Outlook for 2011: a world of opportunity

For years, “globalization” has been the byword of journalists, pundits and Fortune 500 CEOs. While long ago, Columbus told us the world was round, Tom Friedman now boldly proclaims it’s flat. And perhaps that’s helping global investors slide dollars, Euros, yuans and shekels across borders and into attractive businesses across the map. Not to be left out, U.S. venture capitalists are steadily finding cross-border investing a captivating opportunity.

That is what’s reflected in our 2006 Global Venture Capital Survey. This past spring, Deloitte & Touche LLP and the National Venture Capital Association (NVCA) conducted the survey, measuring the attitudes and intentions of venture capitalists in the Americas, Europe, the Middle East/Africa and Asia Pacific. This year, we received 505 responses, a number similar to last year. However, this year’s respondents were far more diverse. Slightly more than half were from the Americas, about one quarter from Europe, 17% from Asia Pacific and 4% from the Middle East/Africa.

As diverse as the respondents were, we found some resoundingly consistent messages that reinforce that we are in the midst of a trend in which venture capitalists are motivated to move into global markets. Both U.S. and non-U.S. venture capitalists indicate that their expanding global footprint will primarily be accomplished by working with foreign firms as opposed to opening new offices or attempting to invest cross border without a local representative. As these cross-border networks grow—and companies around the world establish significant operations in other countries—the definition of what is a “foreign” investment may soften as geographic limitations fade. And yet, not surprisingly, it’s a cautious movement, with U.S. and foreign investors continuing to prefer a U.S. focus, even as they broaden their range to countries like China and India, which remain top targets for global expansion.

Global outlook

One of the surest indications that the venture capital industry is going global is that over half of both U.S. and non-U.S. survey respondents said they’ll be looking to expand their international focus by 2011. U.S. investors are primarily focused on China (30%), India (25%) and Europe (14%).

Interestingly, U.S. venture capital respondents cited India as the No. 1 country outside the U.S. where there is access to quality entrepreneurs. Conversely, they cited China as the No. 1 country to get access to foreign markets.

“This global focus doesn’t surprise me,” says Lip-Bu Tan, chairman and founder of Walden International. “The talent pool is now global, particularly in India and China. Expenses for things such as design can be lower outside of the U.S. And, India and China have a new middle class of 500 million combined. It’s a huge market that most venture capitalists in the U.S. are looking at.”

Of the 53% of U.S. firms that intend to expand globally, only 19% said they expect to decrease their U.S. investment focus. VCs are adding to their current focus, not, for the most part, eliminating it to branch out elsewhere.

While U.S. venture capitalists are reaching out to the rest of the world, two-thirds of European respondents indicated an interest in expanding their global investment focus, with the primary focus being Western Europe. Of the Asian respondents, over half indicated a desire to expand globally, with the U.S. as their primary focus. Those who selected the U.S. as their top destination did so because of higher quality deal flow and access to quality entrepreneurs.

Evolution of networks

U.S. venture capital respondents cited India as the No. 1 country outside the U.S. where there is access to quality entrepreneurs. They cited China as the No. 1 country to get access to foreign markets.”

If any one thing could be said to be driving the expansion into global markets it’s the growing interdependence between U.S. and foreign venture capitalists, which is resulting in unprecedented numbers of strategic alliances. The experiences of growing global enterprises have taught the venture capital industry the ins and outs of working internationally and created global networks between investors and entrepreneurs. In many ways the trend toward global investing is simply a continuation of these ongoing business relationships and is a natural progression of a maturing venture capital industry.

Certainly, the bulk of investor funding resides in the United States, but with a vast entrepreneurial talent pool being discovered beyond U.S. borders, investors are seeking collaborators in these home countries to help identify the best opportunities and create an investor group that can help the company succeed globally.

“One of the fundamental precepts in this business is that when you go to a place away from home and expect to be successful, you must work in accordance with local customs and knowledge,” says Dixon Doll, co-founder and managing general partner of DCM-Doll Capital Management. “So you have to have partners there you can trust who know local culture and dynamics and who can help build strong management teams.”

In turn, nascent investors in countries like China and India, inspired by entrepreneurial ideals fed by U.S. investors, are turning to the United States for their investments. As these cross-border networks develop and mature over the years, we believe we will continue to see a deepening of global investment, both in-bound and out-bound, enhanced by global relationships and experience.

Global advantage

While it may appear that “global” investing is a straightforward push of capital from investors in one country to a startup business in another, it’s actually subtler than that. Many venture capitalists indicated they have investments in companies that are headquartered locally but have operations such as manufacturing or research and development in countries abroad.

A significant number of U.S. respondents said that at least some of their portfolio companies have the majority of their operations outside of the United States. Among these respondents, China is the top location for manufacturing operations, while India is No. 1 in R&D and engineering. So, not only are investors looking specifically to make investments in these two countries, but they’re also investing in U.S. startups with operations there.

That, however, is far from the full story. For all the worried talk about operations moving from the United States to China and India, in fact, the United States remains the primary destination for all operations—manufacturing, R&D and engineering—according to non-U.S. respondents.

What can we take away from this? Here’s the straightforward piece—it’s all about finding competitive advantage and being willing to break down geographical barriers to find it.

Is the U.S. competitive?

Just over half of U.S. respondents felt that the cost of complying with corporate governance requirements is too high. Non-U.S. respondents seemed less perturbed by this issue, with only 28% of respondents citing it as an issue.”

With entrepreneurship growing everywhere in the world, the United States is naturally going to experience increased competition. This new competition raises interesting questions, such as, is the cost of corporate governance too excessive? These are among the new questions we asked this year.

For example, 55% of U.S. respondents felt that the cost of complying with corporate governance requirements is too high. Non-U.S. respondents seemed less perturbed by this issue, with only 28% of respondents citing it as an issue.

Litigation proved an even greater concern to U.S. respondents, 70% of whom found that it creates an additional financial risk. Among non-U.S. respondents, only 36% found it to be a problem.

However, investing outside of the United States has its challenges, too. U.S. respondents found intellectual property laws, or the lack thereof, the greatest impediment to investing in China, followed by travel time and a lack of knowledge or expertise in the business environment. Travel time and effort was the greatest obstacle to these respondents for investing in India, followed by a lack of knowledge or expertise in the business environment. The latter was the greatest investment hurdle in investing in both India and China to non-U.S. investors.

Clearly, according to respondents, there are trade offs, but the benefits of investing in the United States outweigh the perceived impediments, even if these impediments are issues the United States continues to need to address.

Moving toward globalization

U.S. investors appear to be very much aware of expanding opportunities around the world and are well aware that there are a growing number of quality entrepreneurs everywhere. The data clearly indicate that VCs are broadening their geographic focus and are carefully selecting investment opportunities that generate better returns for their investors.

And, while the United States remains king in terms of generating investment dollars, the presence of growing opportunities outside of the United States means that it’s incumbent upon these firms to develop global networks—think strategic alliances and investor outreach—to maintain a presence and take advantage of unique opportunities. How quickly globalization in the U.S. venture capital industry will grow in the years ahead is certainly subject to speculation, particularly given the historical preference that small- to medium-sized firms have of working with companies within driving distance. But with more than half of U.S. respondents this year saying they plan to expand internationally, the suggestion is that this community is on its way to meeting the world head on.

Mark Jensen is a partner and national director of Deloitte & Touche LLP’s Venture Capital Services Group. He can be reached at mejensen@deloitte.com. Mark Heesen is the president of the National Venture Capital Association. He can be reached at mheesen@nvca.org.