Venture capital as a form of development acceleration and increase of market share and company’s profitability in Ghana

TABLE OF CONTENTS

1. INTRODUCTION

2. VENTURE CAPITAL AS DEVELOPMENT ACCELERATION, INCREASE OF MARKET SHARE AND COMPANY’S PROFITABILITY
2.1 Venture Capital
2.1.1 Definition of Venture Capital
2.1.2 Characteristics of Venture Capital Concept
2.1.3 What Venture Capital Expect
2.1.4 The Venture Capital Investment
2.1.5 Financing Stage of Venture Capital
2.1.5.1 Venture Capital versus Private Equity
2.1.5.2 Type of Investee Firm
2.1.5.3 Use of Proceeds by Investee Firms
2.1.5.4 Type of Risk
2.1.6 Venture Capital Funding
2.1.6.1 Clear-Cut Policy and Regulatory Framework
2.1.7 History of Venture Capital
2.1.8 Growth of Venture Capital
2.1.8.1 Venture Capital in Europe
2.1.8.2 Venture Capital in Africa
2.1.8.3 Venture Capital in Ghana
2.1.9 Summary
2.3 Definition and Overview of SMEs in Ghana
2.3.1 Financing Constraints of Large and SMEs
2.4 Definition of Market Share
2.4.1 Market Change Position
2.4.2 Behavioral Difference between High and Low Market Share Companies
2.4.3 Limitation of Market Share Concepts
2.4 Profitability in Business
2.4.1 Measure of Profitability
2.5 Relationship between Market Share and Profitability in Business
2.5.1 Influence of Venture Capital on Financial Management of SMEs
2.7 Methodology
2.7.1 Research Design
2.7.2 Sources of Data
2.7.3 Study Population
2.7.4 Sample Technique
2.7.5 Survey Instrument
2.8 Analysis of Data
2.8.1 Venture Capital Trust Fund
2.9 Data Analysis and Results Discussion
2.9.1 Profile of SMEs
2.9.1.1 SMEs Ownership
2.9.1.2 Board Composition
2.9.1.3 Sectorial Distribution of SMEs Surveyed
2.9.1.5 Age of Existence
2.9.1.6 Location of SMEs and Sectorial Cross Tabulation
2.9.2 Stage/Reason for Applying for Venture Capital
2.9.3 Contribution of Venture Capital to Growth
2.9.3.1 Sales Before and After the use of Venture Capital
2.9.3.2 Profit/Loss Before and After the use of Venture Capital
2.9.3.3 ANOVA Test
2.9.3.4 Value of Net Asset Before and After the use of Venture Capital
2.9.4 Contribution of Venture Capital to Financial Management of SMEs
2.9.4.1 Budget Preparation Before and After the use of Venture Capital
2.9.4.2 Cash Planning Before and After the use of Venture Capital
2.9.4.3 Debt Management Before and After the use of Venture Capital
2.9.4.4 Inventory Control Before and after the use of Venture Capital
2.9.4.5 Interest on Loan
2.9.4.6 Exit Strategy

3. CONCLUSION

4. LISTS OF ABBREVIATIONS

5. BIBLIOGRAPHY

AFFIDAVIT

By inserting the final thesis into the Student Information System of LIGS University, I - Gladstone Stanley – an Interactive Online PhD student, honestly declare that I have prepared this dissertation thesis myself with the help of my supervisor and using only the literature presented in the thesis. I further confirmed that I have no objection to the lending or publication to this final thesis or part thereof with approval from LIGS University.

FOREWORD

This dissertation thesis is in the fulfillment of partial requirements towards the award of Doctor of Philosophy Finance to the student. The study focuses on venture capital as a tool for accelerated development and increasing market share and profitability of Small and Medium Scale Enterprises in Ghana. The study affirm that venture capital is a hope for success of SMEs as it contributions to growth, sales, profit and assets of the firms interviewed. The study further suggested recommendation for vibrant venture capital in Ghana.

ACKNOWLEDGEMENT

I am very grateful to God for the granting me life, energy, self-confidence and resources to start and end this dissertation thesis successfully. I am also grateful to the founders and staff of LIGS University for admitting me into the university to pursue an Interactive Online PhD Finance degree. I am most indebted to Dr. Kamila Tislerova who took time out of her busy schedule to assist me during the preparation of this dissertation thesis; I say may God grant you long life and prosperity.

I want to thank the management of Venture Capital Trust Fund for accepting me to undertake this dissertation thesis data collection with them and their fund managers.

God shall establish your firm on a foundation that success will only be your portion. To the SMEs that responded to my questionnaires, God will reward you exceedingly.

