Usaid Venture Capital Experiences

USAID Program and OperationsAssessment Report No. 17

The Venture Capital MirageAssessing USAID Experience

With Equity Investment

by

James W. FoxCenter for Development Information and Evaluation

U.S. Agency for International Development

August 1996

U.S. AGENCY FOR INTERNATIONAL DEVELOPMENT

The views and interpretations expressed in this report are those ofthe author and are not necessarily those of the U.S. Agency for International Development.

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Page

Introduction v

Glossary vii

1. The Rationale for Equity Finance 1

2. What Does the ‘Real’ VentureCapital Industry Look Like?

3

Profile of the Venture Capitalist 3How Venture Capital Companies Are

Established4

Relevance of the Venture Capital Modelfor USAID

5

3. USAID’s Experience with VentureCapital Projects

6

Analysis and Interpretation 11

Page

4. The Enterprise Fund Model 14Quality of the Equity Portfolio 16Operational Issues 16

5. Experiences of Other Approaches,Other Places

18

Private Ventures 18Multilateral Agencies and Other

Governments20

Where Was Venture Capital in the ‘AsianMiracle’ Countries?

22

6. Why Is Venture Capital a Mirage? 23

7. Conclusions for USAID Programs 24

Bibliography

Table of Contents

The Venture Capital Mirage iii

iv Program and Operations Assessment Report No. 17

IS USAID FUNDING for equity investment inbusiness enterprises a useful way to reduce

poverty and stimulate development? Thisstudy looks broadly at previous experiencewith equity investment to answer that ques-tion. It examines 13 USAID venture capitalprojects. It also reviews USAID’s recent expe-rience with enterprise funds in Eastern Europeand surveys related experience of others.

USAID venture capital projects have almostuniformly failed, the study finds. At the pro-ject level, USAID’s approach clearly appearsflawed. Two problems are evident. First,USAID often promoted venture capital pro-jects in unpromising country environmentswhere the business climate was uncertain orthe prospects for expanding firms were poor.

Second, the Agency usually treated an activ-ity requiring great flexibility and initiative asif it were straightforward and simple. Projectswere overdesigned: they set too many goals orspecified the approach to be used. A variantconcept, enterprise funds, developed in East-ern Europe , improves subs tant ia l ly on

USAID’s traditional approach, because it dele-gates most decision-making to the implement-ing enti ty. Some enterprise funds haveperformed relatively well, but others have in-curred significant losses. None has yet shownpromise of substantial profitability.

Beyond the design issues, some aspects ofthe experience of USAID and other donors andenlightened private efforts suggest a more fun-damental reason for failure. The allure of eq-uity investment in emerging companies indeveloping countries is a mirage. Conceptu-ally, it appears likely to pay high returns. Inpractice, it does poorly.1 Because donor pro-grams are unable to produce results, venturecapital should be left to private organizationswilling to accept the risks.

This report is organized as follows. Chapter1 lays out the traditional rationale for venturecapital activity. Chapter 2 describes the struc-ture of the industry in the developed countrieswhere it is most advanced. Chapter 3 summa-rizes USAID’s experience with venture capitalprojects, and chapter 4 discusses enterprise

Introduction

The Venture Capital Mirage v

1

Hope springs eternal, however, and the poor track record of venture capital in developing countries has done littleto dissuade people from seeing it as a magical remedy. See for example ‘‘Venture Abroad,’’ by Larry Schwartz inthe November 1994 Foreign Affairs for evidence that transplanting the U.S. venture capital industry to developingcountries continues its allure.

funds, used by USAID in Eastern Europe.Chapter 5 examines the experience of privateenterprises and multilateral agencies that havepromoted venture capital in developing coun-

tries. Chapter 6 responds to the question ofwhy venture capital projects usually fail, andchapter 7 provides conclusions.

vi Program and Operations Assessment Report No. 17

ADELA Atlantic Community Develop-ment Group for Latin America

ATI Appropriate Technology Incorpo-rated (Asia)

AVT Agricultural Venture Trust (east-ern Caribbean)

BVP Business Venture Promotion(Thailand)

CDC Commonwealth DevelopmentCorporation

DFC Development Finance Corpora-tion (Haiti)

HIAMP High Impact Agribusiness Mar-keting and Production (easternCaribbean)

HPAEs high-performing Asian economies

IBEC International Basic Economy Cor-poration

IFC International Finance Corporation

IIC Inter-American Investment Cor-poration

JADF Jamaica Agricultural Develop-ment Foundation

LAAD Latin American Agribusiness De-velopment Corporation

PED Private Enterprise Development(Kenya)

PIC Private Investment Corporation(Costa Rica)

PICA Private Investment Company ofAsia

SIFIDA Société Internationale Financièrepour les Investissements et de De-velopment en Afrique

Glossary

The Venture Capital Mirage vii

PEOPLE IN DEVELOPING countries are poorin part because they have far less capital

than people in industrial countries. Because ofthis shortage, workers have little in the way ofspecialized machinery and equipment, andfirms lack money to obtain more equipment.As a result, productivity of workers in devel-oping countries is low compared with that ofworkers in industrial countries.

Financial-resource flows from industrial todeveloping countries are an obvious means toovercome this inequality. But financial re-sources are not enough. Some developingcountries have natural resources such as oil orminerals that, when sold on world markets,have provided large amounts of money. Inmany cases (such as Ecuador, Iran, Nigeria,and Zaire) the money has failed to stimulatesustained economic growth or increased pro-ductivity and income for the average person.

In part, failure to use capital productivelyresults from the way these resources flow. Insome countries the government gets themoney, which it uses to perpetuate itselfthrough military spending or through in-creased consumption spending (‘‘bread andcircuses’’). In other cases, resources flow towealthy individuals who use them to maintainhigh levels of conspicuous consumption or totravel to the watering places of Europe.

Donors and development strategists haveproposed various approaches to channel finan-

cial resources to ‘‘the right places’’ to alleviatethe shortage of capital in poor countries. Inpart, this is the role of the banking system inany country. It performs an intermediary func-tion, hiring money from those who need moneylater rather than now and renting it to peoplewho can use it productively now. In most de-veloping countries, the banking system playsthis role only imperfectly. Governments arepartly responsible, because they use the finan-cial system to transfer resources from the pri-vate to the public sector, or they establishpolicies (setting low interest rates, for exam-ple) that interfere with banks’ intermediaryfunction.

Even in the best of circumstances, however,banks have limitations. Banks lend money theythemselves have borrowed, and they seek as-surance that funds they lend will be repaid, sothat the bank in turn can repay its lenders at theproper time. The borrower from the bank mustrepay whether the project is a failure or a mod-erate or smashing success. The bank’s primaryconcern is security. It cares less about the useof the money than about the assurance of re-payment. Conservative practices, such as reli-ance on collateral and lending only to largeestablished businesses, are manifestations ofthis quest for assurance.

Banking systems are inherently conserva-tive and status quo oriented. But conservativeapproaches are not enough if developing coun-tries are to reduce poverty quickly. Mecha-

1The Rationalefor EquityFinance

nisms are needed to channel resources to thehighest potential payoff, even though the riskmay be higher than for traditional uses. Smallbusinesses with no credit history need fundingfor expansion so they can grow into large busi-nesses. New, generally small businesses needinitial infusions of capital so the owner’s ideacan be turned into sales, jobs, and profits. Evenwhere medium-term prospects are favorable,the near term may be difficult to predict. It isconsequently risky for such businesses to bor-row money and incur fixed obligations to re-pay because the near-term repayments mayexceed their cash-flow capabilities and pre-vent the firm from achieving sustainability.

There is, therefore, a need for risk capitalfor people with ideas and capabilities but with-out money. Historically, much risk capital hascome from wealthier people who know person-ally the potential user. Extended families playthis role in many cases. Among religious orethnic minorities, group solidarity is oftenhelpful. Indeed, the great economic success ofsome groups (Jews, Lebanese, overseas Chi-nese) results in part from the ability to mobi-lize resources within the community forpromising enterprises. Larger firms in an in-dustry also may provide capital to new, smallerfirms----often suppliers----when they know thenew firms’ capabilities or promise.

