An assessment of the influence of incubators on the
entrepreneurship environment for innovators in
Malaysia.
A policy study towards formulating the National Innovation Strategy
National Women's Month Celebration for PENRO Quezon
The role of incubators in entrepreneurship and innovation
1. STUDY TOWARDS THE NATIONAL INNOVATION STRATEGY : INCUBATORS
An assessment of the influence of incubators on the
entrepreneurship environment for innovators in
Malaysia
Final Report
June 2011
Authors :
Prof. Stephen Ong, MINDS
Ms. Sahar Hassani, Multimedia University
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Table of Contents
Executive Summary 3
Chapter 1 : Introduction 4
Chapter 2 : Technology Parks and Incubators in Malaysia 10
Chapter 3 : Incubators and Innovation Funding in Malaysia 25
Chapter 4 : Evaluation of the Incubators of Innovation 70
Conclusion 83
Appendix – Incubators Survey Questionnaires 84
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EXECUTIVE SUMMARY
This study was undertaken to assess the impact of incubators on the commercialisation efforts
of innovators under incubation in Malaysia. The study involved the detailed background
research of twenty-seven (27) incubator organizations, and the active participation,
interviews and responses from twenty-one (21) incubator organizations. These incubator
organizations are deemed representative of the incubator activities in the national innovation
eco-system.
The findings of this study give a firm base of evidence and understanding to support our
recommendations of forward-looking strategy measures to improve the rate of successful
commercialisation of innovations and business survivability of innovative start-ups in
Malaysia through a more focused framework for business and technology incubation
activities and organisations.
The strategy measures recommended address three broad areas, principally –
1. The establishment of a national agency as a focal point and mechanism for the
coordination of incubation activities and the continued management of the innovation
eco-system;
2. The strengthening of human capital in the areas of management, entrepreneurship,
commercial competence, technical expertise and financial capabilities among players
in the incubation industry;
3. The deepening of financial involvement among innovators, successful entrepreneurs
and investors through global networking; and the broadening of capital marketplaces
and instruments to facilitate investment flows to readily support innovative activities.
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CHAPTER 1 : INTRODUCTION
Overview
Since the late 1990s, business and technology incubation in Malaysia has been actively
promoted by government national and state agencies, universities and the private sector. To
date, the National Incubator Network Association estimates that there are 106 incubators in
Malaysia, of which 24 incubators provide third generation services that include facilities
management, business advisory services and acceleration labs to innovators planning to
commercialise their innovations as tenant companies in the technology incubator parks.
However, few companies under incubation have achieved global commercial success.
Research Study Approach
This study on the role of incubators in Malaysia - “An assessment of the influence of
incubators on the entrepreneurship environment for innovators in Malaysia” – was
commissioned by Unit Inovasi Khas (UNIK) to identify improvements to the existing
incubator models and practices that affect the rate of successful commercialisation of
innovations in Malaysia.
Over the course of this eight week study, the research team set to establish answers to the
following questions :
1. What are the challenges that incubators and innovators face today?
2. What are the entrepreneurship characteristics of incubators and innovators?
3. What alternative models and practices can be observed from existing global
incubation clusters that can be introduced?
4. What are the strategy measures that can be recommended to improve the rate of
successful commercialisation of innovations and business survivability of innovative
start-ups?
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Methodology of Study
The study was conducted through several self-administered questionnaires; selected one-to-one
structured interviews; and directed discussion at focus group workshop sessions. The
workshop sessions organised with UNIK, consisted of key government representatives,
incubator managers, and fund managers of funding programs. The list of organisations from
the public, university and private sectors that participated actively in the study are listed in
Exhibit 1. The information on other organisations that are included in this study was through
available public information sources, previous studies and other survey data.
Additionally, a survey of Malaysian innovators participating in the annual International,
Innovation & Technology Exhibition (ITEX 2011) was carried out through a self-administered
questionnaire and selected one-to-one interviews to provide a basis of
understanding of the characteristics of innovators, innovation capacity and growth in
Malaysia.
Exhibit 1 : Active Participating organizations over the course of this study.
Organisation Stakeholders Engagement
Technology Park Malaysia Government, MOF Survey, Interview,Workshop
Plug & Play Technology Garden Sdn
Government, MOF Survey, Workshop
Bhd, KMP
Kumpulan Modal Perdana Sdn Bhd
(KMP)
Government, MOF Workshop
MAVCAP Government, MOF Workshop
MTDC Government, Khazanah Workshop
MDEC Government, MOSTI Survey, Workshop
SIRIM Government, MOSTI Survey, Interview,Workshop
MARDI Government, MOA Workshop
Furniture Industry Technology
Government, MRRD Workshop
Centre Sdn Bhd (FITEC)
MARA Government, MRRD Workshop
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USAINS Group, Universiti Sains
Malaysia (USM)
University Survey , Interview
Sanggar Sains Sdn Bhd, Universiti
Sains Malaysia (USM)
University Survey
UKM Technology Sdn Bhd,
Universiti Kebangsaan Malaysia
(UKM)
University Workshop
Innovation and Commercialisation
Centre, Universiti Teknologi
Malaysia (UTM)
University Workshop
Technology Transfer &
Commercialization (TTC),
Universiti Teknologi MARA (UiTM)
University Workshop
MAD Incubator Sdn Bhd Private Survey, Interview, Workshop
ICT Incubator Centre Sdn Bhd Private Survey, Workshop
Expedient Equity Sdn Bhd Private Workshop
Teak Capital Sdn Bhd Private Workshop
Astra Partners Sdn Bhd Private Workshop
CIMB Private Equity, CIMB Group
GLC, Khazanah Workshop
Berhad
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Summary of Key Findings and Recommendations
INNOVATION
ECO-SYSTEM
CHALLENGES RECOMMENDED STRATEGY
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MEASURES
Role of Technology
Parks and Incubators
Lack integrated and comprehensive
services to grow sustainable business
enterprises
Establish Global Industry
Innovation Centres of Excellence
between multinationals and
universities in Key Sectors
Government incubators have limited
budget and qualified personnel
Establish a National Centre for
Incubator Management
Private incubators established to
enjoy incentives (MSC status) have
failed to execute incubation
programmes
Incentives for Investment in
Incubators and Technology Parks
in Key Sectors.
Entrepreneurial leadership and
Management capacity limitations
Incentives for Business Mentors;
Retired experts and Returnees
Limited managerial and financial
resources to support business start-ups
at seed and early stages
Incentives for smart partnership
with Angel investors
Role of Innovation
Grants
Improve National Innovation
Funding Strategy
Agency is required to shape the
national public sector funding
strategy and act as a portfolio
manager to track performance
Streamlining grant funding vehicles
to be specialized, either according to
sector focus or recipient type
Reduce the number of early stage
innovation grants to three
Overcome gaps in the fund
disbursement process and
performance.
Implement a systematic
performance management
measurement metrics and
scorecard across all funds
Role of Venture
Capital
Overcome gaps in industry specific
investment capacity
Re-establishing the proven public-private
partnership model through
incentives for foreign venture
capital partnership and corporate
venturing
8. STUDY TOWARDS THE NATIONAL INNOVATION STRATEGY : INCUBATORS
Improve accountability and
performance of government funding
in priority areas
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Committing public sector
financing based on clear
developmental and technology
transfer assessment criteria
Increase private sector funding
exposure
Mitigate risk and investment
allocation in high risk venture
capital funds by savings
institutions through dividend
income tax rebates.
Access to capital markets for high-tech
start-ups
Establish linkages into global
capital markets for high-tech
start-ups
Role of Private
Equity
Lack of focus for private equity
investors on developing capacity in
present or future sunrise industries
Focus PE funding strategy on
three key sectors to build
innovation capacity
Lack of Malaysians with cross-border
PE skills in hi-tech industries
Require experienced Malaysian
managers to be joint-venture
partners of the Fund Management
team
Orphaned hi-tech projects will turn
into “Problem children” without
government support
Implement management
turnaround and consolidation
strategy through the Funds
Role of Debt
Financing
Gaps in the credit evaluation and
monitoring system
Implement community based credit
assessment and monitoring
Valuation and collateralization of
intellectual property
Encourage the establishment of
community of professional IP and
Technology Valuers
Poor asset management and recovery
of intellectual property of defaulters
Establish an Intellectual Property
Technology Exchange with global
networks
Role of Angel
Investors
Limited managerial and financial
resources to support business start-ups
at seed and early stages
Incentives for smart partnership
with Angel investors and a central
data base of angel networks
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Increase involvement of business
angel investors
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Incentives for Angel investors and
Angel networks.
Mitigate the high risks of angel
investment activities
Support a capital market
framework for angel investments
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CHAPTER 2 : TECHNOLOGY PARKS AND INCUBATORS
Overview
The rationale for technology incubators is to give business support to techno-entrepreneurs
who may have the technology business idea but lack the know-how and access to facilities to
make it a reality. Technology incubators typically offer a nurturing environment for resident
companies – providing assistance in forming a company, training and mentoring,
management, business planning, market analysis, technical and legal assistance and
facilitating access to finance, networking, IPR-related assistance, equipment and
infrastructure facilities of the host institution and other shared services. Most residents
graduate out after two to three years.
