investment returns by selected Angels Selected Angels exist within certain companies Encourage attractive financial/migration/retirement schemes in Malaysia for active global angel investors Long Term (2006 and onwards): Long Term (2006 and onwards) Create winning Angels from successful Technopreneurs/ Viable industry funded mechanism for early stage funding Create a sustainable Incubation Industry led by the Private Sector Incubators with specialized domain expertise Track record from Incubators An Environment of early exit Continuous community driven programs to develop Technopreneurs Information on NEF and TeAM: Information on NEF and TeAM New Entrepreneur Forum (NEF) NEF was initially set up as a self support group for young Bumiputra entrepreneurs in 1997. NEF (formally known as The New Economy Forum) was formed by a few concerned individuals involved in the Internet businesses in Malaysia. The concern emanates from the diminutive number of local participants in the industry, on top of the alarming drop-rate in our market share, which is capitalized by foreign players. NEF hopes to increase the number of Malaysia Technopreneurs, and nurture them into world class e-Business players, which will be the showcases for the next generation to come NEF members are existing practitioners of the Industry and have in-depth knowledge of the market Information on NEF and TeAM - cont. : Information on NEF and TeAM - cont. The Technopreneurs Association of Malaysia (TeAM) The Technopreneurs Association of Malaysia (TeAM) was formed by a group concerned “grassroots” Technopreneurs from the ICT industry who have been involved within the industry for the last few years. Recognizing a need to actively support the Government with a view of improving the environment for Technopreneurs in Malaysia and to create a better, stronger ICT industry TeAM and the Government both want the same thing - to ensure that the nation progresses towards Vision 2020 by being competitive in a more globalised and technologically-enhanced world. Conclusion: Conclusion There is an urgent need to direct funds to early stage Technopreneur companies Current environment shows alarming high rate of ventures without the correct funding and support services which results to high turnover of failures This proposal has highlighted the incremental strategic objectives to specifically address this problem and improve Technopreneurs development in Malaysia The successful implementation of the proposed plans will both create a new Incubation industry and the same time improve the survival rate of early stage ventures. Appendix: Appendix Definition of development stages of ventures Pre-Idea A stage where a Technopreneurs has a few ideas for a venture but has not started on any initiative to progress on any of the ideas. This is natural for example many Technopreneurs from educational institutions (student or academic personnel) who are in the initial stages of experimenting and researching on the numerous ideas. Idea The next stage of development is when the Technopreneurs have identified a particular venture and have taken concrete steps to produce the following functions: - Business Plan, together with detailed market research Proof of Concept Alpha to Commercial product or service Seed The initiation of organizational structure or legal entity to operate and mange the venture will commence in this stage of development. Normally the founding shareholders will form a core management team or top management. No revenue or very minimal revenue with slow growth is evident at this stage of development Start-up This stage marks the higher evolution of the venture where a management team will have support functions such as finance, administration and a proper marketing department. Revenue will experience high growth exceeding CAGR of 20% and existing capacities of the venture will reach maximization, which will mark the commencement of the next stage – Expansionary. Expansionary As in its name, this stage symbolizes the high-expanded stage of the company where head counts, capacity (technical and supportive roles) will greatly expand to meet with high growth of demand. This stage will be characterized by multiple cycles where the venture expands to different levels such as a solution development company expanding from a domestic market to a regional market and so forth. Pre-IPO The venture has reached a level of viability and accepted market levels to be floated in a market bourse with minimal accepted regulations and market qualifications such as underwriting and etc.