Venture Capital in Pakistan

Venture Capital in Pakistan: Challenges and Opportunities

CHAPTER # 1

INTRODUCTION

1.1 Background

Venture Capital (VC) has grown significantly during the 1990s and is being associated with improved firm performance. Most recently venture capital has taken roots and is expanding worldwide including new fast developing markets such as China, India and Thailand. Recently a lot of importance has been given to the venture capital industry in Pakistan. There are few venture capital firms that are registered in Pakistan but so far there are no tangible results of these firms at the Pakistani venture capital market.

1.2 Rational for Project Research

Final project is an essential degree requirement for the completion of the Masters program in Business Administration. For this purpose we have selected venture capital as an area of our study to research and analyze so as to give a macro view of what venture capital is all about and then narrows it down to the specific topic of venture capital in Pakistan: challenges and opportunities. This will help to practice the topic covered as a part of the course studied “Multinational Financial Institutions” in a realistic way.

The purpose of this study is to first analyze the importance of venture capital, from the point of view of investors and then entrepreneurs. The importance can be further seen from the role of Venture Capital in Developing Countries from Pakistan's perspective. It also aims to determine whatever developments of venture capital have been done in Pakistan and to identify avenues where venture capital has a potential.

1.3 Problem

To understand the importance of venture capital in developing countries from Pakistan's perspective and what are its prospects and challenges in Pakistan.

1.4 Project Objectives

Following are the objectives of our project,

1. Importance of having venture capital in Pakistan

2. Major sectors where opportunities exist

3. The efforts to create a venture capital industry in Pakistan

1.5 Project Audience

* Private wealthy investors and investment banks who are seeking private equity stakes in small and medium-size enterprises with strong growth potential.

* This study will act as a basis for further studies conducted by other willing students.

* .The study will also help the policymakers in general for promoting venture capital as a mode of finance in Pakistan.

1.6 Research Design & Methodology

As it is a descriptive type of study it focuses on developing the understanding of venture capital and its importance in emerging markets like Pakistan. This project has been carried out through:

1.6.1 Secondary data

* Annual reports of Governmental departments, ministries and regulatory bodies

* Business publications

* Online web resources

1.7 Limitations

The project has been undertaken with certain limitations. Finding of this study cannot be generalized but might give an insight into the issue and about that topic which the researchers are working on.

Every study is bound to have limitations. The difficulties faced in collecting data and analyzing them will be in great numbers but as far as scope is concerned they will provide an adequate insight on the issues that will be discussed. The scope of the project is limited to the venture capital industry of Pakistan.

Lastly, as structured researches and study take a long period of time to develop; in the researchers' case it is not possible to provide such length of time. But researchers have tried their level best to present a clear picture of the topic.

Chapter # 2

LITERATURE REVIEW

Venture capital in the first half of the 20th century was mainly the realm of wealthy individuals and families before World War II with some exceptions (en.wikipedia.org). Wealthy families and individuals like The Vanderbilt's, Whitney's, Rockefellers and Warburg's were notable investors in private companies in the 1920's & 30's, providing the start up money for companies that would later become famous (www.indianmba.com). In medieval Islamic society there was a form of partnership that resembled the current system of venture capital. However, the true private equity investments and venture capital began to emerge after the foundation of the first two venture capital firms in 1946 namely: American Research and Development Corporation (ARDC) and J.H. Whitney & Company. ARDC was set up by a professor at Harvard Business School, General Doriot. It was the first firm to finance the technologies developed in US universities as compared to private individuals.

Small and Medium Enterprises growth and formation are considered one of the vital factors for the economic growth (Storey 1994, Davidson et. al 1996; cited in Isaksson, 2006, p.1). Thus financing of small businesses and new start-ups is an area of interest for academics as entrepreneurship is very important for the development of an economy (Petreski, 2006). According to Berger & Udell (2002, p.32), small firms are often highly susceptible due to informational inconsistency and high start-up risk. Thus these firms face harsh financing issues as the investors refuse to support the business in early stage as pointed out by Gans & Stern (2003).

Reynolds (2000, p.52) put the same idea in these words, “the problem is that once you have bled your friends and family dry of cash, sold the cat and remortgaged the house, where do you go in order to get the wad of cash needed to progress your get-rich idea further?”

“Venture capital firms are firms that are specialized in co-investing equity with the entrepreneur to fund an early stage (seed and start-up) or expansion venture (the term venture capital is more fully discussed in later sections). Doing that implies that they need not only to contribute with growth capital, but also with the necessary competence to help the entrepreneurial firm to grow.” (Isaksson, 2006, p.2)

These start-up or young firms face problem accessing to traditional financing sources such as debt (bank loans) or equity (raising capital through an IPO) because of limited track record or lack of steady cash flows. As Manigart et al, (2002) points out, “Venture capital is thought to be an important alternative for companies that have difficulties accessing more traditional financing sources”. Also the resources or capital of the entrepreneur is not an alternative to finance the business as they are either already used or are too small (Bygrave & Timmons, 1992). “This is the point where the role of venture capital becomes important in financing small businesses. Moreover, economists agree that venture capital “provide[s] a boost of adrenaline” (O'Brien, 2001, p.9) for small start-up, innovative and dynamic firms, especially in the high-tech industry (Bottazzi and Rin, 2002). Therefore, it is said that venture capital fuels the growth and development of entrepreneurships.” (Petreski, 2006, p.2)

The question arises that why start-up firms need venture capital financing? Before a brilliant business idea can be put into effect, the entrepreneur needs funds. Therefore, entrepreneurs short of finances have to rely on external source of financing in order to start their business (Lulfesmann, 2000). As start-up innovative firms find it difficult to access traditional sources of financing due to fact that these firms have limited track records or are in their infancy. Also there is an element of uncertainty arising from asymmetric information and high risk with the opportunity to die away. Therefore, these fast growing firms have to recourse to venture capitalists.

According to Amit et al (1998, p.443), there are two major types of informational asymmetry. First, “hidden information”, which occurs one party has relevant information to a transaction that the other party is not aware of. This problem arises when the party privy to such information has an incentive to fake or distort the information. The investor may find it difficult to differentiate between low and good quality projects. This phenomenon is often referred to as adverse selection. The second type of informational asymmetry is known as “hidden action.” In such a scenario the actions taken by one party are difficult to observe by the other party. This leads to the problem of ‘moral hazard'.

Once the capital is put into the business, the brilliant business idea turns into a reality. But it is not only the capital that venture capital brings into a business. According to Barth (1999), start-up firms with high growth potential also tends to suffer from a ‘competence gap' besides equity gap and as the business matures, it increases the complexity of the management of the firm thus giving rise to new demands on the management of the firm (cited in Isaksson, 2006, p.1). When venture capitalist invests in a business they became partners in the business and mentors of the entrepreneurs because now what the destiny of the firms turns out is a concern for them too. Holding this in mind, this should result in higher future returns and thus improved performance for venture capital financed firm (Petreski, 2006). The above discussion raises another question: why venture capitalists invest in promising new businesses which have high risk associated with them?