For the most part, however, budding entre-preneurs lack access to capital from thesesources. If they are to obtain capital, it mustcome from a source with whom they have nopersonal acquaintance. This is where venturecapital enters the development business. Aventure capital financier looks for promisingenterprises to back with funding and limitedtechnical advice, perhaps for a considerableperiod of time. If the enterprise fails, the fin-ancier simply loses his stake. If it succeeds, the

financier has acquired an equity stake in thecompany that allows him to benefit in propor-tion to the success----and sometimes far out ofproportion to his initial investment.

This need for venture capital is not limitedto developing countries; the United States hasthe most developed venture capital industry inthe world. The U.S. industry is particularlycritical to growth of new firms in high-technol-ogy industries such as computers and biotech-nology. A typical venture capitalist expects tosell off the equity after a five- to seven-yearperiod, during which the firm has had time todevelop its market niche and mature finan-cially.

The case for equity financing is, on the sur-face, a compelling one. The rationale forUSAID involvement in venture capital pro-jects has typically been to demonstrate the ex-istence of a profi table market for suchfinancing, thus catalyzing private flows forthis purpose.

Venture capital activity is aimed primarilyat small and medium enterprises. Large enter-prises are a different matter, as they have thecapital base and visibility that make them can-didates for conventional lending, as well asbond sales and equity sales on a broad scale.There is some confusion about the relationshipof venture capital to stock market develop-ment, and some USAID projects used stockmarket development as part of the rationale forventure capital activity. This approach is notborne out by experience. The universal experi-ence seems to be development of public own-ership and stock markets in a graduallybroadening process, with securities of largeand stable enterprises providing the backboneof stock market expansion.

2 Program and Operations Assessment No. 17

THE VENTURE CAPITAL industry is well de-veloped only in Canada, Great Britain,

the United States, and a handful of other in-dustrial economies. Venture capital can be fur-nished by an entrepreneur’s family, aninformal lender, a pension fund, an insurancecompany, a development finance institution, asmall bank, a commercial or investment bank,a formal venture capital company, or any otherfunder willing to provide financing withoutcollateral in return for an equity stake in theenterprise. Although the industry continues toevolve around the world as entrepreneurs varyits implementation to suit their specific finan-cial needs, some characteristics remain thesame.2

The venture capital industry evolvesthrough a combination of a) demand for alter-nate, unconventional forms of financing and b)a financial sector mature enough to absorb ahigher level of risk and uncertainty in invest-ment decision-making.

Profile of the Venture Capitalist

Venture capitalists are usually specialists inone or a few industries. They make their in-vestment decisions solely on the basis of theprofit potential they see in business proposals.The only objective of managers of venturecapital companies is capital appreciation. Thusthey channel all their energies into choosinginvestments that, with technical and financialoversight, can grow in sales and profits to thepoint that the equity stake increases in valueand can be converted into cash or liquid assets.Although venture capitalists may appreciatethe need for economic development in thirdworld countries, their sole motivation is toseek out and invest in high value-added com-panies, to influence as much profitable growthas possible in the shortest amount of time,3 andto profit from that investment through stockmarket divestiture or any other viable exitstrategy.

2What Does the ’Real’Venture CapitalIndustry Look Like?

The Venture Capital Mirage 3

2This description of the characteristics of the venture capital industry is drawn mainly from Frustace (1994a), whoreviewed academic literature (such as Wellons et al. 1986), USAID project documentation, and interviewed venturecapitalists in the United States.

3Typically, venture capitalists look to make investments in countries or industries that can yield an expected returnof 30 percent a year by permitting divestment after five to seven years for three to five times the original value ofthe investment.

The high risk--high reward nature of venturecapital often steers fund managers towardhigh-margin industries that can benefit fromvalue-added management and technical and fi-nancial assistance. High margin and profit po-tential usually come in the form of a companywith new technology but little knowledge ofhow to finance, produce, market, or distributeit. Accordingly, venture capitalists often playa major role in moving newly developed tech-nologies into the commercial sector. A fundmanager sees the commercial potential of anew product and can translate that potentialinto a viable and highly profitable businessundertaking.

Investments with high growth potential areoften specialized windows of opportunity, vis-ible only to the trained eye; venture capitaliststypically choose 3 percent or fewer of the busi-ness plans submitted to them for financing. Topass the rigorous standards set by venture capi-talists, business proposals must provide evi-dence of how a company can, with specializedassistance from the venture capital company,earn returns well above the market rate. Evenso, venture capitalists expect to make most oftheir profits from a minority of their invest-ments. One rule of thumb is that a fourth of theinvestments will fail, half will break even oryield a modest profit, and a fourth will be bigwinners.

Most USAID projects were designed underthe assumption they could implement and in-fluence the growth of venture capital compa-nies and industries without meeting therigorous standards venture capitalists set forthemselves. Those standards include hiring ex-perienced and specialized fund managers whohave 1) the knowledge and expertise to chooseportfolio companies with convincing and vi-able business proposals, 2) the ability to man-age those investments with the attention and

care needed to nurture potential into reality,and 3) some of their own money at risk.

How Venture CapitalCompanies AreEstablished

Traditionally four steps are involved in put-ting together a venture capital fund in the U.S.private sector:

1. Assemble a group of professionals withproven track records and both domestic andinternational connections. These connectionsare needed to raise capital initially and to as-sist in disposition of fund assets later.

2. Have each of the fund’s managers legiti-mize his participation in the company by con-tributing personally significant capitalization.Acceptable levels of internal fundraising sig-nal to both commercial investors and potentialinvestee companies that the venture capitalcompany has a dedicated management staff.Investment funds are generally capitalized at$8--10 million per professional. Normally aminimum of $25 million4 under managementis needed to generate adequate managementfees.

3. After assembling a dedicated and well-capitalized management team, the venturecapital company must raise a predeterminedexternal minimum amount and have a firstclosing.

4. The company can now pursue proposalsfrom companies seeking investment capital,otherwise known as developing a transactionsflow.


4

Well-established venture capital companies in the United States have pools of capital ranging from $5 million to$30 million and have grown as large as $200 million in recent years.

Relevance of the VentureCapital Model for USAID

Wide differences exist between financialmarket conditions in the industrial countrieswhere venture capital companies have thrivedand those in developing countries. USAID hasmost commonly made two major assumptions:1) the U.S. experience can be transferred di-rectly to developing countries by professionalsusing techniques learned in the United Statesand 2) venture capital development is a vehiclefor stock-market development. Both assump-tions are open to question.

Conditions in developing countries are suf-ficiently different from those in industrialcountries to call into question the first assump-tion. Information----about the company’s fi-nances, about market condit ions, aboutrelevant government policies----is likely to bemuch scarcer in developing countries. Legalsystems are frequently less transparent, andgovernment policy may change more quicklyand dramatically than in industrial countries,making the prospects for any company lesspredictable. Developing countries are farsmaller economies----a typical developingcountry has a gross national product the size ofthat of one U.S. city. Prospects for profits fromindividual transactions are therefore likely to

be much smaller. In sum, risks are likely to bemuch larger, and profit prospects muchsmaller, than in the United States.

Venture capital was not a vehicle for stock-market development in the United States. Vi-b ran t equ i t i e s marke t s long p recededdevelopment of the venture capital industryhere. Moreover, emerging companies are un-likely to be an important part of any country’sstock market. The backbone of such marketshas to be equity and debt of very large andstable companies with long track records anda need for additional capital.

Every country has such blue-chip enter-prises, ranging from banks, breweries, and ce-ment plants to public utilities. Public utilitydebt would seem an important factor even ifsuch enterprises are government owned. Givenefforts to privatize utilities in many develop-ing countries in recent years, these enterpriseswould also seem a more promising means forstock market development than unknown smallcompanies. Overall, a well-established marketfor equity and debt in large enterprises wouldseem to indicate the possibility of developingtrading in smaller companies. Where no suchmarket exits, it seems unlikely that promotionof equities in small companies would produceone.


USAID HAS HAD a modest interest in ven-ture capital over the past few years.

