Back in the 1990s, many Silicon Valley venture capitalists had a rule of thumb: only invest in companies that are less than an hour's drive from your headquarters. In those days, firms could get away with a distance screen?most of the world's most cutting-edge technologies were indeed being developed within an hour of Sand Hill Road.
But thanks in part to the rise of instantaneous communication and the unstoppable pull of globalization, US venture firms can no longer afford to ignore start-ups in faraway places. Emerging markets in particular, such as China, India and Israel, have become hotbeds of innovation.
Expanding into an emerging market, however, can be a daunting process, particularly for venture firms that traditionally rarely forayed out of the Menlo Park bubble. ?It puts a strain on the traditional startup model,? says BlueRun Ventures' founding partner John Malloy. ?You have to start thinking globally much earlier than you ever did before.?
In this article, four venture capital firms that have successfully become global firms told PEI Manager about the obstacles and successes they've encountered while establishing operations in emerging markets. The firms also discuss the issue of sharing profits across borders.
Crawling, walking, running
When moving into a new region, venture capital veteran NEA follows what chief operating officer and general partner Gene Trainor calls a ?crawl, walk, run? strategy. In the ?crawl? stage, the firm begins to send members of its team to the target country to meet with local professionals, scope out opportunities, build a network and begin to make investments. Only after all of this groundwork is in place and the firm has seen some success in the market, Trainor says, does NEA move into the ?walk? stage, in which the firm builds an office in the target country and establishes a local team.
?We saw and continue to see great opportunity in India, with its growth and all the technical expertise in the country.?
The first country in which NEA followed that three-stage strategy was China. More recently, NEA made its foray into India, with the opening of its Bangalore office in January of 2007. At that time the firm had already made several investments in the country, and had also made a commitment to NewPath Ventures, a local fund run by tech guru Vinod Dham. Impressed by the market, NEA ultimately decided to establish its own team on the ground.
?We saw and continue to see great opportunity in India, with its growth and all the technical expertise in the country,? Trainor says. ?We just felt like it was a natural extension for us.?
NEA already had a team of US-based professionals dedicated to India, and through one of them the firm found Ben Mathias to be its man on the ground. Mathias had spent a few years at Coopers & Lybrand Consulting, and then gone on to head several tech startups in India. Mathias, along with advisor Amit Sharma and one administrative assistant comprise the current staff of the India office, in Bangalore.
The India team's function is effectively a consulting role, Trainor says. Investment decisions are still made by the US office, where two general partners, a partner and a principal work on India investments. The team in India serves to help NEA build its network in the country, look for investment opportunities, conduct due diligence and monitor and support NEA's existing investments.
NEA tries to address compensation in a uniform way throughout its offices, but each country has unique practices, and the firm is sensitive to local compensation structures and practices, Trainor says.
In India, this means dealing with a ?heated compensation market? for investment professionals, Trainor says. Particularly at the partner level, demand significantly outstrips supply, and the result is that there is very little distinction between compensation levels in India and the US. Currently, NEA's India partners do not share in the fund's carried interest, although Trainor says that such a compensation structure could evolve in the future.
The firm's India operations are conducted through its subsidiary, New Enterprise Associates (India). The fund is based in the US, but makes investments through a special purpose vehicle registered in Mauritius, in order to take advantage of that country's tax treaty with India. NEA has also made an investment in IndoUS Ventures, the successor vehicle to NewPath. NEA has two GPs on the advisory board of the fund as well, and shares deal flow in India with IndoUS Ventures.
NEA's investments into the Mauritius vehicle are made in US dollars, and the Mauritius vehicle's investments in Indian portfolio companies are made in rupees. NEA employs a local accountancy in Mauritius to handle the vehicle's bookkeeping and tax filings. The Menlo Park team will visit Mauritius once or twice a year to check the books, Trainor says, but the structure is not a significant burden on NEA.
?The accounting matters are fairly straightforward and they don't tend to change that frequently,? Trainor says. ?It's really just a matter of getting the right service providers in place and having processes and controls in place.?
The exit process in India does impose some restrictions, however. In the US, when a portfolio company is listed on a stock exchange, a venture firm can offer its limited partners the option of selling or holding their shares. But in India, only the Mauritius vehicle is legally entitled to hold the shares, so NEA can only return cash to its investors.
Good morning Vietnam
IDG Ventures is the venture capital arm of the IT media firm International Data Group, a company that conducts market research, publishes industry data and organizes conferences. Its venture arm comprises six funds operating in North America and Asia, with offices in Boston, China, India, Korea, San Francisco and Vietnam.
