March 13, 2011 Presented at Global Strategic Innovation Presented by Peter S. Cohan U. Srinivasa Rangan Luksic Professor of Strategy.

March 13, 2011

Presented at Global Strategic InnovationPresented by Peter S. Cohanhttp://www.petercohan.comU. Srinivasa RanganLuksic Professor of Strategy and Global Studies, Babson College

Capital Rising:Global Capital Flows, Entrepreneurial Ecosystem, and

Opportunities for Entrepreneurs and Capital Providers

This material was used in an oral presentation.

Without the accompanying oral comments, it is incomplete as a record of that discussion.

http://www.petercohan.com/

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Today’s Agenda

• Our research– Global Capital Flows– The Entrepreneurial

Ecosystem (EE)

• Capital providers – Issues– Case Studies– Broad Lessons

• Managers– Issues– Case Studies– Broad Lessons

• Startup CEOs– Issues– Case Studies– Broad Lessons

• Policymakers– Issues– Case Studies– Broad Lessons

Our recent book focused on global capital flows

• Capital flows and the entrepreneurial ecosystem

• Implications for:– Policymakers– Capital Providers– Managers– Start-ups– Promoters of

entrepreneurship (NGOs)

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While FDI grew at a 17% annual rate between 1993 and 2007, more recently private capital flows have risen faster, at a 31% annual rate

Global Capital Flows

Source: UNCTAD, World Investment Report, 2009; IMF, Balance of Payments StatisticsNote: Private portfolio inflow data is a rough estimate

Global Foreign Direct Investment Inflows and Private Portfolio Equity Inflows (1993 to 2007). $ in Billions

$225$375 $475

$1,000$800

$600$775

$2,000

$30 $70 $110 $150

1993 1995 1997 1999 2001 2003 2005 2007

Global FDI Private Portfolio Flows

Our research focused on four questions

• How and why are these capital flows occurring?

• What is the impact of these flows on the global economy and on the economies of countries?

• How will these flows affect my life as a capital provider, entrepreneur, manager, and policy maker?

• What are the ways I can benefit from or protect myself from this new wave of globalization?

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Source: Cohan and Rangan, 2010

Global Capital Flows

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We posited that capital flows to countries with Entrepreneurial Ecosystems (EEs) that are conducive to entrepreneurship

IntellectualPropertyRegime

FinancialMarkets

CorporateGovernance

HumanCapital

National-levelEntrepreneurship

Entrepreneurial Ecosystem


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Silicon Valley’s strong EE helped Google rise


FinancialMarkets

CorporateGovernance

HumanCapital




1. Stanford grad students Brin and Page found company

2. U.S. IP regime lets them patent their page-rank algorithm

3. Sequoia and Kleiner Perkins invest

4. U.S. corporate governance lets Google hire talent using options and gives VCs patience to develop business model

5. Successful 2004 IPO

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Infosys founders had to seek success by working around India’s weak EE


FinancialMarkets

CorporateGovernance

HumanCapital




1. Seven middle class Indian engineers start Infosys

2. India’s IP regime makes it hard to patent IT innovation so they decided to use low cost, Indian talent to build software for U.S. companies

3. India provided no risk capital so they self-financed

4. Lack of protection for minority shareholders scared Indian banks from investing so they tapped U.S. EE

5. Successful IPO through U.S. ADRs

EE has implications for key stakeholders such as capital providers, managers, startup CEOs, and policymakers

Policymakers (6)

Implications for EE Participants

Need to build off EE strengths and offset weaknesses

Capital Providers (7)

Ways to invest in fast-growing countries while overcoming their EE weaknesses

Managers (8)

Need to acquire to grow globally by building on core capabilities

Start-Up CEOs (9)

Ways to create global value chain that optimizes country-specific EEs

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Capital providers face challenging questions

• Within emerging markets, how can capital providers choose the right industries and companies in which to invest?

• How should capital providers build networks that will give them the best deals?

• How can capital providers enhance the value of companies in which they invest?