I am finally indebted to my wife and my children, namely; Mrs. Elizabeth Funmilayo Stanley, Miss Justine Mawulikplim Stanley and Master Jephthah Mawuyram Stanley for your support and encouragement. God richly bless you.

ABSTRACT

The SME sector in both developed and the developing countries are plagued with several factors that impede their growth. SME’s plays a special role in the contribution to the health of nation’s independent; (a) individuals who might have been frustrated under –achievers in a larger control environments, (b) contributors to the variation of products and services made available to consumers in specialized markets considered to be too small for larger companies (c) compete to the monopolistic tendencies of large companies.

The study reviewed literatures on the venture capital in order to appreciate the theoretical perspective of the concept to guide the type of instruments and data to gather from the industry players.

This study focuses on a period spanning 2006-2016, aims at assessing the contribution of the venture capital trust fund on the operation of the beneficiary SMEs in the area of financial management, corporate governance, profitability and market shares.

Using purposive sampling method, all the 27 SMEs benefiting from the Venture Capital Trust Fund were interviewed to appreciate the issues surrounding the use of venture capital for effective recommendation.

The study identifies contributions and challenges venture capital utilization and recommended vibrant policy to sustain the industry.

KEYWORDS

After the use of venture capital, Asset Turnover, Average Profit, Average Sales, Before the use of venture capital, Corporate Governance, Financial Management, Ghana, Market Share, Maximum, Minimum, Profitability, Return on Asset, Small and Medium Scale Enterprises, Value of Net asset, Venture Capital

LISTS OF PICTURES, TABLES AND CHARTS

Table 2.1 Percentage VC Capital Investment by type of Financing – Gompers

Table 2.2 Top 15 Countries based on Private Equity Funds Raised and Invested in US$ Billions

Table 2.1 SME’s Ownership

Table 2.2 Board Composition

Table 2.3 Human Resource Strength

Table 2.4 Age of SMEs Surveyed

Table 2.5 Location and Sector of the SMEs Cross Tabulation

Table 2.6 Stage/Reason for applying for Venture Capital

Table 2.7 Sales Before and After the use of Venture Capital

Table 2.8 Correlations of Sales

Table 2.9 Chi-Square Test

Table 2.10 Profit Before and After the use of Venture Capital

Table 2.11 ANOVA Test

Table 2.12 Value of Net Assets Before and After the use of Venture Capital

Table 2.13 Return on Asset Before and After the use of Venture Capital

Table 2.14 Asset Turnover Before and After the use of Venture Capital

Table 2.15 Number of Employees Before and After the use of Venture Capital

Table 2.16 Budget Preparation Before the use of Venture Capital

Table 2.17 Budget Preparation After the use of Venture Capital

Table 2.18 Cash Planning Before the use of Venture Capital

Table 2.19 Cash Planning After the use of Venture Capital

Table 2.20 Debt Collection Before the use of Venture Capital

Table 2.21 Debt Collection After the use of Venture Capital

Table 2.22 Inventory Control Before the use of Venture Capital

Table 2.23 Inventory Control After the use of Venture Capital

Table 2.24 Interest on Loan

Table 2.25 Exit Strategy

1. INTRODUCTION

The focus of this study is to evaluate the awareness of Venture Capital Financing scheme within the SME community in the Ghana. According to Abor and Biekpe (2006), there is limited access to financial resources available to smaller organizations as compared to their larger counterparts which have occasioned their low growth and development. They posited that, this twigs from the reasoned that SMEs have limited access to the capital market partly due to the perception of higher risk, informational barriers, and the higher cost of intermediation for smaller organizations. Again ILO (2005) indicated that, starting a business is a risky venture and warns that the chances of small businesses making it past five year mark are very slim. It is based on these finding that has influenced the researcher to examine the role that venture capital financing could have on growth and development of SMEs.

The general objectives of this study are:

I. to assess the contribution of venture capital on financial management of the SMEs;
II. To appreciate the relationship between venture capital finance on growth of SMEs;
III. To approve whether venture capital finance impact on the governance of the SMEs;
IV. To examine the correlation between support from Venture Capital Firms and SMEs market share and profitability.

Small and Medium Scale Enterprises (SMEs) are the pivot around which the success of every country revolves. They contribute immensely to the Gross Domestic Product (GDP), Tax, employment, inflation reduction, economic stability and poverty alleviation. The SMEs are stepping stone to industrialization and spine to national economies in the work and represent about 80% of the world economy (Asian Development Bank Report, 2013). This calls for efficient and sustainable SMEs in the world especially Ghana. However, these SMEs are challenged with the sector. The enactment of small Business Investment Act of 1958 in the USA to assist small businesses realizes and contributes its firm. The passage of the SBI Act, 1958 was believed to have done little to gain the needed impact knowhow”.