It is now widely accepted and proven that venture capitalists only invest in businesses with strong potential growth. According to Mason & Harrison (2004), investors are dubious and answers with more no rather than yes at the beginning. Moreover, to reduce information asymmetry and initial problems, venture capitalist collects information regarding the business, its management team and market approach (Berger & Udell, 1998; cited in Baeyens & Manigart, 2003). Thus, venture capitalists put much time and effort on assessing the potential business opportunity in terms of its market size, customer adoption and strategies etc before venturing into the business (Kaplan & Stromberg, 2001b).

In addition to investing capital in innovative and fast growing firms, many researchers have argued that besides receiving capital, such firms also receives additional services from the venture capitalists which are as much important as the capital invested. Giudici & Paleari (2000) have argued in their research that as the venture capitalists become stakeholders in the business, they gain rights and power to influence the management of the firm in many different ways. The main objective of the venture capitalist is not just to get reward but to raise the business as the rewards will come automatically once the business grows (Pandey et al, 2003). This means that the venture capitalist introduces a services package that enhances its performances and value (Petreski, 2006).

One of the key services that the firm's entrepreneur receives is the expert advice. The investors act as entrepreneur's mentor as they have sufficient knowledge about the industry and can be involved in designing the business strategies, improving the network of contracts with suppliers and customers and hiring the best executives (Bottazzi & Rin, 2002). Jungwirth & Moog (2004) asserted that it is this specific knowledge of the industry which enables the venture capitalist to assess the viability of a project, that is, whether it will be successful or not and also allows them to monitor it at lower agency costs. The discussion till now leads us to conclude that venture capital is an excellent to finance and raise a new business. Although the role of venture capital in funding start-ups is notable but this type of financing has its ‘dark side' too. (Petreski, 2006)

Once the venture capitalist has introduced the capital into the business, joint efforts of his and the entrepreneur should lead to improved performance and higher returns. “Moreover, confidence is crucial in entrepreneur - venture capitalist relationship and corresponds with a certain level of certainty and trust, which in turn promotes mutually compatible interests, but not acting opportunistically” (Shepherd & Zacharakis, 2001; cited in Petreski, 2006, p. 8). At some point of time, a conflict of interest may arise between the entrepreneur and venture capitalist. In such a situation, the investor may strengthen the monitoring process that follows the pouring in the capital to the business. Now he does not only provide services but is also actively involved in running the firm so as to restrain or eliminate the opportunistic behavior by the entrepreneur and thus force him to perform effectively (Lerner, 1995). As a result an agency problem occurs.

Notwithstanding, venture capital has a dark side too but it does not lessen its role in financing fast growing startups. “Rather than that, potential conflicts between investor and entrepreneur could be avoided with confident and trustworthy behavior, where the role of the entrepreneur and that of the venture capitalist are going in the same direction, in order to extract the maximum benefits for the firm and for themselves, of course” (Petreski, 2006, p. 11).

Schertler (2002) in her research identified two conditions which must be fulfilled for a venture capital market to emerge using a general equilibrium model. The model has taken “the main agents that are active in these markets: venture capitalists, entrepreneurs, and outside investors.” The first condition necessary for a venture capital market to emerge is if the value added by the venture capitalist cannot be generated by the entrepreneurs themselves. “Second, the demand for venture capital by young high-technology enterprises must exceed a critical level. This critical level is determined by the indivisibility of innovative ideas and by the specialization of venture capitalists on particular fields of technologies” (Schertler, 2002, p. 19). Moreover, the researcher also asserted that the emergence of such markets depend upon the innovation and financial systems. Lower level of innovation means low demand for venture capital.

The success of the venture capital backed companies like Microsoft, Apple and Intel has given the U.S. venture capital model reputation at global level and many countries try to replicate this model. The venture capital markets have emerged widely in the last two decades worldwide. But this growth has not been without disturbances. “The bursting of the Internet and dot-com bubble during 2000 also marked a historical peak in the history of the venture capital industry”. (Isaksson, 2006, p. 3)The bursting of the dot-com bubble had a great impact on the venture capital industry especially in U.S. (NVCA, 2002).

The venture capital firms are expected to grow exponentially in China due to the flourishing Chinese economy and relaxed government regulations. But there are some inherent risks in the Chinese venture capital industry such as the lack of management talent in China and cheap loans offered by government owned banks which encourages the firms to seek financing from government instead of venture capital firms (Trombly, 2006). To compensate for this the Chinese Government announced 70% tax deduction to venture capital firms that provide funds to high-tech companies.

Bowonder & Mani (2002) in their research identified three phases through which the Indian venture capital industry flourished. The financial strategists sought mass awareness of the concept of venture capital in the first phase. This was followed by formulating different strategies to implement the concept in second phase and to make guidelines which will make it easy for firms to enter the venture capital market. The third phase was aimed to expand the market by attracting external investors into the industry.

The reason for performing research on venture capital is its growing economic role and creating growth in society. Mason & Harrison (1999, p 13-14) puts it: “Venture capital is now recognized globally as playing a key role in innovation, wealth creation and job generation and is increasingly a key element in government efforts at both national and sub-national levels to generate economic growth. It is therefore important that our knowledge of this form of finance increases.” Despite its importance, this research field is at a young stage, not least in Pakistan.

An understandable argument for conducting research on venture capital industry in Pakistan is due to the different economic and legal structures which may create a market that is different from the U.S. model of venture capital. According to the World Bank Ease of Doing Business Index, the ranking from Doing Business 2010 report which covered the period between June 2008 to May 2009, Pakistan ranked 85th compared to other emerging and neighboring economies like China (89rd) and India (133th) indicating that it is far easier to do business and make investments in Pakistan (www.doingbusiness.org).

The overall purpose of this thesis is to first analyze the importance of venture capital, from the point of view of investors and then entrepreneurs. The importance can be further seen from the role of Venture Capital in Developing Countries from Pakistan's perspective. It also aims to determine whatever developments of venture capital have been done in Pakistan and to identify avenues where venture capital has a potential.

Chapter # 3

VENTURE CAPITAL INDUSTRY: AN OVERVIEW

3.1 Introduction

Venture capital is a term that is used widely but has no specific definition. Venture Capital began in United States in the first half of 20th century and was mainly realm of wealthy families. After World War II, the true private equity investments emerged and soon it extended to Europe and other countries.

