I can say, without a doubt, that none of the contents in the pages to follow would have
been possible without the guidance and friendship of many individuals. I do not think I can
properly express my thanks in a few simple words of gratitude, because I know that this effort is
a product of all the support I have been so lucky to receive.
First of all, I would like to thank my mentors for their sincere interest and encouragement
throughout this paper-writing process: Prof. George Siedel for devoting your time to helping the
Senior Seminar students accomplish what we thought was not possible, Prof. Judith Calhoun for
helping me develop skill in the highly confusing world of academic research, and Prof. David
Brophy for encouraging me to tackle a mountain of an issue.
To my friends and family, I want to say I am only motivated to reach for the stars
because of you. Thanks to: my friends for being there when I’m in need of a distraction; Marisa
for your incredible editorial skills; Nina for being my life companion in just about everything;
Eric for your amazing ability to be a source of positivity, motivation, and encouragement; and
my wonderful family for their endless love and understanding.
Additionally, I am lucky to have many resources at my fingertips through the Ross
School of Business. I would like to thank Michael Herbst for his excitement and interest in this
subject, as well as Prof. Ted London for pointing me in the direction of valuable resources.
Lastly, to my fellow seminar classmates, I would like to say I am thoroughly impressed
with the talent and amazing ability that everyone has shared through the seminar. I hope that all
of us are able to pursue the interests we are passionate about, and are able to encourage and
motivate others to action.
The purpose of this paper is to develop possible best practices for developmental venture
capital in India and China, under the premise that investing in sustainable development will be in
the best interests of both the community (by alleviating poverty) and venture capital (VC) firms
(by creating new highly profitable markets).
The first section of this paper provides a brief overview of private equity/venture capital
(PE/VC) investment by examining the structure and investment strategy of firms in developed
PE/VC markets. Key factors that successful VC requires and simultaneously helps contribute to
include promoting a culture of entrepreneurship, increasing transparent government policy,
encouraging the formation of functional markets, and drawing more capital from willing
The second section of the paper examines the current trends of private equity and venture
capital markets in India and China, illustrating the lack of venture capital funding despite
promising market conditions. To explain the lack of performance in Indian and Chinese markets,
differences that arise in the entire venture investing cycle between developing and developed
venture capital markets are discussed. These differences include increased difficulty in
structuring VC firms, finding capital, conducting due diligence, structuring and monitoring
investment, and exiting. Difficulties in the VC investment process in India and China are
possibly explained by the inability of firms to correctly adapt to environmental conditions of
The third section of the paper discusses approaches to dealing with the key environmental
aspect of the markets in India and China: poverty. Many theorists suggest the need for private
sector initiatives that promote development of small and medium sized enterprises and increased
entrepreneurship to alleviate poverty. Community development venture capital incorporates
these development initiatives into the VC investment process. The paper will examine how VC
firms can effectively combine social and financial goals by integrating strategies highlighted by
Prahalad’s Bottom of the Pyramid business model, focused on serving the poor and
The fourth section examines how to evaluate the impact of VCs in India and China. VC
firms must augment traditional performance metrics to incorporate a double bottom line
approach that assesses performance based on both financial returns and social impact.
The last section of the paper presents case studies of several innovative venture funds
currently operating in India and China that incorporate financial and social goals. Discussion of
these funds will conclude by presenting possible best practices for venture capital firms
participating in these economies.
Venture Capital (VC) and Private Equity (PE) 2
Structure of VC Firms 3
Structure of Investment 4
Prerequisites and Effects of Successful VC 5
China and India: Current Trends of VC/PE 9
Comparison of Macro-Economic Trends 10
VC/PE Market in Asia 10
VC/PE Market in China 11
VC/PE Market in India 13
Differences in VC/PE Cycle in India/China vs Western Markets 14
Overcoming the Pyramid of Poverty in India and China 23
Sustainable Development for Alleviation 24
Private Sector as Key Player 25
Importance of Small and Medium Enterprises 25
Community Development Venture Capital (CDVC) 27
Target Market: Bottom of the Pyramid (BOP) 29
BOP Business Model 32
Evaluating the Impact of VC in Developing Markets 35
Best Practices of Current Innovative Funds 37
Microfinance Fund: responsAbility 37
Nonprofit Philanthropic Fund: Acumen Fund 40
Social Venture Fund: CARE Enterprise Partners 44
Emerging Markets Private Equity Investment: Actis 48
Analysis of Best Practices 51
Conclusion: Approaching New Frontiers in PE/VC 55
At first glance, the streets of New Delhi, capital of India, seem to be filled with
destitution, poverty and sadness. Typical views include rail-thin boys no more than 15 years old
pulling rickshaws three times their size, families of five maintaining a balancing act on one
motor-scooter for transportation, and plastic tarps covering a small village of huts a few feet
from the roadside. The view is filled with bustling life, as one would expect of a country with a
population of 1.08 billion. In actuality, the typical views themselves signal all sorts of economic
activity and commerce. With the second glance, it is easy to explain why India and developing
countries hold strong potential to be the next economic giants of the world. With some additional
investment in equipment and perhaps some advice on operations management, the 15-year-old
could be operating a profitable network of rickshaws servicing the greater Delhi area. The key to
creating economic success stories in these markets lies in the possibility of involving the massive
populations by developing innovative approaches to include even the poorest of people.
On the other side of the wealth spectrum, an increasing number of private-sector firms
are realizing the potential profitability of emerging markets. Private equity activity, specifically,
is increasing throughout the developing world, as investors are finding better opportunities
relative to the saturated market of developed economies. Hailed as the “New Kings of
Capitalism,” private equity firms are perceived as contributors of “smart money,” able to add the
most economic value to growing companies throughout the investment lifecycle (Samdani 1).
The pool of private equity investment has ballooned over the past decade, growing from less than
$10 billion in 1991 to over $180 billion in 2000 (Reyes Private Equity Overview and Update
2002 in Kaplan and Schoar 2). Private equity funds, specifically venture capital funds, are the
cheapest source of financing in uncertain business environments, given their ability to lower
informational asymmetries and uncertainty between private firms and the market (Ljungquist and
Richardson). Many even credit venture capital firms with sparking the growth of major
industries, such as telecommunications and biotechnology. Strong potential exists for venture
capital firms to assist in the private sector development of emerging markets such as India and
The purpose of this paper is to develop possible best practices for developmental venture
capital in India and China, under the premise that investing in sustainable development will be in
the best interests of both the community (by alleviating poverty) and VC firms (by creating new
highly profitable markets).
The first section of this paper will provide a brief overview of venture capital investment
and highlight factors that lead to successful venture capital performance. The next section will
discuss the current trends of private equity and venture capital markets in India and China,
illustrating the lack of venture capital funding despite promising market conditions. To explain
the lack of performance in Indian and Chinese markets, the paper will look at differences that
arise in the entire venture investing cycle between developing and developed venture capital
markets. The next section of the paper will examine the Bottom of the Pyramid business model,
highlighting a necessary shift in operational strategy that venture capitalists need to adopt when
working with India and China. The final section will examine several innovative venture funds
currently operating in India and China that incorporate financial and social goals, in order to
present possible best practices for venture capital firms participating in these economies.
Venture Capital (VC) and Private Equity (PE)
Private equity refers to a broad range of investments in unlisted companies (Da Rin,
Nicodano, Sembenelli 2), and includes but is not limited to leveraged buyouts1, venture capital,
growth capital, angel investing2, and mezzanine capital3. As a group of investments, private
equity is divided into two main segments: venture capital (investment in entrepreneurial
companies in developmental stages) and non-venture private equity (management buy-outs,
turnaround, and restructuring of established companies) (Da Rin, Nicodano and Sembenelli 2).
Exhibit 1 illustrates the different stages of development during the life of a company, and the
associated financing structures for those stages. Most commonly, private equity firms will focus
on one or the other because of fundamental differences in operational strategy: venture capitalist
interest lies in building companies, while non-venture private equity firms are interested in
financial returns from proven business models (McKnight and Parker 6). In regards to private
equity in developing economies, venture capital firms are most relevant to discussion because of
the highly-risky, highly-entrepreneurial markets of these countries.
Structure of VC Firms
Venture capital (VC), a major subset of private equity, is especially important in driving
economic growth through its focused investing in early stage firms. Entrepreneurs hold the key
to business development by recognizing innovative opportunities and having the necessary
motivation to start businesses. Venture capitalists provide entrepreneurs with the financial ability
A leveraged buyout of a firm involves a purchase transaction where the price is largely financed through debt
(Leach and Melicher 492).
Angel investing is obtained from wealthy individuals who are willing to invest in early stage ventures due to the
“excitement of launching a business and a share in any financial rewards” (Leach and Melicher 604).
