Venture capitalists: Challenges of equity investment

Days are coming when educated youths would tend to take the entrepreneurial leadership rather than focusing only on jobs. Capital may not be a cause of concern, as the venture capitalists are beside them. The Dhaka Chamber of Commerce and Industry (DCCI) and the Bangladesh Bank have jointly organised a programme on 'DCCI entrepreneurship and innovation expo' seeking proposals from entrepreneurs with a view to supporting 2,000 of them. Such initiatives are undoubtedly a great support for entrepreneurship and venture capitalists.
The venture capitalists may be very trusted and good partners of them in carving out their success story through equity investment. Venture capitalists can prove that capital is not a problem where entrepreneurial leadership is strong and there is a clear goal. This scribe stated in one of his articles that venture capitalists needed a legal framework. That article focused on the basic elements of the framework in line with standard practices as required by the venture capitalists to work comfortably on a legal base in the country. Given the framework of operation, the following bottlenecks to equity investments still remain:
CORPORATE LEGAL STRUCTURE: Most of the SMEs (small and medium enterprises) are based on either proprietorship or partnership. As the corporate legal structure does not suit the equity investment, such enterprises need to go for investment under the mezzanine or quasi-equity investment model (a hybrid of equity and debt) or get registered with the Registrar of Joint Stock Companies and Firms (RJSCF) as limited companies (private or public) to seize equity either as ordinary or preference shares. Entrepreneurs do not show very positive interest in getting their ventures registered as limited companies with the RJSCF. They have the tendency to avoid registration as limited companies, as they do not want to be compliant with the related regulations by submitting necessary documents or income tax return or do not feel comfortable to have any new institutional investor as the influencing or controlling authority for their business. They expect easy loans and repayment thereof, instead of sharing their profit with investors controlling their business.
LACK OF OPERATIONAL AND FINANCIAL CREDIBILITY: The entrepreneurs have the tendency to hide operational efficiency and hence the operational results presented in the financial statements do not give a true picture. They do not like to be transparent to lenders or investors as well as to regulators to avoid repayment of investments and taxes on income. At the initial level or expansion level i.e., at the startup or growth stage, when venture capitalists' financial and technical support are essential, entrepreneurs must be transparent in presenting the financial statements for continuous growth of the company with a view to obtaining supports of venture capitalists. Venture capitalists do not dare to invest in the form of ordinary equity, when there is a lack of operational and financial credibility, in fear of losing money unduly.  
LACK OF ENTREPRENEURIAL LEADERSHIP: Most of the sponsors or promoters in our country tend to get involved with a business, when he sees others making hefty profit from it, in spite of having little or no knowledge about the matter. Sometimes it is observed that sponsors express their willingness to undertake the business in the sector where investors make investment or feel comfortable to invest. Sponsorship and entrepreneurship are completely different from each other. Entrepreneurship involves an innovative approach. Entrepreneurial leadership means action to manage resources successfully by applying new innovative ideas or concepts or research findings. Unless the sponsors are strong enough in entrepreneurial leadership, their businesses may fail in most of cases and the venture capitalists may not go for equity investment.
LACK OF VENTURE CAPITALISTS' SOURCE OF FUND: The source of funds of venture capitalists is a big challenge. Borrowing funds from banks and financial institutions will not be viable because of: (i) higher costs of funds, (ii) repayment mismatch because of immediate regular payment of installments of loans taken from banks, while the return from equity investment is always deferred, irregular and not specific, and (iii) risks associated with SMEs and equity investments accordingly. The private equity management against fees could be a good source of funds. The private equity fund management system, other than mutual funds traded in the capital market, has not been introduced in the absence of required skills and experiences, a legal framework and sponsors from development partners or agents, local pension fund, insurance companies etc. The government and regulators should take initiatives to formalise the management of private equity under a legal framework.
LACK OF REGULATIONS AND POLICY ASSISTANCE FOR QUASI-EQUITY: Venture capital does not mean only an investment in the form of equity in limited companies. Venture capital is a risk capital. Depending on the structure of the entity, the product may be in the modified form of equity without collateral. The venture capitalists need the policy and regulatory assistance in line with the modified equity of investment or quasi-equity model like revenue sharing based on proprietorship or partnership. Such regulations and policies are required to legalise the quasi-equity investment made by venture capitalists and to avoid any debate about their monetary transactions like those of banks and financial institutions (FIs).
INVESTEES' NON-COMPLIANCE WITH LAWS AND REGULATIONS: Non-compliant organisations lack integrity and sometimes risk operations and investors may not be interested to invest. As equity represents ownership, the equity investors take full risks and reward of an organisation and hence they need to be compliant with all applicable laws and regulations to keep their investment safe and have a safe exit strategy. We are hardly careful about laws and regulations, particularly at the SME level.