However, it was until after the passage of the Employee Retirement Income Security Act which was perceived to have unlocked the critical resources. Afterwards, there was an unprecedented flow of money into the Venture Capital sector. The contribution of pension funds rose dramatically, snowballing annual new contribution from US$100-200m during the 1970s to the excess of US$ 4b in the mid-eighties. This boosted the growth of new ventures especially in the area of technology which before then had been plagued by lack of financing. The critical role that Venture Capital Companies played in the transformation and growth of new and existing ventures cannot be overemphasized.

In the early 1990s, there had been a set up of two non-bank financing companies to hold funds and they were venture Fund Management Company and Ghana Venture Capital Funds make investment decisions. The venture Capital role it played in the provision of financial assistance to the new and existing ventures as has been that of Silicon Valley in the United States of America.

This good example encouraged Ghana government to pass the Venture Capital Trust Fund Act in 2004, which Act 680 was supposed to provide financial resources for the development and advancement of venture capital funding for the Small and Medium Enterprises in the priority areas of the economy. The specific objective of the Venture Capital Act, Act 680 is to provide equity and debt finance to appropriate venture capital financing companies to support the Small and Medium Enterprises and to provide monies to support the activities and programs for the promotion of venture capital financing.

According to Andersson and Nappier (2007),” Small and medium –sized enterprises form the backbone of the European Economy.” They are considered as the critical key to entrepreneurial soul and innovation in the European Union competitiveness. Appropriate of which enterprises especially SMEs make it easier to identify their needs and to develop efficient policies to compensate for the exact problems related to their small size.

This is vibrant for the competitiveness of an enlarged European Union, its growth and development. Again, according to Hayford (2012), SME’s tends to be the crucial driver for job formation as they are labor intensive and employ more labor per unit capita than the larger enterprises thereby creating more jobs in the economy. This is also apparent in developing countries like Ghana as it is estimated that, the SME sector employs about 35% of labor (Mensah and Roland).

It is instructive to note that, the SME sector could be the key determining factor in job creation for both skilled and unskilled labor. Due to their structure and their chain of operation, they are a conduit of achieving millennium development goal 1, 3 and 8. Aside the provision of jobs, the SME sector offers a platform for investment prospects, professional skills and training and also serves as an avenue for tax income for governments. In spite of the acknowledgement of the pivotal role serves as an avenue for tax income for governments. In spite of the acknowledgement of the pivotal role that the SME sectors is perceived to have played and continue to play in developing countries such as Ghana, the sector still faces a lot of challenges. The SMEs are the pillar of global economies, and are key contributor to Gross Domestic Product (GDP) growth and employment creation. The sector typically accounts for 95% of enterprises, employs almost 2/3 of the labor force, contributes 30-60% GDP of countries, has grown at approximately twice the rate of GDP in most markets and it is expected to grow at 10-12%p.a, in footprints across, Asia, Middle East and the Africa (Tim Hinton,2012).

The needs of SME’s, especially in Africa are changing; many of the issues that large companies face, now impacts SMEs. They need their banks to assist in managing the uncertainties in their business-fluctuating currency rate, changing interest rates, and commodity prices. SMEs face challenges expanding their operations into new markets; enterprise recognition access to credit (Tim Hinton, 2012). Mindful of the critical role that SMEs play in the developed and the emerging economies, led to the passage of the Venture Capital Trust Fund Act in Ghana in 2004.

Act 680 among other things, was supposed to provide legislative backing to the fund in providing financial resource for the growth and development of venture capital financing for SMEs in the priority sectors of the economy and the provision of debt and equity finance to eligible venture capital financing companies to support Small and Medium Enterprises. A special amount of money equivalent to twenty-five percent of the proceeds of the National Reconstruction levy was made available to the VCTF with effect from the 2003 financial year. It is reported that, the VCTF was resourced with an amount of GH₵22.5M.

The action taken by the Government of Ghana served as an incentive for the formation of the first four Venture Capital Companies such as activity venture finance company, Gold Venture Capital Limited, Bedrock Venture Capital Finance Company, Fidelity Capital Partners Limited and lately Ebankese Venture Fund. Geographically, they are all located in the Greater Accra Regional Capital even though there are ten administrative regional capitals in the country and SMEs are scattered all over the country. It is estimated that, about 69% of the country’s population are employed in the SME’s and majority of are located in rural areas. Thus the sector provides employment for a substantial number of people in the rural areas (Ampadu, A.R, 2010)

If policies are devised and well-tailored to focus on SME development in the country, the sector would be able to contribute its quota to the GDP and enhance its tax contribution and generate enough employment opportunities to halt the raising graduate unemployment. According to Agyemang D. 2009, “the low level of awareness on the activities of VC firms still remains a major challenge. However, this challenge can be addressed through intensive advertisement and other educational and interactive programs. By so doing, the SMEs would be better informed, adopt healthy business practices and then be able to access finance or partner with the VC firms and then be able to play their role by contributing to the economic development”.

