SCHOOL OF ECONOMICS, FINANCE AND BANKING

BWFF3033 FINANCIAL MARKETS AND INSTITUTIONS

SECOND SEMESTER 2019/2020 (A192)

GROUP B: GROUP 5 (VENTURE CAPITAL)

Writing Assignment

Lecturer:
Dr. Sabri Nayan

Group Members:
Name Matrix No Program No in list name

1 Nor Afira Binti Khalid 264128 Finance 50

2 Nurain Nabilah Binti Hafiza 264274 Accounting 59

3 Loo Chin Yee 261215 Economics 32

4 264206 Finance 53
Noor Hidayah Binti Mohd Sony
5 264252 Finance 58
Rabiatul Adawiyah Binti Mat Hussin
6 Nur Syamimi Binti Zakaria 264227 Finance 55

7 Lim Moon Jun 261854 Economics 39

8 Yong Yi Min 263438 Accounting 44

 Table of Content
No Content Pages

1.0 Introduction 1

2.0 Literature review 2-4

2.1 Summary of the Literature Review 5-6

3.0 Main Issues 7-8

4.0 Data & Diagram of Venture Capital 9-13

5.0 Advantageous and Disadvantageous to the Venture

Capital in Malaysian Capital Markets.

5.1 Advantages 14-15

5.2 Disadvantages 16-17

6.0 Policy Recommendations 18-19

7.0 Conclusion 20

References
1.0 Introduction

A venture capitalist is an investor who either provides funding for start-up companies

or funds small businesses that want to grow but have little exposure to equity markets.

Venture capitalists are willing to invest in these companies because if such businesses turn

out to be profitable and they will gain an amazing return on the investment. Usually, the

venture capitalists are searching for a good potential business in many perspectives such as a

good management team, a wide market opportunity and a new product or service with a clear

competitive advantage. They are usually also searching for opportunities in sectors with

which they are familiar, and the ability to own a large company stake so that they can

influence its course and the investment.

Lately over the few years, venture capital has doing well in Malaysia that there has

been a spike over venture capital firms. Therefore, the amount of increasing was giving a

very positive term for Malaysia's start-up climate. In addition to that, venture capital has a

significant effect on a rising economy as well as on job growth and the transition to an

information economy and it is considered extremely important for Malaysia. The venture

capital industry set foot in Malaysia in late 1980s with four Venture Capital firms and

US$20m funds (Boocock, 1993). However, business ventures were quite pessimistic about

the conventional venture capital operation which resulted in poor early-day responses.

Researchers claim that on the Malaysian venture capital market, there are an adverse

selection and grand standing impacts. As a result, the Malaysian government initiated join

venture programs with the private sectors and foreign investors in 2004. The Government

remained the largest contributor of venture capital funds attributing to almost 40% of Venture

Capital funds here. Venture capital continued to gain popularity under the 9th Malaysian plan

where government played a prominent role in promoting the industry in Malaysian Venture

Capital Development Council (Cheedradevi Narayansamy, 2012).

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2.0 Literature Review

The Economic Impact of Venture Capital is a journal written by Annaleena

Parhankanges. She stated that nowadays the venture capital is giving a high impact to push

the grow and development some of business and market in the country. It is also taken a role

in boosting the firm performance is due to the support of the venture capital can encourage

the innovation and development on new technologies and industries. The business of firm in

some of the countries can grow rapidly is because the success of the venture capital industry

in look for ways to nurture a national venture capital industry (Sallard, 1998). There are

majority of entrepreneurship scholars believe that venture capital can bring such as economic

benefits to the firms and as a solution for the economic recession and high unemployment.

However, some of the scholars shows their opinion that venture capitalist investments just

bring few of benefit that only small numbers of companies, regions and industries. Thus, this

situation let them don’t have ability to create the reputation for development in economic and

wealth creation in long term. This effect of venture capital is different among of view of

scholars and not necessary to become a powerful tool to continue to grow and proliferate

productivity among the business leaders and policymakers.