There has been a steady flow of project activ-ity, but not enough for the Agency to developa cadre of experienced specialists. USAID hasapproved at least 13 projects since 1970 (seetable 1) that included at least one componentaimed at venture capital or equity investment.

For this study, the author reviewed availabledocumentation in USAID’s central documentscenter to learn the projects’ outcome. Wheregaps existed in documentation, the author at-tempted to clarify the record by contactingindividuals knowledgeable about a project.5

Venture capital projects, however, are gener-ally slow to mature. USAID disbursementstypically end after all funds are committed,usually four to five years after inception. Atthis point the final evaluation report is written,and the written record (as well as USAID staffinvolvement) ends. Another five years or soare likely to elapse before a sound determina-tion can be made of the value of the invest-ments. Given this difficulty, as well as gaps indocumentation, conclusions reached on avail-able data must be tentative.

Project papers generally used justificationin accord with the theory above----the activitywould stimulate flows of funds to high-payoffinvestments, which would stimulate develop-ment by creating jobs and raising output. TheUSAID project would be a catalyst, leadingother private organizations to begin providingventure capital. Often there was also the ex-pectation the increased supply of equities re-sulting from the project would help developthe capital market, or the stock market, in thecountry.

In three projects, the venture capital compo-nent was not implemented. For the remainingprojects, the result as compared with the ven-ture capital expectation was uniformly disap-pointing. In none of the cases did the genericventure capital scenario proceed according toplan----that is, the firm acquires shares in a setof firms, sells them for a profit, and invests theproceeds in new firms. The specific cases vary.

1. Latin American Agribusiness Develop-ment Corporation (LAAD) and its subsidiariesreceived six USAID loans totaling $44 millionfrom 1971 through 1989. LAAD was estab-lished by 12 U.S. agribusiness firms in 1970with an initial capital of $2.4 million to invest

3USAID’s ExperienceWith Venture CapitalProjects


5

Teri Frustace of DAI, Inc. prepared detailed case studies of the AID projects (Frustace 1994b) which provided thebasic data for this section.

in Central American agribusiness enterprises.The initial USAID loan was intended to in-crease LAAD’s involvement as a lender andequity investor in agribusiness enterprises inCentral America. The corporation was to make

equity investments wherever possible, as ameans for capital market development.

LAAD was to use at least two thirds of the$6 million in its first USAID loan for equity orfor loans convertible into equity. LAAD’s eq-

Table 1. USAID Approved Venture Capital Projects

Year Country Amount*($million)

Purpose Implemented?

1971 Latin America 20.0 Latin American AgribusinessDev. (LAAD)

yes

1979 Egypt 1.0 Private InvestmentEncouragement Fund

no

1982 Haiti 12.0 Establish developmentfinance corporation forlending and venture capital

no

1984 Jamaica 21.2 Grant for JamaicaAgricultural DevelopmentFoundation for loans,equity investments

yes

1985 Costa Rica 26.0 Private InvestmentCorporation for lending,equity

yes

1985 Asia na Appropriate Technology, Inc. yes

1986 Eastern Caribbean 40.0 High-impact agribusinesspromotion

yes

1986 Ireland 50.0† Part of cash transfer forventure capital lending

yes

1987 Thailand 3.0 USAID Private EnterpriseBureau loan to a newventure capital firm

yes

1987 Jordan 0.7 Establish a venture capitalfund and other activities

no

1987 Kenya 9.6 Fund two equity capitalcompanies

yes

1988 Sri Lanka 2.4 To launch a venture capitalcompany and otheractivities

yes

1989 Africa 2.4 Africa Growth Fund forequity investment

yes

*Project amounts are not necessarily for venture capital; in some cases, the USAID funds are usedfor lending by firms using other funds for venture capital activities.

†Total project; documentation unclear on amount for venture capital activity.


uity investments, however, were not particu-larly successful, and LAAD saw little prospectfor sales of equity holdings that would permitit to avoid the risk of illiquidity. In a secondloan in 1976, USAID agreed to eliminate theequity requirement and sought instead to haveLAAD put greater efforts into promoting agri-business investments that benefited smallfarmers.

After that, LAAD established itself as anefficient financial intermediary for private ag-ribusiness investment in Central America. Itmaintained a low administrative cost structureand closely managed its portfolio. Commerciallosses averaged less than 1 percent of the port-folio, according to a 1989 evaluation. Never-theless, LAAD experienced serious financialproblems in the early 1980s, when politicaland economic turmoil enveloped most of Cen-tral America. Most of its Nicaragua portfoliohad to be written off, and the imposition ofdebt-service restrictions by other governmentsin the region undercut its financial position.

In 1993, 91 percent of LAAD’s assets werein loans, only 9 percent in equity. Its capitalbase had risen to $20 million, and its loans andequity holdings to $62 million. Of all the insti-tutions USAID promoted in the venture capitalfield, LAAD is the only one that is a sustain-able, profit-making enterprise. USAID’s sub-s tan t i a l suppor t p layed a key ro le .Nevertheless, the return earned by LAAD onits USAID resources was modest. Had LAADinvested the Agency’s resources in six-monthU.S. Treasury bills rather than in developmentprojects, the corporation’s capitalizationwould have risen to more than $40 million.

2. The Egyptian Private Investment Encour-agement Fund was designed in 1979 to providefinancial assistance in the form of loans andequity investment to large private sector com-panies. USAID authorized up to $1 million inequity investments, but no investments wereactually made. The venture capital componentof the project had not been carefully designed.The entire project had serious implementationproblems, with four chiefs of party during its

relatively short life. Part of the funds werelater deobligated.

3 . Appropriate Technology Incorporated(ATI) venture capital initiatives. ATI receivesUSAID grant assistance, which it has used tofund several venture capital initiatives in Asia.During the early 1980s, ATI developed venturecapital funds in Indonesia, the Philippines, SriLanka, and Thailand. All four funds were man-aged by nonprofit organizations headquarteredin the host country. All ended poorly. Each fellfar below design objectives in number of in-vestments, capitalization rate, and financialself-sufficiency. ATI concluded that nonprofitorganizations cannot successfully managefunds that have the sole purpose of makingmoney. ATI established a second generation ofventure capital funds in Indonesia and Thai-land in the late 1980s with more experiencedventure capitalists. Neither fund had begundivestiture by 1993, but ATI considers the in-vestments to be satisfactory and potentiallymarketable.

4. The Jamaica Agricultural DevelopmentFoundation (JADF) was a venture capital ac-tivity initiated in 1984. The foundation re-ceived PL 480 Title II surplus U.S. dairycommodities, which it processed and sold tocapitalize an investment and loan fund. Prob-lems came in the form of a lack of clear under-standing regarding sustainability. AlthoughUSAID identified sustainability as one of theprimary project goals, JADF relied continuallyon granted surplus commodities as its solesource of investment funds.

After experiencing bottlenecks in process-ing and marketing cheese and butter, the foun-dation met with cash-flow problems and reliedon a USAID grant facility to subsidize operat-ing costs. Although the project took steps toimprove its operating procedure and cash flow,the USAID project assistance completion re-port indicated that JADF had not been able tobuild a capital base and was still dependent onUSAID-granted dairy commodities as the solesource of operating income and investmentcapital.


5 . The Private Investment Corporation(PIC). This entity was established in 1984 topromote private investment in export-relatedenterprises. PIC was owned by a consortium ofCosta Rican banks, private companies, and theCoalition for Economic Development Initia-tives, a private sector export promotion agencyheavily funded by USAID. The purpose was toprovide credit, equity investment, and otherservices for investors in the export sector. PICwas to emphasize risky ‘‘nonbankable’’ proj-ects in this sector, including start-ups. USAIDprovided $26 million in funding----$20 millionfor relending, $1 million for technical assis-tance, and $5 million in USAID-managed localcurrency for equity investment.

PIC’s early lending and equity investmentexperience was disastrous. Many of the proj-ects it financed failed completely, and otherswere not making interest payments. The insti-tution flirted with bankruptcy. Managementwas replaced, and operations shifted awayfrom high-risk efforts. PIC ended its equityinvestment activities and concentrated onlending and other financial services. The cor-poration’s financial viability was subsequentlyrestored, and it has become a respectableprovider of medium-term lending.