Venture capital is typically referred to as investment funds or partnerships in the form of equity (or sometimes in debt or hybrid form), made in start-up and innovative firms having high growth potential or “made in new or untried concepts promoted by a technically or professionally qualified entrepreneur”. Jane Koloski Morris, editor of the well known industry publication, Venture Economics, defines venture capital as “providing seed, start-up and first stage financing' and also 'funding the expansion of companies that have already demonstrated their business potential but do not yet have access to the public securities market or to credit oriented institutional funding sources.” According to The European Venture Capital Association, it is financing of growth orientated companies in form of partnership with the entrepreneur for medium or long term to maximize returns having a high risk associated with them and where the investor adds value by bringing in his knowledge and expertise. (www.indianmba.com)

According to SECP, a Venture Capital company is, “a company which is engaged in financing any venture project, through equity or other instruments whether convertible into equity or not and provides managerial or technical expertise to venture projects, or acts as a management company for management of venture capital fund. SECP defines a VC Fund as "A company which is managed by a venture capital company and raises funds through private placement of equity and other securities, as specified under these rules and invests its resources in venture projects". The fund is managed by a venture capital company (the Management Company). For example, TMT-PKIC Incubation Fund is a VC fund managed by TMT Ventures.” (www.tmtventures.net). Venture capital is an important source of financing for start-up firms as they do not have access to traditional sources of financing such as bank loans or to raise funds from capital market due to the inherent high risk that arises from their limited track record.

Besides receiving capital, the business also receives managerial and technical expertise from the venture capitalist. Most of such financing comes from wealthy investors (also known angel investors or business angels), investment banks or financial institutions that are looking for equity stake in businesses with strong potential to grow big. The disadvantage for the entrepreneur is that the venture capitalist gets a say in company management and thus in decision making in addition to equity stake. The negative aspect for the venture capitalist is that he is taking high risk in a business that may or may not yield high or above average returns that he expects or even the business may fail.

3.2 Stages of Financing

3.2.1 Early/Development Stage

At this stage the business is in process of making a business plan. The financing done at this stage is known as ‘seed capital' and is mainly provided by the entrepreneur, friends and family, angel investors &/or a strategic partner (see Table 3.1).

* Seed Capital – Business is in early stage and is not in a position to market its product. It needs to do some feasibility studies or market research in order to see the whether the venture is feasible both practically and economically. The business also may go for product development. For these activities, the business needs seed money in order to bring the idea into a reality.

3.2.2 Start-up stage

* Start-up Capital – At this stage the business is ready to take its product into the market after its initial research on the product and the chosen market. The business is ready to receive financing known as ‘stat-up capital and this money is used to give physical shape to the idea by making the business operational.

3.2.3 Early Growth/Expansion Stage

At this stage, the business has sufficient knowledge and understanding of both the market and the product. The business is either already producing or ready to initiate the production. “There are usually four stages to expansion capital:

* 1st Stage – 1st stage funding is used towards full-scale production of a product.

* 2nd Stage – Usually for companies in production and generating revenue, but not yet making a profit, second stage capital helps to grow receivables, inventory, etc.

Table 3.1: Sources of New Venture Financing

Development

Start-up

Early Growth

Rapid Growth

Exit

Entrepreneur

Friends and Family

Angel Investors

Strategic Partner

Venture Capital

Mezzanine Lender

Public Debt

IPO

Acquisition,LBO,MBO

Black shading indicates primary focus of investor type. Gray shading indicates secondary focus, or focus of a subset of investors

Source: Kalim M, 2005, “Venture Capital as the Mode of Business Finance in Pakistan: Challenges and Opportunities”, MBA Thesis, NUST Institute of Management Sciences, Rawalpindi, Pakistan.

* 3rd Stage – Third stage, or “mezzanine” financing, helps businesses perform major expansion and perhaps even develop and introduce new products.

* 4th Stage – Also known as “Bridge Financing,” companies in this stage are in need of capital to help smooth the way to a potential IPO within about six to twelve months.” (www.ventureden.com)

3.2.4 Exit

Generally the venture capitalist seeks to exit his investment in 3 to 7 years depending upon the investment plan of the venture firm. Upon expiry, companies in the Venture Capital portfolio are merged with other companies and the proceeds are distributed among the investors of the Venture Capital fund (Feurst & Geiger, 2003).

3.3 Types of Venture Capital Firms

“There are three types of Venture Capital firms. These are briefly discussed below:

3.3.1 Captive Venture Capital Firms

These are specialist venture capital firms that are subsidiaries of a larger financial institution. They receive their capital from the parent firms. These subsidiaries are set-up to provide a portion of their own funds into venture capital or risky enterprises. The investment packages often include a higher debt element and a greater emphasis on income producing instruments than is the case with funds from non-banking venture capital groupings.

3.3.2 Independent Venture Capital Firms

These firms raise their capital for investment either from private investors or from financial institutions like pension and insurance companies, academic institutions and government agencies. A common feature of independent firms is that no one investor or shareholder has a dominant position in the firm's ownership.

3.3.3 Semi-Captive Venture Firms

In this kind of venture capital firm, subsidiary of a bank or other investment management group has established its own in-house fund and at some stage invites a number of investors to join the fund. This type of venture capital firm often starts as a captive firm and then raises money from sources other than the parent company.” (Zahid et. al, 2008)

3.4 Differences between Bank Lending and Venture Capital

§ Where banks are only concerned with interest and principal payment, a venture capitalist seeks above average returns from a business which may have tremendous potential to grow in future.

§ Banks only provide financing to those firms that have an operating history and high credit worthiness whereas venture capitalist offers his managerial expertise besides financing based upon the perceived success of the business idea or venture.

§ Traditional sources of financing requires a proven operational history before lending as compared to venture capitalist who finance a new start-up firm that has limited track period but huge potential to grow.

§ Banks provide loan without any affiliation or attachment to the borrowed firm, whereas there is a high degree of involvement between the venture capitalist and the entrepreneur in the project (Aftab, 2003).

3.5 Venture Capital Global Trend

The recent global economic recession of 2008-09 is being summed up by the cliché ‘The Perfect Storm'. Economic environment has significantly changed today as compared to what venture capitalists were operating in few years back. The venture capital industry was just recovering from the bursting of the dot.com or tech bubble five years ago and was seeing the venture capital industry moving towards globalization.

Despite of the fact where today's global economy stands, there is still a sense of optimism and the venture capitalists are accustomed or familiar to the global economy. The industry is witnessing the maturation of sectors like semiconductors and telecom while new avenues for investment with greater growth potential are opening up like clean technologies and life sciences. With this shift, venture capitalists are tuning their investment strategies in order to adjust to this storm and establish groundwork to flourish in the future. According to the Global DTT TMT venture capital survey of 2009, the venture capitalists have decreased their investments (see Fig. 2.1) by sticking to their best companies and increasing their share to later-stage investments (Global DTT TMT, 2009, [p.4]).

Nonetheless, most of the firms are upholding the same stratagem when it comes to industry sector with 7 out of 10 Venture capitalists plan to stick to the same strategy

In terms of industry according to the Global DTT TMT venture capital survey of 2009. According to the survey, very few of the venture capitalist firms have shifted to early-stage investment with about half of the firms maintaining their current strategy. A majority of the firms are shifting to later-stage companies due to the damage done to the capital markets and also it cut down the development period and allows venture capitalists to exit earlier (Global DTT TMT, 2009, [pp.5-6]).

