1.The Global Venture Capitaland Private EquityCountry Attractiveness Index2011 annualAlexander Groh, Heinrich Liechtenstein and Karsten LieserSponsored byand in cooperation with

2. The Global Venture Capital and Private EquityCountry Attractiveness Index2011 annualAlexander Groh, Heinrich Liechtenstein and Karsten Lieser Sponsored by and in cooperation with 3. This publication contains information in summary form and istherefore intended for general guidance only. It is not intended tobe a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of theglobal Ernst & Young organization can accept any responsibilityfor loss occasioned to any person acting or refraining from actionas a result of any material in this publication. On any specicmatter, reference should be made to the appropriate advisor. 4. Contents Foreword from the research team . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7 Sponsors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 About the editors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 Research team . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9I. The Global VCPE Country Attractiveness Index. . . . . . . . . . . . . . . . . . . . . . . 10 How to measure a countrys attractiveness for limited partners . . . . . . . . . . . . . . . . . . . . . . . . . .12 Building the 2011 index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 The VCPE country attractiveness ranking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Comparisons of countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24 Emerging countries, and exceptional opportunities in BRIC? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28 Tracking power of our index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Our index and historic VCPE returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Summary and outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34II. How are fund size and fund performance related? . . . . . . . . . . . . . . . . 36 Giants at the gate: diseconomies of scale in private equity investment returns. . . . . . . . . . 38 Fund size, limited attention and valuation of VC backed rms . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40III. An insight into different VC and PE markets . . . . . . . . . . . . . . . . . . . . . . . . . .42 Is the Eurozone still an attractive location for VC and PE investors? . . . . . . . . . . . . . . . . . . . . . . 44 Investing in Africa challenges and opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50IV. Regional and country proles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54 How to read the country and regional proles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 Regional proles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 Country proles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74V. Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 234 Computation of the index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236 Statistical validation of the index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .238 Table with sources and explanations of the data series . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 248 5. Forewordfrom the research teamWe are pleased to present the second edition of our Global Venture Capitaland Private Equity Country Attractiveness Index. The index seeks to measurethe attractiveness of countries for investors in venture capital (VC) and privateequity (PE) limited partnerships.There are two notable changes with respect to the rst index edition. First, wehave increased our coverage to 80 countries and include many more emergingeconomies. Second, we have optimized the index structure and excellentlytrack real VC and PE market activity. This optimization also allows a betterinterpretation of the VC and PE driving forces. However, we do not only presentevidence for a high explanatory power of our index with respect to investmentactivity. We also analyze how aggregate country performance matches our indexranking. This way, we demonstrate the quality of our composite measure andits value to investors.We invite your feedback to help us improve future index editions. In the future,selected data series may be substituted by newer or more appropriate data.Additional data could be added, while other series with poor explanatory powercan be deleted. The quality of data and the number of countries covered willincrease in future indices and as a result, our index remains a dynamicresearch product that always considers the most relevant and recent data.We believe this index is unique in providing information on the VC and PE capitalmarket segment with such a broad scope. We trust investors appreciate theinformation generated to aid their decision-making; politicians may utilizethe index to benchmark their countries and to make improvements to attractinternational risk capital.We would not have been able to realize this project without contributions fromour sponsors, and we greatly appreciate the support of Ernst & Young and IESEBusiness School, with their International Center for Financial Research (CIIF).Beside our own analyses, we invited other academic researchers to contributeto this annual. Therefore, you will nd two guest articles discussing the linkbetween the size of VC and PE rms and their success. We hope that you ndour our 2011 VCPE Country Attractiveness Index of value.WebsitePlease visit our website http://blog.iese.edu/vcpeindexwhere you will nd more information, links to literature,and several analytical tools for country benchmarking purposes. The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 7 6. SponsorsWe are grateful to our sponsors Ernst & Young