SME sector in Ghana still faces an ominous task in trying to raise funds for large scale projects yet the availability of such funds is crucial to the sustained growth and global competitiveness of firms in Ghana (Owusu Adjei K. 2010).

The mode of financing by the Venture Capital Companies to especially, the SME sector has all over the world, gained countless interest on the meadow of government policy formulation and academia research.

These Venture Capital firms brings a lot of resources to the SMEs they partner to develop their comprehension in their operations. They also ensure that good business practices are adhered to at all departmental levels. To be able to harness the full potential of the SME, adequate financial assistance should be made available the sector for innovation and expansion. However, in Ghana in general and Ashanti region in particular, there is somewhat a collaborative gap between the activities of the VC companies and the SMEs. This might be as results of the fact that, the providers of these vital resources or economic transportation are either missing the path of meeting the end users of their product or the end users themselves are oblivious of the availability of these resources.

The focus of the researcher is on the financial muscle and technical knowhow of the venture capital firms and how they balance it with the beneficiary SMEs’ organizational principles to achieve their objectives simultaneously. The researcher further investigates the extent to which the supports received from the venture capital firms increase the market share and the profitability of the SMEs. The study also investigates the corporate governance of both the venture capital and SMEs to know if it has any role to play in assisting the both sectors in achieving the purpose of the organizations. The study covers the operations of the venture capital and the beneficiary SMEs from 2006– 2016.

The findings of the study will provide insight for the venture capital professionals, the regulatory body and the SME sector. The findings would also provide a snapshot of the needs of the private equity firms to the policy makers to propel the SME sector to play its expected role in the achievement of the millennium development goals.

The research will also make investee companies to understand well the operations of venture capital companies. It will also help other SMEs and entrepreneurs to be aware of the existence of such firms which finance startups, late stage and expansion stages of businesses and therefore could approach them for funding as and when it becomes necessary for them to do so. The recommendations made after this study will enlighten Ghanaian SMEs and the general public on how venture capital works and what benefits it promises to them.

It will also serve as a guide in fostering a closer collaboration between all stakeholders and also elicit further research in the area of private equity financing activities and to create awareness of how the private equity financing could be sourced.

2. VENTURE CAPITAL AS DEVELOPMENT ACCELERATION, INCREASE OF MARKET SHARE AND COMPANY’S PROFITABILITY

The main thrust of this research is to examine the contribution of Venture Capital to the success of the SMEs in relation to market share and profitability in Accra and Ghana at large. In order to achieve this goal, this chapter examines the existing literature relative to the objectives of the research study.

2.1 Venture Capital

2.1.1 Definition of Venture Capital

Venture capital (VC) bears over spilling definition due to the surging public interest in the industry. It is significant to realize that the differences in definition represent the investment posture of the author and more notably the economic orientations. Wright and Robbie (1997, p. xiii) broadly defined VC as “a concept of investment by professional investors of long-term risk equity finance where the primary reward is the eventual gain, rather than interest income or dividend yield”.

Moreover, Cumming & MacIntosh (cited in Gatsi, 2006) explained VC as “financial intermediaries who receive capital contributions from intuitional investors or high net worth individuals across the economic spectrum, and invest the pooled deposits in small, private and mainly high technology businesses or entrepreneurial firms with potentially high growth”. With regards to the different perspective by these authors on the concept of VC, their definitions points to a common investment orientation; equity investments in growth potential but highly risky firms. In short, the concept thrives on investors desire to assume higher degree of risk in anticipation of a higher investment returns (Hinton, 2012). Venture capitalist often function as financial intermediary of investors who are suppliers of capital on one hand and investee companies who are recipient of risk capital on another hand. Given the above definitions, Venture Capital Organizations (VCO’s) could be grouped into three major categories, although other authors (e.g., Agyemang, 2010) proposed it to be five. These are: Independents, whose funding are provided by independent investors. In contrast, Captives are schemes whose funds are provided by a parent company or some key shareholders.

Finally, Semi-Captives are hybrid in nature, their funding are provided by a parent company and also have the latitude to source funding from private investors. Venture capital firms are financial intermediaries that are primarily concern with the provision of capital to small; fast-growth start- up companies that mainly high risk and not attractive to more traditional firms.