LACK OF HIGHLY PROFESSIONAL VENTURE CAPITALIST TEAMS: To conduct due diligence, structure investment deals and monitor investment, the venture capitalists should have highly skilled professional teams. As venture capital is a very new model of investment in Bangladesh, it is very difficult to get such an experienced and skilled team. Those who are experienced in this area working outside the country deserve high pay packages and new setups. Venture capitalists may not have the financial capability to pay such compensation packages.
INDIFFERENCE TO SOCIAL AND ENVIRONMENTAL IMPACT: Compliance is a significant factor, when it comes to development partners or agents. An entity should work for profit, people and planet (3Ps). Most of the entrepreneurs do not care about the planet and the people, i.e. the social and environment compliance. As such, it is a hurdle to get private equity from development partners or agents. A lot of SMEs in Bangladesh can take foreign equity funds from development partners or agents by complying with social and environmental indicators. Those development partners and agents may be sponsors for SMEs' equity funds managed by venture capitalists or invest directly in equity, if entrepreneurs are meticulously compliant with the social and environmental requirements.
LACK OF GOVERNMENT FOCUS: India has identified its most vibrant sectors for financing and other support services from the government, development partners and venture capitalists, especially through foreign direct investment (FDI). We should have identified such sectors to attract investments from venture capitalists. The sectors that remain in focus become organised, have more growth potential and get the government support. In those sectors the venture capitalists can invest in the form of equity in a safer way.
TAX EXEMPTION AND INCENTIVES: Venture capitalists support emerging sectors in all stages even at the early growth stage. So, their investment may become bad and sometimes fully lost, when the business does not click. There is a very common characteristic that one-third investments of venture capitalists may be bad fully and impact on profits of them. As it is the very early stage of venture capitalists in Bangladesh and the SME sector is not organised or structured aided by laws, policies, tax incentives etc., the investment loss may be more and resultantly they need exemption of taxes on income. To support emerging SMEs, tax-efficient equity investment is necessary. At present, the venture capitalists pay 37.5 per cent tax on income for non-listed public limited company that makes them discouraged to work in the risky SME sector.
EXEMPTION OF DEFAULT STATUS FOR VENTURE CAPITALISTS: Venture capitalists may want a seat on the board of an investing company. If the investing company becomes classified or loan defaulter, the venture capitalist concerned will also be a defaulter being the director of that company. The investing company may be a defaulter, but the venture capitalists should be exempted from the default status for their borrowings from banks and financial institutions or managing funds from them.
EXIT PROCESS: The exit process including drag, tag, public offering etc., are merely standard in theory, but enforcement is a big challenge. A company can go for initial public offering (IPO), when the company's total capital structure including capital market portion is Tk 300 million, of which 30 per cent will be sponsor capital. In most cases, the companies in which venture capitalists invest cannot raise the required minimum capital from sponsors. To exercise both drag-along and tag-along rights in a straight way may be difficult due to the lack of entrepreneurial leadership, philosophy and integrity. The whole exit process may be really stressful to get back the amount due.
OTHER FACTORS ADVERSELY AFFECTING THE OPERATION LACK OF STRATEGY: Due to the lack of entrepreneurial leadership, sponsors lack the strategy. They run their businesses traditionally without being methodical to make the organisations differentiated. So, the entrepreneurs must be strategically differentiated by approaching innovation in operating and marketing to attract equity investors.
POLITICAL UNREST: Political unrest makes the business environment riskier. This has reached an extreme stage that causes obstacles to work severely. Organisations are failing to meet their targets or earn profit. Investors generally will not invest, unless the political stability exists to ensure a better business environment in the country. Due to political unrest, foreign direct investments (FDIs) move to other countries. Equity becomes risky and venture capitalists, being investors, do not feel comfortable to take full equity risks.
UNETHICAL AND GREED-DRIVEN BAD CORPORATE CULTURE: Some organisations do not care about ethical standards and are driven by the greed and ego of entrepreneurs that lead to corporate scandals. Most of sponsors and entrepreneurs show the attitude that they need to earn money in any way. The equity investors should assess the corporate culture to find out whether it is coach able to run the operation ethically and legally.
Both dividend and capital repatriation are easier to attract investors for FDI either directly or in the form of private equity. Foreign private investment (Promotion and Protection) Act, 1980 guarantees repatriation of capital subject to the rights and circumstances as per applicable laws and regulations.
All challenges as stated above cannot be addressed overnight. The government and regulators should come forward to prepare a green field for venture capitalists. By dint of professional practices of venture capitalists over the years, Bangladesh could be a very promising land for SMEs that can turn into good companies before entering the capital market here.
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The writer is an Associate Member of ICAB and Head of Finance of Venture Investment Partners Bangladesh Ltd. (VIPB).  roy_dipok@yahoo.com