and IESEBusiness School/CIIF for their support, feedback andtheir direct and professional contributions to the index.IESE CIIF, International Center for Financial Researchis an interdisciplinary center with an international outlook anda focus on teaching and nance research. It was created at thebeginning of 1992 to channel the nancial research interests heldby a multidisciplinary group of professors at IESE Business School University of Navarra.CIIFs main objectives are: To nd answers to the questions which confront both the owners and managers of nance companies, and the nance directors of all kinds of company within the performance of their duties To develop new tools for nancial management To study in depth the changes that occur in the market, and their effects on the nancial dimension of business activityIESE Business School University of Navarra is one of theworlds top 10 business schools and has pioneered executiveeducation in Europe since its establishment in Barcelona in 1958.With a truly global outlook, IESE currently runs executive-educationprograms in four continents. IESE is distinguished for its general-management approach, its extensive use of the case method, itsinternational outreach, and its emphasis on placing people at theheart of managerial decision-making.Ernst & Young is a global leader in assurance, tax, transactionand advisory services. Worldwide, our 141,000 people are united byour shared values and an unwavering commitment to quality. Wemake a difference by helping our people, our clients and our widercommunities achieve their potential.Potential is a key word for equity capital management. Deal successdoesnt end when the deal closes. Acquirers know success andstakeholder value lie in portfolio companies continued growthunder their watch and after their exits.Our private equity and venture capital practices therefore offera holistic, tailored approach that encompasses the needs of funds,their M&A process and portfolio companies while addressingmarket, industry and regulatory concerns and opportunities.We hope that the Global VC/PE Country Attractiveness Indexproves to be a valuable tool in helping funds navigate through thisuncertain time. For more information please visit www.ey.com8 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 7. About the editorsProf. Alexander GrohResearch teamDr. Alexander Groh is Associate Professorand Accounting, the Journal of EuropeanAlexander Grohof Finance at EMLYON Business School,Financial Management, the Journal ofAssociate Professor,France. He held visiting positions at TheAlternative Investments, and in VentureEMLYON Business School,University of New South Wales, Sydney, Capital. He is involved in training coursesgroh@em-lyon.comAustralia, IESE Business School, Barcelona,for the European Venture Capital and Pri-Spain, and INSEAD, Fontainebleau, France.vate Equity Association (EVCA), and hasHeinrich LiechtensteinHis research activities focus on VC and PE,worked for Quadriga Capital, a FrankfurtAssistant Professor,and include valuation issues, performancebased Private Equity fund, since 1996.IESE Business School Barcelona,measurement and socio-economic deter- Dr. Alexander Groh was born in Frank-hl@iese.eduminants for the development of vibrant furt, Germany. He received a joint MastersVC and PE markets. His papers have beenDegree of Mechanical Engineering andKarsten Lieserpublished in the Journal of Banking andBusiness Administration from DarmstadtProject Manager,Finance, the Journal of Corporate Finance, University of Technology, where he alsoIESE Business School Barcelona,the Journal of International Money and gained his Doctoral Degree in Finance.klieser@iese.eduFinance, the Quarterly Journal of FinanceThomas LangProf. Heinrich LiechtensteinResearch Assistant,IESE Business School BarcelonaDr. Heinrich Liechtenstein is Assistant Pro- gies at Liechtenstein Global Trust, a familyfessor of Financial Management at IESE holding, and as a consultant at The BostonMarkus BiesingerBusiness School, Barcelona UniversityConsulting Group. He has previously foun-Research Assistant,of Navarra, Spain. His areas of interest are ded and sold two companies.IESE Business School Barcelonaentrepreneurial nance, VC and PE, wealth Dr. Liechtenstein was born in Leoben,management and owners strategies. He is Austria, and received an MA in BusinessMoritz Huismannactive in several supervisory and advisory Administration from the University ofResearch Assistant,boards of family holdings and founda-Graz, an MBA from IESE Business School,IESE Business School Barcelonations, as well as a private equity rm.and a Doctoral Degree of Business andDr. Liechtenstein has experience inEconomic Sciences from the University ofFlorian Braunwealth management and owners strate-Vienna.Research Assistant,IESE Business School BarcelonaKarsten LieserSarp VardariziKarsten Lieser is a Project Manager at the in the asset and fund management de-Research Assistant,IESE International Center for Financialpartments of REInvest, SCM Strategic Ca-IESE Business School BarcelonaResearch (IESE CIIF) in Barcelona. He cur- pital Management, and AXA Real Estate.rently manages the Global VCPE CountryCurrently, Mr. Lieser is enrolled in aAttractiveness Index project and works Ph.D. program in Finance at Darmstadton strategy and research assignments inUniversity of Technology, Germany withthe Alternative Investment sector for va-a full-time research position at IESE Bu-rious consultancy rms. The focus of his siness School Barcelona, Spain. He gra-research is the investigation of determi-duated as Master in Business Administra-nants of Venture Capital, Private Equity,tion and Civil Engineering from Darmstadtand Real