Consensus has it that venture capitalist after obtaining equity position in the corporation also play a more dynamic role in the overall corporate governance. In other words, they sit in the board of directors and regularly monitor performance (Isaksson, 2006). Key characteristics in venture capital financing are staging the commitment of capital and preserving the option to abandon the project. Staged investment allows venture capitalists to monitor the firm before they make refinancing decisions. Project activities e.g. monitoring helps to gather vital information about the viability of a project, and assist venture capital is a subset of risk capital, in which the risk taken by the investor is offset by participation in the future success of the firm as part owner. Independent VC organizations represent firms with diluted ownership making no single investor a majority shareholder (EVCA, 2007, P. 12). With this type of VC organization, investment resources are usually sourced from varied investors and it stands out as the most popular among all VC organizations. Captive VC organizations are firms that are established by parent company and also draw its investment resources from that organization (Isaksson, 2006, p.22). Semi-captive VC organizations are firms wholly established by a sole enterprises but with significant of its funds being sourced through third part investors (EVCA, 2007, p.12).

2.1.2 Characteristics of Venture Capital Concept

The definitions and organizational characteristics as indicated above apparently confirm the statement that differences in the understanding of VC concept could be due to the fact that author’s investment mindset or economic environment influence. However, they all reveal key characteristics of VCs that need to be carefully discussed.

The highly potential growth firm attracts venture capital investment; these firms are highly risk group; most of the investee firms are unquoted; assist in management with expertise and strategic guide lines; a class of investment with a finite life; anticipation of annualized returns Pike & Neal (cited in Akuffo-Duah 2011). Some explanations to key characteristics of the concept of VC investment are given below.

Finance of risky ventures and higher investment returns

As widely noted by various authors, VC investment are usually into highly risky business ventures due to this preference for small cap and unquoted firms, it is therefore noted that investment into such ventures have higher possibility of recording 100% investment loss.

Understandably, targeted firms for VC investment are usually ventures without significant operational history. For that reason, VC investors unlike other traditional investors have higher expectant investment returns in capital gains as compensation for the risk assumed Fuerst & Geiger (cited in Hinton, 2012). In the developed countries, VC investment has the possibility of returning 25% to 335% averagely.

Provision of equity capital and monitoring interest

Investment from VCs is often in the form of equity or quasi-equity capital to investee firms. Investments from venture capitalists are mainly in the form of ordinary or preference share with convertibility option attached Fuerst &Geiger (cited in Hinton, 2011). According to Gatsi and Nsenkyire, (2010), though the venture capitalists assist in the financial and material resources for value added investment, the independence of their investee firms are ensured. For this reason, VC companies normally remain minority investors in all respective investee firms.

Management support and monitoring

The concept of venture could easily be associated with the operation of any financial institutions e.g. bank. VC companies are more involved in the operations of their investee firms and therefore the whole VC concept dwells more on provision of financial and managerial support. Investee firms are assisted in areas such as structures for modern business practices, key personnel recruitment and training services to ensure efficient investment thereby increasing the value of investee firms. In a nut shell venture capitalist could be described as an investor that seeks to it that their investee function accordingly to the agreed investment plans through effective monitoring and supervision.

Limited Time Horizon and Longer Investment Process

The unique characteristics of VC investment are a definite investment time limit usually longer period. On this note, venture capitalists have a pre-determined time of investment exit. The average period of venture capitalist investments ranges from 5 to 10 years after which they earn from their investment though appropriate exit channels.

2.1.3 What Venture Capitalist Expect

Empirical contributions have been made to analyze the screening process, identifying the most important selection requirement used by the venture capital community, in addition to how each criterion was valued. The studies of Wells, MacMillan et al., Ray (cited in Gatsi, 2006), among others, suggest that the most common selection criteria are related with the experience and personality of the entrepreneur and their team. The study further established that venture capitalists base the evaluation of a new investment on the ownership and uniqueness of a product or service.

Pandey & Jang (cited in Akuffo-Duah 2011) suggests that, the key feature to justify the funding of venture capitals it’s the return of its investment. Nonetheless the differences in results and conclusions across various studies leaves open the question regarding to what type of factors play the most significant role? When assessing and choosing new proposals, the investment behavior is highly dependent on the existence of asymmetric information problems which, in turn, might be driven by the characteristics of the venture capital company. Again, Brander et al (2010) find that public and private investors have various investment techniques which attract then towards project in different stages of development. According to Lerner and Leleux & Surlemont (cited in Brander et al, 2010) “public venture capitalists are compared to private venture capitalists, lacking in the knowledge and experience which are requisite in the screening process and due diligence of the companies.”

2.1.4 The Venture Capital Investment

The venture capital process describes an investment process for a given venture capital company. It starts from the fund raising stage to the point where investments are harvested.

The subsection would generally be used to provide brief explanation on the investment process of the VC.