The publishing and conferences side of IDG's business usually paves the way for IDG Ventures to enter a new market, says IDG chairman and founder Pat McGovern. Such was the case when IDG Ventures decided to open an office in Vietnam. IDG had been operating in Vietnam since 1992, and over the years the firm had observed improvements in the country's business conditions, and rapid market growth across sectors.
But the Vietnamese government has historically been relatively suspicious of, and unreceptive to, venture capital investment, so IDG Ventures had to spend more time than usual preparing its entry into the country. The firm sent representatives as early as 2002 to meet with the government and explain how venture investment helps to develop local companies and foster local entrepreneurial talent, as well as create new jobs and exports.
By 2004 Vietnam was preparing to enter the World Trade Organization, which would simplify international business and investment conditions. By that time talks with the government had also proceeded to the point where IDG felt confident in setting up a fund. In August of that year the firm opened its first office in Ho Chi Minh City.
IDG began looking for a local partner to run the proposed fund, and found Hoang Nguyen. Nguyen had previously worked for Goldman Sachs' technology and enterprise software group in New York, and had then gone on to grow the Asian business of a US start-up telecommunications company, VITC.
?[Nguyen] was a well-qualified person who had been a local entrepreneur, and also had an MBA degree from the US, and good business understanding and expertise,? McGovern says.
With Nguyen in place, IDG looked at the capital needs of the country, and decided to raise around $100 million for its first Vietnam fund. Like NEA in India, the IDG fund makes its Vietnam investments through an offshore special purpose vehicle, which is based in the Cayman Islands. That fund has invested in 24 local companies to date.
IDG's Vietnam operations are now split between an office in Ho Chi Minh City and another in Hanoi. The firm has four partners on the ground and a support staff of 16, including a CFO, an operations and public relations director, a president of technology development, a business development professional and a legal counsel. The legal counsel, Binh Pham, has a particularly critical role; she is responsible for interfacing with the government.
Each of the partners has a share in the fund's carried interest, as well as a 2 percent to 2.5 percent management fee. The management fee alone is on par with a typical senior executive level salary in Vietnam, McGovern said.
In the first year out, the Vietnam team submitted potential investments back to the US team, who would review the deals and provide advice. The investment decision was solely in the hands of the Vietnam team, however, and by the team's second year out the US office would only provide advice at the Vietnam team's request. That progression is IDG's standard policy when setting up a new fund, McGovern says.
?I think they appreciate our sharing our knowledge about what seems to be working well in terms of markets, company strategies and deal structures, which gives them a competitive advantage in their own countries.? McGovern says.
IDG's Vietnam team can also seek advice from IDG's other partner funds. Although the overseas teams have a high level of autonomy, communication between all of the firm's offices is still regular. Each fund's investment team receives monthly reports from every other fund, and four times a year IDG has a general meeting for all of its partners. Knowledge sharing can be very helpful in markets that have similar characteristics in different countries, which is often the case in the Asian tech sector in particular, McGovern says.
IDG has had several home runs in Vietnam, where growth rates can be staggering. In 2004, IDG provided seed funding for online social gaming website Vinagames. Since then the company's profits have risen from around $400,000 per year to more than $40 million per year, McGovern said.
?Before a China deal goes through, it's subjected to scrutiny on a global standard. The investment has to be something that our colleagues in other markets see as something that meets their standards as well.?
But investing in Vietnam hasn't been all smooth sailing. When IDG first began investing in the country, the government capped foreign ownership of companies at 30 percent. The regulation presented a problem for IDG, which found that it was not able to adequately capitalize its portfolio companies. To work around this regulation, IDG had to set up independent companies that were majority owned by Vietnamese groups, which would then make investments in a portfolio company on behalf of IDG once IDG had reached the 30 percent limit. Fortunately for IDG, foreign ownership laws in Vietnam have since been liberalized.
BlueRun Ventures defines itself as a single fund that operates globally. This description contains the germ of its international strategy: though the firm has offices in China, Finland, Israel, India and Korea, all of its teams are integrated as seamlessly as possible, and follow a standard set of practices in their operations.
The firm, formerly the venture unit of Nokia, recently opened an office in Beijing, its second in China. BlueRun typically follows a three-stage strategy when entering a new region: studying deal flow, making investments, and finally opening an office, according to founding partner John Malloy. The process can take years, but when BlueRun is interested in a market the firm is willing to plan for the long run.
BlueRun started looking at deals in China in 2000, and in 2001 hired a partner dedicated to China investments, Jui Tan. Tan had the perfect mix of international and local experience to lead BlueRun's team on the ground, having worked as director of global service development at Singapore Telecom, in addition to several positions at IBM.
