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A recent paper in Nature Biotechnology by Chakma, Sammut & Agrawal (2013) (1) investigates the state of venture capital financing in emerging markets. The authors took a closer look at the state of VC affairs in the life sciences sectors of Brazil China, India, and South Africa.

I’ll highlight some of their findings and conclusions they have drawn. I’ll present my personal conclusion, which is largely related to the availability of public information, at the end of this post.

Findings

One of the key findings presented in the article is that government spending on biomedical R&D in the countries investigated exceeds VC-funding quite significantly, with the exception of India. Why India deviates from the trend is not clear.

Figure-1-12-March-2013

Figure 1: Gvt vs VC financing in health biotech

Another finding is that the number of non-VC backed health biotech firms exceeds VC-backed ventures 5-18 fold. The paper cites difficulties in obtaining good quality data and this is evident from the number of non-VC backed firms cited for South Africa (date of assessment was 2007) which – at face value – appears too high.

Figure-2-12-March-2013

Figure 2: VC vs Non-VC backed firms

The paper suggests 3 dominant strategies employed by VC-funds in emerging markets (my categorization):

  1. Incremental investment strategy: This is a strategy predominantly employed by local VC firms embarking on a learning-by-doing strategy. Size, scope and risk profiles of investments increase over time, in line with the learning curve.
  2. Leveraged knowledge strategy: International funds with a footprint in emerging markets and a track record in the developed world (e.g. the US) blend the benefits of both worlds to overcome emerging market challenges (e.g. lack of experience, communication, and trust).
  3. Eco-system strategy: This is a strategy employed by funds that build up- and down-stream capacity for individual investments. For example, a drug development venture may be supported by investment into a local CRO, in order to facilitate effective screening work locally.

Questions

I think for those of us who work in an emerging economy environment, these findings are not particularly surprising. What matters is the exploration of the factors that cause, drive or exacerbate the current situation.

Here are questions that bugged me when studying the paper:

  1. What is keeping VC-financing at low levels in emerging markets? Could it be the opportunity costs of making investments into biotech ventures vis-a-visalternate options, such as ICT, retailing or the property market? This seems to be a common thread across the 4 countries investigated and can possibly be ascribed to the lack of experience on behalf of VC funds in emerging markets. A possible remedy to this is syndication, of emerging market funds or through inter-national collaboration, all aimed at speeding up exchange and generation of knowledge.
  2. Is there not enough demand for VC-backed financing in emerging markets? In other words, are VC-firms outside of emerging countries spending all available capital on opportunities in the developed world? Here, the picture is more complex. In China, for example, VC funds do play an active role, albeit at lower levels than in the US, and up to a third of the capital is provided by foreign funds. This would suggest that the Chinese are doing more in terms of risky life science investments, whereas funds in other emerging markets tend to play it safe.
  3. What influence does quality of institutions and/or infrastructure in emerging markets have on the extent of VC financing in the life science sector? The question hasn’t been addressed in detail in the paper; it’s certainly something that warrants closer investigation, in my mind.
  4. What role does the amount and quality of information about emerging market opportunities play? If I am an investor in the US, how would I know about an opportunity in Brazil, China, India or South Africa? What would be the distinctive advantage of that opportunity over others in the US? Again, the paper’s findings suggest a differentiated picture. It is evident from the situation in China where up to 40% of deals are syndicated with foreign VC firms that the country has managed to establish a decent flow of information to and from the country. Presumably, this has to do with the way Chinese VCs are being managed. In addition, I think it is fair to speculate that the enormous amount of Chinese studying and working in relevant sectors in the US, and later repatriate, contributes significantly to the greater success of VC-financing in the life science sector in China. I think it is also fair to say that the Chinese government has done its share in terms of public spending and branding to make it attractive for expats to seek new ventures in their country of birth.

Major issues

By and large, this is a study about the importance of information in building new sectors or industries in emerging markets. Firstly, where VC funds work in collaboration with international peers that contribute experience, they tend to be more active, and more successful. Learning-by-doing is an option but comes with drastically extended learning curves and probably greater risks of failure. Secondly, in a flat world, emerging economies that want to attract financing, from local or international sources, ought to be very vocal about opportunities their countries may harbor for VCs, local and international. Thirdly, in the absence of good quality data about sector-specific successes and failures, it’ll be difficult for emerging country governments to make the right policy decisions. How can funds with lack of contextual or sector specific experience be enticed to spend their capital in an emerging market, if it is difficult for them to get hold of essential information?

If I plan to fly to the moon but have got no means to measure speed, location, and life-sustaining parameters, how do I make sure I don’t end up on Mars?

References

1. Chakma, J., Sammut, S. M., & Agrawal, A. (2013). Life sciences venture capital in emerging markets. Nature Biotechnology, 31(3), 195-201.