• How should capital providers find the most profitable exit door?

Issues for Capital Providers

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Capital providers need to understand the varying goals of all EE participants

Capital Providers

Existing Firms and

Industries

Policymakers

New Firmsand

Industries

Eco-systemValue

Capital market regulatorsIntellectual property regulatorsImmigration policymakersTrade policymakers Education policymakersCorporate governance policymakers

Private equity Hedge fundsInstitutional investorsVenture capitalCorporate venture capital



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Capital providers should anticipate how capital flows can spur countries to upgrade their EEs

GlobalCapitalFlows

ExistingEntrepreneurial

Ecosystem

ModifiedEntrepreneurial

Ecosystem

DemonstrationEffect



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In deciding where to invest, capital providers may want to look at a country’s capital receptivity index


FinancialMarkets

CorporateGovernance

HumanCapital

National LevelEntrepreneurship

Minority shareholder rightsOperational transparencyCorruption prohibitionsFunctional barriers to entry Government independenceShareholder value orientationRestructuring barriers

Global capital barriersFinancial reporting requirementsTransaction volume and depthRelative valuationsCost and time to complete IPOBalance of “fast” vs. “slow” moneyBuilding proprietary informationDepth of management pool

Strength of educational systemCultural bridging skillsFunctional skill competitivenessRelative labor costs

Legal protection of IPDepth of IP enforcementCourt system efficiencyAbility to monitor IP enforcement

Capital Receptivity IndexSource: Cohan and Rangan, 2010

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U.S. CRI of 82 exceeds Portugal’s 57 due to advantages in corporate governance, financial markets, and IP regime

Capital Receptivity Index

Source: Cohan and Rangan, 2010, Mira Amaral, Portugal's former Industry and Energy minister

24 3015 13

82

17 17 143

57

2635

22 17

100

CorporateGovernance

Financial Markets Human Capital IntellectualProperty Regime

CRI Total

Capital Receptivity Index Components (U.S., Portugal, and Maximum)

U.S. Portugal Maximum

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To get CRI of 57, Amaral scored Portugal’s EE elements on 23 factors from 5 = world’s best to 1= world’s worst


Corporate Governance Score

Minority Shareholder Rights 4

Operational Transparency 4

No Functional Barriers to Entry 4

Independence from Government 3

Shareholder Value Orientation 2

No Restructuring Barriers 3

Financial Markets Score

Financial Innovation 1

No Barriers To Global Capital 3

Strict Financial Reporting 3

High Transaction Volume & Depth 2

High Relative Valuations 2

Quick and Cheap IPOs 3

Balance of Fast and Slow Money 3

Insider Trading Prohibitions 3Human Capital Score

Deep Management Pool 3

Strong Educational System 3

Good Cultural Bridging Skills 4

High Functional Skills 2

Low Relative Labor Costs 4

Intellectual Property Regime Score

Legal Protection of IP 4

Deep IP Enforcement 2

Efficient IP Court System 1

IP Enforcement Transparency 3

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We are conducting research into national CRIs and have gathered some initial data


Source: Peter Cohan interviews with country experts from Linklaters and Sovereign Ventures, 2010Note: Percentages are calculated by dividing each country’s score from 5 = world’s best to 1 = world’s worst on several factors for each EE element by the maximum possible score

Corporate Governance

Financial Markets

Human Capital

IP Regime Total CRI

China 10 15 17 4 46

India 15 23 12 9 58

Russia 10 10 16 3 38

Maximum 26 35 22 17 100

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Our case studies show how EE analysis helped capital providers to profit

• Global Venture Network Invests in China– Lesson: Great investment returns flow from screening

investments and placing capital in fast-growing companies that comply with strict governance standards

• Warburg Pincus Profits in India– Lesson: High profits can come from investing when things look

too risky to most players and selling when peers pile in to replicate your high returns by anticipating changes in capital markets

• IDG Ventures Invests in Asian Service Businesses– Lesson: Profits flow from adapting to an EE that does not respect

