Raising Entrepreneurial Capital

these same phenomena. Argentina,

21

Brazil, India,

22

China, and many

nations in the Middle East and Central Asia are further examples.

The parallel issues of access to finance and corporate governance form the

backdrop against whi ch entrepreneurship plays out in transitional and

emerging free market economies. The reasons are not difficult to locate.

Under a command or ‘‘crony’’ economy, the usual mechanisms of capitalist

enterprise are not relevant. Financing is doled out by a central authority

based upon a central plan that seldom bears any resemblance to economic

reality. Political expediency or family ties determine the selection of man-

agement teams, certainly at the senior level. Loyalty to the appropriate

authority is the most significant criterion for job security and advancement.

During the transition period to a more transparent market economy,

there is a partial vacuum in terms of both access to finance and corporate

governance. Simply put, investors want to see experienced managers in place

before investing, yet the only way to find and attract these managers is to

have the financing in place.

The management skills in greatest demand are marketing, sales (including

customer service), and financial management. In a highly controlled econ-

omy, marketing and sales are largely irrelevant because there are chronic

shortages of most products. What supply does exist is allocated by fiat or

through the more efficient mechanism of the black market. Financial man-

agement exists, but its primary goals are evading taxes and preparing false

statistical reports. By contrast, technical skills are often in good supply and

of high quality, though management of the supply chain and proper atten-

tion to quality control frequently need significant improvement.

This situation can work to your advantage, provided you understand its

implications and how to respond to it. Simply put, you bring the manage-

ment expertise and experience that is lacking or under-developed locally.

DUE DILIGENCE

Since the risk profile of the environment in which they operate is high, VC

firms and other investors in transitional economies subject entrepreneurs to

a particularly strenuous examination. The key elements are screening, valu-

ation and monitoring, and exit strategies.

21

‘‘A contrast of Argentina and Uruguay: the effects of government policy on entrepreneur-

ship.’’ West Virginia University, Journal of Small Business Management, Bureau of Business

Research, Vol. 35 No. 2, April 1997, pp. 99–105.

22

‘‘The Venture Capital Industry in India,’’ Journal of Small Business Management, West

Virginia University, Bureau of Business Research, Vol. 38 In. 2, April 2000, p. 67.

364 Opportunities to Do Business and Raise Capital Globally

SCREENING

You should expect a very detailed screening of all aspects of your pro-

posal. The most important screening criteria will be as follows.

Management

The most important factors for investors in evaluating the riskiness of an

investment involve the skills and experience of the management team. An

exceptionally strong management team can often make a marginal idea into

a success, but a great idea almost never succeeds with weak management.

Be aware that there can be extreme dislocations in the local labor market

from time to time, making it either impossible or extremely expensive to hire

people with certain skills and experience. For example, people with financial

management and accounting experience in the West were in extraordinar y

demand during much of the 1990s in central and eastern Europe, until the

local supply of experienced people caught up with the demand.

Timing and Nature of Exit

The investor wants to know when and by what means he or she will

monetize his or her investment and walk away.

Percentage of Ownership and Total Size

The investor will specify a desired percentage of owner ship in the enterprise

and a range of accepta ble amounts for any indivi dual investment. For

example, individual investments must be between $500,000 and $2,000,000

each, and the investor will accept no less than 20% ownership for that initial

investment. Your proposal must fall within the investor’s range on both

counts.

Financial Benchmarks

The investor will typically require your proposed venture to project a

specified internal rate of return (IRR). For start-ups, this number may well

be as high as 60%. For later-stage investments, the IRR hurdle will be lower

because the risk is less. Very few investors actually expect to see an IRR of 60%

in practice, but if you are a start-up, you must be able to make a convincing

case that it is possible, even likely, or you will not be funded. They will also

demand financial projections for at least 3 and probably 5 years, knowing full

well that anything beyon d 18 to 24 months is mostly fantasy.

Market Metrics

Your evaluation of the market for your product or service must be very

detailed and specific, preferably gathered fir st-hand by you. General infor-

mation culled from magazines and newspaper articles can be used as back-

ground, but will not suffice on its own.

Opportunities to Do Business and Raise Capital Globally 365