Estate investments and the de-University of Technology, Germany andvelopment of tools to guide investors on also studied at EPFL and HEC Lausanne,their geographic asset allocation deci-Switzerland, and IESE Business Schoolsions. Prior to joining IESE CIIF, he worked Barcelona, Spain. The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 9 8. I. The Global VCPE CountryAttractiveness IndexWritten by Alexander Groh, EMLYON Business School, groh@em-lyon.com,Heinrich Liechtenstein, hl@iese.edu, and Karsten Lieser, klieser@iese.edu, IESE Business School Barcelona.10 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 9. The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 11 10. I. The Global VCPE Country Attractiveness Index How to measure a countrys attractiveness for limited partners If institutional investors are unfamiliar with the preparing and analyzing a large quantity of socio-economic environment of countries they socio-economic data. However, not only the cannot make rational international allocationnancial community can benet from our decisions. They try to overcome potentialresearch, also politicians may conclude that information decits and gather data and analyzevibrant risk capital markets increase innovation, the determinants they deem important beforeentrepreneurial activity, economic growth, investing in a particular country. However,employment, competitiveness and wealth and this process is time consuming and costly. hence, might be interested in increasing the Additionally, due to the current pace of economicsupply of risk capital for their countries. development of many emerging countries,Currently, there is a major shift of focus from selecting those that support VC and PE activitytraditional VC and PE countries towards becomes more and more cumbersome. Our indexemerging regions. Emerging countries attract guides institutional investors solving the problem investors by exceptional growth opportunities where to allocate capital. We aggregate andthat require substantial funding. This shift is provide the most important information theyalso supported by the aftermath of the nancial require for their international VC and PE allocation crisis that strongly affected the established VC decisions. However, this information cannotand PE markets. It is sometimes argued that substitute investors own efforts to build upexceptional growth in emerging markets fuels country knowledge and experience. It can onlyfuture VC and PE activity, and that the whole facilitate this process. business model needs to be redesigned. However,as we discuss in this index, growth opportunities We propose a composite measure that benchmarks are not the only factor that renders countries the attractiveness of 80 countries to receive VC attractive for VC and PE investors, and it is these and PE allocations from limited partners. Ourbroader conditions that motivate our index. intention is to serve the investment community,12 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 11. What are institutional investors one single composite measure. The de-(1979) argues that a situation of economicinternational VC and PE allocationcisive factors that render a country at- prosperity and development facilitates en-criteria? tractive and the determinants of vibrant trepreneurship, as it provides a greater ac-Our index addresses institutional investorsVC and PE markets have been extensivelycumulation of capital for investments. Theconcerns and evaluates countries with res-studied. In our index we give a brief over-ease of start-ups is expected to be relatedpect to their criteria for international VC view over the ndings of these studies and to societal wealth, not solely due to theand PE allocations. These criteria include, group the articles into six sub-chapters.availability of start-up nancing, but alsoin the rst instance, the expected deal These sub-chapters reveal the structure of to higher income among potential cus-opportunities in a country or region from our index: each heading represents one oftomers in the domestic market. However,a macro perspective. Of course, they also six key drivers for the attractiveness of aGDP is measured in current market pricesinclude particular investment strategies of country for limited partners:that are affected by ination. Therefore,fund management teams, the general par- 1. Economic activity only real growth rates signal quality dealtners competences, their track records and 2. Depth of the capital market opportunities arising from the economicother parameters.1 The limited partners 3. Taxationdevelopment.evaluate these determinants in their due4. Investor protection and corporatediligence process before committing to a governanceImportance of the depth of theparticular general partner. However, these5. Human and social environmentcapital marketcriteria are beyond the scope of our index6. Entrepreneurial culture and dealBlack and Gilson (1998) discuss major dif-because they depend on individual casesopportunities ferences between bank-centered and stockand undisclosed data.market-centered capital markets. TheyAnother concern investors commu-These key drivers name and dene a subsetargue that well-developed stock markets,nicated to us is the level of valuations in of criteria we need to assess for all of our which allow general partners to exit viavarious countries. But, unfortunately, asample countries.2 IPOs, are crucial for the establishment ofcomparison of international transactionvibrant VC/PE markets. In general, bank-multiples is impossible for us for two rea- Importance of economic activitycentered capital markets show less abilitysons. First, little information exists on tran- Intuitively, the