IP by investing in service businesses that meet growing consumer needs thus avoiding IP issues

Case StudiesSource: Cohan and Rangan, 2010

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GVN earned 100% IRRs through stakes in Chinese jewels

• Opportunity– Chinese companies with good management were growing at a

rate of 30% internally and 30% globally

• EE Complication– Inconsistent levels of corporate governance created a risk of

losing capital

• Solution– Found jewels -- 1% (or 3,000) of private Chinese companies with

potential for NASDAQ listing – Did this by screening for companies whose management

complied with Sarbanes-Oxley and could be “scaled up”

• Results– Earned 100% IRRs between 2002 and 2006


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Warburg Pincus made five times its $300 million investment in Bharti Tele-Ventures

• Opportunity– India is huge market with a growing need for mobile telephony

services as economy grows

• EE Complication– India had weak infrastructure and high government barriers to

Western capital flows

• Solution– Viewed weak infrastructure as opportunity for mobile telephony – Anticipated Indian liberalization of capital markets

• Results– Between 1999 and 2005, Warburg Pincus’s $300 million stake in

Bharti Tele-Ventures grew to $1.5 billion– Warburg Pincus earned 35% annual IRRs over 10 years by

selling to competitors who came in after its Bharti gains


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IDG earns 100 times its money on an investment in Asia by adapting to EE weaknesses

• Opportunity– Asian economies are large and growing very rapidly

• EE Complication– Asia, in general, has weak Intellectual Property (IP) protection

and inconsistent corporate governance standards

• Solution– Invested in service-oriented investments, such as online music

communities and social networks – whose success does not depend on IP

– Conducted intensive due diligence on managers and employees

• Results– IDG had one company that was worth 100 times what it invested

Case Studies


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Use the EE to assess and profit from emerging market investment opportunities

1. Assess opportunities and risks in the country’s EE

2. Identify the industries in those countries most likely to benefit from foreign capital

3. Build deal source network within those industries

4. Based on your firm’s strengths, find the best companies within those industries in which to invest

5. Work with the entrepreneur to set goals and obtain the capital and other capabilities needed to achieve the goals

6. Pick the best means of exiting the investment


Broad Lessons

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Managers in existing industries must balance the need for growth against pressure to limit risk

• Should they preserve the corporate strategies that got their companies to their current position?

• Do those strategies represent a core rigidity that makes their companies unable to adapt to change and thus vulnerable to up-start competitors?

• If so, do acquisitions represent a profitable means of reviving a moribund company’s growth?

• How do we tap into private capital to grow?

Issues for Managers

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Our case studies show how EE analysis helps managers in existing industries to profit

• Mittal Acquires Sicartsa – Lesson: Profits flow to a skilled acquirer of under-managed

assets in a country with untapped profit potential by transferring corporate governance advantage from the acquirer to the target

• Japan Tobacco Buys Gallaher – Lesson: Financial markets enable a company in a declining

industry to revive itself by acquiring a company in a rapidly growing new market

• Lottomatica Buys Gtech – Lesson: A smaller Italian company used its access to global

financial markets to tap the intellectual property and corporate governance advantages of a larger U.S.-based firm to create a more vertically integrated competitor for global lottery market opportunities.


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Use the EE to profit from emerging market acquisition opportunities1. Pinpoint large countries growing fast with industries in

which your company competes

2. Identify risks and opportunities in the country’s regulations regarding foreign ownership and other corporate governance matters, its capital markets, its human capital, and its IP regime

3. Identify companies in those countries/industries which that could be acquisition candidates

4. Rank the companies based on their fit with your company’s skills and the potential for an attractive investment return

5. Complete the acquisition and integration of the company that best fits these criteria

6. Set performance milestones and manage the company to achieve


Broad Lessons

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Startup CEOs must achieve rapid growth while limiting risk• Is it likely that there will be a big market in the country I seek to

sell? If so, what trends will drive that market’s growth?