Mezzanine financing is used to fund plant expansion, marketing expenditures, working capital or improvements. It
involves debt financing attached to warrants, which are convertible options to equity stakes in the company (Leach
and Melicher 24).
to “turn ideas into companies, which employ staff and generate economic value” (McKnight and
VC firms in Western economies are structured as limited partnerships that serve as an
intermediary to channel capital from wealthy investors towards firms struggling with cash needs.
This type of firm invests using equity stakes to finance “high-risk, potentially high-reward”
private startup companies that are unlikely to receive loan financing (Gompers and Lerner 284).
Third-party investors are silent limited partners (LPs) in VC firms, including wealthy
individuals, pension funds, foundations, endowments, and other institutional sources. The
general partners (GPs), known as venture capitalists, are usually former professionals with
industry experience. The general partners receive an annual management fee of about 2% of the
fund’s committed capital, and typically 20% of carried interest. Funds generally operate for a
fixed life of seven to ten years, in order to cut exposure to risks of any individual investment
(Dossani and Kenney 229).
Structure of Investment
Venture capital firms usually undertake high-risk investments in early stage firms that
demonstrate large potential for above average returns. The recently started firms are expected to
provide VCs with a financial return on investment of ten times or more in less than five years
(Dossani and Kenney 229). Due to the high-risk nature of investment, VC firms will mitigate
risk by investing in several firms and expect anywhere from 20%-90% of their investments to
fail entirely. The possible upside in returns on successful investments more than compensates for
the portfolio firms that do not perform well (Leach and Melicher 22), with returns of 300% to
VC firms usually invest using preferred stock or convertible debt (which can become
equity) combined with common equity. Using large equity stakes in the investment as well as
seats on its board of directors, VC firms are able to actively help and intervene in the growth of
the company. Through recruiting key personnel, providing strategic advice, and introducing
possible contacts for customers, strategic partners, and financiers (Dossani and Kenney 230), VC
firms provide their portfolio companies with resources that would they would otherwise not have
access to. This aspect of VC sets it apart from any other means of funding, as VC provides more
economic value than just money. VC firms ideally exit investments through either an initial
public offering (IPO) of the portfolio company or a strategic sale to another company (Dossani
and Kenney 229).
Prerequisites and Effects of Successful VC
Given high rates of failure in investment, VC firms must carefully evaluate the business
environment they will potentially operate in to best position themselves for success. As
demonstrated in the US and several other countries, successful VC has influenced small business
development and has sparked the growth of entire industries, such as telecommunications.
Additionally, successful VC creates a cyclical growth pattern of policy implementation and
reform that helps to establish a more favorable VC environment (Da Rin, Nicodano, and
Sembenelli 1). Growth of the VC industry encourages improvement in its environment by
helping to incorporate the very factors that make VC successful. These key factors that
successful VC firms require and simultaneously contribute to include: culture of
entrepreneurship, transparent government policy, functional markets, and willing investors.
The VC industry is focused on the funding of new small businesses and is therefore
dependent on entrepreneurial talent to develop innovative ventures. A successful VC
environment can only exist when there is “a constant flow of opportunities that have great upside
potential” (Dossani and Kenney 230). In an atmosphere where pioneering research is supported
and entrepreneurs are encouraged to be innovative and push the limits of imagination, new
business ventures give rise to entire industries. These fledgling industries, such as the Internet
dot-coms, present VC firms with a wide variety of possibilities.
VC investing also encourages and increases sophisticated entrepreneurship that can spark
innovative technologies and developments (Dossani and Kenney 230). Funding from VC creates
positive reinforcement for entrepreneurial activity by developing a competitive market for
entrepreneurial ideas. Also, the existence of venture investing changes the environment it
operates in by reinforcing structural components of the legal and financial world that are VC-
friendly (Kenney 5). The existence of VC activity also helps to address small businesses’ gaps in
capital and knowledge, allowing entrepreneurs to pursue opportunities otherwise not possible. As
entrepreneurs are rewarded for their efforts through partnering with VC firms, a culture can
develop that promotes innovation and creativity, allowing entrepreneurship to thrive (Dossani
and Kenney 230).
To encourage a business-friendly environment, government policy should be developed
in an efficient manner that protects the interests of contractually-involved parties. VC
investments are usually much higher risk in comparison to most other investments and therefore
require fair, transparent, and stable government policy that allows use of risk-taking capital for
private gain (Low and Tierney). Literature suggests that the success of the VC industry is built
on having equity-based financial institutions or common-law legal regimes (Black and Gibson
1998 ctd. in Kenney 3) With better government policy, both the cost of investing and the amount
of information asymmetry are reduced, thereby encouraging more business activity and
investment (Lerner and Pacanins 3). Such government policy includes transparency in terms of
accounting policy, intellectual property protection, and efficient tax structures. Industries
targeted by most VC firms are those where small businesses have high growth potential, most
commonly seen with telecommunications, technology and healthcare. In most of these types of
industries, intellectual property (IP) protection is essential to success of the venture’s business
model. For example, one popular venture capital investment opportunity is an innovative
pharmaceutical firm such as AVEO Pharmaceuticals (focusing on the development of cancer
treatments), whose profitability is based on securing drug patent rights. IP protection laws play a
large role in determining whether VC firms will enter a marketplace and expose their capital to
higher levels of risk (McKnight and Parker 4).
At the same time, the existence of VC encourages policy reform to promote overall
economic growth. In many countries with thriving VC industries, such as Israel and the U.S., the
government has enacted regulations that help small businesses through contract enforcement, IP
protection, and accounting standards. The presence of VC firms in these markets has encouraged
this regulatory reform and therefore has helped to stabilize the entire private sector.
Moreover, because the structure of successful VC also involves the need for liquidation
of investments through exit opportunities, VC activity encourages strong and proficient markets.
VC exits typically occur through an initial public offering (IPO sale of stock) or a strategic sale
(where the venture is merged with an existing firm) (McKnight 6). Jeng and Wells (ctd in.
Dossani and Kenney 229) found that the single strongest driver of venture capital investing is the
number of IPOs occurring in the market, signaling successful investments. Efficiently structured
markets, such as the NYSE and NASDAQ, allow for better information flow and more
successful stock transactions. Using efficient markets, VC investments are able to find higher
returns for their investors, encouraging overall industry growth.
VC activity also encourages development of the necessary infrastructure for functional
markets by building information networks between local entrepreneurs and national/international
level businesses. This infrastructure allows entrepreneurs access to global markets and resources
that they would not have access to without the intervention of VC (Low and Tierney). The
creation of an efficient infrastructure provides a sustainable framework for future market
development. Through the information networks provided by VC, entrepreneurs are able to
access higher levels of expertise as well as build supplier and customer relationships otherwise
not achievable. Additionally, VC encourages the formation of new industries arising from the
characteristic innovative technology of its investments (Christensen, Craig, and Hart 1). VC’s
ability to produce sustainable economic growth through establishing necessary infrastructure is
unparalleled by any other form of investment.
The investment ability of any firm relies on its access to capital. VC firms rely on third-
party investors to provide capital for any potential investment. These firms require investor
confidence in order to raise funds necessary to operate. When operating in overly risky markets
and industries, VC firms have a more difficult time raising funds from investors (Da Rin,
Nicodano and Sembenelli 17). Alternatively, when there is more capital than can be allotted to
attractive investments, VC firms face “money-chasing deals” due to the effect of capital
overhang causing unjustifiable increases in deal valuation (Gompers and Lerner 321). In any
case, VC firms must be backed by sufficient capital in order to carry on investment activity.
When VC has helped to establish functional markets, investors are more willing to put
capital into entrepreneurial ventures as a result of increased availability of information and less
perceived risk. Investors can take comfort in the direct involvement of VCs in overseeing the
investment process while being more informed of risks and rewards for their capital’s use
China and India: Current Trends of VC/PE
East Asia is undoubtedly on the verge of becoming one of the most important economic
regions in the world, as demonstrated by the recent fanfare for the region at the 2006 World
Economic Forum in Davos. Venture capitalists have taken notice of the possible opportunities in
Asia, particularly India and China. Ray Lane, a partner in the top VC firm Kleiner Perkins
Caufield & Byers discussed the potential for successful VC (“Next Silicon Valley will be in
India or China, says top VC” 1): “The next Silicon Valley is likely to come from India or China
rather than from Boston or North Carolina.” The potential of these countries can be attributed to
the startling GDP growth rates of both, as they are the two fastest maturing countries in the world
(China with growth of 9.1% and India with growth of 7.1%) (Asia-Pacific M&A Bulletin 8).
Many of the emerging businesses in these countries resemble the high-risk/high-reward business
model traditionally sought after by venture capitalists. Many Indian companies exhibit
astonishing growth similar to VC-targeted industries, with yearly gains of 15-25% (Zakaria 19).