Also there is a growing interest among the venture capitalist firms to invest in clean technologies and life sciences. This increase in interest can be attributed to the increasing government/political support for clean tech and Venture Capitalists are looking for more to government participation and incentives (Global DTT TMT, 2009, [pp.6-7]).

Another trend that has emerged over the years among the venture capitalists is their increasing interest in emerging markets like China and India. According to Gavin Ni, founder, President and CEO of Zero2IPO, “We are lucky to be sitting at the hub of what we believe will be the most exciting venture market in the coming years— China, If you take a look at the short-term, you see China will be the first to emerge out of the worldwide downturn. China is projecting 7 percent-plus GDP growth in 2009—the highest in the world. Then, looking beyond, you see a swelling middle class—but still a minority of the population—with money in their pockets to spend. That does not even scratch the surface of the eventual buying power of the largest population in the world—1.3 billion potential consumers.” The rising interest in China and India is due to the fact that these are the emerging economies with greater growth potential. “Also, the strained exit markets in the U.S. and the impact of recent government policies appear to be discouraging investors from increasing their risk exposure in North America.”(Global DTT TMT, 2009, [pp.8-11])

Today, the venture capital industry is globalizing in a significant way. Though venture capitalists are adjusting their investment strategies to the changing global economic conditions, the industry is still continuing towards globalization. The current ‘Perfect Storm' is not bringing the venture capitalists to a halt as they continue to look for better investment opportunities seeking good returns for their investors irrespective of the geographical boundaries (Global DTT TMT, 2009, [p.25]).

CHAPTER # 4

VENTURE CAPITAL INDUSTRY IN PAKISTAN

Pakistan, being at the cross roads between East and West Asia has immense strategic importance due to easy access to its markets. Due to its abundant resources, Pakistan is a very appropriate country for investments. It provides competitive advantage over other destinations if right investment is made in the capital and human resources. Pakistan is still at the pre-emergence stage of venture capital and the Government should make efforts to boost this industry. Venture capital industry has grown considerably in the last few years with firms improving their performance in terms of growth and survival rate. Venture capital firms in Pakistan are being run by both local and international players. A successful venture capital firm requires strong pragmatic base, drive to achieve something and a practical business plan.

The US saw extraordinary IT boom in early 1990s. Shortly due to various factors such as burgeon growth of private sector universities in the country, the dot com fever caught Pakistan. The economic reforms introduced in 1990s by the GOP were mainly focused on export orientated sectors such cotton, textiles, sports goods, surgical instruments etc. SBP was granted more independence due to which movement of foreign currency and repatriation of profits by foreign firms became easy. One of the key components of the reforms introduced by the government was the importance given to the development of the small and medium enterprises in the country. SMEDA came into existence that then identified priority sectors and IT being one of them. Pakistan Software Export Board (PSEB) was made an autonomous body to faucet opportunities in the emerging IT sector.

The coup of 1999 by Pervaiz Musharaf brought Dr Atta-ur-Rahman as the Minister of Science and Technology. He cut all the way through the invincible bureaucracy and provided the momentum needed by the IT sector. Under his leadership, PTCL brought down the internet bandwidth rates from US$36,000 per 2Mbps to around US$10,000 in one year making Pakistan competitive in the region.

4.1 Venture Capital Firms in Pakistan

Currently there are three firms engaged in the business of venture capital in the country. They are:

1. TMT Ventures

TMT Ventures was created in 2000 and is the first licensed company in Pakistan and the only one that has survived. TMT stands for Technology, Media and Telecommunication and denotes the avenues where the firm focuses its investment. TMT started as a private owned division within AKD Securities and has grown to a company managing Rs. 250 million Incubation Fund. TMT started operations at a time when there was no understanding of how venture capital works in Pakistan and there was no regulation from SECP. TMT adopted the US model of VC and altered it to meet the requirements of the local environment.

Y-Evolve, a web development company, became the first ever VC backed company in 2000 when TMT provided a very small amount of Rs. 400,000. To-Be Technologies (2BT) was the second experiment that TMT Ventures took on by committing to provide funds of about Rs. 3 million. Application Access (AppXS) was another company that was added to the portfolio later on. In 2001, AKD Securities and TMT Ventures helped the SECP to frame the rules for VC which was earlier not even recognized by tax laws as a mode of investment and thus came the Venture Capital Funds Rules of 2001 and TMT Ventures became the first company to be licensed under the rules.

In 2002, TMT Ventures launched a 200-millionrupee fund called TMT-PKIC Incubation Fund. Pak-Kuwait Investment Company (PKIC) acquired 25% stake in TMT Ventures with three other institutional investors namely Habib Bank Limited, SME Bank and National Investment Trust (NIT) joining the management company. From 2002 to 2005, the portfolio increased to eight companies each having uniqueness: Y-Evolve (2000, first VC investment), AppXS (2001, first online trading applications company), Post Amazers (2002, first large-scale animation and postproduction company in Pakistan), RFM Loyalty (2003, first chip-based loyalty services company in Pakistan), Anilogix (2003, first funding on an experimental basis to fresh IT graduates from a local university to create computer games), Voxel Communications (2004, first investment in call center service provider) and AKN MTech (2005, Among the first few companies focused on mobile content development, aggregation and marketing). In 2004, NIT withdrew its stake from the incubation fund which was bought back by AKD. Later in 2005, PKIC cashed out itself and again AKD bought in the investment (TMT Ventures, 2007, [pp.9-24]).

2. The Resource Group (TRG)

TRG Pakistan is a Pakistan based company which is engaged directly or indirectly in acquiring or managing the call centre business. Through its subsidiary company, The Resource Group International Limited (TRGIL), the firm has operations in Africa, Europe and North America and is also involved in the investments and acquisition of business process outsourcing (BPO) companies. The company is the venture of Pakistani entrepreneur Zia Chishti.

3. AMZ Ventures Limited

The company was setup to promote and develop venture capital in Pakistan and was listed on Karachi Stock Exchange (KSE) in December 2004. AMZ Ventures first investment was in the area of IT where it invested its entire funds in its owned subsidiary AMZ Access (Pvt.) Limited which is involved in the BPO and Business Process Management (BPM) with financial and healthcare sector clients in US (www.amzventures.net).

4.2 Structure of Venture Capital Firms in Pakistan

The structure of venture capital funds in Pakistan is different from the one that exists in USA. In USA, these funds are structured as limited partnerships with investors acting as limited partners (LPs) and the managers acting as general partners (GPs). However in Pakistan the functions of GPs and LPs are carried out by two different companies. The venture capital company where investors have shareholding is similar to the LP that exists in USA. Then there is a venture capital fund managed by a venture capital company which is similar in nature to that of GP in the USA model and which is in charge of the operations of the fund (www.tmtventures.net).

