"Nice memories have their own scent. Whenever you are veiled in its scent...your heart can always return to that unforgettable past...together with your own scenery that will never fade away." - Kyoichi Kanzaki

Saturday, January 15, 2011

A Critique on Venture Capital Investments

This is yet another one of my reaction/reflection/critique on a journal article we reviewed in our MS Finance class. The article entitled "EXITING VENTURE CAPITAL INVESTMENTS: LESSONS FROM FINLAND" was written by Yrkkö, Hyytinen and Liukkonen in 2001. Yes, I also had a hard time reading their names. hehe.


The article by Yrrko et al. discusses the exit choices of venture capitalists particularly those firms in Finland. Two particular exit avenues were emphasized namely trade sale through mergers and acquisitions, and through initial public offering or IPO. The authors argue that their Finnish venture capital industry is too young. And young venture capitalist industry still needs to build its reputation to attract more investors. According to them, exit avenues are important for entrepreneurs and venture capitalists. Most venture capitalists do not look forward into controlling and running investee firms while entrepreneurs, on the other hand, can make use of these exit avenues to regain control of their enterprises from venture capitalists. However, in the case of Finland during their study, venture capitalists were in trouble since the industry is young, thus they are unable to exit through initial public offerings and had to use trade sales or mergers and acquisitions which is significantly less profitable for both entrepreneurs and venture capitalists compared to the former avenue. If we follow the study by Yrrko et al, venture capital firms should have a great exit strategy to attract investors. Their exit avenues should guarantee high profitability for the venture capitalist firm to boost investor confidence. Initial public offering is more preferred compared to mergers/acquisitions, since this is found to be more profitable. As said by the authors, initial public offering depends on the market condition of the country before it can be used as an exit strategy by venture capitalists. Therefore, venture capitalism is highly dependent on market conditions. If this is the case, investing in a young venture capital industry is very risky given the uncertainty of market condition through time. However, if the economy is mature and continuously growing, exit avenues for venture capitalists are easy and hassle-free.

If we look at the choice between trade sale and initial public offering, it is said that trade sale is less profitable compared to the latter. This is due to the idea that for trade sale, mergers and acquisitions, both the entrepreneur and venture capitalist will have to divide their sale according to what is agreed upon. But during an initial public offering, the firm can accumulate funding that is more than the expected stakes of the venture capitalist and that of the entrepreneur. But using the case of Zest-O in the Philippines, from the news and company announcements, the firm was able to acquire Asian Spirit and Seair through their own investment company. After planning to merge the two airlines, Zest-O at some point announced their intention to have an initial public offering. Zest-O spent its investors’ money to acquire the two airline companies. However, through an initial public offering, Zest-O aims to get more funds from the public to replenish its investor funds(venture capital firm). This is the exit strategy employed by Zest-O way back in May 2008. Looking at the present market condition, the economy is not doing well. This could be the cause of the firm’s delayed initial public offering plans. Given this case, the venture capital industry is a very risky one to enter, especially in unstable economy such as that of the Philippines.

I believe that the big gap of income classes in the Philippines is an issue when it comes to venture capitalists when we speak of initial public offering as a means of exit. Since most of stockholders in publicly listed companies belong to the high income class, we can say that there are only a handful of them. I think it would be great to find out if the greater number of shareholders who owns smaller stakes in firms is common among the publicly listed firms in the country. If this is true, then we could say that venture capitalists in the Philippines are simply playing with the same set of investors and stockholders. It is also interesting to determine whether venture capitalism in the Philippines is mature enough to provide investors an avenue to fully maximize their money and for aspiring entrepreneurs to have a source of funds for their business ventures that will help in the development of the Philippine economy.

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