Policymakers, firms and entrepreneurs of India and China have used Silicon Valley as a pattern
to create a successful VC industry by focusing on high technology industries and startup
companies (Kenney 9). Despite the numerous growth prospects, VC returns in China and India
have proven to be much more uncertain than the established industries of the US and Europe.
This lack of performance in such promising markets leads one to speculate as to why firms are
not able to realize the full potential of these markets.
Examining the actual performance of private equity and venture capital markets in Asia
highlights the emergence of a strong venture capital presence in the region. Cambridge
Associates Emerging Markets (EM) VC & PE Index (EMPEA 1) illustrates the increasing
competitiveness in performance between emerging market funds and US/European funds. For
the year ended March 31, 2005, the EM VC&PE Index indicated an 18% 1-year return on 169
emerging market funds. Though this is a lower return than the US PE index (returning 23.5%)
and the W. European PE index (returning 31.2%), the 2004 performance of emerging markets
represents a significant increase from 2003 returns of -9.3% (EMPEA 1).
Comparison of Macro-Economic Trends
The strength demonstrated in terms of several macro-economic indicators provides a
solid background for the growth story of India and China. In comparison to the US, both India
and China present much higher levels of economic growth attainable through a much larger
population, as illustrated in the table below.
ECONOMIC China India U.S.
Population 1.3 billion 1.1 billion 295 million
Consumer Price 1.9% 4.1% 3.2%
(% Change YOY)
Industrial 27.7% 8.2% 3.2%
Real GDP Growth 9.2% 7.1% 3.5%
(% Change YOY)
(“India”; “China”; “United States”)
VC/PE Market in Asia
Overall, VC/PE markets in Asia exhibited strong performance in the past year, with
record levels of funds raised and invested, more prevalent growth/expansion investment, and
healthy IPO markets. In 2005, funds raised in the Asian private equity market totaled over $17.6
billion from 82 funds (a substantial increase over $6.5 billion raised in 2004). This represents the
highest known amount raised in the Asian market. Several funds valued at over $500 million
were established during 2005, illustrating that markets of several countries are reaching further
stages of maturity (APER 2005 Year-End Review).
Investment levels also soared, with over $15.2 billion invested in 2005 (a 29% increase
compared to $11.8 billion in 2004). Although the number of deals (271) remained at a relatively
stable level, the average deal size grew 31% from 2004 figures to $63 million. Buyout
transactions represented less than 50% of all transactions for the first time in the market, with an
increasing presence of growth/expansion investments. The industrial sector drew the most
investment, with over $5.3 billion total (APER 2005 Year-End Review).
Overall, 188 exits occurred in 2005, a 25% increase compared to 150 exits in 2004.
Investors were returned $19.8 billion on these exits, representing a return of 235% on initial
invested capital of $5.9 billion. IPOs represented 50.5% of total exits, illustrating healthy
markets in Asia (APER 2005 Year-End Review).
VC/PE in China
In 2004, China was ranked as the 3rd largest VC market in Asia (behind Japan and
Taiwan). Recent performance in the Chinese VC market is characterized by increased amounts
of investment overall, less investment in early stage firms, and declining performance of
domestic funds. The VC industry in China saw total investment of $1.27 billion in 253
companies for 2004, representing an enormous increase in activity from $418 million in 226
companies in 2002. Similar to the Asian market, the amount of invested capital grew
significantly in 2004 (an average deal size of $5 million compared to $1.8 million in 2002) but
the total number of deals remained relatively stable. IPO and M&A exits returned $802 million
on venture-backed investments in 2004, with 21 venture-backed IPOs raising a total of $4.3
billion in 2004. The 2004 IPO activity from China represented a significant portion of total
global activity, illustrating the strong potential for VC success in China (Global Private Equity
Investment in 2004 was focused less on early stage investment, with 34.4% on expansion
stage deals and 24.2% in mature stage deals. This signifies that funds are looking for quicker
returns on their capital, though several funds interviewed signaled a need for early stage VC
investment. However, examining first quarter results of 2005, the venture capital industry in
China did not demonstrate increased performance. Total funding for VC dropped to $165 million
for this quarter, which was a decline of 24% from the first quarter of 2004 (Global Private Equity
Comparison of foreign and domestic VC involvement in China illustrates declining
performance for domestic funds. From information on 187 funds that disclose operational data
(out of 300 active funds), 130 are domestically-run firms, 40 are foreign firms, and 17 are joint
Chinese-foreign ventures. In the first quarter of 2005, foreign VC funds represent 63% of deals
and 80% of the total invested capital. Current market conditions show a large decline in domestic
activity, compared to 2001 where domestic VC comprised 50% of total activity. A direct cause
of the decreased domestic VC performance is a regulatory structure in China that restricts capital
formation and effective capital structure (Global Private Equity 38). Domestic VCs are not able
to grow to the same size as foreign VCs, which are on average seven times larger than of local
funds and average $200 million per fund. The Chinese government is expected to ease some of
the regulations that present difficulties to the formation and listing of companies (Global Private
VC/PE in India
As the fourth largest economy in Asia, India recently demonstrated strong performance in
terms of its VC/PE industry characterized by increased overall levels of investment. Though
there was less investment in early stage companies, there is a promising future for VC due to
encouraging government regulatory reforms. India represented the largest market for funds
raised in Asia in 2005, attracting a total of $2.3 billion in new capital (APER 2005 Year-End
Review). In 2004, investment of $1.1 billion in 66 companies represented a 100% increase on
the $507 million invested in 2003. Investment was mainly focused on private equity, with
expansion, later stage and private investment in public entities (PIPE) deals representing 72% of
total deal flow and 87% of total value in the market. Startup and early stage venture capital
accounted for 28% of deals and only 12% of total value. Investment was heavily concentrated in
business processing operations (BPO), though these deals represent a declining share over last
year’s BPO deal flow. Industries that saw an increased share of activity include heavy
industrials, pharmaceuticals, and healthcare (TSJ Media ctd. in Global Private Equity 47).
VC in India is expected to demonstrate an increase in activity in the near future due to
industry growth and decreased regulatory environment (including an increased flexibility in
capital convertibility, i.e., transferring funds into and out of India). The Indian IT services
industry is expected to grow at 22% per year, the fastest growth rate out of all Asian countries.
Growth in IT-related fields is closely tied with a strong environment for VC, as VC funding is
well suited for the IT business model. Additionally, growth in the VC industry is expected
following several reforms encouraging foreign direct investment, which specifically lower
regulations required for VC activity and investment in the telecommunication industry (TSJ
Media ctd. in Global Private Equity 49).
Differences in VC/PE Cycle in India and China vs. Western Markets
Though an attempt has been made to develop the next Silicon Valley in India or China,
VC firms have not seen the overall expected performance and level of return in their
investments. Many firms entering the region expect to import the same operational model that
achieved high returns in the US/European markets. However, research indicates that when
investing in India and China, firms encounter a variety of differences in the entire VC investing
cycle that suggest a more customized approach is necessary for investing in these countries
(Lerner and Pacanins 2). More sensitive approaches, required to handle the fundamental
differences, are emerging at every stage of the process, including investment motivation,
structure of fund, method of fundraising, process of deal sourcing, structure of deal, management
of investment, and exit.
Research indicates that VC firms, traditionally thriving in established markets such as the
US and Europe, are increasingly globalizing their investment strategy for a number of reasons.
Lerner and Pacanins (2-3) suggest that firms are increasingly attracted to investing in China,
India, and other developing nations due to the economic progress realized through economic
reforms and the adoption of capitalism. Many developing nations are supporting more business-
friendly environments through encouragement of equity investing, tax reform, lowered
restriction on foreign investment, and improvement of disclosure standards. Additionally,
advancement in technology allows VC firms to achieve higher levels of monitoring investment
and lower transportation costs than previously seen in these economies (Lerner and Pacanins 3).
The decreasing attractiveness of markets in developed nations, such as the US, is also
driving VC firms to globalize. The market for private equity in the US grew from $4B in 1980 to
over $125B in 1995, growing at a rate not sustainable for much longer into the future. The
current market for private equity investment operates at an imbalance, with greater amounts of
capital than of attractive investment opportunities available (Lerner and Pacanins 3). The
resulting environment is highly competitive for VC firms in established markets, where deals are
unjustifiably overvalued due to excess supply of capital (Gompers and Lerner 2). Kenney notes
that VCs are increasingly globalizing due to the additional investment opportunities available
abroad (6). By investing in developing economies, firms are open to a wider variety of
investment opportunities. Firms are also able to achieve economies of scope and diversification
through investing in developing economy firms.