Technology Parks also provide more than physical facilities. The most successful provide
state-of the art research facilities such as labs and virtual information centers connected to a
host of academic institutions around the world. The Parks also solicit venture funds, host
incubators, prepare business pans and assess market opportunities for up-and-coming firms.
Examples include Hsinchu Science Park in Taiwan, ICICI (Genome Valley) in Hyderabad in
India.
Spin-offs from Universities and public research institutes often locate themselves in
technology parks. These consist of researchers at universities and public research institutes
that leave to set up new high-technology companies. In China over 2000 high technology
companies have spun off from universities and public R&D centers.
Malaysia’s program for Incubators and Technology Parks have had mixed results. Many
provide facilities and some business advice. But most lack the capability to provide
comprehensive services as provided by other best practice institutions in its class.
Challenges
i) Lack integrated and comprehensive services to grow sustainable business
enterprises
ii) Government incubators have limited budget and qualified personnel
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iii) Private incubators established to enjoy incentives (MSC status) have failed to
execute
iv) Entrepreneurial leadership and Management capacity limitations
v) Limited managerial and financial resources to support business start-ups at seed
and early stages
Challenge 1: Lack integrated and comprehensive services to grow sustainable business
enterprises
Generally, the government and university run incubators offer an office space at subsidized
rates; general administrative services; outsourced business support services and basic
training. The staff at these incubators lack commercial experience; have weak relationships to
industry and supply chains; and limited knowledge of global markets. Furthermore, managers
at these incubators who have either civil service or academic backgrounds, tend to be
administrators, rather than entrepreneurial. Yet, they are expected to perform the initial
screening of incubatee applications for admission to their incubation programmes. As a result
of this “blind leading the blind” system, the lack of successful entrepreneurial characteristics
in the incubatee is not recognized early on and eventually leads to business failure in the
absence of appropriate countervailing measures.
Over the past few years, another disconcerting trend has emerged where universities have
formed their own investment holding subsidiary to assume full ownership and control of
incubatees in commercialization projects after they either failed to license or collaborate with
industry partners, particularly in global marketing. This approach utilizing university funds
has been taken in spite of clear evidence showing that very few academics have
entrepreneurial leadership and the university organizational culture does not support
entrepreneurial decision-making.
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Recommended Strategy Measure: Establish Global Industry Innovation Centres of
Excellence between multinationals and universities in Key Sectors
The Agency should coordinate a strategic industry-academia research partnering programme
between multinationals operating in the region with local universities to set up Innovation
Centres of Excellence funded by each party on a 50:50 basis. The Centres will house both
industry and university researchers as well as technology facilities. The effort will help
university management to strengthen networking with industry and increase exposure to
global supply chain requirements.
This Global Industry Innovation Centres of Excellence programme should focus on the
twelve (12) National Key Economic Areas, namely - Oil, Gas and Energy; Palm Oil;
Financial Services; Tourism; Business Services; Electronics and Electrical; Wholesale and
Retail; Education; Healthcare; Communications Content and Infrastructure; Agriculture; and
Greater Kuala Lumpur/Klang Valley (i.e. Infrastructure & Construction; and Transportation).
The Agency will identify suitable multinational companies operating in Malaysia for this
partnering programme with local universities. This programme will elevate the focus of R&D
and commercialization of innovation to a global level, which should drive out a higher
quality of innovation from local researchers to meet the needs of global businesses. It will
also force greater effectiveness in the use of university funds in the commercialization of
their innovations. A successful programme will create spin-out companies with higher quality
innovations and market relevant business propositions.
The programme should be incorporated in the list of pioneer status privileges to attract
follow-on investments by multinationals in R&D and innovation activities to supplement
their current production/services operations in Malaysia; and promote the setting up of the
multinational’s global product/service innovation hub.
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Specific programme incentives can include extension of pioneer status of multinational for
another ten (10) years on corporate income tax exemption; five (5) year tax holidays or lower
personal income tax rates (similar to the 15% income tax rate for knowledge workers in
Iskandar Malaysia) for full-time knowledge workers from the multinational and the local
university employed in the Centre (on an unconditional, non-discriminatory basis); access to
employment of foreign knowledge workers; duty free imports of capital equipment and
consumables for the Centre; exemptions from government service tax and withholding tax on
technical and consulting services provided to the Centre; and access to the Agency’s human
capital development innovation grants to subsidise fifty percent (50%) of salaries of PhD or
technical specialists.
The Agency will have a strategic matching service to assist Universities to team up with
Angel investors to co-manage their available funds to invest in spin-outs from the Centre or
other faculties. This Seed Capital Fund can be on a one to one (1:1) matching basis between
the Agency and the University-Angel Capital Partnership. Angel investors will drive
assessment of business viability and survivability of innovation spin-outs; lead commercial
negotiations and investment decisions; provide mentoring, build management teams and be
ultimately accountable to stakeholders for investment returns. Where a single university’s
innovation output lacks critical mass, the Fund can be partnered with several universities or
research institutes with innovations in the same sector.
In general, the university should the Agency to own a small minority stake or less than
twenty-five percent (25%) of the spin-out company as compensation for developing the
intellectual property (based on a cost recovery valuation formula), allowing the balance of
equity to be utilized to raise working capital and to incentivize management.
This strategy measure will refocus university strategic role in incubation of innovation and
reinforce relevance on its commercialization efforts in the global marketplace through smart
partnership with multinationals; encourage technology transfer and best practice synergies
between partners; and strengthen entrepreneurial leadership and decision-making in the
organization.
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Challenge 2: Government incubators have limited budget and qualified personnel
There is too much variation in the management and performance of government incubators.
Many face similar problems and challenges such as; obsolescence of facilities due to
budgetary constraints, lack of management capabilities (i.e. unsuitable personnel with limited
technical and commercial expertise, unable to execute plans, lack business linkages, agency
conflict of interest issues, co-ordination issues with other government and public funding
agencies, etc.). Generally, the value proposition and service offering are not valued by
incubatees.
The incubator projects also face a host of similar problems; unable to commercialize
products, lack of demand from venture capitalist, lack of endorsement for products and
contacts for international markets, etc. Some of the more specialized technological incubators
require enhanced specific infrastructure e.g. bio-tech/pharmaceutical and ICT.
Around the world most incubators receive public subsidies. However, there should be
incentives to make them increase their sources of revenue so that they are self sustainable
especially on the operating expenditure side.
Recommended Strategy Measure: Establish a National Centre for Incubator Management
This national center should be an independent entity to put in place best practice incubator
management practices across all government run incubators. It should promote a model “one-stop”
incubator program where a comprehensive set of services are provided as practiced in
the other world class incubators.
It should develop extensive international linkages so that it can bring linkages to all
incubators. Establish alliances with foreign incubators so as to promote technology transfer as
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well as exchanges of personnel. It should prepare and obtain all approvals of incentives
necessary to promote Malaysia as a new location for foreign incubators to operate.
The Centre should also put in place standard operating procedures, performance management
systems, service offerings, control measures to prevent conflict of interest and appropriate
targets and associated KPIs to promote better management and success of incubators in
Malaysia.
The Centre should have immediate oversight of all new development projects currently
undertaken by government run incubators with MoF development grants. It should manage
the transformation of the development project with new stakeholders and incubator
management organization in line with this strategy measure. Given the present state of public
incubators, their inexperienced managers are unlikely to execute in accordance to the new
mind-set.
The Centre should also create a national data base of experts (technical and commercial) who
can act as mentors and consultants to incubators and other start-up firms. In order to recruit
business mentors and coaches, it should design promotional campaigns with incentive
packages to convince target corporates in key sectors to commit fifteen percent (15%) of their
management time to innovation-related activities.(a.k.a. the 3M way)
The successful entrepreneurs and general managers who commit up to fifteen percent (15%)
of their time mentoring the Agency’s approved incubatee, will enjoy an equivalent
percentage (up to 15% of their salaries from permanent employment) of personal income tax
relief, on condition the mentor does not hold any shares or stock options in the incubatee.
Mentors that hold shares or stock options are already incentivized to ensure the success of the
incubatee.
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The Center should create programs to leverage government research institutes and institutions
of higher learning for technological expertise and scientific equipment. Additionally, it
should be the “one-stop” agency to promote and coordinate the recruitment of foreign retired
experts or Malaysian experts resident overseas under the various government programmes,
i.e. Malaysia My 2nd Home (MM2H) and Talent Corp., and match these experts to the
incubator programmes.
It would provide independent yearly evaluation of all programs and activities of incubators
and the performance of incubatees. It will be the “one-stop” agency to qualify and certify
private incubators, mentors and angel investors for tax incentives covering both corporate
double tax relief and personal income tax relief, thus creating the Agensi Inovasi Malaysia or
“AIM Status” approved incubator. Poor performing private incubators should also be
removed from the MSC and BioNexus approved status listings which will reduce confusion
in the eco-system.