4.3 Ways in Firms Receives Venture Financing

There are two ways in which a firm can receive venture capital or financing: it can be provided by the investors also known as business angels directly; or they can be received indirectly through a company which acts as a venture capital fund. The fund acts as an intermediary between the investors such as individuals, insurance companies, pension funds etc and the firm seeking venture capital.

4.4 Regulation of Venture Capital Business in Pakistan

In Pakistan, a venture capital company needs to be registered with SECP as a NBFC. The rules framed for the regulation of the venture capital business in Pakistan is known as The Private Equity and Venture Capital Fund Regulations, 2008. Some of the rules and regulations for the grant of license to a firm are:

A venture capital company shall not be granted license unless it fulfills the following conditions, namely:

§ Incorporated as a public limited company under the Companies Ordinance, 1984

§ Not involved in any business other than that of investment in venture projects

§ It has a minimum paid-up share capital of Rs 30 million rupees

§ It has certified that the chief executive of the venture capital company does not hold such office in any competing business;

§ It has appointed as its chief accounting officer a person who a chartered accountant or cost and management accountant or a person is having Master's Degree in Commerce or Business Administration from a university recognized by the Universities Grants Commission with at least five years experience in finance and accounting.

§ The sponsors, directors, chief executive and chairman of the Board of Directors should satisfy the Fit and Proper Criteria outlined by SECP

§ Not expose more than seventy (70) per cent of its equity to any single group of companies;

§ Disclose in its accounts all investments in companies and group of companies exceeding ten per cent of paid up capital of Venture Capital Company

§ Ensure that the maximum exposure of the venture capital company to its directors, affiliated companies and companies in which any of the directors and their family members including spouse, dependent lineal ascendants and descendants and dependent brothers and sisters hold controlling interest shall not exceed ten per cent of the overall portfolio of venture capital

§ Not accept any investment from any investor, which is less than one million rupees.

4.5 Tax Status of Venture Firms in Pakistan

The profits and gains generated by Venture capital companies registered under The Private Equity and Venture Capital Fund Regulations, 2008 with SECP as NBFC are exempted from income tax under the clause 101 of Part 1 of the Income Tax Ordinance, 2001 up to June 30th, 2014.

4.6 Role of Venture Capital in Enterprise Development in Developing Countries

Pakistan being a developing country and emerging market, it is vital to identify the role of venture capital in this context. The growing economies of the Latin America, South America and Asia have caught the attention of the venture capitalists in the recent past.

Venture capital plays two major roles in the developing countries of today:

§ The maturation of markets of the developed countries has led to a decline of the returns on the investments of the venture capitalists significantly. The venture capital firms are now diverting their attention to the growing and emerging markets and injecting substantial funds in these countries by investing in start-ups with huge growth potential.

§ Besides providing capital, another vital role that venture capital plays is by providing managerial expertise and knowledge to comparatively less experienced firms in emerging economies. Many firms operating in developing countries become players in the local market due to the immunity provided by the governments in the form of subsidies or tariffs. As we are witnessing a transition to globalization with the dawn of WTO, many firms in these developing countries often find it difficult to compete in international markets. At this stage, the venture capitalists can help by bringing their experienced and professional management and act as catalyst in developing countries' economy.

For the successful enterprise development, it is vital for venture capitalists to have sound stock exchange which makes it easy for them to exit. If the firms where venture capitalists invest cannot “go public” due to stringent regulations or size of stock exchange, it will not be easy for venture capitalists to realize the gain on their investments.

Thus, if the VCs do aim for a high development of the enterprises, local stock exchanges would ultimately benefit as the companies would be in a strong position to be listed in the first place. As venture capital funds in developing countries grow, so will the need for local stock exchanges, thus, similarly, in Pakistan too, more stock exchanges can be developed apart from the only 3 stock exchanges (Islamabad, Lahore and Karachi Stock Exchange) we currently have (www.new-ventures.org).

4.7 Importance of Venture Capital from Investors & Entrepreneurs Perspectives

Venture capital is important for the investors (also known as venture capitalists) and entrepreneurs. Explaining venture capital financing from the perspective of both of the parties, we must answer two questions: What does an entrepreneur have and what does an investor have? Venture Capitalists have money or they are able to raise money from other investors. They have expertise in creating wealth by initiating and raising companies from the start till their exit. They have the necessary network contacts that are vital to the company. They invest in businesses from which they anticipate to yield higher returns than other firms. Whereas entrepreneurs on the other hand have ideas, products or processes that are futuristic or ahead of its time. They have the urge and desire to build and retain their business. Therefore, the venture capital industry brings the two parties together so as to fulfill their needs (Tasci, 2004, p. 2).

Chapter # 5

IDENTIFICATION OF ISSUES

The economy of Pakistan has huge potential and has future prospects for venture capital industry to grow exponentially. After going through the relevant literature for the venture capital funds, we have come across certain gaps which need to be addressed. We have tried to identify some reasons because of which this method of financing has not been fully implemented in Pakistan.

1) Restriction on institutional investors such as pension funds and insurance companies prohibiting them to invest in high risk business areas like the venture capital industry

2) Venture capital firms or Fund Management companies are required to renew their license from SECP on annual basis

3) Weak regulatory framework for the implementation of Intellectual Property Protection in Pakistan

4) Absence of comprehensive legal framework for the venture capital industry

5) Absence of an active secondary market where the listing requirements for smaller firms and their initial public offerings (IPOs) is relaxed as compared to normal listing requirements for other companies

6) Investors when invest in a business, they expect good performance and quick returns from it as most of the investors are impatient. This is not the case for the venture capital firms as it may take 3 to 5 years generally for a venture backed firm to become profitable. Also, there is always a high degree risk associated with the start-ups and their chances of failure are also high. This is why many investors are reluctant to finance such start-up businesses.

7) Although innovative and fast growing start-ups had higher risk associated with them, their returns are also high as compared to market return. As it was the case in China where initially venture capitalists were reluctant to invest in innovative businesses, gradually foreign venture capitalists entered in to the Chinese market and started investing in high technology innovative firms due to the higher returns. Nevertheless, investors in Pakistan are mainly risk averse and do not intend to take on risky investments. The volatile Pakistani market is also another reason for such risk-averse nature of the investors.

8) Countries which have benefited from the venture capital like India and Israel have focused their investment on conducting proper Research & Development which made their investment more genuine(real) and productive. Conversely in Pakistan, business community is more interested in jumping to opportunities rather than conducting research in order to validate whether the idea is feasible in the long run.

9) Lack of awareness among the masses in general and the entrepreneurs in particular is another issue in the development of the venture capital industry in Pakistan. Whereas venture capital firms in India were developed by a three-stage strategy. The financial strategists sought mass awareness of the concept of venture capital in the first phase. This was followed by formulating different strategies to implement the concept in second phase and to make guidelines which will make it easy for firms to enter the venture capital market. The third phase was aimed to expand the market by attracting external investors into the industry.

10) After reviewing the literature, we noticed that the venture capitalists in India were focused on following the guidelines formulated in coordination with the World Bank. The venture capitalists targeted private sector industrial firms and had a target return of at least 20% annually on the portfolio. Pakistan on the other hand does not have any such targets and even if they do exist, they are not accordingly followed.