Structure of Fund
Due to regulatory differences, typical fund structures in India and China vary from the
traditional VC LP formation. In China, until 1992, most private equity was only able to function
as a highly regulated China Direct Investment Fund (known as a CDIF). Under this structure, the
fund could only invest as a minority investor, could not play a role in management, and could not
place more than 20% of total funds in one investment (Bruton and Ahlstrom 236). In many Asian
countries, the limited partner structure is not permitted, causing most domestic VCs to operate as
corporations. The corporate structure limits many key flexibilities VC firms typically use, such
as the ability to ensure that a fund will dissolve at the end of a stated period. By preventing the
limited life of a fund, GPs may draw out the life of a fund, which prevents the LPs’ ability to
force liquidation and have initial funds returned (Lerner and Pacanins). Ernst and Young’s
Venture Capital Report summarizes other common forms of structures found for foreign funds in
• Formal Alliances or Joint Funds: Relation between foreign funds and China-based funds
based on joint investments in deals and mutual deal sourcing, for example, China-based
Accel and International Data Group Ventures (IDG) forming IDG-Accel China Growth
• Joint Cooperation: Joint investment with foreign and local funds without a formal
alliance, such as Venrock Associates and Granite Global Ventures.
• Affiliate Funds: Domestically-established deal sourcing arm of foreign fund (commonly
U.S.-based) in China, such as Sequoia Capital’s China Fund.
• Branch Office in China: Increasingly popular model for foreign funds with branch office
in charge of deal sourcing and business development for portfolio companies, used by
Doll Capital Management.
• Frequent Flyer: Foreign fund with operation in China without a local office in the
country, for example, ComVentures. (Global Private Equity 43).
Domestic funds in India are more likely to be structured like the traditional LP, as the
regulatory environment has become more VC-friendly. Foreign investors, however, more
commonly use a US-based model with a domestic branch office, which allows for easier access
to more liquid US capital markets for easier exit options. The US-incorporated company will
handle sales, marketing and product development, while a subsidiary in India will handle
oversight specific operational details (Global Private Equity 53).
Method of Fundraising
Capital sources for VC firms operating in India and China are similar to those in the US
and developed economies, consisting of pension funds, corporations, insurance companies and
high net worth individuals. Additional parties targeted to assist with developmental goals are also
involved in funding VC in these countries. Such parties include foreign aid organizations, quasi-
government corporations, and multilateral financial institutions (such as the World Bank’s
International Finance Corporation). Though these additional sources present a steady stream of
capital, funding from these organizations can complicate VC investment given that many
government-related funds are accompanied by excessive constraints on investment (Lerner and
Pacanins 5-6). In some cases, such government-related funds impose reporting requirements that
prevent the institutional investor from keeping details of VC investments confidential,
weakening VC firms’ competitive abilities. Several sources indicate a lack of initial funding in
early stage risk capital (called “bootstrap financing”) from angel investors for startup firms in
India, creating difficulties in establishing firms sizeable enough for VC investment (TSJ Media
ctd. in Global Private Equity: Venture Capital Insights Report 2004-2005 53).
Process of Deal Sourcing
Major differences exist between the process of sourcing deals in developed and
developing VC industries. Industry focus for investments is somewhat similar, with most VC
firms targeting high tech-related companies (Global Private Equity 42). Other PE deals are
focused on privatizations and corporate restructurings, similar to established PE markets. China
and India also feature deals that are unique to developing markets, such as strategic alliances
(where major corporations use PE firms to fill lack of knowledge in operating in foreign market)
and infrastructure funds (focused specifically on investing in building bridges, roads, etc.)
(Lerner and Pacanins 6). VC in India operates on a slightly different industry dynamic, due to the
strong performance of the services firms (related to India’s strength in BPO services). Services-
related firms do not promote the usual VC model, which is driven by value held in protecting
intellectual property (such as specific technologies) and capitalizing on the related proprietary
knowledge (Global Private Equity 52).
The actual screening process of potential investments also requires a uniquely-tailored
approach for the funds operating in India and China. In a study of VC firms in China, Bruton and
Ahlstrom (245) found that conducting due diligence on potential deals required much more effort
on part of the VC firm operating in China compared to firms operating in developed markets.
Firms found more success with screening of deals when located close to the potential ventures,
which resulted in using more of a regional focus rather than industry orientation for initial
screening. Close physical presence to portfolio firms is important in both India and China, due to
the fact that many business transactions have strong roots in personal relationships. VC firms
therefore must work to build strong local connections with influential officials, social groups and
businesses in order to gain trust to successfully manage investments (Lerner and Pacinins 7,
Bruton and Ahlstrom 234).
Additional difficulties in sourcing deals come from China and India’s lack of regulatory
environment and from weak corporate governance. In the West, VC firms are able to use
company financial statements to asses the level of risk of a firm. China and India lack uniform
accounting policies as strong as the US’s highly-structured Generally Accepted Accounting
Principals (GAAP), therefore firms are not able to rely mostly on financials in risk assessment
(Bruton and Ahlstrom 245). VC firms operating in China report that due diligence of potential
investments requires up to 6 months more effort compared to investments in the West due to
extensive background checking and less efficient legal systems (Bruton and Ahlstrom 246).
Furthermore, several firms that are currently operating in both India and China have cited
difficulties in managing their investments due to the region’s lack of necessary training.
Specifically, India and China both lack the experienced management personnel required to direct
high stakes ventures (Kenney 10; Actis). The paucity of experienced professionals could be due
to a variety of factors: the educational system’s inability to promote managerial science, low
literacy rates throughout the region, and fewer opportunities for management positions given the
population size. Additionally, there is an immense lack of research funding for creating products
that would attract VC-friendly business models (Kenney 10). In vibrant VC markets such as the
US, research funding allows entrepreneurs to develop the high-tech and innovative products that
may result in high return businesses. Overall, India, China, and VC firms collectively need to
focus additional effort on harvesting talent to support a VC industry.
Structure of Deal
Traditional VC firms assume a majority stake in their portfolio firms to most effectively
drive the change necessary for successful performance, often stifling the entrepreneur’s say in
company matters. In Asian cultures, entrepreneurs are much more reluctant to give away large
portions of equity in their firms, which they see as an expression of themselves and their family
(Kenney 10). As a result, VC firms in Asian cultures must create a trusted and close personal
relationship between themselves and the entrepreneur. Several firms cite success through
maintaining minority stakes in firms, but maintaining close relationships with management
In terms of specific deal structure, India and China PE is characterized by financing
mostly through common stock. Preferred equity and debt instruments are most commonly used
in Western PE markets, which allow firms to stage investment, gain more control over the
portfolio firm, and provide incentives for management performance. In Asia, some markets do
not allow for different classes of stock, which create difficulties in structuring VC deals that
mitigate the risk of startup firms (Lerner and Pacanins 8-9).
The usual minimum investment size for VC firms is $10 million; however, this size
represents an additional challenge when considering VC undertakings in China and India. For
most large foreign funds, making an investment of less than $10 million does not make sense due
to the lack of returns for the amount of effort used in the investment process. Many startup firms
in India and China, however, are not able to absorb large sums of financing because lack of the
proper infrastructure to allocate funds (Global Private Equity 47) and therefore fall below the
radar of VC funding.
Management of Investment
The cultural differences in attitudes of Western and Asian entrepreneurs lead to important
operational differences in VC portfolio management. Again, firms in China reported physical
location close to portfolio firms is of utmost importance in monitoring investment due to a higher
amount of information asymmetry between the entrepreneur and investor (Bruton and Ahlstrom
245). Additionally, fostering a close relationship with the portfolio firm can lead to increased
levels of trust between the two parties, especially due to the increased difficulty in establishing
an “insider relationship” with most portfolio firms (Bruton and Ahlstrom 244). Entrepreneurs in
India and China are much more reluctant to give up control of their firms (Global Private Equity
23, 45) allowing for less value-added and strategy-directing activity on part of the VC firm
(Bruton and Ahlstrom 245). Instead, many VC firms have found much of their input in
improving operations is related to building business fundamentals (such as accounting and
operations) (Bruton and Ahlstrom 244), which many entrepreneurs in India and China lack.
Difficulties in handling the regulatory environment have also led to the failure of VC
firms in India and China. Over-regulation, lack of corporate governance legislation and
transparency all result in a high level of costly risk management required to operate business
(Actis; Kenney 20). A World Bank Case Study of India cites a problem in Indian businesses
specifically due to the fact that markets are “stifled by a web of government controls and
regulations,” causing poor infrastructure and low public investment to further growth (ctd. in
McKnight and Parker 7). Recent liberalization of international investments in India and China
show policy initiatives that address these regulatory issues. In collaboration with governmental
and regulatory agencies, VC firms can help to establish practices that will create a more efficient
As described in the earlier section on common VC structure, IPO exits are the most
common route to achieving returns on investment in developed VC industries. In India and
China, achieving expected returns through IPO is a less likely reality. Though markets in both
countries are evolving to be more efficient, as demonstrated by the level of IPO activity in 2004
and 2005, listing small companies on national exchanges is a difficult task. In China, selection
for listing on national exchanges (Hong Kong Stock Exchange, or Shanghai and Shenzhen Stock
Exchange) is a state decision. The Chinese government currently approaches the evaluation for
public listing with the attitude that VC-backed firms do not need the additional capital that a
stock offering provides due to the strong resources provided by the VC funding (Bruton and
Ahlstrom 239). One possible initiative to promote VC activity in both India and China is to
develop a small-capitalization market like NASDAQ in these countries (Global Private Equity
43). Already, China’s Shanghai and Shenzhen Exchanges have announced plans for a NASDAQ-
type market, and Hong Kong Exchange has created the Growth Enterprise market (Bruton and
Ahlstrom 252). With the development of markets targeted towards smaller firms, VC
investments are poised to achieve more successful returns through IPO.