The Agency will manage a ten (10) year soft-loan based Fund of Funds programme to create
incubator seed funds at the public and private incubators on a one-to-one (1:1) matching
basis. To form the Seed Capital Fund, public incubators can match from their retained profits
achieved through rentals, while private incubators can source from their own capital and third
party investors.
The Agency will have a strategic matching service to assist incubators to team up with Angel
investors to co-manage their available funds to invest in incubatees in the seed and early
stages. This Seed Capital Fund will be on a one to one (1:1) matching basis between the
Agency and the Incubator-Angel Capital Partnership. Angel investors will drive assessment
of business viability and survivability of business start-ups; lead investment decisions;
provide mentoring; strengthen management teams and be ultimately accountable to
stakeholders for investment returns.
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Finally, the Centre will prepare government run incubators for privatization within a three (3)
year timeframe. In the strategic re-alignment programme, government run incubators and
technology parks will be re-organised to be cluster and location specific in their scope of
activities. Privatisation will include a partial sale or complete disposal to existing
management; private or foreign incubators; or public listed companies. In situations, where
the technology park or incubation centre is situated on strategic land owned by the
government or university, the privatization should only involve the incubator management
company to avoid investors with a property agenda.
This strategy measure will transform government run incubators through best practice
development; implement greater oversight and accountability measures; expand the
availability and access of expert human capital resources; make available financing of seed
and early stage ventures; and strengthen entrepreneurial leadership and decision-making in
the organization in preparation for a more market oriented culture as a private entity.
Challenge 3: Private incubators established to enjoy incentives (MSC status) have failed
to execute incubation programmes
The growth of private incubators is associated with MSC development in the country. The
key benefits to incubator operators include; access to world class telecommunications
infrastructure, employment of foreign workers, income tax exemption, tendering for MSC
infrastructure projects. Most of the tenants are early stage growth firms. The private
incubators provide shared facilities and limited business advisory support.
Many of the private incubators are also facing similar issues as public incubators. Their
shortcomings include – a lack of focus and core competences, limited financial partnerships,
weak linkages with incubators overseas, low leveraging on existing industry players, lack of
experienced account managers to mentor and manage incubatees, etc.
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Several private incubators set up by large Malaysian public listed conglomerates to take
advantage of pioneer status tax exemptions have also failed to collaborate and execute
successful incubation programmes, but instead pursued narrow internal agendas exclusively.
Recommended Strategy Measure: Incentives for Investment in Incubators and Technology
Parks in Key Sectors.
The private sector should be encouraged not only to invest in incubatees but also in owning
incubators and technology parks as businesses. There are several incubator revenue models
where royalty sharing arrangements can be made with incubatee graduates; or where
incubatees are provided with capital in exchange for equity stakes and the proceeds from
successful investments can be used to subsidize future capital expenditure of the incubator.
This initiative should focus on developing private incubators in the twelve (12) National Key
Economic Areas (NKEA), namely - Oil, Gas and Energy; Palm Oil; Financial Services;
Tourism; Business Services; Electronics and Electrical; Wholesale and Retail; Education;
Healthcare; Communications Content and Infrastructure; Agriculture; and Greater Kuala
Lumpur/Klang Valley (i.e. Infrastructure & Construction; and Transportation).
Each private incubator cluster will be anchored with a leading public listed company
providing the incubator facilities developed based on tax incentives; with formal linkages to
one or more supporting Universities/Research Institutes with technical expertise focused on
innovations specific to the sector; and managed by the private incubator management staffed
by managers or retirees with industry experience.
The Agency will identify suitable Malaysian public listed companies as anchors to the sector
cluster. This programme will drive the commercialization of innovation to meet the needs of
the industry, and kick start the growth of industry led corporate innovation activities.
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Specific programme incentives can include pioneer status of anchor public listed company
for ten (10) years on corporate income tax exemption; five (5) year tax holidays or lower
personal income tax rates (similar to the 15% income tax rate for knowledge workers in
Iskandar Malaysia) for full-time knowledge workers employed in the private incubator
cluster (on a unconditional, non-discriminatory basis); access to employment of foreign
knowledge workers; duty free imports of capital equipment and consumables for the private
incubator cluster; exemptions from government service tax and withholding tax on technical
and consulting services provided to the private incubator cluster; and access to the Agency’s
human capital development innovation grants to subsidise fifty percent (50%) of salaries of
Ph.D or technical specialists.
The programme should adopt a “carrot and stick” approach to mobilize the Malaysian large
corporate sector to build up innovative capacity to compete globally. An innovation tax
equivalent to one percent (1%) of revenues will be imposed on Malaysian public listed
companies (similar to the MPOB palm oil cess for funding R&D) in all the 12 NKEA sectors
and Gaming sector. The innovation tax proceeds will be administered by the Agency for
funding the NIP programmes. (similar to the utilization of UK’s National Lottery proceeds.)
Any Malaysian public listed company can qualify for tax exemption from the innovation tax
through utilization for capital and operating expenditures related to the setting up of R&D
facilities at a technology park or incubation centre; and by way of procurement of product
innovations or technology licences from the private incubator clusters or local universities.
To set the pace for the private sector, Government-Linked Corporations where Khazanah
Nasional has substantial stakes in, will provide the initial ten (10) private incubator clusters in
the following sectors – Agriculture; Automotive & Transportation; Basic materials; Financial
Services; Healthcare; Infrastructure & Construction; Media & Communications; Electronics
(Wafer); Retail; and Utilities (Energy).
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In the private incubator clusters where Malaysia faces intense global competition and lack
critical mass in innovations, foreign incubator management companies will be actively
sought through incentives, joint ventures or acquisition to set up operations locally. The six
(6) sectors that need special attention are : Oil, Gas and Energy (including Renewable Energy
and Cleantech); Electronics and Electrical; Healthcare (including Biotech, Pharmaceuticals
and Medical Devices); Communications Content and Infrastructure; Business Services; and
Wholesale and Retail. The foreign incubator management companies’ role will include
strengthening collaboration and facilitating technology transfer between incubatees in their
home countries with incubatees in Malaysia; as well as leveraging Malaysia’s comparative
advantages as an outsourcing partner.
This strategy measure will develop innovation capacity in key economic sectors; mobilize
domestic industry investment into innovation activities; create a self-funding mechanism for
innovation programmes; build core competencies of private incubators in focus sectors;
encourage transfer of foreign incubator expertise to enhance global competitiveness of
product innovation; and unleash under-utilised domestic expert and entrepreneurial human
capital.
Challenge 4: Entrepreneurial leadership and management capacity limitations
The lack of experienced account managers to mentor and manage incubatees by incubators
has led inevitably to the low survival rate of start-up businesses. Evidence confirms that the
overwhelming majority of innovators, especially from academia, lack successful
entrepreneurial characteristics and leadership potential. Without the support of experienced
mentors and managers from industry, the chances of survival of any business formed to
commercialise an innovation are extremely limited.
The availability of mentors and managers from larger companies is constrained due to time
committed to developing their businesses; and the absence of a reward system aligned to the
overall CSR mission.
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Recommended Strategy Measure: Incentives for Business Mentors; Retired experts and
Returnees
In order to recruit business mentors and coaches, the Agency should structure incentive
packages to convince target corporations in key sectors to commit fifteen percent (15%) of
their management time to innovation-related activities.(a.k.a. the 3M way)
The successful entrepreneurs and general managers who commit up to fifteen percent (15%)
of their time mentoring an the Agency approved incubatee, will enjoy an equivalent
percentage (up to 15% of their salaries or compensation from permanent employment) of
personal income tax relief.
The Malaysian retired expert who mentors an the Agency approved incubatee, will qualify
for a tax holiday in terms of personal income tax relief for the duration of the contract.
The retired foreign experts for any key sectors will be eligible to work as a permanent
resident under an augmented MM2M programme. The foreign experts working in any the
Agency approved programme will qualify for a tax holiday in terms of personal income tax
relief for the duration of the contract.
The Malaysian returnees under government programmes, such as Talent Corp., who mentors
an the Agency approved incubatee or works in any the Agency approved programme, will
qualify for a tax holiday in terms of personal income tax relief for the duration of the
contract.
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The income tax relief provisions are subject to the condition that the mentor does not hold
any shares or stock options in the incubatee. Mentors that hold shares or stock options are
already incentivized to ensure the success of the incubatee.
However, full-time or contract employees who are eligible for employee stock options in the
incubatee will not be excluded from qualifying for their tax holidays. This is to enhance the
attractiveness of the employment conditions at high risk business enterprises.
This strategy measure will transform corporate culture to align with innovation prerogatives;
improve corporate social responsibilities to nurturing infant industries; and unleash under-utilised
domestic experts and incentivise brain gain efforts to recruit the Malaysian diaspora.