11) Emerging markets where venture capital has contributed significantly like China and India have focused on investing in high tech Information Technology industry which has a lot of potential. Whereas in Pakistan, financial institutions like banks are reluctant to finance these firms due to absence of tangible collateral as these firms cannot be sold off in case of default.

12) In most of the developed economies and some developing economies, there is a system for extending loans, verifying the credibility of the business and recovery of the loan. Although SECP has several regulations in place for investors interested in setting up a venture capital fund (firm), there firms lacks systems and procedure to verify the credibility of the entrepreneur and authenticate the information provided by him. This has lead to a high default rate.

These are some of the gaps and issues that need to be dealt with by the Government in order to improve and promote venture capital in Pakistan.

Chapter # 6

MICRO CREDIT FINANCING: AN ALTERNATIVE TO VENTURE CAPITAL?

In this chapter we will briefly describe what micro credit financing is and whether it's a good alternative to the venture capital (or micro venture capital).

Micro credit is the loan provided by micro credit banks to low income households that follows a weekly payment collection schedule. Such loans tend to carry high interest rates as compared to conventional bank financings. Lenders of such loan require borrowers to form groups. If any member of the group defaults a payment, the entire group might be denied further loan until the delinquent loan is brought current. This persuades the group to ensure that every borrower in the group makes timely repayment of his loan. Micro venture capital (MVC) is different from venture capital in terms of the exit points (time when venture capital funds end their participation in the business). Venture capitalists use acquisitions, IPOs, buyout or mergers as exit points where as MVC exit when they recover their original investment plus a return (normally it ranges from 50-100%) and fee. MVC only recovers money when the business becomes profitable.

As such lenders of micro financing earn lower returns because they assume low risk. The default rate of micro credit financing tends to be higher as the lender insists on weekly repayment irrespective of the fact that whether makes profit or not. The lender is not interested in the success of the business. Also as these loans are extended to households who does not have a good credit rating and they cannot offer any collateral against the money borrowed, the micro credit lender has no means to recover in case of the borrower defaults. On the other hand, MVC earns higher returns because of taking on higher risk. The rate of default is considerably reduced as the investor provides managerial expertise besides capital. Investors in MVC are more interested in the business to grow and become profitable instead of receiving fixed interest payments.

The cost structure for the micro credit institutions is fixed and has a higher overhead cost as compared to MVC. Also micro credit requires a considerable workforce for visiting and collecting weekly payments from the borrowers. Moreover, if the borrower defaults, the lender has to send employees to recover the loan. So, where the revenue of the lender declines, his cost increases. Furthermore, if the number of defaults increases, the lender can be out of the business. Whereas cost structure for MVCs is flexible and have less overhead cost as they require fewer employees. MVC are mainly consultants providing expert advice besides capital to the start-ups.

It is generally agreed that about 1/4th of the micro credit obtained is used for personal consumption rather than using it for income generating activities. The rest of the 3/4th of the credit is used in business that generates nominal returns for the borrower and rarely generates any additional employment opportunities. Whereas MVC invest in businesses that are larger than those funded through micro credit financing. According to Goldman Sachs & Co., profit margins for projects financed by MVC are 10 times higher than micro credit financed projects.

The MVC financing model encourages entrepreneurs to educate themselves. Entrepreneurs who receive MVC financing also receive training in basic business skills and managerial skills from the investors. MVC increases innovation in the economy as compared to micro credit. MVC model of financing creates job opportunities and thus help to reduce unemployment and poverty in developing countries. Whereas, micro credit financing does not place great importance on skills and knowledge of the borrower. Hence, MVC is more effective and helps more in improving the economy of a developing country. According to a report by Goldman Sachs & Co, following holds true for MVC as compared to micro credit financing (MCF):

* Its financing has a 10 per cent higher return than MCF

* A 5 per cent lower default rate

* They have 10 per cent less overhead cost than micro credit banks.

* The cost structure for MVCs is flexible while the cost structure for micro credit banks is fixed

CHAPTER # 7

POTENTIAL SECTORS/INDUSTRIES FOR VENTURE CAPITAL IN PAKISTAN

Pakistan, sixth largest country with a largely young population of 181 million (www.prb.org) due to its geographical location serves as a gateway to the Central Asian States which are rich in energy sources, emerging economies of Far East and financially liquid Gulf States. Pakistan's strategic location coupled with growing economy makes it an attractive destination for investors. According to the World Bank Ease of Doing Business Index, from Doing Business 2010 report which covered the period between June 2008 to May 2009, Pakistan ranked 85th compared to other emerging and neighboring economies like China (89rd) and India (133th) indicating that it is far easier to do business and make investments in Pakistan (www.doingbusiness.org).

The economy of Pakistan grew at a slow pace of 2% against a target of 5.5% in the year 2008-09 due to the global financial crisis. However due to its attractive investment environment, the country managed to attract US$3.720 billion in 2008-09 (Ministry of Finance, 2008-09). The structural reforms in tax administration introduced by FBR and the efforts by SBP re-energized high returns on investment in the sector. The SECP has also enhanced the regulatory framework and environment for the stock exchanges, bond markets and the leasing sector. The country is following the policy of privatization and deregulating Public Sector Enterprises (PSEs) which are running into losses due to weak and inefficient management. These policies have resulted in increase in investments and growth of the overall economy.

The recent security threats and worsening law and order situation in the country has raised the concerns for investment environment in the country. However, it is a normal business for the people of Pakistan. According to the World Bank Doing Business 2010 Report, Pakistan ranks 27th in terms of protecting investors (see Fig 7.1). Currently Pakistan has the most open foreign direct investment (FDI) policy allowing 100% equity to foreign investors and full profit repatriation.

There researchers have identified some sectors where there are opportunities for the venture capital to earn high returns. They are:

§ Entertainment/leisure (amusement parks, cinemas)

§ Education (universities of international caliber)

§ Computer hardware vendors

§ Automobile spare parts vendors

§ Software development

§ Surgical instruments and utensils

§ Apparel/ branded clothing (export)

§ Sports goods

§ Leather garments and shoe manufacturers, and

§ Electronic appliances

§ Alternate Power generation sources such as solar and wind energy

§ Dairy and livestock

The researchers will be focusing on the three main sector which offers huge potential for the venture capitalists. These sectors are telecom, media and technology.

7.1 Telecom Sector

Regardless of the slow overall economic growth, the telecom sector registered positive growth in terms of teledensity, revenue and subscription. The sector was able to attract US$815 million in the year 2008-09. However most of the operators are foreign who have a pessimistic outlook of the economy due to the global financial crisis. Most of the operators adopted cost cutting measures to overcome negative impact of the economy. Pakistan Telecom Authority (PTA) is assigned with the task to regulate the sector and formulate policies to promote investment and encourage competition in the industry. The strategy adopted by PTA is that of a light regulatory approach with ensuring that all operators, large or small, have level playing field. The outcome of this strategy is a transparent and deregulated sector (PTA, 2009).

