Venture capitalists: Challenges of equity investment in Bangladesh

--Dipok Kumar Roy ACA

Days are coming when the educated youth would tend to take entrepreneurial leadership rather than focusing only on jobs. Capital may not be a cause of concern because of being venture capitalist beside them. In spite of being late, Venture Capitalists started operation in Bangladesh. Dhaka Chamber of Commerce and Industry (DCCI) and Bangladesh Bank have jointly organized a program title “DCCI entrepreneurship and innovation Expo” seeking proposal from entrepreneurs with a view to supporting 2000 entrepreneurs.

Such initiatives are undoubtedly a great support for entrepreneurship and venture capitalists. Venture Capitalists may be very trusted good partners of them registering success history through equity investment. Venture Capitalists can prove that capital is not a problem where entrepreneurial leadership is strong and effective towards an innovative expected goal. I stated in one of my articles that venture capitalists need a legal framework. That article contended the basic elements of framework in line with standard practice as required for the venture capitalist to work comfortably on a legal base in the country. Given that the framework of operation, the following subject matters are still blockade for equity investments:

Corporate legal structure

Most of the SMEs are either proprietorship or partnership. As equity investment is not fit with this legal structure, such enterprise needs to avail investment under mezzanine or quasi-equity investment model (a hybrid of equity and debt) or be registered with Registrar of Joint Stock Companies and Firms (RJSCF) as limited company (private or public) to avail equity either as ordinary or preference shares. Entrepreneurs do not show very positive interest to incorporate as limited company with RJSCF. They have tendency to avoid registration as limited company as they do not want to be complaint with regulators by submitting the related documents or return of income from business or do not feel comfort to have any new institutional investor as influencing or controlling authority over their business. They expect easy loan and repayment thereof, instead of sharing of their profit with investors controlling their business.

Lack of operational & financial credibility

The entrepreneurs have tendency to hide operational efficiency and hence, the operational result presented in the financial statements does not show a true and fair view. They do not like to be transparent to lender 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 start up or growth stage, when Venture Capitalists’ financial & 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 under the scenario of having lack of operational & financial credibility due to fear of losing money unduly.

Lack of entrepreneurial leadership:

Most of the sponsors/promoters in our country tend to involve with a business seeing others in hot business in spite of having no or a few business knowledge. Sometimes it is observed that sponsors expressed their willingness to undertake the business in the sector where investors make investment or feel comfort to invest. Sponsorship and entrepreneurship are completely different from each other. Entrepreneurship is an innovative approach for a new product & market. Entrepreneurial leadership means actions to managing resources towards a success with a new innovative ideas or concepts or research findings. Unless the sponsors are found strong and technical enough in entrepreneurial leadership, the business may be shutdown or may not be a success one in most of cases and the venture capitalists will not go for equity investment.

Lack of source of fund of venture capitalists

The source of fund of venture capitalists is a big challenge. Borrowing fund from banks and financial institutions will not be fit being (i) higher cost of fund (ii) repayment mismatch because of immediate regular payment of installments of loan availed from banks where harvest from equity investment is always deferred, irregular and not specific (iii) tremendous risk associated with SMEs and equity investments accordingly. Private equity management against fee could be good source of fund. Private Equity Fund management system, other than mutual fund to be traded in capital market, has not been introduced due to lack of skill and experiences, legal framework and sponsors from development partners/ agents, local pension fund, insurance companies etc. Govt. and regulators should take initiatives to formalize the management of private equity with legal framework.

Lack of regulations & policy assistance for quasi-equity

Venture capital does not mean only an investment in the form of equity to limited companies. Venture capital is a risk capital and 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 regulation assistance in line with the modified equity of investment or quasi equity model like revenue sharing for proprietorship or partnership to emerge SMEs and secure the investment. Such regulations and policies are required to legalize the quasi equity investment made by venture capitalists and to avoid any debate of banking or financing operation like banks and Financial Institutions (FIs).

Non-compliance with laws & regulations by investee

Non-compliant organizations record their lack of integrity and sometimes bring risk of operations and investor may not be interested to invest. As equity represents ownership, the equity investors take full risk & reward of organization and hence, they need to be compliant with all applicable laws and regulation to keep their investment safe for return as well as exercising safe exist strategy. We are hardly careful in respect of laws and regulation particularly in such SME level.