Challenge 5: Limited managerial and financial resources to support business start-ups
at seed and early stages
The early efforts of Government venture capital agencies to develop a venture financing eco-system
for seed and early stage businesses through direct investments and outsourcing to
investment professionals have met with limited success. The government venture capital
capacity building programmes (under MTDC and MAVCAP) concluded that financing of
seed and start-up businesses have resulted in significant investment losses and a high rate of
business failure. The bitter lessons learnt demonstrate that neither top-down driven direct
investment in priority sectors, nor outsourcing to smaller private sector teams of qualified
investment professionals can improve business survival of start-ups at seed and early stages.
Neither managers of government agencies nor private sector venture capital funds have the
commercial experience to assist and mentor business start-ups irrespective of the strength of
their innovation or technology platforms.
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Furthermore, a new strategy by way of co-investment by government (through Khazanah,
MTDC) as limited partners of foreign managed venture/seed capital funds (MLSF,
SpringHill) focused on life sciences have to-date yielded little impact in terms of technology
transfer, knowledge spill-overs, domestic capacity development, jobs creation or investment
returns. The problems lie in the wrong choice of competent partners; poor enforcement of
obligations; lack of critical evaluation and monitoring; limited transparency and
accountability; and failure to ascend the learning curve. The government’s failure is in stark
contrast to Singapore’s qualified success in a similar programme (Bio*One Capital)
implemented at around the same time.
To date, all financial investors involved have lacked successful entrepreneurial characteristics
and leadership; as well as experience as entrepreneurs.
Without combining funding with relevant mentors from industry, the long term survivability
of these businesses formed to commercialise innovations is destined to fail.
Recommended Strategy Measure: Incentives for smart partnership with Angel investors
While it is necessary for the Agency will coordinate and maintain a directory of mentors and
experts as a resource facilitator, most mentors in current incubator programmes are rewarded
through low, risk-free basic compensation on terms dictated by government grant schemes,
such as CIP.
Such risk-reward compensation structures are unlikely to attract the “best of breed” mentors
and insufficient to incentivize passionate commitment to grow incubatees.
Mentors drawn from Angel investors remain the most balanced risk-reward formula for
successful business incubation support. Since angel investors have a direct financial exposure
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to the business survival and growth of the start-up, motivation and commitment to business
success remain high.
The Agency should structure tax incentive packages for Angel investors to invest some seed
capital and their time mentoring an the Agency approved incubatee. Their investment will be
entitled to one hundred percent (100%) deduction as personal income tax relief.
The Angel investor who mentors an the Agency approved incubatee will qualify for a tax
holiday in terms of personal income tax relief for the duration of the contract.
The Agency will manage a ten (10) year soft-loan based Fund of Funds programme to create
incubator seed funds at the public and private incubators on a one-to-one (1:1) matching
basis. The Fund of Funds programme will seek to develop smart partnerships with Angel
investors for each of the NKEA sectors.
The Agency will have a strategic matching service to assist Angel investors to team up with
incubators or Universities to co-manage funds to invest in incubatees in the seed and early
stages. This Seed Capital Fund will be on a one to one (1:1) matching basis between the
Agency and the Incubator/University-Angel Capital Partnership. Angel investors will drive
assessment of business viability and survivability of business start-ups; lead investment
decisions; provide mentoring; strengthen management teams and be ultimately accountable to
stakeholders for investment returns.
This strategy measure will align financing with business expertise; expand the availability
and access of experienced entrepreneurs; accelerate the rate of success of seed and early stage
ventures; and strengthen entrepreneurial leadership and decision-making in incubators.
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CHAPTER 3 : INCUBATORS AND INNOVATION FINANCE
Overview – Cross-cutting challenges
Malaysia has evolved in the past 15 years a range of risk capital instruments in the form of
grants, equity or loans. There are gaps in providing a comprehensive innovation funding
landscape so that firms can obtain capital through all stages of its life-cycle. If gaps persist,
firms will fail.
Access to finance for innovation is an important link in the innovation cycle. Early stage
financing is a big challenge even for economies with well developed capital markets. The
perceived risks arising from introduction of unproven products and business models into
markets makes financiers less comfortable. Risk capital is typically provided by government
grant institutions, angel investors and venture capital (VC). Late stage funding is provided by
private equity (PE), debt financing and public equity market.
Government funding has played an important role in Malaysia’s early-stage technology
development. However, it has not achieved the desired output. There is considerable scope in
strengthening the capital market instruments for innovation funding. Malaysia’s risk capital
base appears to be more weighted on start-up and seed financing. The government has
attempted to fill the gap in the private capital market for supporting knowledge creation and
commercialization in the form of grants, soft loan, equity and government-funded incubators.
Financing from wealthy individuals, early stage private VC, corporate venturing, insurance
and pension funds has been lacking in early stage funding. International early stage capital
funds have not witnessed significant presence may be because the demand side, it terms of
quality deal flows has not been attractive. In the best practice early stage capital market
model, governments provide 25 to 30 per cent, angel investors 20 to 25 per cent, and venture
capital about 5 to 10 per cent.
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The supply from other funding sources for different stages of the innovation lifecycle also is
conspicuously underdeveloped. PE, project financing, debt financing, loan guarantees and
public equity markets for innovation-driven firms are less developed. Innovation strategy will
address the shortcomings in all these innovation funding instruments.
There should seamless connectivity between the different components in the innovation
funding ecosystem. This should also be supported by a healthy rate of firm formation with a
well populated pipeline of potential ‘quality deal flows’ that ensures that the funding
ecosystem is nourished in a virtuous circle. Risk capital and late stage funding are equally
important.
Risk capital instruments are extremely important to fund firms from start-ups through to
commercialization. Well before they have revenues, entrepreneurs seek funding to conduct
the R&D needed to demonstrate the value of their idea, build prototypes, conduct trials,
obtain patents and launch their products or technologies into market-ready products and
applications. At the stage of pre-revenue and pre-commercialization, risk capital plays a
crucial role in selecting viable value propositions, nurturing them into commercial engines of
innovation and economy growth.
There are several innovation funding challenges to that need to be overcome for the country
to achieve an innovation economy. These include;
• Decrease Government role as provider of risk capital
In Malaysia, the end goal of innovation strategy is to have the private sector assume a
leadership role in innovation funding. The aim of innovation strategy is to facilitate the
development of private-sector led risk capital. Currently, there is minimal private funding at
the early stage. The desired aim of the strategy is the emergence of a comprehensive
spectrum of risk capital with specific roles by the government in the early stage and with a
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declining role at the later stages. Hence, role of government as a player, facilitator and
regulator should have an optimal balance.
Presently, the bulk of risk capital is sourced mainly from the government. Going forward, the
strategy focus is to accelerate the growth of private sector capital in innovation funding.
There is a need for a broader investor base and to incentivize financial institutions and private
sector corporations to invest. Wherever possible, even at early stage funding, private sector
involvement should be invited.
• Eliminate the Structural Issues Hindering Deployment of Risk Capital
There is inadequate private capital to fund nascent firms. There are structural issues within
the VC industry that limit the growth of the industry and the extent of risk taking. The
establishment of angel network to finance seed stage has not happened. The other alternative
risk capital instruments such as private equity, debt back guarantees, debt financing
(convertible soft loans) and exit markets have not developed despite government initiatives to
foster their development.
• Limited Impact of Innovation Funding
The government has invested a sizeable amount in early stage grants but this has not resulted
in commercially viable products/processes. The recipients of these grants have a low
commercialization rate. It is crucial that all innovation funding programs should identify
within its mandate priority areas taking into account the leverage from Malaysia’s core
strengths where it has a sustainable competitive advantage. Currently heavy focus is on ICT
and biotechnology. There are concerns that the sectors that generate meaningful impact on
the economy are not well covered by existing early stage innovation funds.
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• Improve Management of Funds
Another challenge facing Malaysia is in the quality of innovation funding management. Risk
capital, be it a VC fund or grant program, should be managed by a team with strong
capabilities. They should be skilled in financial matters, possess domain expertise,
capabilities in nurturing skills and experience in bringing early stage innovation-based firms
all the way through to commercialization success. Most managers have strong financial
background but lack competencies in other areas.
There is inadequate linkage support from innovation funding to recipients. The linkage
support to foster growth is an essential part of early stage financing. The range of linkage
support starts with idea development (i.e. linking to academics, industry specialists, etc). It
then leads to capability building (i.e. commercial mentors, etc.), and access to infrastructure
(i.e. hard-asset tools such as laboratories or IT systems, etc.). Finally the most important
component is commercialization (i.e. potential customers, prospective investors or ‘exit’
partners). These linkages areas need considerable improvement by innovation fund
institutions.
• Improve Accountability and Performance
The funding vehicle should be designed to match the risks and cash flow profiles of the
recipients in each stage. It is also important to mitigate potential moral hazards where
innovators in the R&D stage typically have no cash-flow and limited financial resources to
contribute to the funding. They have also have limited assets on their balance sheets to be
used as collaterals, making it hard to access private sector funding. Thus, herein lays the
difficulty for public funding agencies to use matching grant. However, there must be a
strategy in place for funding vehicles to move from pure grant to matching grant to soft loan
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to equity financing. Fund recipients should also be gradually required to make funding
contributions (‘skin in the game’).
