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March 13, 2011

This material was used in an oral presentation. Without the accompanying oral comments, it is incomplete as a record of that discussion. Capital Rising: Global Capital Flows, Entrepreneurial Ecosystem, and Opportunities for Entrepreneurs and Capital Providers.

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March 13, 2011

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  1. This material was used in an oral presentation. Without the accompanying oral comments, it is incomplete as a record of that discussion. Capital Rising: Global Capital Flows, Entrepreneurial Ecosystem, and Opportunities for Entrepreneurs and Capital Providers Presented atGlobal Strategic Innovation Presented by Peter S. Cohan http://www.petercohan.com U. Srinivasa Rangan Luksic Professor of Strategy and Global Studies, Babson College March 13, 2011

  2. Today’s Agenda • Startup CEOs • Issues • Case Studies • Broad Lessons • Policymakers • Issues • Case Studies • Broad Lessons • Our research • Global Capital Flows • The Entrepreneurial Ecosystem (EE) • Capital providers • Issues • Case Studies • Broad Lessons • Managers • Issues • Case Studies • Broad Lessons

  3. 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)

  4. 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 Source: UNCTAD, World Investment Report, 2009; IMF, Balance of Payments Statistics Note: Private portfolio inflow data is a rough estimate Global Capital Flows 4

  5. 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? Source: Cohan and Rangan, 2010 Global Capital Flows

  6. Corporate Governance National-level Entrepreneurship Financial Markets Intellectual Property Regime Human Capital We posited that capital flows to countries with Entrepreneurial Ecosystems (EEs) that are conducive to entrepreneurship Source: Cohan and Rangan, 2010 Entrepreneurial Ecosystem

  7. Corporate Governance National-level Entrepreneurship Financial Markets Intellectual Property Regime Human Capital Silicon Valley’s strong EE helped Google rise 4. U.S. corporate governance lets Google hire talent using options and gives VCs patience to develop business model 3. Sequoia and Kleiner Perkins invest 2. U.S. IP regime lets them patent their page-rank algorithm 5. Successful 2004 IPO 1. Stanford grad students Brin and Page found company Source: Cohan and Rangan, 2010 Entrepreneurial Ecosystem

  8. Corporate Governance National-level Entrepreneurship Financial Markets Intellectual Property Regime Human Capital Infosys founders had to seek success by working around India’s weak EE 4. Lack of protection for minority shareholders scared Indian banks from investing so they tapped U.S. EE 3. India provided no risk capital so they self-financed 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 5. Successful IPO through U.S. ADRs 1. Seven middle class Indian engineers start Infosys Source: Cohan and Rangan, 2010 Entrepreneurial Ecosystem

  9. EE has implications for key stakeholders such as capital providers, managers, startup CEOs, and policymakers Capital Providers (7) Ways to invest in fast-growing countries while overcoming their EE weaknesses Managers (8) Start-Up CEOs (9) Policymakers (6) Need to acquire to grow globally by building on core capabilities Ways to create global value chain that optimizes country-specific EEs Need to build off EE strengths and offset weaknesses Implications for EE Participants

  10. 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

  11. Policymakers Capital market regulators Intellectual property regulators Immigration policymakers Trade policymakers Education policymakers Corporate governance policymakers Eco-system Value Capital Providers Existing Firms and Industries Private equity Hedge funds Institutional investors Venture capital Corporate venture capital New Firms and Industries Capital providers need to understand the varying goals of all EE participants Source: Cohan and Rangan, 2010 Entrepreneurial Ecosystem

  12. Global Capital Flows Existing Entrepreneurial Ecosystem Modified Entrepreneurial Ecosystem Demonstration Effect Capital providers should anticipate how capital flows can spur countries to upgrade their EEs Source: Cohan and Rangan, 2010 Entrepreneurial Ecosystem

  13. Corporate Governance Minority shareholder rights Operational transparency Corruption prohibitions Functional barriers to entry Government independence Shareholder value orientation Restructuring barriers National Level Entrepreneurship Intellectual Property Regime Financial Markets Legal protection of IP Depth of IP enforcement Court system efficiency Ability to monitor IP enforcement Global capital barriers Financial reporting requirements Transaction volume and depth Relative valuations Cost and time to complete IPO Balance of “fast” vs. “slow” money Building proprietary information Human Capital Depth of management pool Strength of educational system Cultural bridging skills Functional skill competitiveness Relative labor costs In deciding where to invest, capital providers may want to look at a country’s capital receptivity index Source: Cohan and Rangan, 2010 Capital Receptivity Index

  14. U.S. CRI of 82 exceeds Portugal’s 57 due to advantages in corporate governance, financial markets, and IP regime Source: Cohan and Rangan, 2010, Mira Amaral, Portugal's former Industry and Energy minister Capital Receptivity Index 14

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

  16. 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, 2010 Note: 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 Capital Receptivity Index

  17. 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 Source: Cohan and Rangan, 2010 Case Studies

  18. 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 Source: Cohan and Rangan, 2010 Case Studies

  19. 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 Source: Cohan and Rangan, 2010 Case Studies

  20. 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 Source: Cohan and Rangan, 2010 Case Studies

  21. Use the EE to assess and profit from emerging market investment opportunities • Assess opportunities and risks in the country’s EE • Identify the industries in those countries most likely to benefit from foreign capital • Build deal source network within those industries • Based on your firm’s strengths, find the best companies within those industries in which to invest • Work with the entrepreneur to set goals and obtain the capital and other capabilities needed to achieve the goals • Pick the best means of exiting the investment Source: Cohan and Rangan, 2010 Broad Lessons

  22. 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

  23. 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 andcorporate governanceadvantages of a larger U.S.-based firm to create a more vertically integrated competitor for global lottery market opportunities. Source: Cohan and Rangan, 2010 Case Studies

  24. Use the EE to profit from emerging market acquisition opportunities • Pinpoint large countries growing fast with industries in which your company competes • 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 • Identify companies in those countries/industries which that could be acquisition candidates • Rank the companies based on their fit with your company’s skills and the potential for an attractive investment return • Complete the acquisition and integration of the company that best fits these criteria • Set performance milestones and manage the company to achieve Source: Cohan and Rangan, 2010 Broad Lessons

  25. 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

  26. 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 Source: Cohan and Rangan, 2010 Case Studies

  27. Use the EE and global capital providers to profit from emerging market new venture opportunities • Build a top-notch management team with cultural bridging experience • Identify a rapidly growing market which that can benefit from the management team’s competitive strengths • Talk to potential customers to gain deep insights into their unmet needs • Raise Angel capital to finance a prototype of a product/service that will satisfy those unmet needs • Pick venture capital firms who can provide the additional skills needed for the company to succeed • Use the capital to build the company and take it public Source: Cohan and Rangan, 2010 Broad Lessons

  28. 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

  29. 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 Source: Cohan and Rangan, 2010 Case Studies

  30. Policymakers can shape a country’s EE to attract global capital flows • Form an EE team • Identify key EE improvement opportunities • Rank the EE improvement opportunities • Analyze the costs and benefits of implementing the high priority EE improvement opportunities • Implement those EE improvement opportunities with the highest net benefits Source: Cohan and Rangan, 2010 Broad Lessons

  31. 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! A New Era

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