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.