There should sufficient incentives within each fund to be performance driven. There should
be disincentives when milestones are not met. Independent audits by third parties should be
used to conduct ex-ante, intermediate and post-project monitoring.
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INNOVATION GRANTS
Overview
Effective funding of grants by the public innovation organizations is one of the key factors
that will define the success of the national innovation agenda. Individuals, businesses,
educational and research institutions, and even government agencies all need access to
adequate early stage funding to help catalyze commercialization.
Early stage funding is one area where market failure prevails as private sector funding
inadequately addresses the needs of innovation agents. The government has realized the
needs and benefits of innovation grants and funding to help plug the funding gaps
insufficiently addressed by the private sector. It has allocated RM2.45 billion across fourteen
funding programs along the entire innovation lifecycle, to be utilized over a period of two
years from 2011 and 2012.
Challenges:
i) Improve National Innovation Funding Strategy
ii) Streamlining grant funding vehicles to be specialized, either according to sector
focus or recipient type
iii) Overcome gaps in the fund disbursement process and performance.
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Challenge 1: Improve national innovation funding strategy
The national grant funding strategy should have a clear focus on sectors where Malaysia can
potentially develop sustainable competitive advantage. The limited resources need to be
prioritized to leverage Malaysia’s core strengths in the past and in the future. The national
grant funding strategy must also align itself to the overall national economic strategy.
Recommended Strategy Measure: Agency is required to shape the national public sector
funding strategy and act as a portfolio manager to track performance
EPU and MOF should continue their role as the country’s economic and finance master
planner and for disbursing budgets related to innovation grants. The National Research
Science Council (NRSC) will identify, monitor and evaluate priority fundamental/scientific
research areas and expenditure at the national level. MOSTI and MOHE would continue to
plan and execute the Science and Technology (S&T) agenda of the country.
In addition, there is a need to for a specialized agency to plan, drive and monitor the
government’s innovation funding strategy across multiple government ministries and
agencies. This agency could be Agency Innovasi Malaysia (the Agency).
There is also the need for continuously improvement of the public innovation funding
organizations. Internal organizational reform is vital to ensure it is stakeholder driven with
alignment with national strategic interest. Improving linkages across the funding ecosystem
(public and private) is equally important.
Implementation evaluation tools such performance metrics and innovation scorecards need to
be established for each agency and its funding programs. With appropriate key performance
indicators (KPIs) in place quarterly/annual tracking of the performance of public innovation
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funding agencies should be undertaken. It is equally important to assess their impact on
stakeholders and society at large. Independent third party audit and evaluation across all
funding programs and projects should be the norm.
Coherence in strategy design and implementation is a prominent characteristic of all
successful innovation funding initiatives. In Malaysia there is a need to execute better what is
planned. The apex agency should have a high-powered strategy monitoring and evaluation
board (with inter-ministry and inter-industry private sector representation) where all
evaluation reports are tabled for remedial action. With all these mechanisms in place the
reform and transformation agenda of innovation funding should flourish.
Challenge 2: Streamlining grant funding vehicles to be specialized, either according to
sector focus or recipient type
As a result of mapping of the existing programs against their industries of focus and stages
along the innovation lifecycle the following problems were observed:
i) Existing funds target a few sectors (ICT and Biotech). There is limited funding
provided to all stages in the innovation lifecycle across all sectors. Those sectors
that are critically important (i.e. electronics, resource based industries such as
palm oil, rubber and wood, etc.) lack public funding support at the early stage.
ii) Multiple agencies are providing funds to a particular sector (such as ICT). These
agencies are unable to have cohesive accountability or responsibility to generate
the desired impact on the particular sector.
iii) There is more than one funding agency targeting the same group of recipients.
iv) Within certain sectors or sub-sectors, there is a problem of disjointed funding
effort from one stage to another in the innovation. This is especially prominent
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between the pre-commercialization and commercialization stages. There is the
absence of seamless access to funding from one stage to another to foster the
growth of the firm.
The transformation of the existing government grant funding institutions cannot be done in a
piece meal. Simply maintaining the existing funds and eliminating overlaps will not lead to
any significant improvement in the efficiency and effectiveness of public funding for
innovation. A comprehensive overhaul is required.
The real effective option requires the reduction and re-organizing of the funds to overcome
all the shortcomings in the present grant funding landscape. The limited national resources
should be better deployed in a cohesive manner so that there is greater impact on a sector and
stage in the innovation life cycle.
There are several strategic principles that should be observed;
i) When creating sector specific fund, the fund managers must have domain
knowledge to nurture development of early stage firms.
ii) Targeted funding should be where Malaysia can create present or future
sustainable competitive advantage. Given the resource constraint, it is unlikely
that Malaysia will be able to dedicate a fund or a cluster of fund to every sector of
the economy. Hence the sector selected must be able to exploit the existing
economic base (i.e. electronics and resource base) and its core strengths to build
new industries. Alternatively, it could focus on new industries where the prospects
for future sustainable competitive advantage can be realistically created (i.e. ICT
and agri-biotechnology).
iii) The fund should provide comprehensive innovation funding along different stages
of the innovation lifecycle.
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iv) In the event the fund is focused on a specific stage in the innovation life cycle (i.e.
pre-seed stage, etc.) across all sectors, linkages to next stage of funding should be
effectively be in place. It should enhance the efficiencies in the funding process as
it is dealing with recipients with similar profiles and needs.
Recommended Strategy Measure: Reduce the number of early stage innovation grants to
three
The number of funds should be reduced to give greater depth and scope in funding. The
mandates should also be re-scoped to eliminate overlaps in sector focus, target recipient
groups and fund all stages along the innovation lifecycle.
It is recommended that the three funds be structured in the following manner;
i) Bio-Medical Fund
This is a sector-specialized fund similar to the Biotech Corp’s Biotechnology
Commercialization Grant Scheme (and its cluster of sub funds). As this is a highly technical
sector it should continue to remain a technically competent agency like Biotech Corporation.
The fund should be managed by domain experts who have deep technical knowledge and are
business savvy. This fund provides cross-stage (pre-seed to commercialization) funding to
ensure seamless transition from one stage to the next within this sector. Since this is a ‘green-field’
sector with higher risks, it attracts low-private sector funding. It should also model after
the Malaysian Life Sciences Capital Fund (MLSCF) where some of its sub-sectors can be co-managed
by Malaysian VC/PE together with a globally recognized firm/group of individuals
in the bio-technology sector. The foreign partners must be linked to global networks that can
enhance the quality and quantity of deal flows. The sub-funds must be structured as private
entities; investments are decided in an independent, transparent and consistent manner.
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ii) ICT and IT Technology Enabling Fund
The fund would have the same characteristics as the above bio-medical fund accept it will
focus on the ICT sector and to IT technological enablement across all sectors. It would also
provide end-to end funding with a sub-funds with a public-private sector funding (seed
fund/VC/PE) partnership model. ICT as a sector requires a lot of sector-specific expertise.
There is also no funding program with a dedicated focus on technological IT enablement.
This fund will cluster all previous funds that have a focus on IT. By having one fund
dedicated to the ICT sector (rather than multiple funding as present) will ensure
cohesiveness, accountability and impact for this sector.
iii) A General Early-Stage Fund
This is a general end-to-end fund that will focus on all sectors apart from bio-medical and
ICT. This fund is also a merger of three existing funds namely; MOSTI’s Pre-
Commercialization Fund, MTDC’s Commercialization of Research and Development Fund,
and MTDC’s Technology Acquisition Fund.
It will also adopt all the characteristics of the above parts especially the public-private
partnership model in its sub-sector funds. One of the sub-sector funds will be to shift the
scope of the existing Cradle Fund to provide seed funding to all sectors apart from bio-medical
and ICT. It is important to have a fund specialized for this specific recipient type
across multiple sectors. The strengths and lessons in managing the existing Cradle Fund
should be leveraged upon across a broader range of sectors.
There is a risk of generalization and risk of linkage loss; by focusing on a broad range of
sectors. The Fund risks losing strategic focus or the necessary domain expertise, and may not
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be able to add value and nurture recipients into growth firms. In order to mitigate these risks,
the Fund managers must decide on a few priority sectors/recipients based on a bottom-up and
market conforming approach. It should invest where there is demand and the potential for
Malaysia to build its sustainable competitive advantage position. Also prioritization is needed
to create impact and domain expertise.
It is envisaged that within the Fund, there will be multiple sector-specific teams, each with a
dedicated focus on a particular sector or clusters of sectors. This will ensure sector expertise
and to elevate up to a separate funding program once it has become sufficiently large or
strategically important to warrant the establishment of a separate fund – dedicated to that
particular sector or cluster.
Challenge 3: Gaps in the fund disbursement process and performance
There is a need to improve the disbursement of funds across the entire landscape. There are
process gaps and operational challenges. There is inadequate commercial and technical
expertise among staff, lack of linkages between entrepreneurs and the broader innovation
system. There is a need for performance tracking to map outcomes to funds.