A standardize venture capital process usually follows a sequential five (5), steps; Isaksson, 2006). These are:

- Establish fund: Determine investment objectives, raise capital for investment.
- Flow of deal: Opportunity creating activities (venture base), recognize and identify entrepreneurial opportunities.
- Investment decision: Screen and evaluate deals select/deselect deals, valuate and negotiate structure deals.
- Monitoring/ value adding strategy development, active board membership, outside expertise, other stake holders, management, contact and access to info, people, institutions, staging and syndicating investment.
- Craft and executing exit strategies.

Fund establishment is the juncture where the venture capitalist set out the firm’s investment objectives with clear-cut potential investment activity path and finally gathers the needed resources (funds) to carry out those objectives.

Flow of deal also represents a stage where VC firms uses various prospecting tools to identify and select firms with high growth potential.

Investment decision stage consists of activities such as evaluations of investment deals received through screening, valuation, contracting issues and financial structuring. According to Tyebjee and Bruno, (cited in Gatsi, 2006), activities at this stage require more time and industry experience to reduce the risk associated with VC investments.

Monitoring and value adding stage ensures that the business operations are run in line with the project activities and programs of the investment objective and the activity path set out by the VC firm.

Crafting and execution of exist strategies are done at the final stage to ensure that venture capitalists conveniently utilize available exist options such as issuing of initial public offering (IPOs) to harvest their investment in the investee firm. Crafting and executing successful exit strategies requires meticulous investment planning before exit date.

2.1.5 Financing Stage of Venture Capital

VC firms may choose to invest at the various developmental stages of an investee firms. The views of authors on this ground vary which may be due to the differences in economic environment. Emphatically, Cowrie (cited in Gatsi & Nsenkyire, 2011) stated that VCs in United States of America does not include buy out deals. He emphasized that VC financing comprises of four major stages: early stage, expansion, replacement and buy-out. On the contrary, other author Ogden et al, (2006). Though this is the stage where much time is utilized, the involvement of capital is minimal; this could be attributed to the fact that actual business production does not take place at this stage. Financing is mainly buttressed by the entrepreneur and other business angels.

Start –up stage begins only when the seed stage has been successful. Major activities at this stage include prototype testing; assemble of management team, and the development of business vision conceived at the seed stage among others Sahlman (cited in Agyemang, 2010). Owing to the much workload at this stage much funds are needed as compared to the seed stage. However, commercial manufacturing does not start at this stage. Financing usually comes from business angels and VC companies.

Early development stage as described as the first stage of investment follows the facts that various product development, market testing and prototype have all been proven successful Sahlman (cited in Agyemang, 2010). Much fund is needed at this stage because the venture needs adequate capital injections to secure Property Plant & Equipment (PP&E) for the commencement of commercial manufacturing of products for onwards sale. According to Ogden et al (2006) “providers of capital at this are usually Business angels, VCs and government.”

Expansion stage: This is the second stage of development of a venture where products and produce have been confirmed to be viable as results of positive feedback from customers/ consumers. As results, more working capital is needed to see through the expansion of more product lines. Stillman, (2006) also intimated that the venture at this stage has not made profit yet but mainly adopt cost effective minimization operations to brake-even.

Profitable but cash poor stage is the next level where the venture has seen terrific growth in sale values and these values have been translated into huge profit margins. However, the venture at this stage is regarded as cash poor because cash flow generated from operations could not satisfy huge capital requirement for rapid expansion Salman, (cited in Agyemang, 2010). Financiers at this stage are VCs, banks and to a small extent, retained earnings.

Rapid growth stage as the fourth on investment and financing ladder where the venture’s marketing strategy is redefined because substantial growth have been accomplished. The ventures default risk is regarded to be much reduced because sustainable growth and higher profit margin achieved at this stage. There is still requirement of funds by the venture from banks and VCs in order to maintain the growth level standards.

Mezzaine or bridge stage is the point where the exit timing for the venture is made known and for that matter any funding at his stage are strategically assumed to ensure successful exit where proceeds from it could be used to pay back loans Stillman, (2006). Other sources of funding at this stage often come from VCs and banks.

Harvest or exit stage is the point in the life of a venture where venture capitalists finally liquidate their investments in the investee firm for cash. The process could take a form of the venture issuing an IPO, acquisition and leverage buyouts Sahlman, (cited in Agyemang, 2010).