Global Journal of Business Research of Venture Capital Pre-Investment Decision

Making Process: An Exploratory Study in Malaysia is a journal by Cheedradevi

Narayansamy, Athena Hashemoghli, and Rasidah Mohd Rashid. According to the authors,

venture capital not just providing benefits in supply-side to the business ventures, but they

also provide demand-side benefits to the business ventures. There are 6 types of venture

capital decision making process which are stands from 3-step decision model by Wells

(1974), 4-step decision model by Tyebjee and Bruno (1984), 6-step decision model by Hall

(1989), 6-step decision model by Fried and Hisrich (1994), 7-step decision model by

Boocock and Woods (1997), and 4-step decision model by Gluer (2003). Fried and Hisrich

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(1994) model was widely accepted among all the proposed models. This model also tested in

different regions and it was adapted by Bliss (1999) to investigate decision making process

for transition economies.

Furthermore, Venture Capital and Growth is a journal written by Sophie Manigart and

Harry J. Sapienza. They stated that government intervention and macroeconomic can cause

the impact in venture capital. There are two types of indirect government programs can carry

out the intervention, first is financial incentives for venture capital such as tax credits or

guarantee schemes. Second is investor regulations such as broadening the types of institutions

permitted or encouraged to invest in venture capital. The governments are proactive in

promote venture capital despite only small number of companies funded through formal

venture capital. This practice indicate that governments believe the power of venture capital

to successfully affects general economic growth. Several studies, commissioned by national

venture capital associations and executed by consultant companies found that VC-backed

companies perform above average on some of criteria such as job creation, tax payment,

growth in sales and export, and R&D expenditures. Therefore, venture capital can indirectly

to create a great impact on macroeconomic of countries.

Next, Growing the Malaysian Venture Capital and Private Equity Industry is a journal

written by Syed Adil Hussain. According to the author, the promoting innovation and venture

capital was central to securing further economic growth. Venture capital groups bridge the

funding gap, help build an ecosystem of entrepreneurs and it can encourage the innovation

and provide a mechanism through which seasoned management can work with newer

management teams and companies to improve their corporate governance and execution

strategies. The venture capital funds also have ability to increase additional money from

investors and help to create the next generation of technology firms. However, the lack of

transparency in reporting will occurs the challenging to measure the investment returns in

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venture capital. Besides, there are also have another major challenge to face during carry out

the venture capital such as limited funding, risk aversion of the venture capital, cyclical

industry and difficulty to exit the industry.

Besides that, Managerial Factors and Management Conflict in Venture Capital

Financing in Malaysia is a journal written by Hisham bin Mohammad, Mohd Sobri bin Minai

and Esuh Ossai-Igwe Lucky. The purpose of the study is to investigate the managerial factors

contributing to the appearance of management conflict in venture cooperation between

Malaysia venture capitalists and their investee firms in various Malaysian economic sectors

and also the intention to solve the conflict. The findings of this study gives a demonstration

that there are 6 managerial factors which is contracting and deal structuring, deal origination

and screening, evaluating venture proposal, management conflict, monitoring and post

investment activities and risk management. The authors advise that Malaysian capitalists

involve in venture capital investment should take note to these factors if they want to

minimize the possibility for management conflict to arise between them and their investee

firms in their venture cooperation. The results in the study further suggests that they should

focus more on the venture evaluation process, the contents and clauses included in the

venture financial contract. Such strict venture evaluation process will help venture capitalists

to choose only qualified entrepreneurs to be financed.

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 2.1 Summary of the Literature Review (Previous Empirical Work)

No Author Data / Variables Empirical Conclusion

(year) Country Method
1 Cheedradevi Panel  Venture capital  descriptive Venture capitalists
Narayansamy Data  Investment stage statistics experience does not
, Athena  Investment  chi square correspond to
Hashemoghli, criteria inferential expertise in decision
Rasidah  Investment test making.
Mohd Rashid timing
(2012)  Venture capital’s
risk
 Decision making

2 Annaleena Cross-  Venture capital  qualitative Venture-backed firms

Parhankangas section  Business angel approach are more successful
(2012). data  Firm  quantitative than are other firms in
Performance approach terms of sales growth,

 Industrial tax revenue generation

renewal and job creation and

 Innovation its impact are highly

 Productivity limited to selected

growth companies, industries

and regions.
 GDP
 Economic impact

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3 Sophie Cross-  Venture capital  qualitative Venture capital do
Manigart and section  Economic growth approach enhance the growth
Harry J. data  Government  quantitative prospects of their
Sapienza intervention approach portfolio companies
(1999)  Macroeconomic and may help

 Decision process economically but is

 Portfolio not a necessary

company condition for value

adding.