There can be considerable improvement in the efficiency and effectiveness in the current
disbursement of public innovation funds. After mapping of all the application evaluation,
fund disbursement and post-project processes across all public early funding programs – it is
evident some funds adopt best practice processes across the entire disbursement process
while in others there are multiple gaps.
Some of the glaring shortcomings include; pre-disbursement stage (insufficient due diligence
conducted on applicants, proposal evaluation is outsourced with funding agency staff having
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little accountability), disbursement stage (quarterly monitoring of pre-agreed milestones
undertaken by outsource partners with agency staff with little accountability, limited
capability building support) and post disbursement stage (lack of strong monitoring, no
linkages to subsequent sources of funding). Hence, there is a need for consistence
performance metrics and availability of aggregate data in the public domain on allocation
decisions and performance of all funds.
Recommended Strategy Measure: Implement a systematic performance management
measurement metrics and scorecard across all funds.
A suitable set of performance metrics to track the performance of each fund can be
introduced to effectively monitor the input, throughput and output performance of the fund
disbursement process and the fund managers. The performance metrics will be important as
a management tool to assess operational efficiencies and compliance to the required
standards. Furthermore, the performance metrics should ultimately measure the
developmental impact of the investments on the successful commercialisation of innovations
and high technology enterprise growth in Malaysia. It should be noted that successful foreign
direct investments into high technology start-ups that may give a decent Return On
Investment (ROI) but yields no technology transfer or knowledge jobs through the
localisation of commercial activities in Malaysia should still rate poorly on output
performance metrics due to the lack of an economic developmental impact for the nation.
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VENTURE CAPITAL
Overview
Venture Capital (VC) plays an instrumental role in nurturing the next generation technology
and innovation driven entrepreneurial firms. Apart from providing financing, VC provide
other invaluable support services such as management support, advice, mentoring and
linkages to domestic and international partners. They are also important in planning for the
growth of the firm through exit and other value realization strategies.
The challenge is in creating a healthy and vibrant early stage VC in Malaysia. In most
instances, VC does not fund R&D but prefer to support firms that have moved beyond the
product development stage and those with attractive business models. There is a bias toward
later-stage ventures and their reluctance to do smaller transactions.
Venture capital firms in Malaysia are under capitalized.
The impact of funding innovation-based early stage firms on the US economy has been extra-ordinary.
As of 2008, eleven percent of private sector jobs are in firms backed by venture
capital. In comparison, the revenues of these firms contributed 21% to US GDP – evidence of
the high value created per person employed by VC-backed firms.
Challenges:
i) Overcome gaps in industry specific investment capacity
ii) Improve accountability and performance of government funding in priority areas
iii) Increase private sector funding exposure
iv) Access to capital markets for high-tech start-ups
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Challenge 1: Overcome gaps in industry specific investment capacity
The government’s efforts spanning twenty (20) years initially through specialized enabling
agencies MTDC and MAVCAP to build up emerging high-tech industries; venture capital
investment capacity; and human capital capabilities have neither created critical mass in this
financial services sub-sector nor developed a portfolio of globally competitive high-technology
firms.
The early success met by MTDC in the initiation stage was primarily due to the public-private
partnership model with large Malaysian public listed corporations’ investor
participation (Sime Darby, Berjaya) as co-funders and the leveraging of foreign venture
capital management expertise through a joint venture. This accountable and professional
management structure strengthened with in-depth business experience, was supplemented by
attractive deal flows from the growth and maturing of firms in the global supply chain in the
export oriented sectors, particularly Electrical & Electronics. In the New Economic Strategy
(NEP) regulated environment then, the venture fund was well positioned to benefit as a
qualified Bumiputra institutional investor, and selected the best mezzanine pre-IPO deals in
the market.
The next generation follow on funding programmes failed to follow the proven public-private
partnership model but instead promoted a “know-who” rather than a “know-how” investment
management process. Due to the growing agency, conflict of interest and lack of transparency
issues by MITI-related parties that resulted in substantial investment write-offs, the
government attempted to redress the strategy instrument implementation with the subsequent
creation of MAVCAP directly under the purview of the MoF. Again, the proven public-private
partnership model was not adopted but instead a top-down directed strategy deployed
through government administrators in the management of the majority (70%) of direct
investments, with the balance of funds outsourced to local venture capital fund start-ups on a
“know-who” basis, evident by the number of outsourcing partners who are related to former
employees of MAVCAP. The recent performance assessment of this venture capital
development agenda speaks loudly of the overall implementation failure evident in the high
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number of investment write-offs and the breeding of a “It’s OK to Fail since it’s OPM
(Other People’s Money)” mindset in a deviant version of the entrepreneurial “Not Afraid to
Fail” culture.
Recommended Strategy Measure : Re-establishing the proven public-private partnership
model through incentives for foreign venture capital partnership and corporate venturing
The Agency should implement a strategic initiative to identify the best of breed foreign
venture capital management firms in three (3) high technology areas, particularly Bio-
Medical & Pharmaceutical (BMP), ICT and Renewable Energy, Environmental & Clean
Technology (RECT), from established venture capital eco-systems in USA, Europe and Asia.
In terms of alignment with the National Key Economic Areas (NKEA), innovation projects
undertaken in the following eight (8) sectors will receive attention from the venture capital
funds focused in the three (3) strategic technology areas namely - RECT (Oil, Gas and
Energy; Palm Oil; Greater Kuala Lumpur/Klang Valley - Infrastructure & Construction;
Transportation); BMP (Healthcare; Agriculture;); ICT (Electronics and Electrical;
Communications Content and Infrastructure;) and the developmental agenda will address
capacity building of venture capital services in the Financial Services sector.
At the outset, the incentives supporting this capacity building initiative must differentiate
Malaysia (Kuala Lumpur) as the preferred destination to the current regional investment hubs
like Singapore, Hong Kong, Dubai, Shanghai and Beijing. The opportunity exists as there is
enough pull factors for global venture capital firms from USA, Europe and Japan attracted to
the increasing deal flows of high growth firms in the hi-tech sectors of the emerging markets
of China, India and Indonesia. There are push factors for global venture capital firms already
present in the region who are seeking to expand back-office, due diligence and compliance
support, rising costs of regional operations and deteriorating quality of life in these hubs are
driving “road/sky warriors” to seek out new “oasis” hubs with a comparable quality of living
for expatriate communities; and transportation economies through well connected regional
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flight routes to emerging markets of interest (similar to how Ryanair consolidated London’s
position in Europe, Air Asia is Kuala Lumpur’s comparative advantage).
The incentive package will offer pioneer status, corporate tax exemption and double tax relief
for investment write-downs for foreign venture capital management operations located in
Malaysia. Tax holidays on personal income tax will also be offered to principals, fund
managers and general partners resident in Malaysia; as well as a five (5) year tax holiday
applicable to firm employees on a non-discriminatory basis (ie inclusive of Malaysian
residents) the aim is to attract/retain talent and knowledge workers (both local and foreign) to
build up capacity in this financial services sub-sector.
The Agency will manage a ten (10) year soft-loan based Fund of Funds programme to
promote the establishment of the venture capital funds with foreign venture capital
management firms on a one-to-one (1:1) matching basis. Some of the matching funds will
likely be raised from Malaysian provident, mutual funds and life insurance institutions. As a
guiding principle to promote this sector, a soft-loan of RM1.0 billion drawn down over five
(5) years will attract a minimum of three (3) foreign venture funds to be located in Malaysia,
and result in about 30 to 60 investee companies in the first year. However, an attractive
proposition to regional venture capital firms will be to allow up to seventy percent (70%) of
funds to be invested in hi-tech companies residing outside Malaysia but with a proviso that
the investee company will set up a Malaysian operating (R&D or Production) office (similar
to conditions of Singapore’s Bio*One Fund) in any of the new incubator clusters. The net
impact will be at least 10 to 20 homegrown global hi-tech companies backed by domain and
network rich global venture capitalists; and job creation and knowledge transfers from the
balance of 20 to 40 representative offices at incubator clusters.
The Agency can add a second strategic initiative to attract the corporate venturing
subsidiaries of global multinational companies already with business presence in Malaysia.
The overall objective of corporate venturing activities has been to expand their innovative
product portfolios; to enhance existing intellectual property banks; and discover new markets,
business models or disruptive technologies, in order to maintain their competitive position in
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global industry. Corporate venturing tends to be exclusive rather than inclusive of the market
demands of other players in their industry (existing competitors or potential competitive
threats from new entrant firms); and is therefore focused on leveraging on strengths of
member firms in their own global supply chain; or acquiring smaller firms and intellectual
property portfolios seen as potential threats to their bargaining position in the industry, thus
promoting concentration of market power.