Due to the current lack of small IPO-friendly markets, VC firms in India and China find a
higher probability of exit through strategic sale or through selling back of stock to the portfolio
company (Bruton and Ahlstrom 252; Lerner and Pacanins 9-10). The sale of companies to
strategic investors does not provide for same returns expected in an IPO due to the purchaser’s
power in pricing at a lower premium (Bruton and Ahlstrom 252; Lerner and Pacanins 9-10).
Other possible exit routes that have achieved more success for VC-backed firms include listing
shares in a more profitable foreign market’s exchange or pursuing an acquisition by a strategic
buyer in a developed economy (Lerner and Pacanins 10).
Analysis of the current state of venture capital investing in India and China highlights
many difficulties that arise when trying to apply the Western VC business model to create a
successful investing industry in these countries. Those difficulties illustrate several key
misunderstandings that prevent successful investment in India and China. Most VC firms that
have entered the China/India market have not been able to properly overcome the cultural
differences, the lack of necessary training, and the difficult regulatory environment in order to
achieve the desired level of return on their investment. Firms must adapt the traditional operation
model in order to address the key differences between developed and developing markets
discussed in the VC investing processes to rectify the lack of successful performance. In
adopting an approach tailored to the Asian culture and environment, VC firms can potentially
realize greater success in the region. These current misunderstandings stem from the VC
industry’s inability to address a fundamental aspect of the environment in both India and China:
Overcoming the Pyramid of Poverty in India and China
Poverty is undoubtedly one of the most disastrous conditions plaguing the world today. A
majority of society’s problems can claim poverty as their root cause, including but not limited to
AIDS and other infectious diseases, terrorism, environmental damage, illiteracy, malnutrition,
human rights abuses, human trafficking, narcotics trafficking, illegal immigration, ideological
intolerance, tyranny, genocide, and debt slavery (Magleby 6). In recent years, organizations such
as the United Nations, World Bank, and the World Economic Forum have all recognized poverty
as a global issue to be addressed with utmost importance and urgency.
Wide-spread poverty is entrenched in society by the pyramidal distribution of wealth and
capacity to generate income most commonly found in developing countries. The top of the
pyramid comprises of a small number of individuals with numerous opportunities for generating
wealth. At the bottom of the pyramid (BOP), more than 4 billion people live on less than $2 per
day, with purchasing power of less than $2000 per year (Prahalad 4). This population represents
a staggering 65% of the world’s total size. This pyramidal distribution of income has stifled the
economic potential of the 4 billion people at the BOP, who have previously not been offered
opportunities to participate in the formal economy as consumers or producers (Prahalad 7).
Attempts to find a solution to poverty have been long been a hot topic of discussion.
Charitable donations from non-government organizations (NGOs), countries, and individuals are
traditionally thought of as the most helpful approach. However, these methods of addressing
poverty have not been effective, as there are still 4 billion people at the BOP (Prahalad 4).
Solutions to poverty thus far have not created a long-term resolution, as charity runs out and
development has not been encouraged. Many current approaches to this global issue emphasize
the importance of sustainable development as the most effective principle to aid in promoting
human development and fighting poverty.
Sustainable Development for Alleviation
Sustainable development is based on the premise that “interests of future generations
should receive the same kind of attention that those in the present generation get.” (Anand and
Sen 1). Many forms of aid to impoverished countries today represent only temporary aid, as they
do not consider how to promote and maintain the positive benefits they achieve over a long
period of time (such as donating in emergency situations such as a tsunami to preserve life, but
not investing in infrastructure to prevent such a situation in the future). To eradicate poverty,
Magleby summarizes six metrics, which when increased, signal the sustainable effectiveness of
any anti-poverty actions: freedom, transparency, human development, equality, ecological
sustainability, and enterprise sustainability (13). Enterprise sustainability has recently drawn
more attention as an important metric, pulling in more private sector involvement to fight
Poverty interventions can be characterized on a scale of long-term economic
development effectiveness (as determined by Stephen W. Gibson and Jason Fairbourne ctd. in
Magelby 19): disaster aid (least long term effect), poverty relief, excursions, microcredit,
microfinance, microenterprise, and lastly microfranchising (greatest long term effect). As is
evident from the preceding list, the most effective long-term economic solutions involve private
sector businesses pursuing a “triple bottom line of profitability, environmental stewardship, and
social responsibility.” (Magelby 20) The new breed of solutions to poverty focus on sustainable
development initiatives stemming from efforts of private sector businesses, which are able most
effectively able to address Magleby’s six metrics of anti-poverty actions (referenced in the above
Private Sector as Key Player
The increased role of the private sector in development initiatives is rooted in healthy
competition encouraged by for-profit ventures. Business competition encourages innovation,
creating more efficient processes and other positive externalities for the markets in which they
operate, as described by the World Bank:
Private firms are at the heart of the development process. Driven by the quest for
profits, firms of all types – from farmers and microentrepreneurs to local
manufacturing companies and multinational enterprises – invest in new ideas and
new facilities that strengthen the foundation of economic growth and prosperity.
They provide more than 90% of jobs – creating opportunities for people to apply
their talents and improve their situations. They provide the goods and services
needed to sustain life and improve living standards. They are also the main source
of tax revenues, contributing to public funding for health, education and other
services. Firms are thus central actors in the quest for growth and poverty
reduction. (World Bank’s 2005 World Development Report ctd. in Doing
Business in 2006 3).
Market-based solutions to development promote competition and spur innovation,
providing incentives for sustained development that are not found through most other forms of
aid. At the same time, private businesses will also benefit from developmental initiatives that
address unmet needs in impoverished areas. The low-income market represents tremendous
opportunity for business growth, as many other mature parts of the market become saturated and
are highly competitive.
Importance of Small and Medium Enterprises
Many organizations suggest that the key to growing the economies of developing countries
lies within the scope of small- and medium-sized enterprises (SMEs), which are usually more
prevalent in areas of lower income. SMEs are a diverse group covering a “range of sophistication
and skill, and operate in very different markets and social environments” (Hallberg 2). Examples
of SMEs include village handicraft makers, restaurants, and internet startup firms. Small
enterprises employ anywhere from 5-50 people, where medium enterprises employ about 100-
250. SMEs usually “operate in the formal sector of the economy, employ wage-earning workers,
participate in organized markets, and have strong potential to grow and become competitive in
domestic and international markets” (Hallberg 2).
SME development has numerous benefits that aid economic growth within developing
countries. Economic theory suggests that SMEs support job creation, as many SMEs tend to be
in more labor-intensive industries than larger firms (Hallberg 3). These firms are also credited by
some with having the ability to more equitably distribute income, due to the fact that workers
employed by such firms are usually from lower levels of wealth (Hallberg 3). Also, SMEs can be
a strong source of innovation in the economy because they consist of emerging businesses with
innovative technologies that compete with established firms (Making Markets Work for the Poor
7). SMEs promote market creation, as smaller-scale businesses depend on each other to develop
productive networks and supply chains to deliver their products (Making Markets Work for the
Poor 9). However, all of these benefits are debated by scholars who believe the biggest benefit of
promoting SME development in developing countries arises simply because “they are there” and
account for a large share of the market serving lower levels of wealth (Hallberg 6).
Regardless of the debated benefits, entrepreneurship is the driving factor behind most SME
development, and is thus the most important societal characteristic to encourage. SME
development promotes entrepreneurial ideas that allow individuals to create employment
opportunities for those around them. Christensen, Craig and Hart (1) support entrepreneurial
development through their theory of “disruptive technologies,” which are innovations that
“create major new growth in industries they penetrate by allowing less-skilled and less-affluent
people to do things previously done only by expensive specialists in centralized inconvenient
locations.” Through encouraging entrepreneurial efforts, VC funding drives the innovation
needed for disruptive technology development, and thus helps to spur economic growth.
International Finance Corporation (IFC)’s pillars-of-enterprise model provides a
framework for analyzing successful factors that encourage entrepreneurial venture creation.
