Technology Risk Management Primer for Portfolio Companies (Part 1)

Private equity and venture capital firms often face the threat of risk within their portfolio companies, but are not always certain of their portfolio firm’s competency in this area. Risk Management within Information Technology is especially critical as it affects all operations as well as the eventual valuation of the portfolio investment. CSC, Inc. specializes in helping investment firms make the best technology decisions for their portfolio company’s technology needs.

This article serves as a primer for PE & VC firms who must ensure that their investments are secure and may need to proactively engage the IT management of their portfolio company. This primer can act as a template for those IT managers that are tasked with developing an IT risk management plan and who need guidelines for the process. It will also provide examples of how to implement each step and a validation structure for the investment firm to follow the process.

I.T. Risk Management Primer

The pervasive nature of technology has increasingly made information the most valuable commodity for the majority of modern organizations. It is because of this that information itself has become one of the most prevalent areas of focus regarding the management of risk within any enterprise-level business. Since risk management is the identification and control of threats that can impact an organization, few things can affect it more than a loss of data or communications.
While many organizations have a designated risk management officer, that officer may not have specific exposure to the management of technology operations. Nor is it the case that all technology managers have extensive understanding of the tenants of risk management. The components of a generalized risk management plan can be found in many well written articles in publication or online; however, the purpose of this article is to provide a step-bystep framework for the technology executive or risk manager charged with developing an IT risk management assessment and plan for their organization with specific focus on actionable items and reporting procedures to ensure a successful project.
A well executed risk management plan for information technology is primarily a linear process with a focus on the completion of each step as a prerequisite. A recurring theme is the necessity to define terms, methodologies and goals throughout the process in order to maintain a structured and focused plan. It is for this reason that the methodology is presented in the form of the TRMP (Technology Risk Management Plan) Step-Ladder (see below) as each step in the process creates a foundation that enables the next step along a gradual move towards completion.

Venture Capital in China Part 2

Another area of concern is the lack of appropriate tax incentive policy crucial to encouraging new business investment. Most Chinese based VC type firms pay exorbitant tax rates which discourages their operation thereby limiting new business investment.

            The China economy is structured differently in many ways and they currently do not have the equivalent of a US NASDAQ system. VC backed firms must meet strict requirements in order to function on the current local stock market. Further, there is no way for institutional investors to trade shares in the existing public markets in China.  A domestic exit option for venture-funded companies does not exist which poses a critically difficult challenge for investment vehicles.

            On a less technical note there are cultural differences to be acknowledged as well as accepted norms that are established in western business transactions. It is has been reported that ethical failings or corruption occur in situations where more due diligence should have been performed. Essentially, anyone doing business in unfamiliar territory should take care to guard themselves and take extra precautions to protect against inaccurate representations.

            The next prominent issue at hand is how investors keep what they invest in. This is the intellectual property problem is being faced in China. Currently very weak regulations and enforcement exist in regards to intellectual property in China which raises the risk involved in investment in certain areas. The area of software has yielded very few investments as the regulatory environment does not exist to protect the product. As mentioned previously, the lack of venture capital law further exposes any new I.P. created to immediate piracy and devaluation of investment. Again, China’s economic environment is evolving and efforts are being made to alleviate these shortcomings. In 1994 China formally established the Intellectual Property Executive Conference (IPEC) which delegated committees in all 30 provinces to initiate nationwide action to protect intellectual property rights. While there is a long way for China to go progress is being made.

            Regarding venture capital specifically China poses a problem as the existing government regulations entail bureaucratic hurdles of listing on the Chinese stock exchange as well as constraints of having a Chinese-based venture capital fund. To avoid this issue completely VC firms find it necessary to have foreign-based investment entities that operate in China but are managed elsewhere. This allows them the ability to transfer funding but bypassing the government approval process.

            It is critical to avoid attempting an all inclusive opinion of the reality of China as a venture capital investment target. It is a complex scenario as is any economic environment in the global arena. However, certain basic tenants hold true. Just as the United States VC industry experiences boom and bust dynamics with some periods of equilibrium so will the Chinese market. It is also necessary for China as a free market socialist economy (a hybrid market/government system never attempted before) to be allowed to mature as a larger system before predicting the future of one type of investment vehicle. Undoubtedly the potential for success will continue to outweigh the pitfalls of foreign investment in China. The success of firms will be partially dependent upon creating stable, long-term investment and investment vehicles that would be just successful in more mature economies and should do so in China. Just as in other scenarios investors seeking to extract immediate profits will likely not be accommodated. However, firms who seek legitimate opportunities within proven markets and business models can leverage the size and resource dynamism that China clearly offers.

