Capitalists Play a Critical Role

¶ … Capitalists play a critical role in the formation of businesses within a free market economy. There are many theories concerning the impact of venture capitalists as it relates to development in the private sector. The purpose of this literature review is to evaluate these theories as it relates to developing countries. Let us begin this review by defining the purpose of venture capitalists.

According to an article found in African Business, venture capital is based on the concept of assisting "the development of small and medium size companies, creating wealth and employment, but at the same time guaranteeing a return on investment to the venture capitalist providing the capital (Berger, 2004)." Such investments can be made in both the private and public sector. For the purposes of this discussion we will focus on the private sector in developing countries.

An article found in the journal Law and Policy in International Business throughout the world there are clear differences between developed countries and developing countries. On the one hand developed countries are industrialized and their citizens have access to a high quality of life because there is a significant amount of capital available to invent and to continuously improve (Sorabella, 2000). On the other hand, developing countries to be less industrious, the quality of life that citizens have access to is less sufficient and capital is not available to ensure innovation and improvement (Sorabella, 2000).

With this being the case, venture capitalists can have a profound impact upon the quality of life that is present in developing countries; these quality of life issues include such things as healthcare and education (Sorabella, 2000). The presence of venture capital can play a role in improving educational opportunities and healthcare because the countries can improve economically which ultimately results in additional funding for such things as healthcare and education (Sorabella, 2000). If developing countries are to ever offer its citizens the opportunities afforded to citizens in industrialized countries there must be development in the private sector (Sorabella, 2000).

In addition, if venture capital is to have this type of positive impact on developing countries it must be sustainable. The author asserts that even when venture capital in the private sector has a positive impact; it can take a number of years before this impact is felt for all of the people in a population (Sorabella, 2000). As such in many developing nations there is a significant gap between the rich and the poor (Sorabella, 2000). The author also points out that the sustained growth provided by venture capital in the private sector makes the population more confident and also encourages further investment in the nation by foreign and regional firms alike (Sorabella, 2000). The author further explains

To develop quickly, nations need access to capital to invest in industry, technology, and an educated population. However, because LDCs lack internal sources of capital, they are forced to look to outsiders. Those in control of foreign capital are primarily concerned with the risk and return of an investment. Unfortunately for developing countries, cross-border investing adds many additional levels of risk, such as sovereign risk, currency risk, and unfamiliarity with financial and market structures (Sorabella, 2000)."

As a result of the aforementioned risks, many developing nations must attempt to reduce these risks by providing greater security for investments (Sorabella, 2000). On the other hand, these nations could also make certain that the returns made by these investors are so significant that they are willing to endure the risks (Sorabella, 2000). The author asserts that making a choice between these two scenarios is indicative of a significant connection between economic systems and government policy that affect one another and create a certain tone in the overall market (Sorabella, 2000).

Indeed, there are significant risks associated with venture capital investment in foreign countries. This risk is evident in the fact that there is very little data available on the amount of venture capitalists that have invested in developing countries. According to Megginson (2001) there is some evidence that the amount of venture capital coming into developing countries has increased in recent years, this increase pales in comparison to the amount of Foreign Direct Investment that has occurred in developing nations over the same time period. The author also points out that a great deal of what is viewed as venture capital in developing nations can actually be defined as high-risk debt financing Megginson (2001).

Sheela & Chua confirm that there is a great deal of risk associated with venture capital investment in foreign countries. The authors also point out that although the increase in Venture capital investment has only grown nominally overall, in certain developing countries there has been significant growth as it relates to venture capital. Such is the case in various parts of Asia. The authors explain that because there has been a great deal of economic restructuring in addition to a reduced appeal to invest in developed countries there has been some increase in venture capital investment in developing countries starting as early as the 1990's (Sheela & Chua). In fact in an article by Aylward (1998) the author found that since 1992, the amount of venture capital investment in Asia has risen significantly when compared to Europe (Sheela & Chua).

Nevertheless, the increased investment of venture capital in developing countries on the continent of Asia still presents some inherent risks (Sheela & Chua).

These risk encompass a lack institutions and government agencies that are fully developed which can present both challenges and problems for venture capitalists as is relates to corruption and augmented transaction costs (Hamori, 1999; North, 1990; Sheela & Chua). As a result, venture capitalists that invest in developing countries are conducting business in environments that present distinctive risks and challenges. Conducting business in such an environment often mandates the use of a different type of venture capital model than models that were used in developed nations (Sheela & Chua).

In addition Pacanins (2001) asserts that there exist two recent trends in private venture capital activity in developing nations. The first trend has to do with a noteworthy increase in activity, and subsequently a recent decline in activity (Sheela & Chua). The second trend is that of venture capital going toward more early-stage investments (Sheela & Chua). Pacanins (2001) also asserts that "private equity investments increased in developing countries because many developing countries have implemented economic reforms, which have resulted in both economic progress and an easing in restrictions for foreign investors (Pacanins 2001; Sheela & Chua)." Lastly, Pacanins (2001) asserts that the reason why developed countries have experienced a decrease in venture capital investment is because ther are too many investors and too few opportunities (Sheela & Chua).