Under this model, there are three categories of business needs: access to capital, business
development services, and an enabling environment (IFC in Making Markets Work For the Poor
9). Most developing nations face conditions that make entrepreneurial ventures difficult
undertakings and inhibit one or more of the IFC’s pillars, creating many challenges for the
success of a VC industry. Private sector development in these countries is challenged due to the
following factors: an inhibiting regulatory environment, a lack of access to credit, and negative
market conditions (Making Markets Work For the Poor 9). In order to successfully operate in
developing countries and to address these three key challenges, innovative business models must
be able to promote sustainable development and overcome the national economic problems
caused by poverty.
Community Development Venture Capital (CDVC)
CDVC is a fast growing practice in development finance that is based on the abilities of
venture capital to “create jobs wealth, and entrepreneurial capacity to benefit low-income people
and distressed communities” (Tesdell 24). Venture capital is particularly well-suited to handle
financing for development, especially in low income areas where seed capital required to start
new companies is not readily available (Tesdell 24). Micro-credit banks are not able to offer the
long-term debt and equity financing most SMEs need to expand BOP-viable businesses. On the
other hand, large regulated institutions do not usually undertake the high risk associated with
loans to such businesses. Socially-motivated investment is able to best fill the gap between more
traditional development financing (such as grants and charity) and private-sector investment
driven solely by pursuit of profits (Making Markets Work for the Poor 2)
This type of VC operates on the premise of traditional VC investment in high-risk, high
growth enterprises, but includes the dimension of investing to pursue a “double-bottom line” of
financial and social returns (Making Markets Work for the Poor 2; Tesdell 24). CDVC focuses
mostly on companies whose growth would benefit social development, such as those that target
the needs of minorities and women, or those that are environmentally focused (Tesdell 24).
Benefits of socially responsible VC are numerous for both communities and investors.
In terms of community impact, VC has a unique ability to add value to the business
environment of low-income areas. Many CDVC firms provide the valuable entrepreneurial and
managerial assistance that most businesses in developing areas may lack. Specific value-added
activities of VC firms for community development include acting as an intermediary between
workforce development programs and portfolio companies to facilitate employment. Another
highly-valuable contribution of VC firms is the ability to coach portfolio firms in taking
advantage of government tax incentives for locating in low-income areas (Tesdell 25). By
creating a competitive business environment focused on pursuit of profits, VC firms investing in
developing areas are able to help reduce market inefficiencies and encourage a more business-
friendly environment (Making Markets Work for the Poor 9). Most importantly, VC firms are
able to achieve a “ripple effect” through development of their portfolio companies in low income
areas. These portfolio companies not only provide for job creation, but also provide health
benefits and pension plans for employees and their families (AVCA 5).
Socially responsible VC also holds benefits for the investor. Garnering a lower expected
return, CDVC allows investors to make a more effective contribution to poverty than those
achieved by simply granting funds. Instead, by encouraging accountability of investment through
returns, this type of investment uses capital more efficiently by reinvesting and recycling the
initial invested capital (Making Markets Work for the Poor 9). CDVC also addresses growing
concerns in investor behavior. Investors are increasingly looking for ways to diversify their risk,
to encourage sustainable development, and to capitalize on new niche markets. Investment in
most developing areas is less correlated with traditional market returns, as there are more
opportunities for niche market growth in these areas (Making Markets Work for the Poor 9).
Target Market: Bottom of the Pyramid (BOP)
BOP development theories, such as those of Prahalad and Hart, suggest multinational
corporations and other private sector investors can further their bottom line while helping to
eradicate poverty by focusing on serving consumers at the BOP. Such theorists predict that in the
near future, the most successful businesses will be those that incorporate a dual bottom line of
profits and societal benefit into their core practices. VCs are most uniquely positioned to succeed
under these circumstances, as they are best equipped to help start firms in high-risk business
environments including the BOP. In order to profitably operate at the BOP, businesses must
challenge traditional views by adopting two key understandings: that developing countries hold
great amounts of internally-trapped capital and that the BOP population will make a highly
profitable consumer group.
Traditional tactics such as foreign aid and charity have based their efforts on the
assumption that poor countries are poor because they lack resources. By comparison, foreign aid
represents only a fraction of the potential for capital that is trapped within most developing
countries (Prahalad 79). This insight was first discovered by economist Hernando DeSoto, who
noted that the poorest populations collectively own about $9 trillion in unregistered assets due to
inefficient local policies blocking property rights (Prahalad 80). Due to the lack of land rights,
entrepreneurs are not able to use houses as collateral as they do in developed economies to obtain
loans. In most developing countries, local commerce is conducted in the informal sector (or
blackmarkets) because of the lack of enforceable contract law (Magelby 8-9).
The sheer difficulty of doing business in most developing markets creates a self-
enforcing cycle that discourages market growth. For example, opening a new business takes an
average of 198 days in Laos, costs an average of $61,000 in minimum capital in Syria (51 times
annual average income), and requires payment of 164% of a company’s gross profits in business
taxes in Sierra Leone (Doing Business in 2006 1). As a result of the immensely challenging
conditions, many firms operating in such environments are not able to attract or retain capital and
are thus unable to grow (Making Markets Work for the Poor 2). Potential for business
sustainability is realizable; developing economies can mobilize the capital found within their
own countries and can help the private sector exponentially increase profits while reducing
poverty. For VC, understanding the potential of trapped capital within the BOP suggests the
ability to harvest high value businesses in this market with the proper expertise.
Another key understanding VC firms must adopt to do business in developing countries
is a view of the BOP as a highly profitable consumer group. The sheer volume of this segment of
the population (over 4 billion people) suggests enormous potential profits if the BOP is provided
the opportunity to consume. Currently, most businesses do not offer accessible products to this
market. Most products are targeted towards higher income individuals who have necessary
technologies such as washing machines, or are able to buy a large amount of product at one time.
Though the BOP consumer cannot afford the same type of lifestyle, Prahalad discusses
characteristics of the BOP consumer that suggest the possibility of creating a highly attractive
mass market for businesses (13-17).
The BOP population demonstrates similar consumer characteristics to the usually
targeted wealthy markets. For example, BOP consumers are brand-conscious and value-
conscious, which implies that appealing to customers based on one of these aspects will help
build a loyal, repeat customer base (Prahalad 13). Furthermore, BOP consumers readily accept
advanced technology, adapting to products and innovations (such as cell phones) at much faster
rates than previously seen in the US (Prahalad 15). The rapid adaptation rate is also due to the
fact that the BOP population is highly networked through computer and cellular phone access.
Additionally, a key to serving this part of the market involves creating the capacity to consume
within this population by offering innovative products that fit needs specific to the BOP segment
(Prahalad 16-17). These consumer characteristics suggest the possibility that firms traditionally
supported by VC, such as telecommunications and biotechnology, would find a highly viable
market if the firms were to adequately address the needs at the BOP.
In focusing on the BOP market, businesses will see the most success when “creating
opportunities for the poor by offering choices and encouraging self-esteem” (Prahalad 5).
Building a sense of dignity and worth in poor individuals positively encourages this population
to take part in formal segments of the economy. Prahalad suggests developing BOP-targeted
business models that focus on product characteristics traditionally withheld from this population:
affordability, access, and availability (18). If firms are able to create products appealing to the
BOP consumer and their needs, this population could serve as a new highly profitable market for
high risk/high reward businesses.
BOP Business Model
New operational constraints are posed in developing economies that make it difficult to
respond to the needs of the overall population. In response to these operational constraints, VC
firms must accordingly adjust the traditional business model that has achieved success in
America and other developed nations. Both the VC operational strategy and the portfolio firm
operational strategy must evolve to incorporate BOP-friendly best practices. Overall, BOP
markets require “entrepreneurship on a massive scale” (Prahalad 2), due to the fact that BOP
entrepreneurs already have the best understanding of what needs are to be met for their own poor
population. Three key strategies that must be addressed for companies to succeed are: high
volume/low margin production, attention to quality of service for clients, and intensive risk
High volume/low margin production
To achieve profitability in the BOP market, small micro-entrepreneurs must be able to
create a business model that is scalable to the entire population of 4 billion impoverished
individuals, as low margins realized in this market must be balanced by high volume of sales.
The BOP consumer has a lower disposable income than the wealthy consumer but will typically
pay similar price points. The difference in the two consumer’s behavior is that the BOP
consumer buys more on a needs basis than a want basis. Thus, Prahalad cites several key
business practices companies must keep in mind to be successful when approaching a BOP
initiative: focus on small unit packages, low margin per unit, high volume production, and high
return on capital employed (24-46). This production strategy should be encouraged in the
portfolio companies in which VC firms invest.