6. The International Fund for Ireland wasestablished in 1986 for $50 million and wasappropriated by the Reagan administration inresponse to the Anglo--Irish Terrorism Reduc-tion Agreement. The fund aimed to promoteeconomic and social development by stimulat-ing private investment in troubled areas inNorthern Ireland and the adjoining provincesof the Irish Free State.

One of several project components involvedestablishing an equity investment fund in theRepublic of Ireland and another in NorthernIreland, for ‘‘providing venture capital on nor-mal commercial criteria to both start-up proj-ects and existing businesses’’ (InternationalFund for Ireland 1992, 43). The equity invest-ment activity started slowly, and a U.S. Gov-ernment Accounting Office audit in 1989criticized the fund for receiving disbursementsof several million dollars for venture capital

activities while actually committing or dis-bursing only a small fraction of the alloca-tions.

Investment activity began to pick up in 1990and 1991. By 1994 the two funds had invested$14 million in 34 enterprises in the two coun-tries. Annual reports of the International Fundfor Ireland give no indication that any equityhas been sold, nor do they give any indicationof performance of the portfolio. The fundsthemselves had not achieved profitability. To-gether, their operating deficit accumulated toabout $800,000 during 1990--94.

7. High Impact Agribusiness Marketing andProduction (HIAMP) was authorized in June1986, for $40 million, for the eastern Carib-bean region. Centerpiece of the USAID strat-egy, the project was based on a belief thatentrepreneurship was critical to growth in theregion and that venture capital funding andre la ted ac t iv i t i e s would s t imula te en-trepreneurship. Of the total, $12.8 million wasfor equity investment in small agribusiness-re-lated projects.

Because of technical and legal issues, in-cluding a prohibition on use of Agency fundsfor purchase of equity, considerable time andeffort were required to establish an intermedi-ary to manage the funds intended for equityinvestment. By 1988 a nonprofit AgriculturalVenture Trust (AVT) had been created to re-ceive the USAID grant funds and to investthem in promising agribusiness enterprises inthe islands of the eastern Caribbean. AVT wasto establish a buy-back arrangement with eachenterprise.

By the time of the close-out evaluation ofthe project in June 1993, AVT had invested in28 subprojects, mainly in private agribusinessfirms. But the trust had not sold its shares inany of the firms, nor did there appear to beearly prospects for doing so. The evaluationnarratives suggest that none of the firms hadbecome profitable, and a half dozen had ceasedoperations. A notional estimate, based on theevaluation narratives, puts the value of AVT


investments in 1993 at 51 percent of its origi-nal cost in nominal terms.

8. The Haiti Development Finance Corpora-tion (DFC) was designed in 1986 to provideloans and equity to investors for industrial proj-ects in Haiti. A small equity component wasdesigned into the project, although it wasgiven little definition. During implementation,the DFC concluded that it lacked the capabilityto manage equity investments, and the equitycomponent of the project was never imple-mented.

9. The Jordan Private Services Sector De-velopment Project was designed in 1986 toprovide several forms of financial and techni-cal assistance to the Jordanian private servicessector. A $700,000 equity component was tobe used to assist in capitalizing a venture capi-tal fund.6 The project ran into problems at theoutset and was prematurely closed by USAIDwithout any venture capital activities havingtaken place.

10. Thailand Business Venture Promotion,Ltd. (BVP) was established in 1987 for slightlymore than $6 million, including $3 million inequity provided by Thai financiers, $3 millionin USAID loans, and $50,000 in a USAIDgrant for start-up costs. Over its lifetime BVPdrew down on only 30 percent of the total loanand grant facilities, for a total of 10 invest-ments. Of those, all but two registered substan-tial losses or went bankrupt.

The main problem for BVP was its unwieldymanagement style. The board of directors,made up of representatives of six commercialbanks, became involved in the fund’s everydaymanagement decisions. Conflicts among boardmembers resulted, and BVP had great difficul-ties closing on investment decisions. Addition-ally, investments that were funded were

chosen without any specialized industryknowledge.

11. The Sri Lanka Private Sector PolicySupport project was begun in 1988 as a multi-part initiative. One part was to provide financ-ing for the start-up costs of a venture capitalcompany. By completion of project activity in1993, the company had not yet attempted todivest any of its holdings. The evaluators dididentify several problems with portfolio qual-ity. The main problem had to do with invest-ment conservatism and the links of the venturefund manager to the commercial banking sec-tor. Many fund shareholders were commercialbanks, which saw the equity fund simply as atool for improving the borrowing capacity oftheir portfolio companies: a larger capital basemade them able to lend more. The evaluationalso concluded that the fund manager lackedexperience or outside connections that couldhelp fund portfolio companies develop exportmarkets.

12. The Kenya Private Enterprise Develop-ment (PED) project was a serious effort thatfailed to achieve its intended result. From pre-feasibility and design through implementa-tion, USAID made a number of inappropriatedecisions. Problems started with faulty as-sumptions about the existence in Kenya of ademand for venture capital and an enablingenvironment to support venture capital invest-ments. Owners of small and medium-size com-pan ies t a rge ted by the p ro jec t had noperception it would be desirable to reduce theirdebt in exchange for part ownership in thecompanies. Moreover, many companies re-fused to disclose real financial statements,making it impossible for venture capitalists toaccurately assess investment potential.

The second problem was inadequate capi-talization. Under the project, USAID provided


6

Although the design document spoke about ‘‘capitalizing’’ the investment fund, it is likely that the $700,000 wouldhave been used to cover operating costs and technical assistance associated with venture capital industrydevelopment.

money for two investment funds: Kenya Eq-uity Management (a USAID-formed company)and Industrial Promotion Services of Kenya.But the Agency provided insufficient financ-ing to support even one venture capitalist. In-sufficient funding is perhaps why 17 of the 18firms asked to submit proposals for the projectshowed no interest.

Because of the lack of interest by potentialfund managers, the project contracted as fundmanagers firms inexperienced in venture capi-tal. Two companies were hired. One was theproject designer, and the other was a holdingcompany based in Kenya. By the end of theproject, neither company was engaged in main-stream venture capital activities. Each redes-igned its mandate to provide financial servicesmore in demand----one as a merchant bank andthe other as a holding company. Although thefund managers of both companies were smartand hardworking, and although both realizedand fulfilled an unmet demand for assistancein financial services, the project strayedwidely from its intended purpose of equityinvesting.

13. The Africa Growth Fund was incorpo-rated in 1985 with a planned $10 million inequity participation from institutional inves-tors (to be raised by First Boston Corporation),buttressed by $20 million in credit guaranteedby the Overseas Private Investment Corpora-tion, and a USAID grant of $150,000 to coverstart-up costs. The start-up process took muchlonger than anticipated, and First Boston with-drew from participation. A merchant bankingcompany known as Equator Holdings Ltd. tookover management, agreeing to make at least 12investments a year for 2.5 years, or a total of30 investments. (Equator Holdings was parentcompany of the same merchant bank that un-successfully managed the Kenya Private En-terprise Development project describedabove.)

But the fund was able to raise only half theintended $10 million in capital. The shortfalljeopardized the company’s cash flow, and itsability to meet its original investment schedulewas put into serious doubt. A 1993 evaluation

concluded that although the fund had madegood investments, its high costs relative to itsportfolio size made its ability to be profitablequestionable. It seemed likely the fund wouldhave to divest early from its holdings to meetimmediate cash needs.

Analysis andInterpretation

The USAID projects reflect differing de-grees of sophistication about the venture capi-tal industry, ranging from vague aspirations todetailed analyses. Many projects made poorinvestments; nearly all had cost structures thatmade them unsustainable. Only one institu-tion----the Latin American Agribusiness Devel-opment Corporation----has proven over time tobe clearly sustainable. It did so, however, byshifting from equity funding to more conven-tional agribusiness lending, combined withsubstantial subsequent USAID funding.

For the nine USAID projects that were im-plemented, table 2 provides some summaryjudgments based on available evaluations.These reports were reviewed for evidence ofthe quality of the implementation structure,speed of implementation compared with ex-pectat ions, qual i ty of investments , andwhether the company made any profitable di-vestments.