state of a countrys eco- to produce an efcient infrastructure thatsaction multiples. Second, multiples reect nomy affects its VC/PE market activity. An supports VC/PE deal-making. They afrmthe relationship between growth expecta-economys size and employment levels are that it is not merely the strong stock mar-tions and opportunity cost of capital. It isalso proxies for prosperity, the number of ket that is missing in bank-centered capitalnot feasible for us to estimate these pa- its local corporations and entrepreneurial markets; it is also the secondary institu-rameters for all our sample countries and activity, and hence, also for expected VCtions, including the bankers conservativeto nd a correct benchmarking approach. and PE deal ow. Capitalizing on economicapproach to lending and investing, and theOur index follows a practical approach andgrowth requires investments and provides social and nancial incentives that rewardpoints to the opportunities that should a rationale for institutional investors to entrepreneurs less richly (and penalize fai-arise from the current socio-economic enter into certain countries. Gompers andlure more severely), that compromise entre-environment in a country, and as a result,Lerner (1998) argue that more attractive preneurial activity. Jeng and Wells (2000)contribute to the macro perspective of theVC and PE investment opportunities exist stress that IPO activity is the main forcecapital allocation process. if an economy is growing quickly. Romain behind cyclical swings because it directlyOur index provides valuable informa-and van Pottelsberghe de la Potterie (2004)reects the returns to the VC/PE funds.tion to investors as it summarizes all thend that VC/PE activity is cyclical and si-Kaplan and Schoar (2005) conrm this.important socio-economic factors into gnicantly related to GDP growth. Wilken Similar to Black and Gilson (1998), Gom- pers and Lerner (2000) point out that risk2. For a comprehensive review please refer to Groh,capital ourishes in countries with deep1. For more details please refer to Groh, Alexander and Alexander, Liechtenstein, Heinrich and Lieser, KarstenLiechtenstein, Heinrich (2011): The First Step of the Capital (2010): The European Venture Capital and Private Equity and liquid stock markets. Likewise, Schert-Flow from Institutions to Entrepreneurs: The CriteriaCountry Attractiveness Indices, Journal of Corporateler (2003) uses either the capitalizationfor Sorting Venture Capital Funds, European FinancialFinance, Volume 16, Issue 2, April 2010, pp. 205 224.Management Journal, forthcoming. Related working papers Related working papers are available at http://ssrn.com/ of stock markets or the number of listedare available at http://ssrn.com/author=330804author=330804 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 13 12. I. The Global VCPE Country Attractiveness Index companies as a measure for stock markettion to develop a vibrant capital market. Lazear (1990) and Blanchard (1997) dis- liquidity and nds that it has a signicantGlaeser et al. (2001) and Djankov et al.cuss how protection of workers can reduce impact on VC and PE investments. (2003 and 2005) suggest that parties in employment and growth. It is especiallyAlongside the disadvantages of bank-common-law countries have greater easeimportant for start-up and medium-size centered capital markets, Greene (1998)in enforcing their rights from commercial corporations to respond quickly to chan- emphasizes that low availability of debt contracts.ging market conditions. Black and Gilson nancing is an obstacle for start-ups Cumming et al. (2006) nd that the (1998) argue that labor market restric- in many countries. Entrepreneurs needquality of a countrys legal system istions inuence VC/PE activity, though not to nd backers whether banks or VC/more closely related to facilitating VC/PEto the same extent as the stock market. PE funds who are willing to bear risk. backed exits than the size of a countrysDjankov et al. (2002) investigate the Cetorelli and Gambera (2001) provide stock market. Cumming et al. (2009) role of several societal burdens for start- evidence that bank concentration pro-extend this nding and show that cross- ups in different countries. They conclude motes the growth of those industrial sec-country differences in legality, inclu- that the highest barriers and costs are tors that have a higher need for externalding legal origin and accounting stan-associated with corruption, crime, a larger nance by facilitating credit access todards have a signicant impact on the unofcial economy and bureaucratic de- younger companies. governance of investments in the VC/PElay. It should be noted that this argumentindustry. Desai et al. (2006) show, thatis probably of particular importance in Importance of taxation fairness and property rights protection some emerging countries with perceived Bruce (2000 and 2002), and Cullen andlargely determine the growth and emer-higher levels of corruption. Gordon (2002) prove that tax regimes gence of new enterprises. Cumming and matter for business entry and exit. Djan-Johan (2007) highlight the perceivedImportance of entrepreneurial kov et al. (2008) show that direct and in- importance of regulatory harmonizationculture and deal opportunities direct taxes affect entrepreneurial activi-with respect to increasing institutionalThe expectation about access to viable ty. Poterba (1989) builds a decision model investor commitments to the asset class.investments is probably the most impor- showing the advantages to becoming anLa Porta et al. (2002) nd a lower cost oftant factor for investors international entrepreneur, driven by taxation incen-capital for companies