• What capabilities are required to succeed in that market?

• Does my team have the skills needed to design and sell a competitively superior product in that market?

• If not, how can I close the capability gap? Can a foreign source of capital help bring the needed skills to the company?

• Will the benefits of bringing in such foreign capital outweigh its costs?

• Is there a reliable corporate governance process in the country to protect my investment in the country?

• Does the country respect intellectual property rights? If not, is there a way to build a viable business there?

Issues for Startup CEOs

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Our case studies show how EE analysis can help startup CEOs in new industries to profit

• Tutor Vista Bridges the India-U.S., Knowledge Gap– Lesson: A successful Indian entrepreneur used his excellent

track record of corporate governance skills coupled with carefully chosen U.S. capital providers to create a new industry

• Focus Media Rewards Private Equity through Quick Thinking– Lesson: A quick-thinking Chinese entrepreneur raised private

equity capital to capture a newly created market and to tap financial markets for a $1 billion IPO

• In contrast, Sawyer Research Products Lost Its Investment to Russian Expropriation– Lesson: A U.S. corporation lost its investment in a Russian

quartz plant because it failed to conduct sufficient research into Russia’s confiscatory financial markets and corporate governance practices


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Use the EE and global capital providers to profit from emerging market new venture opportunities

1. Build a top-notch management team with cultural bridging experience

2. Identify a rapidly growing market which that can benefit from the management team’s competitive strengths

3. Talk to potential customers to gain deep insights into their unmet needs

4. Raise Angel capital to finance a prototype of a product/service that will satisfy those unmet needs

5. Pick venture capital firms who can provide the additional skills needed for the company to succeed

6. Use the capital to build the company and take it public


Broad Lessons

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Policymakers must balance the need for economic growth against pressure to preserve the status quo• What can policymakers do to shape the EE to attract global

capital flows?

• What useful lessons are available to policymakers based on the experiences of other countries in trying to make the key trade-offs involved in creating a vital EE within their countries?

• How do these choices affect the economic performance of their countries?

• What tools are available to help a policymaker assess what changes, if any, the country must undertake to attract global capital flows?

• How should a policymaker use such tools to decide whether to make a country more receptive to such flows?

• And if so, what changes should a policymaker try to implement?

Issues for Policymakers

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Our case studies show how EE analysis helps policymakers attract global capital

• India’s banking system did well during the recent financial crisis by sticking to conservative regulatory practices – Lesson: India’s conservative financial market resist urge to follow U.S.

down the path of risky subprime mortgage securitization – this making India better able to withstand financial crisis and attract more capital

• Satyam’s collapse after governance failure forced Indian policy makers to strengthen governance practices– Lesson: Illusion of good corporate governance is punctured – which

caused financial markets to lose faith in Satyam and to doubt transparency of India’s capital markets

• Indian policy makers used governance rules to force Wal-Mart/Bharti partnership to transfer supply chain know-how to India– Lesson: India’s corporate governance rules prevent Wal-Mart from

opening a store their so it decides to share its logistics knowhow with Bharti Enterprises


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Policymakers can shape a country’s EE to attract global capital flows

1. Form an EE team

2. Identify key EE improvement opportunities

3. Rank the EE improvement opportunities

4. Analyze the costs and benefits of implementing the high priority EE improvement opportunities

5. Implement those EE improvement opportunities with the highest net benefits


Broad Lessons

Global capital flows are changing the business systems all over the world

• Private capital has begun to recognize how the evolving EE opens up new opportunities especially in emerging markets

• Private capital has begun to find ways to exploit opportunities by adjusting to EEs in emerging markets

• Entrepreneurs and managers in emerging markets have begun to tap into global private capital markets

• Policy makers have begun to make changes in EEs

• A New Era of Global Entrepreneurship has arrived!

31 A New Era

March 13, 2011 Presented at Global Strategic Innovation Presented by Peter S. Cohan U. Srinivasa Rangan Luksic Professor of Strategy.

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