VC firms should also accordingly alter their operational strategy to offer a high volume,
low margin service. The adaptation of VC services in developing/BOP economies is similar to
the principal of microfinance and micro-credit banking, where small informal loans are issued to
individuals at a rate of interest that covers the cost of operations (Silverman D1). Most BOP
businesses, even when highly scalable, do not require and cannot handle the same amount of
investment as traditionally-targeted VC portfolio firms. As a result, VC investors should consider
investing smaller amounts of capital that will potentially realize higher returns than those
traditionally sought. With this strategy, firms will also be able to handle a larger number of
Attention to quality of service for clients
Responding to the needs of the BOP consumer, as mentioned earlier, will best position
firms to succeed in this market. London and Hart found that firms cannot simply rely on the
transfer of knowledge and resources developed in top of the pyramid markets when operating at
the BOP (9-11). Firms accustomed to operating in developed economies must adjust their
practices to address and understand the local environment and local consumer. Firms should
focus on fostering capability in “social embeddedness,” which London and Hart describe as “the
ability to create competitive advantage based on a deep understanding and integration with the
local environment” (15). To develop social embeddedness, successful BOP market entrants
should focus on “collaborating with non-traditional partners” (such as local and non-profit
organizations), “co-inventing custom solutions” (to address specific needs of BOP consumers),
and “building local capacity” (such as offering training programs and developing infrastructure)
(London and Hart 12-15). Prahalad notes several steps that firms can take to tailor their services
and products: innovate using hybrid solutions (such as single serve laundry detergent packets
tailored for low-income purchase), create solutions that are transportable across multiple cultures
and countries, understand the appropriate functionality for BOP needs, and educate customers on
product usage (24-46). Attempting to understand and serve the needs of BOP consumers will be
the most important strategy for firms in this market, as it creates “the capacity to consume”
(Prahalad 16) and builds purchasing power in this market segment.
Again, VC firms must incorporate this strategy into both their own operations and their
portfolio companies. In terms of VC investing, firms must consider working more closely with
local entrepreneurs, especially given the importance of fostering close relationships in doing
business in developing countries. Chambers (ctd. in London and Hart 3) found that one key to
success in these markets is the ability to understand and respond to the existing social
infrastructure. VC firms should work to build trust with entrepreneurs through illustrating their
deep understanding of local customs, most effectively done through establishing local offices in
the BOP markets in which they operate. Microlending institutions have achieved high repayment
rates through a similar tactic, and many theorists credit the proximity of these institutions to their
success (responsAbility Global Microfinance Fund). Additionally, VC firms should work with
non-profit organizations and universities to encourage the development of entrepreneurial
networks and innovative research.
Intensive risk management
Given the extremely high risk environment presented by the instability of most BOP
markets, successful business operations in these markets must take precautionary measures to
ensure proper risk management. The lack of transparency and certainty in day-to-day business
operations requires the challenging task of close coordination with the local regulatory agencies
to develop more appropriate business standards. As mentioned earlier, successful performance in
BOP markets is furthered by building community relations through a local office (Bruton 241-
246). This will also allow for VC firms to lower informational risks by providing the ability to
closely monitor their portfolio investments and will encourage the development of a close
trusting relationship between VC firms and entrepreneurs (Bruton 246; Wright et al. 19).
Through utilizing a BOP-oriented business model in India and China VC markets, firms
will better be able to address challenges presented in these countries. The three key aspects of the
business model discussed in this paper represent the most relevant BOP strategies for VC firms.
Additionally, changes to the VC business model must incorporate sustainability objectives. The
best way to ensure that sustainability is maintained as a priority is to incorporate a system of
measurement of the societal impact of VC investment.
Evaluating the Impact of VC in Developing Markets
As venture capitalists create new business strategies for operating in India and China,
they should also augment the metrics used to measure performance outcomes. Any investment
approach in both countries requires a long-term approach in understanding that increased social
impact now will lead to increased financial returns in upcoming years. Assessing fund
performance must incorporate the “double bottom line” not only of financial returns but also of
social impact. Financial returns are necessary to drive competitive performance that will lead to
increased efficiency while also attracting a growing pool of investors, who are looking for
additional investment opportunities. Measurement of social returns is required to encourage
sustainable development in the economies in which the VC firms operate. Firms will be able to
realize more profits as more sophisticated market structures are developed through efficient
investing, consequently increasing both social and financial returns.
Methods used to assess financial returns and performance for funds in India and China
are virtually the same as for firms operating in the West. The internal rate of return method (IRR)
is the most common form of reporting financial returns of funds. IRR is calculated as the annual
percentage return that annual revenues produce on the total costs of investment (Clark et al. 38).
For most established VC markets, the expected IRR is around 30%. Funds in developing
economies should expect lower returns (around 8-15%) given the unsophisticated markets in
these countries. These lower financial returns, however, are compensated for in terms of
increased social returns.
Social returns should be measured and tracked as part of fund performance; however,
firms face a large problem in avoiding subjective standards when coming up with an appropriate
method of measurement of social returns. Social returns can be defined as any increase in factors
that lead to sustainable income generation. Magleby’s six metrics of effective anti-poverty
actions (13) can be used to gauge progress of the development in terms of increased freedom,
transparency, human development, equality, ecological sustainability, and enterprise
sustainability, as discussed earlier. A systematic system to monetize the value of these metrics
would provide the most effective way to measure social returns. Returns should be evaluated by
the impact of the VC investment, defined as the outcome reached through investment minus the
outcome that would have resulted without the investment (Clark et al. 7). Exhibit 2 summarizes
nine different methods of evaluating social returns in terms of the effectiveness of each method
in addressing assessment of process, impact, and monetization of effects as described by Clark et
al. Many current methods of evaluating social returns are based on measuring the number of jobs
created by the investment and the potential effect of employment generation on the community,
for example: increases in health benefits coverage, income, and education (Clark et al. 18-34).
Another possible method of monetizing social effects is to incorporate real options analysis
(which warrants much further explanation than possible through this paper). Funds that develop
and employ comprehensive performance measures that incorporate both social and financial
returns will carry a distinct advantage in maintaining profitable operations in India and China.
Best Practices of Current Innovative Funds
Following the trend of increased social awareness in the private sector, numerous VC
firms are emerging with funds using pioneering approaches to handle the challenging social
environments in India and China. These funds represent the next generation in VC, integrating
pursuit of financial and social returns into innovative business models. Through examining
several funds based on operational strategy and performance, this paper aims to highlight
strengths and weaknesses of each model in order to direct the development of successful future
funds in India and China.
Microfinance Fund: responsAbility
responsAbility Global Microfinance Fund is an innovative fund seeking dual
returns through moderate financial gains and social benefits. Started in November 2003,
the Fund's main investment focus is microfinance; but also has a limited amount of investments
in SMEs and trade finance businesses for small producers in developing countries
(responsAbility Global Microfinance Fund). Operating as an open-ended investment fund for
private investors, the Fund has $42.99M of assets under management at the end of 2005, an
increase from $22.70M at mid-2005. A total of $41.85M is allocated to a total of 77 active
microfinance investments (compared to $21.99M in 59 investments at mid-2005), with a
projected $30.00M of new funds allocated to microfinance investments. Since inception, the
fund has realized a 4.23% net asset value increase. The Fund currently has microfinance
institution (MFI) investments in 36 developing countries worldwide (Exhibit 3 illustrates the
specific regional breakdown), but reports that future investments will specifically emphasize the
Asian and African regions (Microfinance- The MIX Market).
The Fund is advised by responsAbility Social Investment Services AG (responsAbility –
Social Investment Services), a private sector initiative with partners that represent the main
segments of the Swiss financial market: Credit Suisse, Raiffeisenbanken, Baumann & Cie
Banquiers, Alternative Bank ABS, and the Andromeda Fund (a social venture capital fund)
(responsAbility Global Microfinance Fund). With Credit Suisse’s involvement in this initiative,
responsAbility illustrates a possible structure for larger banks to emulate when entering emerging
markets, using partnerships with firms that have more specific expertise in this investing. As an
advisor to the Fund, responsAbility is the contact point for obtaining access to microfinancing
institutions. It conducts the necessary preliminary assessments that provide information on which
it bases its credit decisions, serving as a reliable quality control mechanism to ensure the loaned
money is also well invested (responsAbility Global Microfinance Fund). In order to diversify the
Fund’s holdings, investments are in two categories: direct investment in MFIs in developing
countries or indirect investment through other institutions which themselves invest in MFIs
(responsAbility Global Microfinance Fund).
Due diligence for screening of investments is usually carried out by sub-advisors, and
occasionally through responsAbility. Potential investments are evaluated on the basis of strategy,
management, financial performance and social performance. Qualification criteria for
investments include a minimal track record and viable business case based on the following
characteristics (Microfinance- The MIX Market): professional management and establishment,
promising young MFIs with strong business potential that pass due diligence or, to a limited
extent, investment in fair trade producers, traders, and SMEs.