4 Hussain, S. Cross-  Venture capital  qualitative A strong venture

A. (2009) section  Private equity approach capital and private
data industry  quantitative equity industry sector
 Economic growth approach would propel

 Innovation Malaysia towards its

 Government development goals.

intervention
 Deal flow

5 Hisham bin Cross-  Deal origination  qualitative Venture capitalist

Mohammad, section and screening approach should address these
Mohd Sobri data  Evaluating  quantitative managerial factors to
bin Minai venture proposal approach avoid management
and Esuh  Contracting/Deal conflict to arise
Ossai-Igwe structuring between them and
Lucky  Monitoring and their investee firms in

post investment their venture

activities cooperation

 Acquiring
liquidity
 Risk management

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3.0 Main Issues

The situation of Venture Capital (VC) and Private Equity (PE) industry in Malaysia is

at a crossroads. According to practitioners the industry despite having received RM3 billion

in government aid, there will be no any privately backed up organizations within five years if

there is no further action is taken. The main issue in the article from Syed Adil Hussain is to

investigate the state of the Malaysian VC/PE industry whether the government should

intervene to take some further action to improve its condition. Venture Capital (VC) is a form

of Private Equity (PE) that is defined as primary funding provided to young entrepreneurs

face the problem of financial constraints and potentially high-growth companies that are

usually not listed on the stock market (Schröder, 2011). It does not necessarily whether the

government should or not to intervene to prop up the industry even if the merits of a robust

venture capital and private equity industry are well established. When the benefits of a

successful program outweigh the costs of intervention more than with uses of public

resources, the government intervention is warranted. To examine the conditions for the

creation of active venture capital market; government acts as a coordinator, whereas

human capital and finance sector are the fundamental in creation of venture in capital

market, support institutions and source of opportunities are the measures of

effectiveness in venture capital (Hellmann, 2000).

Furthermore, although public intervention is warranted in certain cases, due to

past efforts to build a viable VC/PE sector in Malaysia still have not yet been

successful. The article in this section reviews some of the government program and

analyses whether further action is warranted. While the impact of Ekuinas and the

various government initiatives mentioned above remains not yet seen, the Malaysian

VC/PE industry thus far remains undeveloped. David Fong is the Chairman of the

Malaysian Venture Capital and Private Equity Association explained the VC industry

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continues to face many challenges while significant efforts have been made and

progress achieved over the past ten years. It is at a crossroads due to in serious need of

a review or revamp if it is to play its intended role in the coming years. Understanding

of the risk/reward profile involved is a function of the evolution of the Malaysian

financial industry. However, the investors lack an understanding of the risk/reward that

involved in profile.

In a result of the difficulty in raising funds, there are many interviewees

describe as a dearth of independent VC/PE organizations. Thus, the situation become

more problematic due to VC/PE organizations backed by banks or the government is

regarded as organizational hierarchies or other characteristics that lead to poor returns.

As examples, the risk appetite for government-backed VC/PEs as they are currently

structured is low due to government debt must be serviced. Besides, a board member of

banks, tend to be risk-averse and demand stable profitability year after year and must

make the ultimate decision.

In Malaysia, the VC/PE industry is not performing well simply because didn't

get enough deals to increasing growth of the VC/PE industry should be organic. It is as

the number of good investment opportunities increases, same goes to the number of

VC/PE organizations. The government action was necessary to evaluate VC/PE

important to the development of the economy.

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4.0 Data & Diagram of Venture Capital

Table 1: VCs Preferred Investment Stages and Sectors

Survey responses in Table 5 reveal that Malaysian VCs have their own decision-making

procedures. These procedures have similarities to the proposed classical model (Fried &

Hisrich, 1994; Larsson & Roosvall, 2000).