2.1.5.1 Venture Capital versus Private Equity

Venture capital (VC) and private equity (PE) are used interchangeably in several literatures and it is therefore imperative to explain the concept of PE investment because distinction between the two concepts is fuzzy according to Arnold (2008), p. G23). Arnold simply defined PE “as a share capital invested in companies not quoted on an exchange.” Others EVCA, (2007, P; Isaksson, 2006) have all described VC as a subset of PE and this leaves the distinction between the two more muddied. However, Mardle (2009) used the following three parameters leaves to distinguish between the two:

2.1.5.2 Type of Investee Firm

Mardle (2009) further explained that, PEs will be attracted to invest in firms that would afford them the opportunity to leverage their investments with the intention to use the cash flow generated by the investee firm to deleverage the investment. Therefore, PE investors” choice of an investee firm is strongly dependent on the firm’s capability to generate enough cash flow whiles VC firms will invest in firms that holds potential for rapid growth in their business operations.

2.1.5.3 Use of Proceeds by Investee Firms

Another trait that distinguishes the two is the usage of investment returns. He explained that, PE investment returns are usually paid back to the owners of the investee firms in a form of share purchase reward. On the other hand, investment proceed from VC investment are returned by the investee firms because of constant demand for working capital which makes excess liquidity in investee firm very scarce.

2.1.5.4 Type of risk

Though they are all at risk, the level of risk facing each investor varies. The risk associate with PE investment is relatively higher than VC investment. Apparently, VC investors adopt more risk mitigating policies to protect their expected investment returns than the PE investor; Myatt (2006) also explained that the differences between the two could be technically correct due to historical perspective of the two concepts. However, the current trends of ever present competition in the financial markets and more active capital markets have made the operation of the two converge. It is believed that the current stage of capital is such that there is excess supply of capital relative to its demand for equity. This therefore put undue pressure on the limited equity deals at hand.

2.1.6 Venture Capital Funding

The active involvement of government as a key financier in the early stages of development of VC industry is synonymous with many matured market. Typical examples are the US and the UK VC industries and the critical financing roles played by respective governments. The need for adequate provision of funding by government and quasi government institutions has become very relevant in many academic literatures and therefore requires critical review to understand how VC developing market could emulate such gesture. A study by Dossani & Kenney (cited in Gatsi, 2006) into the development and subsequent development of the VC industry in India revealed strong collaboration between the India Government and the World Bank in the finding process.

2.1.6.1 Clear-cut Policy and Regulatory Framework

The establishment of business institution requires a policy framework as a guiding principle for the operation of such institutions. VC investment as a specialized investment class requires a well noted industry specific policies and regulatory framework for infective and efficient investment operation. The emergent trends of the creation of a viable VC industry in developing economics has called for a critical analysis of policies and regulatory framework needed to steer firms in these business environment Murray (2007) in one of his publications in the hand book of venture capital probed into various probable policy direction that could be formulated to support the establishment of VC in developing markets. The focus of his study was to suggest governmental policies that could be applicable for the creation of a viable VC industry.

Murray’s policy recommendations were in reference with the success story of the Silicon Valley in the US for countries willing to develop and establish a viable VC industry to carefully understudy. The Silicon Valley model according to Murray was created based on active involvement of the US government in formulating clear cut policies and regulatory framework for guidance and control. Key policy guidelines that could be useful for a viable VC industry in developing economies according to Murray (2007) are: institutional legal and fiscal frameworks, an incentive structure of personal and corporate tax systems, the regulatory regime’s impact on business, and the efficiency of Venture of the of the market corporate control.

2.1.7 History of Venture Capital

Gompers and P.A, (cited in Agyemang, 2010) explained the concept of modern day Venture Capital to have started in the late 19th century and early 20th Century (It was started by wealthy families in the City of New York who were looking for ways to invest in a potentially high-return, high-tech businesses. According to Gompers (cited in Gatsi, 2006) “David Lample writes in his history of the route 128 Venture Capital region: the City’s great fortunes including those of Vanderbilts, Whiteneys, Morgans and Rockefellers were based on the such ventures as railroads, steel, oil, and banking.

It is worthy to note that, when young entrepreneur Scot Alexander Graham Bell needed monetary assistance to invest in his telephone experiment in 1874, it took a Boston Attorney Garderner Green Hubbard and Salem leather merchant Thomas Sanders to help him out Gomper (cited in Gatsi & Nsenkyire,2011 ). The risk capital market was left largely under recognized and dispersed during the late 19th century and the early 20th century. The first post- World War II venture capital was formed in the 1946 when Karl Taylor Compton, the then president of the Massachusetts Institute of Technology, Merrill Griswold, Massachusetts investor and trustee and the Federal Reserve Bank of Boston’s President Ralph Flanders and a Harvard Business School professor, General George F. Doriots started American Research and Development (ARD).

The goal of the ARD was to finance commercial applications of technologies that were developed during the World War II. Doriots was made president of the American Research and Development (ARD).