In order to accelerate corporate venturing, the Agency should offer incentives including a ten
(10) year pioneer status, corporate tax exemption and double tax relief for the parent
company to invest in their own corporate ventures subsidiary or related corporate venture
partner. The parent company will also be able to claim double tax relief on investment write-downs
arising from the corporate venturing activities. Capital gains arising from investment
disposals and dividend income received are tax exempted. A five (5) year tax holiday
applicable to the employees of the corporate ventures arm on an unconditional, non-discriminatory
basis (ie inclusive of Malaysian residents) aimed to attract/retain talent and
knowledge workers (both local and foreign) to build up capacity in this financial services
sub-sector. However, given the extensive global supply chain managed by multinationals
today, there will be no localisation on the investee companies of corporate ventures operating
outside Malaysia.
the Agency will be the central coordinator to pro-actively engage with leading multinationals
in the 12 NKEA sectors to promote the setting up of their corporate venturing arms in
Malaysia; and arrange for additional tailor-made incentive packages for their investee
companies considering re-location to Malaysia, which may cover financing, facilities, capital
equipment, human resources, university/research institute collaboration, trade issues.
This strategy measure will re-establish a framework for knowledge transfer of global best
practices; bridge the gap between local innovations and global industry with domain specific
investors; and allow private sector to drive informed investment decisions across key
economic sectors.
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Challenge 2: Improve accountability and performance of government funding in
priority areas
Over the last two decades, the government has directed the funding of projects in priority
areas through direct allocation to Ministries and indirect financial support through the special
purpose agencies MTDC, MAVCAP and Khazanah disbursed as “@venture capital”. A sober
performance assessment of these past and continuing projects will show that none have
achieved their intended development agenda to build a global champion that will lead a
sustainable sunrise industry. Investment lessons from top-down strategy initiatives in steel,
automotive, wafer, utilities, transportation, financial services, agriculture, ICT and biotech
industries have failed to change the prevailing public sector “Big Brother” mindset. The
earlier success of private sector driven initiatives in resource based industries like palm oil
and wood, E&E, hospitality, gaming, education and business services, have not gained wide
acceptance as a model for future public-private sector partnerships.
Instead, the government has focused on concentrating market power in a portfolio of
Government-linked Corporations. Although, it was commendable that through this
restructuring process, greater management oversight was put in place through CEOs who are
qualified accountants, the leadership of GLCs have focused on rationalization and cost
accounting based performance measurement systems to the detrimental neglect of innovation
and entrepreneurship. The “bean counting” culture has resulted in under investment in
innovation activities and lower innovation output, even at GLC owned universities and R&D
centres. When compared with their global peers, the GLCs continue to underperform in
innovation capacity, and are performing at a level worse off than local research universities.
At this rate, none of the GLCs can sustain their global competitiveness in the longer run,
when their peers from emerging markets are accelerating investments in innovation.
A second unintended effect of continued government preferential support of GLCs
dominance and increased market power in local industry is the crowding out of private sector
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investment from competitors who perceive the loss of a level playing field. This will lead to a
continued deterioration of private sector investments in R&D and innovation activities in the
absence of government grant funding. Evidence of “crowding out” symptoms for example is
the growing state of neglect of corporate R&D by the majority of cash-rich players in the
palm oil industry; leaving it in the hands of a government research institute due to the “cess
mentality”; and the low innovation output and under-utilisation of internal R&D funds by a
GLC (Sime Darby).
Recommended Strategy Measure : Committing public sector financing based on clear
developmental and technology transfer assessment criteria
The Agency should form the Innovation Performance Unit (IPU) to implement a performance
assessment system based on international criteria, to review all on-going top-down projects in
priority areas, particularly in the automotive, wafer manufacturing, power generation, public
transportation, agriculture (aquaculture), ICT (e-government), healthcare (biopharmaceutical;
vaccines; diagnostics) and biotech (herbal; MLSF; SpringHill) ; and the GLCs’ innovation
capacity.
The IPU assessment will determine the achievement of intended developmental outcomes
measuring innovation outputs, knowledge transfers, knowledge workers, technology
transfers, new jobs creation, export performance, etc. This assessment will form a fair basis
for decision-making by government on the continuation or otherwise of committed financing;
consider alternative financing structures including privatization; and a re-negotiation of
performance contracts (KPIs) and CSR obligations within the public-private relationship
social contract.
This strategy measure will allow re-alignment of public funding with developmental mission;
demonstrate the need for transparency, accountability and performance; create the
opportunity to re-negotiate the public-private partnership; and re-balance private sector
contribution to innovation capacity building.
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Challenge 3: Increase private sector funding exposure
The intended role of government intervention in the development of the venture capital
industry was to be a catalyst in the mobilization of investment funds from the private sector,
particularly long term savings institutions in the financial services sector. While the necessary
regulations have been in place to allow these financial institutions, ranging from public sector
provident, pension, mutual and life insurance funds, to invest in venture capital funds, few
institutional investors are attracted to the present proposition. This is due to a combination of
the perceived high risk/low return from venture capital activities; and the absence of
successful venture capital management teams. Given the recent examples set by the
government run venture funds, such a conclusion by institutional investors is not that far from
reality.
Recommended Strategy Measure : Mitigate risk and investment allocation in high risk
venture capital funds by savings institutions through dividend income tax rebates.
As the Agency will promote the establishment of venture capital funds with foreign venture
capital management firms on a one-to-one (1:1) matching basis, it is important that an
incentive package with risk mitigation measures is in place to mobilize matching funds from
Malaysian long-term savings institutions.
The incentive package will include allowing an income tax rebate on dividend income
payable by the institutional fund equivalent to a hundred percent (100%) of the investment
committed to the venture capital fund. Perceived investment losses from venture capital
investment are fully provided for from the annual tax liabilities of the fund.
Most savings institutions maintain that they are long term investors in the equity market. In
reality, fund managers often turnover a significant portion of their stock portfolios more than
once within the reporting year (a practice known as “churning”) to perform window dressing
of portfolio valuation for reporting purposes. This practice increases market volatility and
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increases intermediation costs and is not in the public interest. The absence of capital gains
taxes and transaction stamp duties has reinforced this practice, as well as short-term “hot
money” flows into the stockmarket.
The Agency should introduce an innovation tax on such capital market practices in the form
of an equities capital gains tax. The equities capital gains tax should be imposed on
institutional funds (but not individual investors) that disposed of any stocks and shares held
for a period not exceeding one (1) year (equivalent to real property gains tax provisions).
This will reduce short-term speculative behavior but not completely stamp it out. However,
as a result these tax receipts can be ironically channeled to longer term investments in
innovation programmes for the economy.
This strategy measure seeks to introduce a risk/reward mitigation mechanism to increase
private sector funding involvement; and to re-align investor mentality for the public good.
Challenge 4: Access to capital markets for high-tech start-ups
Over two decades ago, the venture capital community had proposed a plan to the Malaysian
Securities Commission to establish an open marketplace platform that will provide the
necessary liquidity for the shares of unlisted private hi-tech companies invested by venture
capital and angel investors on a market maker system, similar to London’s Unlisted
Securities Market (USM). The eventual proposal mooted by the SC and KLSE after
intervention by several opportunistic stockbrokers to monopolise control, succeeded in
alienating venture capital firms, culminated in an unworkable business model named
MESDAQ. The failure of MESDAQ (now ACE) as a platform to galvanise financing for
early stage hi-tech start-ups demonstrates the lack of understanding by government regulators
and rent-seeking intermediaries of the development financing needs of the hi-tech industry.
Another significant barrier to access capital for qualified SMEs has been intermediation fees
(advisory and listing expenses) charged by investment banks and stockbrokers, where in
many cases the majority of the proceeds have been paid to intermediaries, instead of being
applied to working capital.
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In the meantime, Singapore, Hong Kong, Tokyo, Osaka and Shenzhen have all established
electronic marketplaces for early stage companies as part of the eco-system to access capital,
Malaysia lags behind again due to implementation.
While Malaysia should not re-invent the expensive MESDAQ wheel, neither can Malaysia
ignore re-discovering an important missing piece in the innovation eco-system if a vibrant
venture capital and angel investor community is to be established over the next five (5) years.
The recent valuation of Facebook Inc. on alternative private investor electronic marketplace
highlights the important role of a functioning Over-The-Counter (OTC) market.
Recommended Strategy Measure : Establish linkages into global capital markets
for high-tech start-ups
The Agency has a central role as a coordinator for the setting up of an open electronic
platform marketplace for (OTC) trading of private company equities of hi-tech start-ups. The
OTC Market should be organized like London’s PLUS market on a self-regulated basis by
founding members from the venture capital community, and adopt best practice market
regulations.
Given the new globalized economic environment and the proliferation of the internet
connectivity, the OTC Market can be linked into all major OTC markets in the world. the
Agency will seek out alliances and network connectivity with other OTC markets in Asia,
North America and Europe, in order to access deeper pools of investors and maintaining
relevance in the global hi-tech industry.
The Agency will perform as a “one-stop agency” on behalf of the SC, for purposes of
membership of venture capital firms, angel investors, corporate advisory firms and
stockbrokers. However, the old market-making system has been made obsolescent by self-directed
internet trading technology.