Table 2: Descriptive Statistics of Venture Capital Decision Making Stages

Evaluation stage and closing stage with a mean greater than 4.00 shows VCs agree their

decision making is similar to past practices in developed nations. The origination, firm

specific screening and generic (investment criteria) screening stage has a mean below 4.00

shows there are some dissimilarity with past practices in developed nations. Malaysian VCs

receive most deals via online access without the need for referral therefore, origination stage

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is not necessary. Developed nations emphasize the need for origination as most funding

comes from private sectors. Unlike in developed nations, in Malaysia almost 40%, funding

comes from government sources and 70% expertise comes from foreign stake, thus there is

less need for referred deals. The regulative environment of Malaysia requires all VCs to

register with Securities Commission, which strengthens VCs credibility and reputation.

Table 3: Comparison of Venture Capital Investment Criteria

We tested the importance of specific criteria for each of the three categories as presented in

Table 9. The specific observation reveals that Malaysian VCs rank investees management

integrity (mean 3.94), leadership (mean 3.81), pre-planned exit opportunity (3.75) and high

return (3.69) as most crucial criteria in their decision making process. Malaysian VCs

consider all the four specific criteria as important however; the degree of importance may

differ. For exit criteria, the findings are consistent with past studies. Past finding reveal that

pre planned exits is important in investment decisions as it provides several benefits, which

include reduce uncertainties in the investment and lead a direction for post investment

decisions (Cumming & Johan, 2008). VCs in Malaysia look for clear exit and creation of

wealth at the time of exit as their pre investment outcome criteria.

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 Table 4: Descriptive Statistic for Specific Investment Criteria

From the responses, we conclude that the VCs in Malaysia are more investors rather than

builders. They lack the abilities to add value to their investee companies. They place higher

reliance to outcome criteria (early exit and high return) instead of nurturing the investee

company toward continued success even after their exit period. VCs concern is on the ability

of business venture meeting VCs desired risk and return during the investment duration.

Diagram 1: Global quarterly venture capital investment by geography ($ billion).

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From the diagram 1, it shows that US have the highest venture capital investment every year

and Canada has the lowest investment in venture capital. So the diagram shows the ranking

from number one until six.

Diagram 2: Venture capital investment in the US by industry sector in 2010

Diagram 3: Venture capital performance versus other investments 1990–200

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 Diagram 4: US Venture capital funds since inception IRR

Vintage funds formed since 2006 are too young to have produced meaningful returns.

Analysis and comparison of partnership returns to benchmark statistics may be irrelevant.

Diagram 5: Amount of angel investment as a percentage of GDP (Bosma and Levie, 2009)

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5.0 Advantageous and Disadvantageous to the Venture Capital in Malaysian Capital
Markets.

Venture Capital Malaysia is a guide for Malaysian Start-ups looking for venture capital

funding to start-up ventures or support small companies that wish to expand but do not have

access to equities markets. Venture capital are willing to invest in such companies because

they can earn an impressive return on their investments if the companies turn out to be

successful. However, there are many advantages and disadvantages of venture capital in

Malaysia Capital Markets also exist at the same time will further discuss at below.

5.1 Advantages

There are many advantages of venture capital in Malaysia Capital Market:

1. Help managing risk

As we know training venture capital helps start-up founders manage the risk inherent

most start-ups. Starts up can avoid major problems or issue if they having

an experienced team overseeing growth and operations. In addition, if someone turn to advice

when a complex situation arises can improve the chances of making a good decision although

the failure rate for start-ups is still 20% in this year.

2. Opportunity for expansion of the company

Venture Capital gives the company the opportunity to expand. It is because it can

provide a vital source of money to company grow quickly that would not be possible through

bank loans or other methods. This is essential for start-

ups with limited operating history and high upfront costs. In addition, the repayment of VC

investor is not necessarily a bank loan obligation. It is because, bank loans are subject to

collateral and there is an obligation to repay the loan.

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 However, in venture capital, investors are taking the investment risk because they

believe in the future success of the company. Venture capital funding is therefore beneficial

to start-ups with high initial costs and limited operating history.