Implementation structure. Most projects en-countered difficulties because the structureconceived in the project paper was not feasiblein practice. In some cases (e.g., High ImpactAgribusiness Marketing and Production pro-ject), the proposed structure was found to belegally impermissible under USAID competi-tion guidelines. In other cases, the manage-ment structure of the implementing institutionprevented effective decision-making.

Implementation speed. Most projects werefar slower disbursing than anticipated. Thisusually reflected a scarcity of investment op-portunities of the desired quality. In turn, thatreflected a poor country climate. Project pa-pers were usually optimistic about the demand


for funding, but such optimism seldom provedjustified in practice.

Average investment quality. The informa-tion base for this variable is limited, and judg-ments a re o f t en based on qua l i t a t ivestatements in evaluation reports. Nevertheless,the evaluation reports contain no evidence ofbig winners, nor do they document any im-provements in national capital markets as hav-ing resulted from the project.

Profitable divestments. The ultimate test ofthe venture capital concept is in the sale ofequity investments in the marketplace for aprofit. This enables the venture capital com-pany to reinvest in new companies. Althoughinformation is incomplete for several projects,no record of profitable divestments exists forany company. (If such divestments had beenmade, it is reasonable to assume they would

have been publicized as evidencing success ofthe project.)

Four characteristics of USAID projectsseem responsible for the poor performance:

1. Choosing the wrong implementer. In mostprojects, the implementing institution had lit-tle or no previous venture capital experience.As discussed above, private sector venturecapital operations start with the managementteam, which then finds the money and the in-vestments. USAID projects typically skip thisstep and go straight to capitalizing the invest-ment fund. In fact, the Agency’s procurementprocess is predicated on allocating and obligat-ing funds before a management team is evenidentified. Characteristically, a request forproposals is released. The request contains thefund’s financial and administrative manage-ment provisions but lacks any input from the

Table 2. Characteristics of USAID Venture Capital Projects

Project Implementation Average Investment

Quality

ProfitableDivestments?

Structure Speed

LAAD eventually sound OK insufficient no?

ATI ? slow poor ?

JADF poor ? poor no

PIC poor good poor no

IFI ? slow ? no?

HIAMP poor slow poor no

BVP weak slow poor ?

Sri Lanka weak ? weak? no

PED weak good OK no

Africa Growth Fund weak slow OK ?

Source: Author’s judgments based on case studies.


implementors-to-be----who are at this stage un-known.

This approach works on USAID projects inother industries but does not work with venturecapital initiatives. That is because venturecapital companies can be successful only iftheir managers have a sense of ownership andvested interest in the fund’s success. By fol-lowing the standard bureaucratic approach toprocuring the services of a fund manager,USAID supports creation and perpetuation ofventure capital companies administered bygroups of inexperienced individuals who a)lack the skills and experience required tochoose or manage the profitable growth of in-vestments, b) are unable to provide adequateinternal capitalization, and c) are incapable ofraising funds from financial sector institutionsand typically fall seriously behind USAID’sproject design capitalization projections. Themodel followed in USAID projects for creat-ing a venture capital company was so differentfrom the typical fund manager’s way of oper-ating that USAID has not been able to interestmainstream venture capitalists in managingUSAID projects.

2. Excessive constraints on the implementer.Venture capital projects tried to target too nar-rowly. Particular USAID concerns (very smallbusinesses, the agricultural sector, women-owned businesses) were written into projects.Finding good investment opportunities in de-veloping countries is difficult enough. Furtherlimiting the ability of the implementer to se-lect investments can make sustainable opera-tion impossible. The HIAMP project aimed toprovide up to $20 million in equity and quasi-equity to firms in the small islands of the east-ern Caribbean, with a population of less than

one million. This already difficult task wascompounded by limiting activity to agribusi-ness.

3. Rigid design. In some projects, actualconditions during implementation differedsharply from those anticipated in the design.Adaptation to such problems was slow. USAIDproject designs are based on the suppositionthat the problem is understood and that a spe-cific remedy is the appropriate one. In devel-op ing-coun t ry cap i t a l marke t s , t h i sassumption of knowledge is simply unwar-ranted.

4. Inadequate demand. In most countries,entrepreneurs were extremely reluctant to sella share of their equity. USAID’s tendency is totarget development of small and medium-sizeenterprises and of capital markets as two pri-mary purposes of venture capital activity.However, a strong small and medium-size en-terprise sector and an operating capital marketare better understood as the elementary build-ing blocks on which a venture capital industrymust grow. Stock markets do not develop be-cause a handful of venture capitalists are readyto divest their holdings in small and medium-size enterprises. Rather, established invest-ment bankers mak ing pub l i c equ i tyinvestments in high-value stocks expand thesecurities market, gradually creating a marketfor such less-than-blue-chip companies. Theythus partly set the stage for development of aventure capital industry for small and medium-size enterprises. In short, USAID is putting theventure capital cart before the equity markethorse.

The first three problems are closely linkedto the ways USAID plans and implements pro-jects. The fourth is more generic.


IN 1989 PRESIDENT George Bush proposedcreation of ‘‘enterprise funds’’ for Hungary

and Poland. Later that year, Congress passedthe Support for Eastern European Democra-cies Act, which defines a broad structure andgoals for enterprise funds in Hungary and Po-land. The funds were to speed the transition tomarket economies by supporting estab-lishment and expansion of private businessfirms. They were to be established as non-profit U.S. corporations operating under theguidance of a board of directors made up of acombination of U.S. and host-country mem-bers.

A wide range of activities was permitted bythe legislation and subsequent grant agree-ments between USAID and the enterprisefunds, including debt and equity investments,leasing, grants, and technical assistance. Theexpectation was that they would be ‘‘venturecapital’’ funds, providing a mix of equity anddebt financing to emerging businesses in re-cipient countries. The enterprise funds were tooperate for a limited period (expected to be10--15 years, though this was vague), afterwhich assets of the funds were to be sold offand the proceeds redeployed for other pur-poses.

To ensure rapid implementation of the enter-prise fund concept, management of the fundswas to be largely independent of the U.S. gov-

ernment, which was to grant the resources toeach fund. Board members were to be the bestminds in the U.S. private sector and were to beappointed by the President. As shown in table3, enterprise funds for Hungary and Polandwere organized in 1990, and funds for Bulgariaand the Czech Republic began operations in1991. Seven more funds were added in 1994--95, but these are only beginning to have sig-nificant operational activity.

The relationship of the funds to the U.S.government was initially confused. The gov-ernment provided the resources but had nomembership on the boards of directors nor anyvoice in disposition of funds. No clear report-ing or monitoring relationship with USAID orother U.S. agencies was established, and fundmanagers initially resisted such oversight.

But use of public funds without public over-sight proved unfeasible. Unfavorable press re-ports in 1993 about one of the funds led to arequirement for semiannual reports to USAIDand an agreement on audits by U.S. govern-ment agencies. The funds agreed formally orinformally to a variety of other procedures,such as a ceiling on salaries of fund officialsand safeguards against export of U.S. jobs----procedures that already applied to direct U.S.government assistance programs.

Each enterprise fund took a different ap-proach to its mandate. The Hungarian and

4 The Enterprise FundModel


Czech7 funds invested almost exclusively inequities, whereas the Polish fund implementeda substantial lending program. The Polish andHungarian funds sought larger enterprises andmade investments averaging $1--3 million,while the Czech and Bulgarian funds soughtsmaller companies. The funds also varied sub-stantially in their approach to staffing, in eco-nomic sectors emphasized, in geographicaldiversification, and in the extent to which jointventures with U.S. firms were emphasized.

The funds were established for the broadforeign policy purpose of speeding the transi-

tion of Eastern Europe to a market economy.The mere act of creating the funds was itself afactor in achieving this purpose. It provided aclear statement of U.S. government supportthat probably encouraged private investmentin the region. An assessment of the success ofthe funds in this broader perspective is beyondthe scope of this report, though an overview ofthe operations and impact of the four operatingfunds is contained in a recent (1995) report byDevelopment Alternatives, Inc. The present re-port is concerned only with the venture capitalaspect of their operations.