The Telecom sector remained the single largest receiver of the FDI receiving one fourth of the total FDI. Pakistan attracted US$ 19 billion in FDI in the last 5 years of which 34% was in the telecom sector (Fig 7.2). Teledensity in the country stood at 62% in 2009 (see Fig 7.3). Despite increasing the taxes and falling exchange rates, the revenue of the sector grew by 19% in 2009 and stood at Rs. 327.8 billion (see Fig 7.4). The sector also contributed Rs. 112 billion in to the national exchequer as taxes. Basic services such as fixed local loop (FLL), Wireless local loop (WLL), Long Distance & International (LDI), and Broadband services also witnessed growth in revenues and its contribution to the sector revenue stood at Rs. 121 billion (about 26%).(PTA, 2009)

The mobile penetration in the country has reached 58.2% (see Table 7.1) and subscriber base of 94.3 million with 90% of the population having access to mobile. International experts still believes Pakistan to be an attractive market for mobile cellular operators as there is still unmet demand in the segment. Also with the introduction of 3G (Third Generation) services, consumers can use improved data services on better speed and the operators at large will benefit from it. PTCL still maintains its dominant position in the fixed local loop or fixed line telephony due to declining teledensity of 2.2% of fixed line with 3.5 million subscriber base. Therefore there is room for deployment of fiber optics in rural areas of Pakistan for potential investors (PTA, 2009).

Wireless local loop has also not been able to win the confidence of the customers with teledensity standing at 1.6% in this area. It was expected that WLL will compensate

for the declining trend of the FLL which did not happen due to the lack of investment by the WLL operators. Also the WLL operators like Wi-tribe and Wateen shifted their investment towards the Broadband expansion and investing new technologies like WiMax. This gap provides an opportunity for investors to invest in fiber networks to secure a position in this segment of the industry.

Pakistan has also experienced astonishing growth in the broadband sector for the last two years. There are 413,809 subscribers currently in the country with PTCL, Wateen and WorldCall being the major players. According Business Monitor International, the subscriber base of this segment will reach to about 21 million in the year 2013 (PTA, 2009).

While a considerable number of licenses been issued to Local Loop (LL), WLL, LDI and Internet Service Providers (ISPs) operators, the government is planning to expand frequency bands for WiMax (Worldwide Interoperability for Microwave Access) while at the same time issuing licenses for 3G mobile networks. Also there are new mergers and acquisitions opportunities in the market as investors are acquiring technical expertise to have efficient operations. All this point to opportunities that not only exist in the traditional sectors but also in new areas of the industry such as MVNO (Mobile Virtual Network Operator), Call Centers, Video Conferencing etc (PTA, 2007).

7.2 MediaSector

The deregulation of the media sector in Pakistan has resulted in opening doors to several new TV and radio channels, production houses (for content development), animation studios, etc. The media market size in Pakistan has great potential. The voyage of electronic media expansion in the country begins from 14th August, 1947, when Pakistan Broadcasting Corporation was formed.

Since its foundation in Pakistan, electronic media in the country stayed in government control until 1990, when Shalimar Television Network (STN) and Network Television Marketing (NTM) was the first private sector TV channel in the country. During mid 90s, a increasing demand for television entertainment in Pakistan smoothed way to foreign TV channels through satellite dishes. “Pakistan Electronic Media Regulatory Authority” (PEMRA) was established in March, 2002 as an independent statutory and regulatory body. In a small period of almost seven years the country has observed unparalleled growth in the number of TV channels, cable TV and FM Radio stations in the private sector. This explosion is due to the government's clear dedication to a free media and the positive role played by PEMRA in helping the growth of the electronic media. The remarkable growth of TV channels, Cable TV and FM Radio stations has indeed contributed extraordinarily in raising the standards of public understanding and literacy. Similar to broadcasting sector, the distribution sector has also been experiencing a continued growth rate in the last few years. Predominantly, the growth of Cable TV Sector in the country can be described as exceptional. In 2008, Pakistan Television Network (PTV) for the first time in the country launched Internet Protocol TV (IPTV) (PEMRA, 2009, [pp.13-18]).

According to an estimate, about US$ 1.5 billion had been invested in the electronic media industry and providing jobs to more than 150,000 people. The investment had been expected to surpass US$ 2.5 Billion in June 2009 if the current growth of 7% per annum continues. Broadcasting is one of the fastest growing sector of the economy where PEMRA is providing investor friendly environment and encouraging the private sector to put up their investment and expertise for the development of this sector in the country (PEMRA, 2009, [pp. 20-23]).

PEMRA plans to commence Digital Terrestrial Broadcasting (DTB) at national, provincial and district level of Pakistan. The idea is aimed at assembling the advantages of digital broadcasting and at the same time keeping up with the millennium development goals of the World Summit on the Information Society. Currently, Analog Terrestrial Broadcasting (video) is under control by Pakistan Television Corporation (public entity) in Pakistan while private sector is depending on satellite delivery platform for broadcasting the content. Introduction of DTB by PEMRA will definitely provide an opening to new players' thus increasing competition and therefore will present more range and better quality content to the viewers (PEMRA, 2009, [p. 29]). DTB will increase the competition in the broadcasting segment of the industry and provide wide range of services to the viewers. Few of the other emerging technologies from venture capitalist can benefit are the IPTV, Mobile televisions and digital cable network etc.

7.3 TechnologySector[1]

According to SBP statement, export s for software / technology are generating currently US$201 Million revenue in Pakistan in the year 2008-09. The total size of the industry is US$ 2.1 billion. There are around 1500 IT companies registered with the Pakistan Software Export Board (PSEB). IT and IT-enabled services (ITeS0 offers attractive opportunities for venture capitalist to tape.

The Government of Pakistan has been actively developing the IT sector in Pakistan. “A few of the inducements offered include tax exemption till 2016, establishment of IT Parks with low rent, foreign ownership of equity invested in IT and 100% repatriation of profit allowed to IT companies. Pakistan offers various competitive advantages over other outsourcing destinations, such as high quality software development, swift and easy establishment of business, lowest cost basis and emerging and state-of-the-art telecommunication and IT infrastructure. Experts estimate an average annual growth of 33% in the sector. This will result in the total IT export revenue crossing US$ 10 billion in the next five years.” (www.pseb.org.pk)

Pakistan's IT industry has been rising steadily since the last three years. A marked increase in software export s are an indication of this booming industry's potential. Since the last few years, the government has taken different steps in order to facilitate the growth of this sector. Following steps have been taken:

* Building of backbone infrastructure

* Slashing backbone prices

* Penetration of internet services in smaller regions

* Manpower training

* Establishment of a regulatory framework.