Tan had plenty of operational experience, but still needed to learn the ropes in the venture capital world. But his lack of financial experience was not a problem for BlueRun, which likes to hire people early and grow them into a position, Malloy said.
?We very much like to develop our own people,? Malloy says. ?We don't generally hire laterally.? BlueRun based its initial operations in China out of Hong Kong, where it opened an office in late 2002. But with Tan's input BlueRun quickly realized that the weight of China's financial markets was shifting to Shanghai, and the firm moved its Chinese headquarters to that city in 2003.
The firm now has four investment professionals between its two offices in China. They interact constantly with the firm's other offices. Every Wednesday the firm holds two conference calls, one at 7 am Pacific Standard Time and a second later in the afternoon for those who couldn't make the earlier call because of time zone differences. During these weekly calls the firm's partners go through all of the firm's potential deals as a group.
In addition to these meetings, the firm's offices use everything from video conferencing to audio conferencing to email and instant messaging to keep in touch. Each office also constantly updates spreadsheets with information on deals and portfolio companies, which are then distributed among all of BlueRun's partners.
Not only is this constant exchange of information useful for resource sharing, but it also has the effect of raising the bar for BlueRun investments in every country, Tan says.
?Before a China deal goes through, it's subjected to scrutiny on a global standard,? Tan says. ?The investment has to be something that our colleagues in other markets see as something that meets their standards as well.?
Maintaining firm-wide standards is something that BlueRun emphasizes. All BlueRun offices review investments and manage their companies in a systematized manner, which Malloy says ties the geographically distant partners together in an important way. The uniformity is also useful because so many of BlueRun's portfolio companies are expanding abroad and conducting cross-border transactions, processes which often require the direction both an in-country and out-of-country partner.
?In order to be effective, you have to be very systematic and have common processes across the firm,? Malloy says. ?It creates synergy within the firm.?
Draper Fisher Jurvetson
Draper Fisher Jurvetson is a seasoned traveler. The firm established its first affiliate partner fund, Polaris Ventures in Anchorage, Alaska, in 1990, back when most other venture funds hadn't even thought of leaving Silicon Valley. Since then the firm's affiliate network has grown to include 23 partner funds managing more than $6 billion in Europe, South America, Russia and Asia.
Don Wood, the DFJ managing director who oversees the affiliate network, refers to it as a ?mesh network?. The affiliate partners are locally based and independent, but share information, limited partners, deals and resources. Importantly, the affiliates interact with each other, not just the Menlo Park office.
Before deciding to move into a country or region, DFJ examines huge quantities of data, developed by Stanford MBA students, on the area's demographics, economics, educational indicators, geopolitical risk and venture capital concentration.
Once a favorable decision has been made, DFJ normally takes from six months to a year to choose an affiliate partner, depending on whether the firm is well established or still getting off the ground. Once a part of the DFJ network, the affiliate partner is responsible for fundraising, although DFJ gives the firm access to its limited partner list and makes introductions.
Affiliate partners share resources with Menlo Park and with each other. The entire network pools contacts, a benefit which DFJ calls ?Rolodex power?, as well as knowledge of deal structures and portfolio company management techniques. DFJ affiliates will often bring in other affiliate partners to co-invest on deals.
And to ensure that each partner has a vested interest in the success of the others, DFJ has set up a carry exchange program. Each affiliate partner swaps one point of their carried interest with another partner, creating an incentive for the affiliates to help each other.
Choosing an established local partner fund has its benefits, eliminating many of the headaches that come with setting up an office in a new country. And the strategy ensures that DFJ's investment team on the ground has cultural knowledge and connections.
But the affiliate partners' high level of independence comes with risk as well. Once a local partner has seen a high degree of success, it may decide that it no longer needs the added benefit of the DFJ brand name. Affiliate partners have left the network: former East Coast affiliates Draper Atlantic and DFJ New England merged to become New Atlantic Ventures in 2006, and are no longer affiliated with DFJ.
?We recognize and [affiliates] recognize that there has to be a balance of benefits that flow in order to keep the relationships together, so we are working hard to make sure that that balance is in their favor, that there's a strong reason why they want to be part of the network and that as part of the network, everybody does better,? Wood told sister publication Private Equity International around the time its added its Brazilian partner, FIR Capital, to the network.
Most recently, DFJ set up affiliate partnerships in Israel and Russia. In Israel DFJ chose 10-year-old venture firm Tamir Fishman Ventures. In Russia, DFJ joined with Russian commercial banking group VTB for form a new Russian venture capital fund, DFJ-VTB Aurora.