Table 3. USAID Established Enterprise Funds

Fund Start up Authorized Amount

($millions)

DisbursedAmount

($millions)

PercentInvested in

Equity

AverageEquity

Investment ($millions)

Albanian 1995 30 0

Baltic 1994 50 5

Bulgarian 1991 55 19 73 0.6

Central Asian 1994 150 22

Czech--Slovak 1991 65 43 88 0.4

Hungarian 1990 70 54 84 1.2

Polish 1990 264 179 67 3.1

Romanian 1994 50 5

Russian 1993 440 53

Southern Africa 1995 100 0

Western NIS 1994 150 7

Total 1,424 386

Source: Authorization and disbursement amounts are as of September 30, 1995, and are fromUSAID internal reports. Equity investment data are from Development Alternatives, Inc., (1995).


7

This fund subsequently created Czech and Slovak funds as separate operations. The general approach is the same,though, so they will be treated as one entity.

Quality of the EquityPortfolio

It is still too early to measure the success orfailure of the European enterprise funds.Though they have been formally in operationfor four to five years, many of their invest-ments were made only in the last two years.Another five years of experience is neededbefore we can arrive at definitive conclusions.Moreover, the ultimate performance of a fundcan be affected dramatically by one or twoinvestments (e.g., a Microsoft of the future)that can compensate for many poor invest-ments. Despite this imperfect state of knowl-edge, the experience so far appears to providesome reasonable expectations about the suc-cess of the individual funds.

In principle, Eastern Europe should be anideal setting for venture capital activities.Since the funds were launched in 1990--91, theprivate sector in each country has grown dra-matically, with governments divesting them-selves of assets, and opportunities for newbusinesses appearing everywhere. Laborforces are much more educated than in devel-oping countries, and the policy climate forprivate business has improved rapidly. Overalleconomic activity has begun to recover in mostcountries----though private economic activitywas rising rapidly even in the early 1990s.Moreover, the Eastern European countrieslacked a banking sector either experienced orinterested in lending to small and medium-sizeprivate enterprises. Therefore, venture capitalproviders faced less competition from banksthan in other countries.

All these considerations would make oneexpect funds in Eastern Europe to perform ex-tremely well in comparison with venture capi-tal funds launched in developing countries.

It is still too soon to judge with any preci-sion the performance of fund portfolios, butavailable evidence suggests it has not beenparticularly favorable. Two of the four funds(in Czechoslovakia and Bulgaria) have suf-fered large losses unlikely to be offset by gainselsewhere in the portfolio. The value of theportfolios of the other two funds appears so farto have increased only slightly, if at all. (Bothhave, however, sold a small number of equityholdings for a profit----an achievement notdocumented for any of the USAID funds dis-cussed earlier.) None of the funds has achievedoperational sustainability. All have had diffi-culty finding equity investments that offerhigh payoffs----calling into question the basichypothesis of a severe shortage of equity capi-tal. The Development Alternatives study con-cludes, ‘‘I t is clear that the market forconventional venture capital is narrower andless profitable than might have been originallyanticipated.’’8

Operational Issues

The funds did avoid some of the problemswith USAID projects described in chapter 3.Boards of directors selected by the Presidentwere largely financial-market professionals,emphasizing private sector profitability andsustainability. Nevertheless, board memberswith investment banking experience predomi-nated over venture capitalists. Some have ar-gued that this biased the funds’ operationstoward conservatism. USAID gave fund staffstotal freedom of action, imposing none of theconstraints or rigid approaches characteristicof Agency-designed venture capital projects.

The new institutions did begin operationsquickly. In comparison with the EuropeanBank for Reconstruction and Development----the major governmental institution with thesame general mandate----the enterprise funds


8

DAI 1995, p. v.

took one year less to achieve normal opera-tions. Almost certainly, they got off to a fasterstart than would have been the case had theybeen designed as USAID projects.

Enterprise funds also adapted flexibly tochanging investment opportunities and coun-try conditions. The Polish fund shifted sub-stantial resources to its small-lending programin response to its initial favorable experience,and created a major niche in the marketplace.The other funds each did useful experimenta-tion. A typical USAID project would have lim-ited the scope for such experimentation. Since

uncertainties in these countries substantiallyoutweighed certainties, the usual USAID pro-ject, with its rigid design, would have been lesssuccessful.

Despite these operational advantages, theexperience with enterprise funds so far ismixed. Freedom from constraints appears tohave produced innovation and flexibility, butit also produced mistakes and errors in judg-ment in some funds. With strong internal man-agement, some funds avoided such problems.In other cases, greater USAID oversight mighthave prevented them.


USAID IS ONLY ONE OF A number of actorspromoting venture capital in developing

countries. Both private entities with a devel-opment goal and multilateral agencies havebeen active in this field. These other experi-ences provide a perspective for assessing thefailure of USAID to identify a successful ap-proach.

Private Ventures

1. International Basic Economy Corpora-tion. IBEC was established in 1947 by theRockefeller Foundation. Its creator, NelsonRockefeller, saw it as a model of enlightenedAmerican capitalism, to demonstrate that fos-tering profitable business activities would con-tribute to economic and social development ofpoor countries.

Originally involved in Latin America, by1968 IBEC operated in 33 countries through119 subsidiaries and principal affiliates. Em-phasizing enterprises that contributed to a na-tion’s food and housing supply, IBEC fundedsuch ventures as mutual funds, agriculturalservices, home building, poultry breeding, andmanufacturing.

IBEC had some notable successes. It pio-neered supermarket chains in Latin America thatgenerally helped reduce retail prices. It helped toimprove egg output through scientific poultrybreeding in several countries. In Brazil, IBECdeveloped a hybrid seed plant that has in-creased corn crop yields. More often, though,IBEC acquired unproductive and marginal fa-

cilities that cost millions of dollars. It got intoventures in which it had no expertise, and itfailed to make consistently good profits.

During its first two decades, IBEC experi-enced steady, if only marginally profitable,growth. Stockholders’ equity grew steadily to$16 million, and assets totaled $30 millionaf ter the f i r s t decade . By 1966 equi tyamounted to $42 million, and total assets hadgrown to $157 million.

The company decided in the mid-1950s toinvest in the United States to provide a steadiercash flow than it was getting from developingcountries. In 1955--57, IBEC purchased twosuccessful U.S. manufacturing companies,V.D. Anderson Co. and Bellows Co.

These companies provided a continuingcash flow to finance IBEC’s foreign invest-ments (Broehl 1968, 260). IBEC’s merger withthe U.S.--based Arbor Acres chicken companyin 1964 also contributed to the company’sprofitability. The merger significantly in-creased the company’s size, with gross salesfor 1965 climbing to $197 million.

By the early 1970s, however, IBEC facedserious financial troubles. In 1973 a group ofbanks led by Chase Manhattan extended IBECa $45 million line of credit. But by 1975, thecompany was unable to meet its financial obli-gations to some financial institutions. IBECagain turned to Chase Manhattan for help. Thisled to later charges of conflict of interest withrespect to Rockefeller family involvement inboth institutions. IBEC’s revenues peaked in

5Experiencesof Other Approaches,Other Places


1974 at $300 million, but management aggres-sively reduced both the work force and IBEC’saffiliations from that time on. By 1979 reve-nues had fallen to $66 million, and the Rocke-feller family decided to dissolve IBEC.

Dismantling IBEC was undertaken for a va-riety of reasons, not all of which had to do withlackluster performance in developing coun-tries. Its investments in U.S. manufacturingcompanies were also weakening by this time.Also, in the early 1970s as a result of actionsby the Organization of Petroleum ExportingCountries, IBEC found itself operating in in-creasingly hostile political environments----inVenezuela because of the rise of nationalismand suspicion of multinationals, and in Brazilbecause of hyperinflation due to balance-of-payments problems.

IBEC’s problems continued to mount. By1979, when Nelson Rockefeller died, IBECfaced increasing losses and a string of law-suits. In 1980 the enterprise was sold to aBritish conglomerate, Booker McConnell, Ltd.There it existed for several years as a subsidi-ary before disappearing entirely.