Bibliography

US Department of State, 2005 INVESTMENT CLIMATE STATEMENT – CHINA, 2005

Ruichin, D, CHINA'S INTELLECTUAL PROPERTY RIGHTS PROTECTION TOWARDS THE 21ST CENTURY, Duke University, 2003, pg 215

John de Yonge, Russ Garland, Brian Gormley, Stephen Harmston, Michelle Jeffers,  The 2006 Venture Capital Industry Report, Ernst & Young, 2006

Forer, G, Renewal and New Frontiers, Global Private Equity: Venture Capital Insights Report 2004–2005, Ernst & Young, 2006

Venture Capital in China Part I

Venture Capital Potential in the Middle Kingdom

While the economic possibilities and promises of China often seem limitless according to the media many serious Western investors also share this unbridled optimism. One area in particular, venture capital, has demonstrated a commitment to bringing the potential of China based investments to fruition. This attempt to tap the benefits of bridging the East and West via a digital silk road is more complex than is generally portrayed by the eager media. China still remains a unique and sometimes implacable culture that offers many obstacles to the over-eager Western investor seeking to extract her resources. To understand the reality of the situation an assessment of current VC trends along with the investment trends and opportunities in China must be performed. Then an understanding of the dynamics of foreign investment in China along with the issues of intellectual property must be gained. Finally, there is the exit strategy dilemma from China which poses yet another unique obstacle to the foreign investor. Overall, this will provide a high level understanding of the subject of foreign venture capital in China and the realities involved in this type of investments.
It is generally accepted that 2004 marked the beginning of a new cycle in venture capital investment as investment vehicles from the late 90s wound down and new opportunities surfaced. The primary areas that define this new cycle are summarized as follows:

1. Restructuring of existing portfolio investments in boom-economy allowed firms to redefine fund focus
2. Economic recovery allowed for new wave of VC capital calls and fund raising – 2004-2005 yielded over $17B
3. New opportunities appear in the life science and technology sectors in both emerging and mature markets
4. Globalization of investment strategies for VC firms and their portfolio companies. In regards to China this meant that there was large funding available focusing on areas that China had demonstrated resources and proficiency in. Also, given the size and classic view as an untapped market, China is an ideal focal point for VC fund managers.

Given the relevance of globalization as a business catalyst, a report from Ernest & Young’s Venture Capital Advisory Group had the following insight:

“As competition grows, regions such as China, India and Eastern Europe are impossible to ignore. The growing consumer markets of the Far East—especially China—present increased opportunities. Indeed, a China strategy has become the top issue for every venture capital firm and corporate investor as the business case for investing in China continues to grow,”

Undoubtedly reports such as this, as well as media-hype, have led to the designation of China as the undiscovered country for new investments.
China truly is a fantastic resource in terms of invention and innovation especially in the area of technology. China is expected to graduate over 250,000 engineering and technology related job candidates in the next year. This greatly justifies China as a source for new investments in 2005 which were largely in the areas of Internet and wireless applications and services which garnered over $205M and IC design with $180M. The high-tech areas are closely followed by Telecommunications which was allocated approximately $190M in invested funds. Traditional services and firms collectively also received almost $200M in investment. In total, foreign capital made up 75% of total venture investing in China in 2005. The majority of these investments occurred in Beijing and Shanghai with additional deals taking place in Shandong, Shenzhen, and Jiangsu.
While the amounts allocated are impressive as are the returns from the more high profile ventures/IPOs such as Baidu and SMIC, the obstacles that are encountered must be recognized. The most basic of the issues encountered are simply a lack of current business law parameters that allow effectively established a venture capital firm type structure. Without the modern VC partnership structure it is difficult and risky to operate an effective venture firm. However, a new regulation was established on March 1, 2003 that replaced preexisting guidelines for establishing foreign-based venture capital funds that eased monetary requirements and allowed for more flexibility in management structure.

(To Be Continued in the Next Posting)

New Collaborative Technologies Not-All-That-New

The messaging industry is highly fragmented but includes very sizable markets such as Email Security (projected at $6.7Bn by 2013, E-mail Security Market, 2009-2013, The Radicati Group, 2009) & Instant Messaging (forecasted at over $12Bn by 2013,Mobile Messaging Futures 2009-2013, Telecoms Market Research, 2008). A new, possibly disruptive, class of messaging platform is emerging and many are wondering how it might affect the market size from an investment standpoint. These platforms are known as collaborative messaging which are cross-breed of email, IMing and real time interaction with others, the poster-child being Google Wave.

The advent of collaborative technologies has given new dimensions to real-time productivity and communications for users worldwide. This segment of technology includes platforms like Etherpad, Shareflow, Microsoft SharePoint & Google Wave which allow multiple levels of interaction on a real-time platform incorporating aspects of email, IM, chat-rooms & document collaboration.

Currently these new technologies all operate on standard packet-based/IP or even SMTP platforms which are compatible with eachother, they would just need specialized APIs to function. These new products are simply repackaging standard data communications in more usable and dynamic platforms.

Messaging Misperception

While evaluating technologies that could impact the overall message management market, a few clarifications need to be made. There is an underlying assumption that new technologies will always supersede existing ones, and therefore, consume their market share. Generally this is correct, but in the messaging space it is critical to note that so far, all existing message platforms are ultimately built on the same IP-based architecture. While they are new products, they are designed with the same technical framework.

