Part #2: China and India: Two models of venture capital catalysis
Editor’s note: This is the second part of a three-part series on what Canadian venture capital can learn from emerging markets.
Commentators tend to group emerging markets into one giant bucket. Rarely do you hear of one the two emerging markets, India or China, without the other. But the two countries have taken diametrically-opposed approaches to creating a healthy life-sciences venture-capital industry. Not surprisingly, each approach reflects country’s policy milieu.
China’s approach has been top-down and government-driven, while India’s has been bottom-up and private-sector driven. But the end-goal has been the same—successfully responding to gaps in the innovation ecosystem, uncertain exits and few/shrinking numbers of venture capitalists through a “systems approach to venture capital.”
The China approach (a top-down, government-driven systems approach)
Government VCs are often the key and active life-sciences investors due to the global scarcity of capital. But the way that successful governments in emerging markets have undertaken this has neither been passive nor piece-meal. In fact, the approach has been quite systemic and structured. China has established an aligned policy combination of investments in quasi-venture capital funds, tax incentives, preferential treatment, and right-of-first-refusal provisions for private-sector venture capital funds, and government and high-tech parks. Indeed over the last fiscal year, the Chinese government spent $9.2 billion on biotechnology R&D through the National High Technology R&D Program (863 Program) and National Basic Research Program (973 Program). According to ChinaBio, a consulting firm, private-sector life-sciences venture-capital investment into China broke $1 billion for the first time in 2010 (approximately a third of which came from government sources). In fact, the Chinese Academy of Science (CAS) just launched its own venture capital fund targeting the life sciences!
Then consider Quebec, which has generous tax credits, but also has significant capital deployment that services its life-science firms all the way from seed financing to exit. In fact, Quebec has had more life-science venture capital investment in both medical devices and biotech over the last decade than British Columbia and Ontario combined, according to data from Thomson Reuters. Innovatech Quebec provides early-stage VC funding from R&D to Series A up to a maximum of $5 million per firm. Tax policy across early-stage business is coordinated by Investissement Quebec, which provides loans and loan guarantees, and grants biotech firms beneficial tax treatment if they operate in a selected cluster. Professionals within Investissement also help firms obtain equity and quasi-equity financing, form strategic alliances with international partners and access the right financing solutions across provincial departments. Finally, late-stage financing comes from SGF (Société générale de financement du Québec), which has assets over $2.5 billion and can structure M&A activity and partnerships among life-sciences firms with a minimum investment of $5 million for a 20% to 49% stake.
The parallel between the two approaches is that the governments have aligned policy instruments and implementation under a single umbrella to improve efficiency, and provide substantial end-to-end financing that attracts private-sector capital all the way from seed financing to Series D investments before exit. By deploying significant capital to all areas of biotechnology across all parts of the value chain, governments hope that the market will choose winning technologies that emerge. Certainly, Quebec and China’s ability to attract heavyweight life-sciences investors such as OrbiMed, a $5-billion hedge fund based in New York City, speaks to the success of this “systems-driven” strategy that supports an entire ecosystem when the value chains and infrastructure are still nascent. Government also plays a key role in shaping partnerships and actively structuring the local industry through its financial and policy muscle. While some economists might argue that this distorts market incentives, this passive approach of investing broadly appears effective in industries such as biotechnology where the market is relatively inefficient at identifying firms with “winning” technologies.
The India approach (a bottom-up, private-sector-driven systems approach)
However, not all countries (or provinces for that matter) have the benefit of taking a capital-intensive approach to life-sciences innovation like Quebec and China. India is a great example—the amount of capital flowing into the life sciences from the government is less than 5% of what China has been investing—the size of regional government-backed VC funds (of which there are fewer) are seeded with less than one-fifth of the capital of their Chinese counterparts. In such cases, the private-sector venture capital investors have to take matters into their own hands. Indian life-sciences VCs such as Nadathur Holdings (established in 2000 by N.S. Raghavan, one of Infosys’ co-founders) purposely link their health-care portfolio firms together through a “systems approach” because the local value chain is fragmented. Its portfolio includes firms operating in drug discovery research, companion diagnostics, pharmaceutical analytics, reimbursement claims processing, patient relationship management and specialty health-care delivery for running clinical trials. In effect, the VCs at Nadathur Holdings serve as the executive team for a miniature biotech innovation ecosystem focused on bringing targeted therapeutics for chronic disease such as stroke, heart disease and diabetes.
The VC situation in India almost parallels the situation in Ontario, where venture capital flow is limited, but on top of that government refuses to choose “winners” due to political considerations as well as lack of expertise. Unfortunately, this means insufficient capital flowing to potential winners as what little capital is deployed is being spread too thin and across too many government funding agencies. Critical parts of the innovation value chain fail to be funded, leaving the entire ecosystem dysfunctional. Governments that take the “China approach” can afford to not explicitly choose winners simply by deploying enough capital across all potential technologies and therapeutic areas. Ironically, Ontario VCs still choose to take a “shots on goal” approach that has largely failed because they cannot maintain investment portfolios large enough to sufficiently diversify risk (owing to the overall paucity of capital). Genesys Capital, one of Ontario’s few remaining life-sciences venture capital funds, has only five portfolio companies right now. In contrast, Atlas Ventures, an early-stage Boston-based fund with a similar AUM of ~$200 million, has more than three times the number of portfolio companies due to the larger amounts of capital and co-investors available in the United States.
While the Canadian (and Ontario) venture industry has looked to the United States as its guiding role model with a “shots on goal” approach, the extremely poor returns of the past decade suggest that a new approach is badly needed. According to various published reports, Canadian venture investors have lost nearly 40 cents on every dollar that they’ve invested into the life sciences. Not surprisingly, retail funds that invested in the life sciences such as Vengrowth have virtually shut down their operations and returned whatever remaining capital to their investors. It is here that I believe VCs and policy-makers in provinces such as Ontario that do not have the political will or large-scale capital available could benefit from a “systems approach” that takes advantage of the potential synergies along a value chain by focusing on a single therapeutic area or modality—for example, our competitive advantage in stem cells, or our relative advantage in medical devices compared to the rest of Canada.
In the final part of this three part series, drawing on local and international comparisons, I’ll describe what concrete steps Ontario can take in order to implement a systems approach.