Half of VCs now invest outside of home country

Sometimes we live in a “hurry up and wait” world. That may very well be the current case where global investing is concerned. The hype over the last two years was about all things having to do with globalization, leaving the impression that investors are feverishly pouring money into countries like China and India. But, we have quite a ways to go before these regions can compete with the United States for venture investing.

According to our 2007 Global Venture Capital Survey, “cautious” would be a far more accurate term to describe global investment trends. “Narrowly focused” would be another. And while we do see a clear commitment to pursuing overseas opportunities, that commitment is limited to only about half the venture capital firms operating today.

This past spring, Deloitte & Touche LLP and the National Venture Capital Association conducted the survey, measuring the attitudes and intentions of more than 525 venture capitalists in the Americas, Europe, the Middle East/Africa and Asia Pacific.

The survey found that venture capitalists prefer to step cautiously into the foreign investment waters, with just a few deals per firm. Many are dipping their toes in by investing indirectly in global markets through domestically headquartered companies with significant operations abroad. The quality of deal flow in the home country, coupled with existing impediments abroad, is holding back a surge of foreign direct investment.

But, more are becoming committed to eventually taking the plunge. The venture capital community has built itself on risky endeavors and will continue to go where the next big thing is. It just must be done prudently.

Currently, 51% of venture capital firms globally are investing outside of their home country. When broken down between U.S. and non-U.S. investors, 46% of U.S. investors and 54% of non-U.S. investors currently invest outside of their home countries.

Behind the numbers

While these numbers may look substantial, a closer look reveals another story. Of the U.S.-based respondents that have invested outside of their home countries, 66% said they have less than 5% of capital under management invested in foreign locations. (Among non-U.S. firms, the number dips to 51 percent.) Globally, the number of respondents who have invested between 6% and 10% of capital under management is only 14 percent.

Venture capitalists are leveraging the global market primarily by investing in domestic companies with significant operations outside of their home countries. This year, 88% of U.S. respondents indicated that at least some of their portfolio companies had significant operations outside the country in which they’re headquartered. (For non-U.S. respondents, the number is 82 percent). More than half of the VCs who responded positively to this question indicated that less than 25% of their portfolio companies had significant operations overseas.

These foreign operations are, in many cases, located in the obvious places. China is the destination of choice for relocating manufacturing operations, while India is the go-to country for R&D among U.S. respondents. Engineering also tends to land in India, but also China. Among non-U.S. respondents, the United States is the place to go for R&D and engineering, while European respondents prefer Central and Eastern Europe for manufacturing, R&D and engineering.

No need to rush

Forty-one percent of non-U.S. VCs say the cost of complying with regulations is too high in the United States. Just 28% felt that way last year.

2007 Global Venture Capital Survey

The future growth of global investing appears to be slow and steady. Among U.S. respondents, 54% intend to expand their investments over the next five years, compared with 68% of European investors. However, of those U.S. VCs who aren’t currently investing globally, 73% have no intention of doing it anytime soon. These figures suggest that firms have committed to their respective strategies, be that global or domestic, and that we’re still in the early stages of global direct investing with growth yet to be realized.

The larger VC firms with greater resources will dominate direct foreign investment. Of those firms with more than $1 billion under management, 85% of U.S. firms and 92% of non-U.S. firms plan to increase their foreign investments.

One of the primary reasons VCs cited for their interest in global investing was higher quality deal flow. Among non-U.S. respondents, 28% gave that as their top priority and were most interested in the United States, China, parts of Europe and Israel as potential partners. Lower costs were a secondary issue. U.S. investors were more interested in the emergence of an entrepreneurial environment, particularly in China and India, with 30% citing that as their primary interest in going global. They were also intrigued, but less so, by access to quality entrepreneurs and a higher quality deal flow.

With all the potential a given country may offer a VC, impediments exist that give VCs more than a moment’s pause.

The downsides

For China, the issue has long been problematic intellectual property laws. Globally, 59% of respondents pointed to China as presenting the greatest challenge in this area. The laxness of regulation and the additional business risk it creates worries VCs as well, particularly when they considered India, Central and Eastern Europe and China. Canada faces resistance because of its perceived unfavorable tax environment.

The United States isn’t immune from concerns, even internally. Both U.S. and non-U.S. firms perceive the United States as having an environment in which the cost of complying with regulation is too high. Indeed, the number grew from 28% last year to 41% this year among non-U.S. respondents. Of U.S. respondents, 45% also found this to be an issue this year.

Additionally, the United States is burdened with a perceived negative litigation environment that investors consider a tremendous concern due to the related financial risk. Globally, 35% of respondents cited this as a key problem, although the number dropped from 46% last year.

Based on the responses to this year’s survey, we believe that certain investors are definitely finding their own comfort zone for global investing, and that, despite the perceived challenges and obstacles, they are developing a greater expertise that will encourage more investment as they look for the next big thing.

Mark Jensen is a partner and national director of Deloitte & Touche LLP’s Venture Capital Services Group and can be reached at mejensen@deloitte.com.

Mark Heesen is the president of the National Venture Capital Association and can be reached at mheesen@nvca.org.