2. The Atlantic Community DevelopmentGroup for Latin America (ADELA) was estab-lished in 1964 with private American andEuropean funding to promote venture capitalfunding in Latin America. The concept of aprivate venture fund for Latin America hadbeen proposed by Senators Jacob Javits andHubert Humphrey, who generated interna-tional support. Initial investors consisted of 54major multinational manufacturing and finan-cial firms, which provided $17 million in capi-tal. ADELA later grew to have $61 million incapital, with 240 investors, none of whom heldmore than 1 percent of equity. With no domi-nant shareholder, ADELA’s large board of di-rectors provided little effective oversight overthe company’s management.

ADELA investments grew rapidly. By 1970the corporation had invested $217 million inloans and equity in 100 companies and hadoffices in 11 Latin American countries. By1977, investments had grown to $485 million

in 600 companies in 18 countries, about twothirds of which were in loans. The rapidgrowth was financed by borrowing from com-mercial banks and by issuing Eurobonds, andADELA became steadily more leveraged. Itreached a debt--equity ratio of 5.3 in 1979.

The company was consistently profitable onpaper through the 1970s, though its financialstatements misrepresented its real condition,which was deteriorating. For example, stockdividends were treated as income, and nonper-forming loans continued to accrue income.Lack of financial controls and a decentralizedstructure permitted deceptive practices bybranch offices. In January 1980, the corpora-tion declared itself unable to meet its debtobligations, and it suspended payments.

For the next decade, ADELA was, in effect,in receivership, as assets were liquidated torepay debt. Tessler & Cloherty (1985) estimatethat ADELA’s annualized rate of return on itscapital over 1969--83 was minus 60 percent ayear. It managed to reduce capitalization of$90 million to $14 million. The company wasfinally liquidated in 1992.

3 . Private Investment Company of Asia(PICA), like ADELA, had been promoted bySenator Javits as a vehicle for private sectordevelopment. Conceived in 1969, it was builton the same model as ADELA (as was SIFIDAlater----see below), with ownership distributedamong more than 100 corporations, each own-ing only a tiny share, and a mandate to engagein equity investment and lending to privatebusiness. With an initial capitalization of $40million, it began operations in 1972 from aTokyo office. It later moved to Singapore, es-tablishing eight other offices and building itsstaff up to 65.

PICA provided a variety of financial serv-ices as well as loan and equity financing. Itsequity portfolio grew to $40 million by 1984.But the combination of increasing competitionfrom other financial entities, relatively highadministrative costs, and the recession of theearly 1980s created severe difficulties for the


enterprise. In 1987 it was absorbed by EldersFinance and Investment Company of Australia.

4. Société Internationale Financière pourles Investissements et le Development en Afri-que (SIFIDA) was established in 1970 to pro-vide equity and long-term capital investmentin Africa. SIFIDA’s stockholders includedmore than a hundred private and public insti-tutions from the industrial countries as well asmultilateral agencies. As with ADELA, SI-FIDA had a large (27-member) board of direc-tors with no single dominant shareholder: theAfrican Development Bank was the largest,with 6 percent of shares.

SIFIDA’s approach was much more conser-vative than ADELA’s. The company concen-trated initially on constructing a headquartersbuilding and staffing its Geneva, Switzerland,headquarters, from which all staff operated. Itsinvestment portfolio grew only slowly duringits first decade, from $6 million in 1974 to $38million by 1981. It was only slightly lever-aged, as paid-in capital was $21 million. SI-FIDA’s s t ra tegy emphas ized equi tyinvestments, but this proved difficult in prac-tice. The corporation had placed $5 million inequity (compared with $9 million in debt) by1977, but equity holdings stagnated for the nextfive years, whereas debt grew to $37 million.During its first decade, SIFIDA had only onesizable capital gain----a profit of $1.5 million onthe sale of its Geneva headquarters building.

SIFIDA’s conservatism did protect it fromilliquidity during the early 1980s. One esti-mate of its return on investment during 1975--82 puts the annualized rate at 2.6 percent. HadSIFIDA’s capital been invested in U.S. Treas-ury bills, the rate of return would have been 9.3percent (Tessler and Cloherty 1985, 19).Worse was to come, though. The economicdifficulties of African countries during the1980s led to a gradual deterioration of the

company’s financial position. In 1994 it be-came insolvent.

Thus, all four ‘‘enlightened’’ private sectorefforts to promote venture capital in develop-ing countries ultimately failed. All four can beconsidered ‘‘benevolent,’’ in the sense they in-tended to do well by doing good: their creatorssought to promote economic development andto enjoy profits as a by-product. All four insti-tutions had difficulties in making business de-cisions. IBEC was reluctant to contest breachof contract by partners because of the adversepublicity for the Rockefeller name. The otherthree institutions lacked a dominant share-holder to enforce a clear purpose or to controlmanagement.

Multilateral Agenciesand Other Governments

1. International Finance Corporation (IFC).The International Finance Corporation was estab-lished in 1956 as an affiliate of the World Bank todirectly fund private businesses in developingcountries. The IFC operates in the venture capitalfield at two levels. First, it has provided directlending and investment in emerging enterprises indeveloping countries. Second, it has invested inventure capital companies in developing coun-tries, having taken an equity stake in eight suchcompanies during 1975--85.

IFC as an equity investor. U.S. oppositioninitially prevented the IFC from investing inequity, but its mandate was broadened in 1961to include both equity investment and lending.IFC equity investments rose rapidly after1961, and the portfolio in 1970 was 60 percentin loans and 40 percent in equities.9 After1970, however, the IFC shifted sharply awayfrom equity investments and toward lending.Equity investment continued to grow during


9

The IFC values its equity investment portfolio on a historic cost basis, so the market value of the equity share maybe somewhat different.

this period, but only slowly, whereas lendingincreased rapidly. At the end of FY 1995, 81percent of the IFC’s total portfolio of $9.5 billionwas in loans, only 19 percent in equities.

The average IFC operation is considerablylarger than those typically pursued in USAIDventure capital projects. The average newcommitment in 1995 was $12 million, andmany of the investments are in very large en-terprises: steel mills, mining companies, pub-lic utilities. Such firms are visible, and theirlarge capital requirements create the possibil-ity for widespread public ownership. Conse-quently, the IFC operates in a segment of themarket where prospects for public sale of equi-ties are far more promising than they are forthe smaller firms favored by USAID. Never-theless, the IFC’s equity portfolio has not seenrapid turnover. In 1995 the IFC sold equitywith a cost basis of only $42 million, comparedwith a cost basis for its total equity portfolioof well over $1 billion. That implies an aver-age holding period for equity substantiallylonger than the five to seven years of whichventure capitalists typically speak.

No studies were found of the relative prof-itability of the IFC’s equity portfolio in rela-tion to its lending.10 The IFC’s gradualreduction in the equity share of its operationssuggests that staff did not consider it favor-able. (Alternatively, equity lending could onaverage be more profitable but hampered bylack of opportunities.)

One apparent benefit of the IFC’s concentra-tion on private sector lending is the opportu-nity to be selective about where it places itsresources. Country conditions are generallyconsidered important to the prospects of busi-

ness enterprises, but the IFC portfolio does notappear to have been particularly successful inthis regard. Its portfolio has historically em-phasized Latin America over Asia. Evenwithin Asia, its resources flowed more to Indiaand Pakistan than to the fast-growing countriesof East Asia. (In 1983 the IFC’s portfolio inYugoslavia was larger than that of the seven‘‘Asian Miracle’’ countries combined. In thatyear, the 10 largest users of IFC resourceswere, in declining order, Brazil, Yugoslavia,Mexico, India, Turkey, Egypt, Argentina, thePhilippines, Pakistan, and Zambia.) In the 12years since then, most of these countries havebeen relatively poor performers.

IFC as investor in venture capital compa-nies. The IFC has also provided resources forventure capital companies. A recent evaluationof eight such enterprises (IFC 1992) in whichthe IFC invested $40 million from 1976through 1986 concluded that this indirect sup-port had serious problems. The venture capitalcompanies had difficulty persuading owners ofpromising businesses to sell part of their eq-uity; managers of venture capital companieswere usually inexperienced and had to learn bydoing; and developing a management structurethat created proper incentives was difficult.