The market is largely service oriented with a bulk of software houses providing low-end services like web designing and hosting. Most of these houses are underfunded and lack the expertise to compete for high-end, value-added business locally and internationally. Because of the availability of low cost technical manpower, these houses are able to work on almost all available platforms. The downside to this approach is that these houses lack focus and are largely unable to achieve critical mass.

Because of these inherent weaknesses, the industry as a whole is largely unable to withstand shocks. This has been evident over the last year as many houses shut down in the face of reduced IT spending by major companies and a general IT slump worldwide. Even the more reputable names had to scale down their operations. So from the venture capital point of view, the benefit lies in investing that technology sector market which aims to provide high-end services.

The example of a “high-end service” can be the open-source software service provider. These days' investors see this as a great potential. Many venture capitalists view open-source software as a rising technological wave that can't be ignored. Open source falls in the top 10 technologies and movements we are seeing overall in the world. Pakistani entrepreneurs, investors, VCs have a great opportunity in this which they can exploit. Apart from open source, the top 10 emerging technologies that will make particularly big splashes and will transform the Internet, computing, medicine, energy, nanotechnology etc are (www.techreview.com):

1. Airborne Networks

2. Quantum Wires

3. Silicon Photonics

4. Metabolomics

5. Magnetic-Resonance Force Microscopy

6. Universal Memory

7. Bacterial Factories

8. Enviromatics

9. Cell-Phone Viruses

10. Biomechatronics

Thus, again, this is a great opportunity for Pakistani entrepreneurs to start up and for venture capitalists to fund these technologies. Some of the emerging opportunities in the IT sector for venture capitalists in Pakistan are:

7.3.1 Animation

One of the truly promising areas in the background of software i.e. gaming has only begun to gain importance in Pakistan over the last few years. “A number of Pakistani IT companies are effectively making use of animation in a variety of possible dimensions. An example of such is the advertisement campaign for 7UP based on the Fido Dido character, which makes major use of animation. (www.pseb.org.pk)

7.3.2 BPO (Business process outsourcing)

Business process outsourcing is another area that gives several cost advantages over the conventional in-house development. “Pakistan has a large untapped labor pool of English-proficient graduates willing to work at wages 60% below their US counterparts. Furthermore, consolidated operating costs are estimated roughly 30% lower in Pakistan as compared to India or Philippines, two of Asia's major BPO contenders. The Government has provided numerous incentives and is willing to invest heavily in the infrastructure required to jumpstart growth in the BPO sector.” (www.pseb.org.pk)

7.3.3 ERP

Enterprise Resource Planning (ERP) is possibly one of the toughest and most challenging software solutions to provide to any customer, involving the complete computerization of the customer's company processes. ERP comes in two basic forms: customized ERP (software made as per the demands and needs of the client) or standard ERP (a solution such as SAP that can be bought ‘off the shelf' to be implemented).(www.pseb.org.pk)

7.3.4 Gaming

Computer games are now an enormous market with firms such as Electronic Arts and Capcom investing billions of dollars into the industry. Game development is up-and-coming in Pakistan's IT Industry as well with some serious work being done in the field indicating progress.With the IT experts of the country recognizing the prospective of the game development market, Pakistan's IT industry is making more investments to develop country's own gaming industry. (www.pseb.org.pk)

CHAPTER # 8

RECOMMENDATIONS

Although Pakistan is a favorable and lucrative investment destination for investors and venture capital funds, changes should be made to existing regulatory and fiscal framework to promote venture capital in Pakistan. The researchers have put forward some recommendations that will be of help to the government as well as the venture capital firms. These are:

§ Pakistan needs to assess the venture capital structure and policies of the countries where venture capital firms are operating successfully in developed countries like USA, Israel and emerging economies like China, India, and Malaysia. Pakistan needs to learn from the experiences of these countries and make an attempt to attract private capital into the economy

§ The regulatory restrictions by SECP on the insurance companies and pension funds refraining them from investing in venture capital firms should be relaxed.

§ Existing regulations of venture capital requiring fund management companies to renew their license needs to be changed as venture capital firms operate on long-term basis.

§ Intellectual Property Protection (IPP) rights infringements are a serious concern for the international investors and have discouraged them from investing in Pakistan as such violations are not dealt strictly. The Government should stringently monitor the IPP rights across the industry and inflict penalties on firms violating such rights.

§ There are rules and regulations in place for VC firms to start business but there is lack of guidelines for VC firms to evaluate whether the opportunity they are investing is credible or not. Similarly due to loan recovery issues, Pakistan Venture Capital Limited exited from the industry as it was faced with serious issue of default risks of the portfolio companies. This high uncertainty in the market discourages investors to enter into the industry and invest in new ventures. Therefore, SECP and SBP should work on to improve the loan recovery procedure in the country.

§ The Government should also provide incentives such as tax rebates and complete exemption of capital gains from venture investments. China provided 70% bonus deduction to those firms that invested in small or unlisted firms in order to promote venture capital firms and venture investment in the country.

§ For the development of venture capital industry in the country, it is vital to spread awareness and educate the institutions controlling various capital sources such as pension funds and insurance companies about venture capital investments. They should also be informed of the risks involved in such investments and how can such risks be mitigated. On the governmental level, forums, workshops and discussion sessions needs to be conducted by industry experts.

§ Listing rules and regulation of the Karachi Stock Exchange should be made flexible or another secondary market such as NASDAQ is in place so that start-up firms can easily list their initial public offering (IPO) and thus provide a smooth exit for venture capital investors.

§ “Although the Government of Pakistan has incentives in place for both foreign and local investors in terms of tax breaks and smooth ‘exit' options it can provide additional support for the early stage or start-up businesses caught in the equity gap. One possible approach to meeting this need might be a variant of the Small Business Investment Company (SBIC) model in the US. A Pakistan SBIC Program would aim to improve the availability of risk capital to start-ups facing the equity gap, by bringing more ‘entrepreneurial investors' into the management of funds which specialize in making small, early-stage deals; offering incentives to make these investments; and enhancing the impact of business angel networks.” (Akhtar, 2007, [p.7])

§ Government can also help in providing experts and qualified professionals particularly at the due diligence stage of the screening of the entrepreneurial idea.

§ There is a need to identify more areas on the demand side along with the IT, Media and Telecom sector where there exists potential for venture capital investments.

§ Co-financing investments with international venture firms and investors will help the private sector and government to learn from the international experience and foster the process of creating a sustainable venture capital industry in the country.

Conclusion

The venture capital industry in Pakistan still in its infancy or pre-emerging stage. The Government should encourage investors by providing a favorable regulatory and investment friendly environment so as unemployment and poverty can be dealt with and also bring innovation and entrepreneurship into the economy. Sound corporate governance, open economy with greater contribution from the private sector with strong free judicial system in working is needed to attract local and foreign investors into the venture capital industry.

[1]Please note here that venture capitalists' involvement in invest in technology sector is substantially larger than any other sector. This is a renowned fact globally. Due to this fact, and the opportunity in technology sector in Pakistan, focus in this project is on the technology sector.

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