Lack of high technical professional VC team

To conduct due diligence, structure investment deal and monitor investment, the venture capitalists should have a high technical professional team. As VC is a very new model of investment in Bangladesh, it is very hurdle to get such experienced technical team. Those who are experienced in this sectors working outside the country deserve a high pay and the new set up venture capitalist may not have financial capability to pay such compensation package unless private equity comes under management.

Indifference of social and environment Impact

Compliance is significant factor to attract development partners/ agents. An entity should work for profit, people and planet (3Ps). Most of the entrepreneurs do not care of planet and peoples, i.e. the social and environment compliance. As such, it is hurdle to get private equity from development partners/agents. A lot of SMEs in Bangladesh can avail foreign equity fund from development partners/agents being complied with social and environment indicators. Those development partners/agents may be sponsors for SMEs equity fund managed by venture capitalist or invest directly in equity form if entrepreneurs are meticulously compliant to ensure positive impact of social and environment indicators.

Lack of Government focus

India has identified the most vibrant sectors to ensure access to finance and other support from Govt., development partners and venture capitalists especially through Foreign Direct Investment (FDI). We should have identified such sectors to attract venture capitalists in investing. The focused sectors become organized and, have more growth potential and Govt. support to emerge where 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 as seed or early growth. So, their investment may become bad and lost fully sometimes when the investment does not click to be success one. There is a very common characteristic that 1/3 investment of venture capitalists may be bad fully that impact profit of them. As it is very early stage of venture capitalists in Bangladesh and SMEs market is not organized or structured with form, requirement of supports, laws, policies, tax supports etc., the investment loss may be more and as such, they need tax exemption facilities from income. To support emerging SMEs tax efficient equity investment is necessary. At present, the income of venture capitalists is taxable 37.5% for non listed public limited company that make them discouraged to work in the so risky SMEs to emerge.

Access to report of Credit Information Bureau (CIB) on Investee

Venture capitalists should not invest any investee financially default with any bank and financial institutions. To uphold the financial discipline, the venture capitalists should have the power and authority to access to report of CIB on investee so that investment does not go to a bad pocket.

Waiver from default status for venture capitalists

Venture capitalists may want a board seat of the investee company. If the investee company becomes classified or loan defaulter, the venture capitalists would be defaulter as well being the director of the investee company. The Investee Company may be defaulter but the venture capitalists should be waived from default status for their borrowing from banks and financial institutions or managing fund from them and conducting a smooth operation without any legal hassle.

Exit process

Exist process including drag, tag, public offering etc. are merely standard in theory but enforcement is a big challenge. The Company can enter into IPO when the company’s total capital structure including capital market portion is BDT 300.00 million and where, sponsors capital will be 30% thereof. In most cases, the companies where 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 lack of entrepreneurial leadership, philosophy and integrity. The whole exist process may be really stressful to get back the amount as due for recovery or to harvest the best return as the investors entitled thereto.

Other factors adversely affecting the operation

Lack of strategy: Due to lack of entrepreneurial leadership, the sponsors have lack of strategy. They operate the business traditionally without being methodical with strategy to make the organization differentiated. The growth is obstructed and investors find the apparent risk to invest in the form of equity. So, the entrepreneurs must be strategically differentiated approaching innovation in operating and marketing to attract equity investors.

Extreme political unrest

Political unrest make the business environment more hurdle and risky. This has reached to an extreme stage that causes obstacle to work severely. Organization fails to target or earn profit. The investors generally will not show any dare to invest unless the political stability exists to ensure a better business environment in the country. Due to this political unrest, many FDIs move to another countries. Equity becomes risky and venture capitalists, being investors, do not fell comfort to take full equity risk where other debt financer can feel comfort in collecting money as per repayment schedule.

Unethical & greed driven bad corporate culture

Some organizations do not care ethical standards and are run by the greed and ego gratification of entrepreneurs that lead to corporate scandals. Culture creates over the periods and any bad cultures created could not be omitted all of a sudden. Most of sponsors/entrepreneurs show this attitude of earning money in any way. The equity investors should assess the corporate culture whether it is coachable to run the operation ethically and legally.

Both dividend and capital repatriation are easier to attract investors for FDI either direct or as private equity. Foreign Private investment (Promotion and Protection) Act, 1980 provides guarantee of repatriating capital subject to exercising the right and circumstances of exceptional financial and economic difficulties as per applicable laws and regulations. All challenges as stated above cannot be daunted overnight. Govt. and regulators should come forward to prepare a green filed for venture capitalists. By dint of professional practice of venture capitalists over the years, Bangladesh could be a very promising field of emerging SMEs and good companies for capital market.