4.5 Risk and Venture Capital, Some Experiences

There is a vast literature on capital-market imperfections in developing countries. Even in developed countries, capital-markets for financing of technology are characterized by special problems. First, and most obviously, investment in new technologies is especially risky. Buying and installing a standard piece of capital equipment poses few risks beyond the normal commercial risk that relative prices will shift against the product to be produced, before the equipment costs have been amortized. When the technology in which the firm is investing has not been utilized extensively or it is a technology whose ultimate shape is not even known at the outset, additional elements of risk and uncertainty will arise. While efficient capital-markets may be able to discount simply on added risk, they do less well in accommodating inherent uncertainty. In order to compensate for these deficiencies, specialized venture-capital markets have emerged in a number of countries, probably the most highly developed being in the United States. Venture-capital financing serves to shift some of the risk from the shoulders of the entrepreneur, and somewhat reduces the uncertainty faced by the outside financier, by allowing the latter a share in management proportional to its share of the equity invested in the venture. The incentive to invest in this case is the prospect of very high returns, coupled, of course, with very high risk.

Besides spreading the total risk, venture-capital financing can fill two other urgent needs of an innovative start-up firm. First, it can enable that firm to bring its new product to the market more quickly and, thereby, enhance the prospects of reaping "first-mover" advantages. Second, it can enable the firm to build up its technical and other resources so as to achieve a critical mass, which would permit sustained innovation and create an ongoing concern capable of sustained commercial exploitation of the innovation.

The requirement for risk-capital becomes necessary, as the governments in developing countries are not always in a position to subsidize the risk associated with the utilization of research-results, and the weak resource base of the local entrepreneurs and their limited planning-horizon restricts them in their venture on the new, unproven technology. The local entrepreneurs are naturally more inclined towards quick and guaranteed returns from the imported technology because the imported technology offers the additional advantage of back-up support, both technically and financially.

However, it is now seen in some of the developing countries that fund managers for risk-capital sometimes require sizeable collateral from the new start-ups in the form of tangible assets. Clearly, any such venture-capital market, strongly biased in favour of collateralized lending is not fulfilling its intended function effectively. The assets of these start-ups are frequently intangible, consisting, for example, of the technical and managerial capabilities of its personnel, its proprietary product or process know-how, or, in some cases, sophisticated software. Loan officers trained in conventional investment-financing institutions, in developing countries frequently lack the expertise to evaluate such assets accurately. This further exacerbates the uncertainty of lending to such ventures. Venture-capital firms require technical competence to evaluate projects involving investment again specialized, often intangible assets. Sometimes, they may have to rely on outside consultants, sufficiently qualified for evaluation of specific projects involving technologies in which internal staff lacks expertise.

A number of countries in the Asian region have begun to build up their venture capital markets during the last decade. Korea was one of the first, with several public and private institutions active in the business. The Korean experience illustrates that such institutions can prove viable even in a country that is not on the leading edge of most technologies. Many of the projects financed have involved the introduction of products, which, while not the first of their kind in the world, were nonetheless the first of their kind to be made in Korea. A substantial part of the financing thus went to foreign technology-purchases needed to localize production. The range of products financed in this way is quite broad, including computer-peripherals, industrial controls, medical electronic equipment, electronic scales and automotive components.

The Republic of Korea, as a matter of policy, puts premium on providing risk-capital. The agencies, such as K-TAC (1976) and KTDC (1981), have registered a quantum jump in the availability and use of risk-capital and financial support by way of soft loans and credit for technology-development. Besides K-TAC and KTDC, some other organizations established for venture business in Korea include:

• Korean Development Investment Corporation (KDIC) 1982

• Korea Technology Financing Corporation (KFTC) 1984

• Korea Technology Banking Corporation (KTB) 1992