The Agency will promote the OTC Market with an incentive package which covers tax
exemptions from capital gains and dividend income arising from both local and foreign OTC
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trading. Also, investment losses arising will qualify for double tax relief for funds; or
equivalent to 100% for personal income tax relief.
In order to reduce intermediation costs, the Agency will promote an incentive package for
advisory firms which includes pioneer status and tax exemption for ten (10) years; and a five
(5) year tax holiday applicable to the employees of the advisory firm on an unconditional,
non-discriminatory basis (ie inclusive of Malaysian residents) aimed to attract/retain talent
and knowledge workers (both local and foreign) to build up capacity in this financial services
sub-sector. As an admission condition to the OTC Market, the advisory firm must follow the
fee schedule charges not exceeding twenty-five percent (25%) of the capital raised for the
investee company.
This strategy measure seeks to establish a marketplace for the trading of private company
equities to enhance liquidity and marketability; access a greater pool of liquidity to support
hi-tech start-ups; and to promote access via lower cost intermediaries.
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PRIVATE EQUITY
Overview
The government’s early experience in mobilizing private equity was to fund Malaysia’s basic
infrastructure projects in the 1990s. In its early privatization efforts to develop public goods
such as highways; transportation systems; healthcare; energy and water utilities, the
government structured attractive long term (25 to 30 year) concessionaire agreements
yielding high returns with the selected private sector players, supported by government
guaranteed debt; and private equity participation from public pension funds; as well as
liberalized access to capital markets. As a result of this strategy, private equity financing
from Malaysia’s public pension funds, life insurance funds and foreign PE funds (eg. AIG)
seeking predictable long term returns, with low risk (mitigated by government guarantees)
invested in toll roads, subways (LRT), power plants (IPPs) and water treatment plants.
This effort has been lauded by developmental economists as the model for other developing
economies that needed a successful public-private partnership scheme to improve basic
public infrastructure as a platform for higher economic growth.
Fast forward to the end of the concessionaire agreements beginning 2010, the government
has been forced to redress the unequal nature of these concessionaire agreements due for
renewal, which continue to impose a rising social cost on the public, without incremental
improvements of public goods provision. In fact quite the opposite effect of under-investment
by the private sector has led to higher costs, waste and inefficiencies in the provision of
poorly distributed electricity; deteriorating water quality; lower quality of public healthcare
services and uncoordinated public transportation systems. This privatization strategy with
little regulatory oversight and a public accountability framework, had encouraged the rent
seeking behaviour of favoured private sector players without trackrecords, in their
negotiations with ill-advised government officials to create a maze of privatized pubic goods
providers that fuels the present inflationary environment with underperforming social
contract obligations.
With the exception of toll highways and IPPs, private equity investors have largely been
disappointed with investment returns on public transportation systems. Private investors are
thwarted by the ill-conceived awards for public transportation systems projects, particularly
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the then three (3), now four (4) Kuala Lumpur centric urban mass transit projects and toll
roads. While Singapore and Hong Kong mass transit systems have all gone public reaping
handsome returns for investors, and are able to re-invest in the continued expansion of their
networks without charging unreasonable ticket prices yet remaining profitable, , Malaysia’s
own systems are still mired in the red, awaiting the fourth MRT system to bail out investors.
Therefore, over the last five (5) years, private equity investors have sought predictable returns
from real estate. With the introduction of new capital market regulations, the government
mobilized private equity funds into real estate asset-backed investment trusts (REIT) to
support an overheated and flagging property market for domestic economic stimulus reasons.
However, this strategy has emboldened public pensions and institutional funds to venture into
REITs and commercial real estate in distressed developed economies seeking arbitrage
opportunities in capital gains over the last two (2) years. These private equity outflows have
little developmental impact for an emerging economy like Malaysia, that still needs to focus
on capacity building and spill-overs for its priority economic sectors from its foreign direct
investment activities.
In the present landscape of private equity investors, Khazanah Nasional represents the single
largest government run private equity investor controlling a portfolio of the largest
corporations in priority sectors aligned to the NKEA, namely – Agriculture; Automotive &
Transportation; Basic materials; Financial Services; Healthcare; Infrastructure &
Construction; Media & Communications; Electronics (Wafer); Retail; and Utilities (Energy).
Similar to Singapore’s experience with SGIC and Temasek, this dominance by a government
agency essentially crowds out any other private sector led PE fund.
The recent attempts by other public institutional and pension funds to create their own private
equity operations (CIMB, Ekuinas, KWP, LTAT) are bound to fail due to the lack of
commercial competence and specific industry management experience which are pre-requisites
for successful private equity investing. The entry of these inexperienced private
equity investors can be seen as opportunistic, as they seek short-term gains in taking over
monopolistic GLCs as Khazanah streamlines its portfolio and embarks on asset reshuffling to
favored public institutions. In short, the current development of the domestic focused private
equity activity is anti-competitive by maintaining market power; and therefore continues the
legacy of declining innovation growth, as already evident in the innovation performance of
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GLCs in key industries, ie telecommunications; energy, oil & gas; pharmaceuticals,
healthcare services; palm oil oleochemicals; automotive; and electronics. The dominance of
GLCs in public sector contract awards breeds a less competitive environment where they
operate, leading to management focus on cost based rationalization to improve corporate
profitability, instead of innovation led growth, and foreign market expansion from successful
competition with global peers.
The raison d'être of PE funds is to seek out control of undervalued market leaders in
particular targeted sectors who are “cash cows” (that generate substantial cashflows) facing
declining profit margins, run by poorly performing management unable to respond to the fast
changing marketplace caused by disruptive innovations and intense competition; or who
possess under exploited resources that do not contribute to their competitive advantage. The
new management teams put in place by PE funds are central to the successful turnaround of
their investee companies and subsequent higher valuations upon exit.
Challenges:
i) Lack of focus for private equity investors on developing capacity in present or
future sunrise industries
ii) Lack of Malaysians with cross-border PE skills in hi-tech industries
iii) Orphaned hi-tech projects will turn into “Problem children” without government
support
Challenge 1: Lack of focus for private equity investors on developing capacity in
present or future sunrise industries
The government’s initial strategy initiative to involve private equity investors, both public
and foreign, was successful in channeling funds to Malaysia’s developmental capital needs in
the upgrading of basic infrastructure for a broad base economic growth in the manufacturing
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and services sectors. The infrastructure sector was characterized by huge upfront capital
investments, mitigated risks and moderate returns over the long term. This risk-reward profile
matched the investment objectives of many long term investors, particularly funds with long
term liabilities such as pension and life insurance funds.
However, the subsequent strategy support of poorly implemented projects (LRT, Bakun,
Klang Valley highways, PKFTZ, Iskandar), growing agency problems and loss of focus by
forays into real estate, have de-railed much of the attractiveness for private equity investors.
It is timely to re-channel efforts to re-gain the support of domestic and foreign private equity
funds of Malaysia’s broader development agenda of building innovative capacity.
Recommended Strategy Measure : Focus PE funding strategy on three key sectors to build
innovation capacity
The Agency should implement the strategic initiative to form three (3) private equity funds
that have industry sector specific focus, namely -
i) Life Sciences & Bio-Medical Fund
ii) Electronics (E&E) & ICT Fund
iii) Renewable Energy & Clean Technology Fund
In general, these funds will be structured on a tripartite matching basis (1:1:1), with
government fund; anchor GLCs or public listed corporations; and foreign private equity fund
manager. The Agency will coordinate its funding in the form of a ten (10) year soft loan to
establish these funds with competent parties. The private equity funds will be managed by
experienced “best in class” private equity managers with established sector specific portfolios
in the developed economies of USA, EU and Japan; or in the emerging markets of BRIC
(Brazil, Russia, India, China). Due to the deal size of private equity investing, the average
committed capital of private equity funds is in the region of USD1.0 billion. With a draw
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down schedule over five (5) years, the Agency will need to arrange a facility of RM600
million for initial matching of the three funds.
The overall strategy of this fund will be to acquire (or be the largest shareholder of)
companies in the developed and emerging markets with on-going product development
pipelines or innovative platforms; product portfolios; manufacturing/services capabilities;
national distribution channels; and niche market supply networks. This investment activities
will augment the innovation capacity of Malaysia’s nascent industry through technology
transfer; knowledge spill-overs and management exchange. The longer term mission will be
to sell these investee companies to Malaysian corporations in order to strengthen their global
competitiveness and market position.
This strategy measure will re-focus innovation capacity building in the human capital
intensive industries; strengthen public-private-global partnership in investing; and
consolidate the nation’s comparative advantages.
Challenge 2: Lack of Malaysians with cross-border PE skills in hi-tech industries
There are but few Malaysian professionals with cross-border PE experience and skills in the
hi-tech industries. The majority of professionals with Khazanah are accountants and
corporate finance specialists who have little entrepreneurial or industry sector experience.
The low innovation performance as a result of the GLC transformation programme bears
testimony to these managerial skill-sets.
Recommended Strategy Measure : Require experienced Malaysian managers to be joint-venture
partners of the Fund Management team
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