3. Valuable guidance and expertise

In addition to capital funding, venture capital is also a source of valuable guidance,

expertise and consultation. A member of the venture capital firm is usually appointed to the

board of directors of the start-up company. The VC firm thus has an intimate involvement in

the management of the company and company’s decisions.

Furthermore, when a VC comes on board with a start-up, they bring with them all that

institutional knowledge, and that can be truly invaluable for a new company. As we know,

venture capitalist who are have many experience in building and expanding start-ups, their

expertise and guidance can prove beneficial. So, they can help with the development of

strategies, technical assistance, resources and others to make a successful business.

4. Additional resources

The most obvious advantage is that venture capital can provide company with

significant additional resources. It is because the additional resources will enable to help

company to cover their purchase of various assets and other start-ups cost and it very

effectively accelerating of company’s growth. In addition, a VC firm can provide active

support in a number of critical areas, including legal, tax and personnel matters, which are all

of that are important key stage in the growth of a young company, and an angel investor

likely has these resources through other methods. In short,

It is vital to maintain a strong sense of responsibility when handling these new funds in order

to avoid over-expenditure waste. This is because full access to so much spending power

could be overwhelming, or even create an inflated sense of financial empowerment.

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 5.2 Disadvantages

There are many disadvantages of venture capital in Malaysia Capital Market:

1. Minority ownership status.

Ownership status is depending on the size of the venture capital firm’s stake in their

company, which could be more than 50%, they could lose management control. They need to

give their own equity so that the new shares can issue to investors when raising fund is

needed.

Many company invested a lot of funding until they need to raise additional rounds from

venture capital firms. Essentially, this may cause the founder giving up majority right of

ownership of their own business. So, in the end, the majority of shareholders can control and

making decision without asking the founder ownership.

2. Loss of Control.

The drawbacks associated with equity financing in general can be compounded with

venture capital financing. The founder could think of it as equity financing on steroids. With

a large injection of cash flows and professional, it possibly leads to more aggressive to

investors, it is likely that the founder of venture capital partners will want to be involved, the

size of their stake could determine how much say they have in shaping their company’s

direction.

Furthermore, with the venture capital firm literally invested in the company’s success, all

business operations will be under constant investigation. The loss of control varies depending

on the requirements of the venture capital deal.

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 3. Limited decision-making abilities.

Limited decision-making abilities can be the breaking point for many new business

owners. If the founder is operating a startup, the founder likely to have a clear vision of

where the founder want their organization to be in one, three, or five years. With venture

capital funding, the founder may have to compromise on their goals.

As part of the management team changes which likely come with venture capital

funding, the founder won’t have full control of their company. Business owners may even

have to meet daily with the investor before they make any important decisions. Decisions

such as content management strategies, partnerships and marketing mixes can all default back

to a compromise between the business owner and the investor.

4. Funding problem.

Since venture capitalists often transfer large sums of money, the capital market can take

time and company owners have to consider it and work through delays. In fact, they may

require such milestones to be meet before the funding is issued. Money is very important for

startups to growth well. So, funding the source or capital need take a lot of months. For

instance, an investor may want to see accurate monthly sales result before allowing or until

they require.

In short, advantages and disadvantages of venture capital must be considered before

funding in Malaysia Capital Markets. In addition, the founders also can rely on some

alternatives to venture capital for funding such as Angel investors, revenue-based financing

and SBA loans.

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6.0 Policy Recommendations

Venture capital investment overall has not outperformed public-market investment

since the 1990s, according to analysis by the Kauffman Foundation. Even worse,

Venture Capital investments struggled to return more money between 1997 and 2012,

following a variety of surprising achievements, than the total amount invested

(Luepker., 2015). So, there are some recommendations that can be done to ensure a

good venture capital investment.

Firstly, they should pay for performance not the percentage of ownership. When

venture capital raise big funds, they are paid more because of the two percent management

charge and the percent profit sharing arrangement that is the norm in the venture capital

industry. The market standards allow venture capital to lock high returns irrespective of the

output of the individual product (Luepker., 2015).