The goal of the ARD was to finance commercial applications of technologies that were developed during the World War II. Doriots was made president of the American Research Development until it was acquired in 1972 by Textron. During this time, his motivation was not just making money out of those ventures they have invested, but rather financing noble ideal (Gompers, 1994). ARD’s innovation shaped the standard of VC paradigm with its exceedingly fruitful investment in Digital Equipment in Company in the 1957. After the fruitful earlier investment in the DEC, the US government decided to play a central role by projecting the development of small firms as both regulator and participant in the financing of small firms.

The Small Business Administration was given the authority to commission a new business investment companies. According to Gompers (cited in Gatsi, 2006), “the initial public offering (IPO) market of the late 1960s was extremely active, and many SBICs were able to bring a number of companies during the public boom”.

2.1.8 Growth of Venture Capital

Venture capital as an industry was still cottage commerce in the United States of America prior to the ‘80s. Annually, the flow of funds into was not more US$200m, or substantially less. It however changed dramatically in the 1980s when it reached a peak of US$ 4.9 billion in 1987. The proliferation in the Venture Capital Financing coincided with two important legislative changes. The first was the Revenue Act in 1978 which reduced the capital gain tax from 49.5% to 28%. The second was the changes in ERISA judicious rule christened “the prudent man rule” in 1974, which unequivocally allowed pension funds to invest in VCs which hitherto was not the case. While both laws had favorable effect on the VC investments, the long term effect of the “prudent man” rule was much greater in substance than the capital gain tax rate (Gompers, 1994). The flow of pension funds into Venture capital activities substantially opened a tremendous door of capital resources.

Table 2.1: Percentage VC capital investment by type of financing-Gompers 1994

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Source: Adapted from Gompers (cited in Gatsi 2006)

The positive contribution of Venture Capital Financing activities cannot be overemphasized as in 1976; Apple Computer’s reception of US$ 3.5 million in venture capital grew over 70% to US$ 271 million when it went to public in December 1980.

Figure 2.1 VC Disbursement by Region- 1992 in the USA

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Source: (Adapted from The Rise and Fall of Venture Capital, Gompers, cited in Gatsi, 2006)

2.1.8.1 Venture Capital in Europe

Unlike the United States where venture capital was a major source of financing startup firms and expansion, private equity investment started in the 1980s in Europe. European Commission 1998, identified risk capital as a key to job creation. Subsequently, a communiqué was issued to develop the risk capital market which is critical for major job creation which led to the development of pan- European risk capital market (Bottazzi and Rin, 2001). Subsequently, amount under management grew steadily to over US$ 30 billion by the year 1997 investing in about 20,000 companies. Not only did funds under management grow, venture capital firms also grew in much greater proportion to over 500 VC firms (Nuechterlein).

In spite of the greater usage of venture capital financing in Europe over few years lately, the same kind of dynamism in start-up that venture capitalist in the United States has helped nurture cannot be said in Europe. Again, venture capitalist has focused in a great deal in only buy outs and work outs as differentiate to start up and expansion in the United States. In 1997, more than 50% of the Europe’s US$ 11.5 billion venture capital funding went into MBOs and workouts with less than 10% invested in start-ups, relative to 37% in the United States. Furthermore, whilst the United States has allowed pension funds to invest in private equity since 1979, some European and Asian countries forbids pension funds from joining in the private equity market.

2.1.8.2 Venture Capital in Africa

Venture capitalists which operate within political boundaries with unfavorable economic indices aforementioned are deemed to be operating in developing economy and are considered in the larger frame of this thesis. Several Literatures has it that the development of VC market in developing economies speaks of direct involvement of government and other developing partners such as international monetary funds (IMF) and the World Bank Dossani & Kenney, (cited in Gatsi, 2006). Current industry report has it that the performance of market in these economies speaks of increasing market yields despite the recent economic crisis Johnson, (2010).

His report revealed interesting statistics about a high record of VC (PE) investments representing 26% of the total investment in developing market funds in 2009. A survey by Coller Capital in collaboration with Emerging Market Private Equity Association Coller/EMPEA (2010) also points to a heartwarming statistics about growing investors‟ confidence in the activities of VCs (PEs) in developing markets.

For instance, highlights of the survey explains that about 70% of investors are either satisfied or very satisfied with the performance of their emerging market PE portfolio relative to their listed equities in these markets (Coller/EMPEA 2010, p.3). The survey again pointed to an overwhelming investors‟ growth expectations of 11-12% which is far higher that their current expectation. Furthermore, performances of VC- backed ventures are reported to be performing better than non-VC-backed firms in Nigeria (Dagogo & Ollor, 2009, p.37). These statistics point to nothing but an obvious positive prospect of VC investment in developing economies.

Table: 2.2 Top 15 countries based on private equity funds raised and invested in

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