Email, SMS, MMS, IM and the variations produced by products like Google Wave are essentially different modes of delivery using the same packet-based communication technology. Most customizable messaging platforms will only need to be customized to fit the format-specific architecture. With this is mind, new products like Google Wave and Etherpad, could, in fact, act as a complimentary market force that will expand the messaging industry

Web 3.0: A VC Primer for the Next Step in the Internet's Evolution

Looking towards the future is an inevitable aspect of VC technology investing,and while we all dislike catch phrases or "trends-dujour", it is critical to understand the implications of the next looming step in Web evolution (download this primer here).

Problem: The Internet is currently a jumble of data categorized for people BUT searched by computers.

Solution: Create a system that allows computers to understand the meaning of the data the way people understand language like using words to form a sentence.

Web 3.0 is the unification of disparate data systems thru standardization making the Internet intuitive for people and computers alike, hence, the "Semantic Web" which emphasizes the

real meaning of data on the Internet. The goal is to treat data objects like ideas and real

language thereby achieving the real meaning of the "information age".

Here are the highlights of the direction of Web 3.0 and what it will mean to any VC investor looking to capitalize off this evolution:

• Personalization: web-experience then focuses on the individual, personalization = iGoogle, Netvibes, customized home pages, aggregators & mash-ups
• Intelligent Search: next generation of search will be dynamic, rather than just keywords-based; it uses the data itself to produce results for user by understanding the context of the data and verbiage in order to produce results, ie search for Bali, results in travel arrangements, backpacker blog, maps of recommended sites, restaurant ratings, local events, etc.
• Relevance: Contextual Advertising: focused, personalized, meaningful & nonintrusive; such Engagement Ads on Facebook that blend marketing, live polls, & mixed media. Also, social media apps that allow for sharing of ratings of purchases and include targeted advertisements based on preferences.
• Unification: vision of the web as joined and empowered by accepted syntax of data taxonomy and standardized programming languages - this allows computers to comprehend the meaning and process it just like people do, hence like real language.

The onus is on VCs to find companies that can create or leverage these new forms of data relation & presentation. Web 3.0 is mainly about convergence and the shifting of websites into web services that provide something tangible out of the garble of the web that users can both use and perhaps pay for.

Examples:

Layar: Mobile augmented reality browser: iPhone App that combines the Internet, cell coverage, GPS, & camera on a smartdevice so you can point your device down a street and see overlays of what shops are where and what you do or buy. http://layar.eu/

PeopleBrowsR: Social Networking Aggregator: Indexes and combines different social profiles into a primary interface to manage and better use them

Facebook Apps - Twangu: Collaborative shopping portal: Create & join teams of buyers for products or services and have vendors bid against each other for your business; review user’s profiles for info on items and share info with them

Download the Web 3.0 Primer here

2009, The Year in VC, so far

Venture Capital Investment Summary for Q1 + Q2 2009, the stats so far:

• 2009 funds invested increased overall, but currently at pre-DotCom levels
• Total of $7 billion in first half of 2009 in over 1200 deals
• Spike in Seed & Early Stage Investments
• Highest percentage from Life Science Investment
• CleanTech still strong and growing stronger spurred by political and social impetus
• International investing on the rise as Globalism lessens geographic disparity

Sources:

PwC/NVCA MoneyTree™ Report based on data from Thomson Reuters

Deloitte: Global Trends in Venture Capital 2009 Global Report

Facebook to Face Facts?: The Monetization of Eyeballs

Facebook has the greatest blessing and curse of a Web 2.0 company - a skyrocketing and captured community of eyeballs but no strategy to monetize it. While there is no clear answer, I strongly believe there are some critical signposts that might lead us in the right direction to understand how Facebook can monetize its constituency.

It took Google several years of providing a revolutionary search service and gaining a monumental following before it created AdWords which resulted in $10Bn per year revenue. Facebook has been striving for a similarly suitable model but has been wasting time with traditional banner ads that undermine its next-gen potential, until now. The next evolutionary step of a more dynamic ad-based system known at Engagement Ads (engagement marketing) is a unique convergence of social networking, advertising & market research. The purpose of these ads is to use video, polls and other interactive media to direct visitors to a specific Facebook Page.

The Engagement Ads are successful on a limited scale as they can bring in revenue from the SMB market but have not been able to bring in the large corporate advertisers which are critical.

Another aspect of the Engagement Ad is that it can involve polls used for market research which differ greatly from intrusive phone calls & questionnaires. These polls are:

• completely optional
• tapped into the social network paradigm
• interactive - allowing user to help develop the brand
• highly targeted to user demographics
• can be completed at user's leisure

And they exist without the awkward phone call! The results gleaned are pure gold for marketing companies who will theoretically pay huge $$$ to Facebook to harvest this crucial data. This is the first significant step towards a monetization strategy and it reflects a forward thinking mindset for Facebook management. This type of media and paradigm convergence (much like Google splicing marketing, data indexing & websurfing into AdWords) is what we need to see happen and Engagement Ads is the first step.