Therefore, creating and negotiating a compensation structure that pays fees based on a

firm budget, and shares profits only after investors receive their capital back plus a preferred

return, would mean limited partner pay venture capital for doing what they say they will

generating excess returns above the public market (Diane Mulcahy, 2012). In short, if limited

partners negotiated a compensation system where, instead of adopting a market norm that

does not promote good results, they pay general partners for their success, there will be more

opportunity to select less risky businesses.

Secondly, they can use Public Market Equivalent (PME) to benchmark Venture

Capital fund performance. Venture Capital funds should monitor the success of companies by

contrasting cash flows with similar indices of publicly traded stocks in similar industries.

For example, use the small capitalization Russell 2000 as a benchmark as they believe

it better reflects the higher price volatility, higher beta, and higher sensitivity of small

18
companies to economic cycles than the large capitalization S&P 500 index does (Diane

Mulcahy, 2012). Adopt Public Market Equivalent (PME) as a consistent standard for Venture

Capital performance reporting, similar to the Global Investment Performance Standards and

require consultants or investment staff to present PMEs as part of any investment decision

and reject performance marketing narratives that anchor on internal rate of return (IRR), top

quartile, vintage year, or gross returns (Diane Mulcahy, 2012).

Other than that, Malaysian government can set up a RM1 billion fund-of-funds (FoF),

where in it would match funds invested from the private sector (Hussain, 2009). Due to the

strong appetite for deals in the region, policymakers may consider providing RM1 for every

RM2 raised from private investors. Fund-of-funds raise capital which is then invested in other

funds; those funds then make investments in companies (Hussain, 2009).

Such an arrangement is desirable in Malaysia for the reasons such as attracting

investors because of its size, which will allow large institutional investors to place capital at

levels worthwhile to them, distributing capital in a way that bolster the Venture Capital that

will ensure the survival of the Venture Capital and reduce investment risk and build good

performance. (Hussain, 2009).

Last but not least, they should create more transparency in Venture Capital firms. This

is because limited investors are often unable to obtain adequate information about the

Venture Capital firms and general investors to make an informed decision about whether or

not to participate. Growing access to knowledge by limited partners will help them make

more informed decisions about which businesses to back up to reduce the risk (Luepker.,

2015).

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7.0 Conclusion

In conclusion, we can say that the Venture Capital industry in Malaysia had

started in the past more than ten years. Even though the industry had evolved over the

last thirty years, the number of participants in this industry can be considered small

(Nor, 2015).

There are several factors that influence the development of Venture Capital

industry in Malaysia and it is learned that the Venture Capital industry in Malaysia is

still developing and that the industry needs some transformation before it can become a

high-income country (Nor, 2015).

We know that capitalist companies might put on higher risks by investing their

capital in relative unknowns of companies or new companies. However, in return, they

will receive preference shares and as it is important to safeguard their investments.

Usually, the real returns might occur when the venture capitalist liquidates its shares,

do the commercial sale and a sale-back shares. So, for the new companies which have

difficulty in raising their capital because they are young in an industry, they might

have partnering with a venture capitalist and the result could be an appealing and

highly beneficial.

In short, we can conclude that Venture Capital may play an important role in

providing early-stage financing and helping the starting companies that may have

difficulty in obtaining loans from banks to start their businesses.

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References

Boocock, G. &. (1993). Venture capital in Malaysia: The role of the government.

Development Policy Review.

Cheedradevi Narayansamy, A. H. (2012). VENTURE CAPITAL PRE-INVESTMENT

DECISION. Global Business Research.

Diane Mulcahy, B. W. (2012). Venture Capital. Kauffman Foundation.

Hussain, S. A. (2009). GROWING THE MALAYSIAN VENTURE. Pluto Journals.

Luepker., E. (2015, october 15). Endeavour Insight. Retrieved from Endeavour Insight:

http://www.ecosysteminsights.org/five-recommendations-to-improve-the-vc-sector/

Nor, E. (2015). Venture Capitalists in Malaysia: Challenges and Future Directions. Sciepub.

Parhankangas, A. (2012). The economic impact of venture capital. Research Gate.

Sophie Manigart, H. J. (2008). VENTURE CAPITAL AND GROWTH. The Blackwell

Handbook of Entrepreneurship.

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