Overall, the IFC’s venture capital portfolioperformed poorly. Estimated real rate of returnon its projects in venture capital companieswas minus 5 percent, compared with +6 per-cent on its overall portfolio.11 In other words,the IFC’s investment in venture capital compa-nies lost 5 percent of its value for each year itwas invested.

Inter-American Investment Corporation(IIC). In 1987 the Inter-American Development


10One IFC study (IFC 1989) examines the economic and financial rates of return to projects in which the corporationhas invested. It includes breakdowns by sector of activity for such variables but, curiously, does not consider thequestion of whether equity or lending activities have yielded better results.

11Even though the 1992 evaluation covered only investments made in 1986 or earlier, the slowness of many venturecapital operations to mature makes valuation uncertain except after a long time lapse. The IFC evaluatorsconsidered their estimates to be conservative. Thus, a later evaluation might produce less unfavorable results.

Bank established an affiliate for investment inprivate sector projects, the Inter-American In-vestment Corporation, along the lines of theIFC. It is too early to make judgments of theeffectiveness of the IIC’s investment portfolio.Nevertheless, the IIC’s early experience issimilar to cases described earlier. Start-up tooklonger than expected, and administrative costsmounted before the corporation began to gen-erate income. It encountered early difficultiesfinding suitable investments. By 1994 it hadfully committed its resources, but inflowswere inadequate to cover operational costs,and the IIC had to sharply reduce its staffing.

3. Commonwealth Development Corpora-tion (CDC) was established by the British gov-ernment in 1947 to promote development inpresent and former colonies. The corporationhas operated as a financial intermediary, witha capital stock and borrowing authority, ratherthan as an aid agency. At least between 1955and the early 1980s, the corporation was con-sistently profitable, though this may owe muchto the fact that its debt is to the British govern-ment at concessional interest rates.

CDC financing has consisted primarily ofloans, particularly for public utilities andhousing. Equity investment has represented10--20 percent of the corporation’s portfolio.The corporation has maintained a relativelylean organization, with administrative costsheld to about 2 percent of the portfolio. More-over, its country portfolio mix appears to havegenerally been better than that of the IFC.Initially confined to the Commonwealth, it ex-panded after 1972 into other developing coun-tries. This was done selectively, with initialinvestments in Costa Rica, Côte d’Ivoire, In-donesia, Liberia, and Thailand. Even withinthe Commonwealth, CDC made no invest-ments in India or Pakistan until the 1980s.

CDC’s early experience was unfavorable,and it apparently lost £11 million on the first£12 million of investments. Subsequent port-folio performance has apparently been reason-ab ly sa t i s fac tory , though no spec i f icinformation was available on the equity por-

tion of the portfolio. It has had at least one bigwinner----a share of a Hong Kong containership terminal. A 1972 loan of £2 million, laterconverted to equity, was sold in 1992 for £45million. Analysis of CDC’s total portfolio for1972--81 (Tessler & Cloherty, 1985) showedthat i t substant ial ly outperformed bothADELA and SIFIDA, producing an internalrate of return on its portfolio of 5.4 percent.(This return is not impressive for the period; itcompares with an 8.2 percent return that CDCwould have earned by investing in U.S. Treas-ury bills rather than its actual portfolio.)

Where Was VentureCapital in the ’AsianMiracle’ Countries?

The most rapid economic growth in recentdecades has occurred in East Asia, where theseven countries called high-performing Asianeconomies (HPAEs) by the World Bank havegrown rapidly and have dramatically trans-formed the structure of their production to be-come manufacturing centers. In 1992 dollars,the value of industrial output from theseeconomies grew tenfold to more than $200billion from 1965 through 1990. What role didventure capital play in this transformation?

The answer seems to be----very little. TheWorld Bank report The East Asia Miracle(World Bank 1993, p. 223) concludes that bondand equity markets ‘‘were not generally a keyfactor in mobilizing investment during theHPAEs’ economic takeoffs.’’ Stiglitz (1993)has calculated that only a small fraction of thegrowth in capitalization of enterprises in eitherthe HPAEs or in industrial countries has comefrom outside equity. Retained earnings werethe primary factor, usually accounting formore than half of financing requirements, butloans and bonds were each more importantthan equity financing in most cases. The studyconcludes (p. 226) that stock market activity,which has boomed in recent years in East Asia,is ‘‘a result rather than a cause of East Asia’srapid growth.’’


CONCLUSIONS ABOUT the success or fail-ure of USAID venture capital projects

must generally be tentative, as the documenta-tion trail in most cases ends with a final pro-ject evaluation report. Such reports aretypically written after project activity hasended, perhaps five years after the project be-gan. For venture capital projects----particularlysince they often take several years to get up tospeed----this time period may be too short. It ispossible that a few winners will emerge thatpay such handsome gains that all else can beforgotten. Although this is possible, theweight of available evidence suggests it is un-likely.

Moreover , the exper ience of IBEC,ADELA, PICA, and SIFIDA is not encourag-ing in this regard. All had a decade or two ofexperience that, in theory, allowed for theemergence of big winners. Some winners didemerge, but they were inadequate to compen-sate for the losers. Even working with enter-prises far larger than those USAID has tried toencourage, the IFC’s record leaves no indica-tion that this area is one of high payoffs. TheCDC’s experience similarly suggests low pay-offs. Quite simply, there is just no evidencethat donor-supported equity financing activityis a desirable or sustainable use of scarce re-sources.

It is important to emphasize that this is quitedifferent from concluding that venture capitalis not an important source of developing-coun-try growth. It is possible that private venturecapital may be useful or important to future

growth in developing countries. Experiencesimply suggests that donors cannot do it suc-cessfully, and that venture capital activity, atwhatever level, should take place in the privatesector.

The main characteristics of venture capitalin the private sector seem to be

• Quick decision-making

• Investment officers with direct financialinterest in results

• Relentless concern about profitability

• Relentless cost control

Donors are not particularly good at any ofthese. Although the first and fourth could con-ceivably be designed into donor projects, thesecond and third characteristics pose seriousproblems. Donors find it difficult to justifyenriching a private individual or groupthrough use of public funds. This is an almostinsurmountable obstacle except in exceptionalcircumstances----such as the opening of EasternEurope. The third characteristic is a seriouschallenge because donors usually are seekingmultiple goals. They want profitability, ofcourse, but they seek to achieve it while sup-porting particular activities (such as agribusi-ness or women’s enterprise) and in particularplaces (the more remote or backward parts ofa country). Inability to concentrate on the bot-tom line almost invariably leads to failure inthis keenly competitive business.

6 Why Is VentureCapital a Mirage?


SIX CONCLUSIONS FLOW from the analysisin this paper:

1. The Agency’s experience with venturecapital projects has been unsatisfactory.

Poor project design, partly caused by USAIDprocedural requirements, has contributed tothis failure.

2. The experience of other ‘‘official’’ and‘‘benevolent’’ venture capital funds stronglyreinforces the conclusion that this is a sectorwhere donors, or socially oriented private in-stitutions, are likely to perform poorly. More-over, evidence from the rapidly growing Asianeconomies suggests that dynamic activity inthe equity market is more likely an effect thana cause of rapid private-sector growth.

3. The enterprise fund concept avoids manyproblems associated with USAID venture capi-tal projects, but the funds so far have had onlymixed success. A fund’s success depends heav-ily on the quality of its management and theclarity of its purpose.

4. Even successful enterprise funds have notdemonstrated that lack of equity capital is aproblem that donor funding can solve. There isno evidence so far suggesting their portfolioswill yield as much as a 10 percent rate ofreturn, and the return could well be muchlower.

5. Enterprise funds do, however, provide ameans for developing instruments adapted to acountry’s private sector financial needs. It isthe flexibility of the enterprise funds’ abilityto innovate and to look for market niches thatprovides the likely payoff. Such niches areunlikely to be in equity financing.

6. In sum, there is no basis for believing thatequity funding----either as venture capital or insome other form----is a high-payoff activity fordonors. Experience suggests the opposite.Consequently, USAID should leave this activ-ity to others.

7Conclusions


General Documents

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Documents

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