Fixed income is the Fund’s major asset class, mostly short- to medium-term debt
securities with fixed or variable repayments of principal and interest. The portfolio consists of
direct loans and indirect lending through partners and mandates or through specialized
investment instruments. All loans are ultimately used to refinance MFI credit portfolios. The
Fund may also have a very limited exposure in equity investments in MFIs (responsAbility
Global Microfinance Fund), as illustrated in Exhibit 3.
In order to address the diverse environments of the microfinance industry, responsAbility
employs the “Best Partner” concept as a key operating strategy. Through involving organizations
that are local leaders in their respective fields in the investment process, the Fund is able to
achieve “a local presence, specific expert knowledge, and many year’s experience”
(responsAbility – Social Investment Services). Through this initiative, responsAbility aims
to recognize and understand local needs and to best impact the allocation of investments for both
social and financial gains.
responsAbility measures successful financial performance based on the aim of achieving
growth in value and returns in excess of the US dollar money market. Additionally, the Fund
gauges returns on the basis of social performance through measurement of various local social
effects. A yearly report is prepared that analyzes social indicators of successful performance
observed at individual, local community, and regional levels. These indicators measure the
impact of microfinance in terms of advancement of the banking industry, financial empowerment
of individuals, and creation of jobs (responsAbility Global Microfinance Fund). Several
examples of indicators include: structured descriptions of MFI clients and their economic
activity, number of branches or credit officers operating in rural/urban locations, number of
active borrowers/outstanding loans, and percentage share of women, as part of total clients.
Investors targeted by the Fund include private and institutional clients with medium to
long-term horizons who are seeking both financial returns and social benefits through their
investment (responsAbility Global Microfinance Fund). Many current investors in the fund
are seeking social impact through their contributions, specifically through supporting
“enterprising individuals who are forced to work under extremely difficult circumstances and
who are seeking very small sums to expand their business activities” (responsAbility – Social
Investment Services). Investment in the Fund also offers the attractive benefit of portfolio-
diversification. MFIs and their customers fulfill basic needs that are largely independent from
macroeconomic cycles. Additionally, investments in microfinance exhibit low correlation with
other investment categories or asset classes (responsAbility Global Microfinance Fund).
Several additionally noted funds specializing in microfinance investing are listed in Exhibit 3.
Nonprofit Philanthropic Fund: Acumen Fund
The Acumen Fund was founded in 2001 to link high net worth individuals with
innovative experts on global issues. In response to charity’s lack of effectiveness in addressing
poverty, the Fund was started to develop a means to fill the financing gap for smaller,
financially-sustainable ventures in developing countries. The Fund was established with seed
money from the Rockefeller and Cisco Foundations and several Silicon Valley investors
(Zaidman 3). The Fund had raised $22 million from over 100 individuals, corporations, and
foundations by December of 2004 (Zaidman 3). Using both measurements of social and financial
returns, the Fund operates as a non-profit venture fund. The fund’s mission is to “use
entrepreneurial approaches to address poverty through identifying, supporting and scaling
sustainable enterprises to deliver critical goods to target two-thirds of the world’s population
who live on less that $4 a day” (Acumen Fund).
As a non-profit organization, the Acumen fund invests charitable donations in both non-
profit and for-profit organizations that focus mostly in South Asia and East Africa. Donors to the
Fund, referred to as “partners”, play the role of silent investor LPs in the investing process but do
not receive returns on their investment. Partners donate anywhere from $1 to $1 million (referred
to as the Leadership Circle partners) (Acumen Fund).
The Fund is divided into three sector investment portfolios; a portfolio manager with
extensive experience and technical knowledge in his or her particular market directs each
portfolio. The portfolio manager is responsible for selecting the investment opportunities and for
transferring knowledge to individual portfolio firms from networks of entrepreneurs, funding
institutions, philanthropists, and corporations. Portfolio managers are also supported by advisory
panels consisting of field experts. Additional support to local entrepreneurs is provided by the
on-the-ground American Fellows Program, which matches volunteer expertise with the specific
support needs of individual ventures (Zaidman 4).
Acumen’s main regions of focus are South Asia and East Africa, “where a $2-$3 per day
income meant increased economic stability” (Zaidman 2). In these regions, investments belong
to one of three sector portfolios: health technology, housing/financing, water innovations.
Potential investments (listed in Exhibit 4) are assessed in terms of fit with the specific strategy of
• Health Technology: Assessed on ability to leverage technology to improve access to
quality healthcare through “reducing cost of treatments, new pricing models, novel
delivery systems, and public health communications technology” (Zaidman 5)
• Housing/Finance: Assessed on ability to prevent “social exclusion and economic
inequality through enterprises that expand economic opportunity” (Zaidman 5) as
well as increase access to technology, capital and markets
• Water Innovations: Assessed on ability to “improve access to clean water and water
management tools” (Zaidman 5)
Like many social investors, Acumen’s efforts are based on belief in the power of the
capital markets to create opportunities for the poor. The Fund functions as a model for
innovation, hoping to help spur larger flows of private capital to enterprises that serve the poor.
Acumen places importance on creating a viable model for venture investing in developing
countries by focusing only on a few investments to which significant resources and capital are
committed (Acumen Fund).
Through its involvement with high-profile partners, such as the Gates Millenium
Foundation, Acumen utilizes extensive networks of entrepreneurs, philanthropists, experts, and
corporations to channel necessary knowledge into its investments (Acumen Fund). Acumen’s
highly-localized operations allow the Fund to closely monitor and provide the necessary help to
foster business development. The focus on building a large network of resources has benefited
Acumen in being able to provide assistance to entrepreneurs with four fundamental concepts of
• Design: Focus on innovations that are “inexpensive, useful, and elegant while integrating
an understanding of poor as consumers.”
• Marketing: “Create demand through creativity and understanding individuals in the
• Pricing: Find optimal pricing that poor can afford while sustaining enterprise.
• Distribution: Overcome infrastructure inadequacies by creating “distribution networks
that are inexpensive, flexible, and scalable.” (Acumen Fund).
As a non-profit organization, Acumen focuses on achieving both social and financial
returns. Targeted investors, however, do not receive any financial return on their philanthropic
capital. The Fund is unable to compensate such investors for the additional risk caused by the
creation of innovative services and products for low-income individuals in emerging economies.
To compensate for the lack of financial returns, Acumen informs investors about the impact of
investment compared with alternative uses for philanthropy (Zaidman 3).
Acumen is highly focused on performance metrics as a core part of operations. Monthly
reporting on investments allows the firm to measure portfolio performance along four criteria:
financial sustainability, social impact, scale, and cost effectiveness. In examining social impact
and scale, Acumen focuses on evaluating the investment’s output (count of goods/services
delivered on superior scale and cost), impact (measurable improvement in quality of life), and
systems change (transformation in marketplace for critical goods and services) (Acumen Fund).
The Fund also maintains a “scorecard” analysis for each investment to evaluate performance
along the four criteria mentioned as portfolio performance measures. Through the use of
scorecards, Acumen emphasizes the concurrent pursuit of both financial and specific social goals
for each investment (Acumen Fund; Clark et al. 28). Investors can clearly see the benefits of
donation thus far in the Fund’s life through measurement of investment impact:
Since making our first investment three years ago, more than 500,000 people have been
protected from malaria, 12,000 women have received micro-finance loans, 5,000 farmers
have increased their income by purchasing drip irrigation systems, and 11,000 families
have bought life-saving de-fluoridation water filters (Acumen Fund).
Social Venture Fund: CARE Enterprise Partners
CARE Enterprise Partners (CEP) is at the forefront of innovative social venture capital,
aiming to draw larger private investors into the arena. CEP is an extension of CARECanada, a
non-profit organization focusing efforts on the developing world. The investment approach of
CEP is based on the premise of creating wealth to bridge the gap in the “missing middle,” or the
space between formal and informal economies in these countries. Business models targeted by
CEP generate both economic and social value in BOP markets that are usually disregarded by
traditional investments because of their small size (CARE Enterprise Partners). The organization
is based on the following goals: to implement a comprehensive approach to providing technical
help and capital deployment for use by entrepreneurs serving the poor, to demonstrate viability
of investing in SMEs in the developing world, and to pilot a Canadian fund as a model for filling
the “missing middle” (Making Markets Work for the Poor 19).
CEP’s funding consists of $10 million Canadian from CIDA-related (Canadian
International Development Agency) funds and $5 million Canadian from private investors.
Operating as a non-profit, CEP reinvests any returns back into the fund. To promote competitive
returns, however, CEP is organized as a for-profit venture fund with the following staff:
• Investment committee: Prominent Canadian professionals who function to add expertise
and management oversight
• Fund manager: Senior leader of daily operations who has background in developing
• Market analyst: Catalyst in identifying investment opportunities through examining