in countries with risk capital allocations. Especially for tives. Bruce and Gurley (2005) explain better investor protection, and Lernerthe early stage segment, we expect that that increases in the personal income taxand Schoar (2005) conrm these n-the number of potential investments can raise the probability of becoming an dings. Johnson et al. (1999) show thatis related to the research output in an entrepreneur: large differences betweenweak property rights limit the reinvest-economy. Gompers and Lerner (1998) personal income tax rates and corporatement of prots in start-up companies. show that both industrial and academic tax rates provide an incentive for self-em-Finally and more broadly, Knack and research and development (R&D) expen- ployment.Keefer (1995), Mauro (1995), and Svens- diture signicantly correlates with VCson (1998) demonstrate that propertyactivity. Kortum and Lerner (2000) Importance of investor protectionrights signicantly affect investmentshighlight that the growth in VC fundrai- and corporate governance and economic growth.sing in the mid-1990s may have been due Legal structures and the protection of to a surge of patents in the late 1980s property rights strongly inuence theImportance of the human and socialand 1990s. Schertler (2003) emphasizes attractiveness of a national VC/PE market. environment that the number of both R&D employees La Porta et al. (1997 and 1998) conrm Black and Gilson (1998), Lee and Peterson and patents, as an approximation of the that the legal environment determines(2000), and Baughn and Neupert (2003) human capital endowment, has a posi- the size and extent of a countrys capi- argue that cultures shape both individual tive and highly signicant inuence on tal market and local companies ability to orientation and environmental conditions, VC activity. Furthermore, Romain and receive outside nancing. They emphasize which may lead to different levels of en- von Pottelsberghe de la Potterie (2004) the differences between statutory law andtrepreneurial activity. Megginson (2004)nd that start-up activity interacts with the quality of law enforcement in some argues that, in order to foster a growing the R&D capital stock, technological op- countries. Roe (2006) discusses and com- risk capital industry, the research culture portunities and the number of patents. pares the political determinants of corpo- with respect to universities and national However, innovations and R&D are not rate governance legislation for the majorlaboratories plays an important role. only important for early stage invest- economies and focuses on the importanceRigid labor market policies negativelyment activity. Without sufcient R&D of strong minority shareholder protec- affect the evolution of a VC/PE market. activity it will be impossible for esta-14 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 13. blished businesses to create or maintainonly competitive legal environments allowachieve a more comprehensive result andmarket positions with strong products the development of the societal require- to facilitate interpretations.and brands, which, once established,ments that support innovations, economicIn a rst step, we differentiate the sixattract private equity investors. growth, the capital market, and VC and key drivers from the foregoing review of Despite the innovative output of a PE activity. There is a fourth alternative,prior research: economic activity, depthsociety, Djankov (2002), and Baughn and which may be more relevant for emergingof the capital market, taxation, investorNeupert (2003) argue that bureaucracy ineconomies: low taxes attract investors protection and corporate governance,the form of excessive rules and proceduralwho provide nancing for growth whichhuman and social environment, and en-requirements, multiple institutions fromleads to modern and educated societies.trepreneurial culture and deal opportuni-which approvals are needed and cumber-All lines of argument are reasonable ties. We conrm their choice via a surveysome documentation requirements, mayand actually validated by the economic among institutional investors, reportedseverely constrain entrepreneurial activity.development of various selected countriesin Groh and Liechtenstein (2009) andLee and Peterson (2000) stress that the in different historic periods. Nevertheless, (2011), and base our index structure upontime and money required to meet suchit seems to be the combination of all thesethem. Unfortunately, none of these keyadministrative burdens may discourage factors which need to be improved in pa- drivers is directly measurable, so we seeknew venture creations.rallel to increase VC and PE attractivenessdata series that adequately express theirof countries and regions. For this reason, characters. Hence, we try to nd the bestSummary on the determinants ofwe do not rely on a selection of a few possible proxies for the aforementionedvibrant VC and PE markets parameters: for a country to receive a drivers of VC/PE activity, which must beThe research ndings discussed abovehigh index rank, it needs to achieve a highavailable for a large number of countriesemphasize the difculty of identifyingscore on all of the individual criteria. The-at the same time.the most appropriate parameters for our refore, we structure the determinants toindex. There is no consensus about a ran-king of the criteria. While some parame-ters are more comprehensively discussed,and certainly of high relevance, it remainsunclear how they interact with others. Forexample, it is arguable whether the VC/PEactivity in a country with a high corporategovernance level is affected more by theliquidity of the national stock market orby labor regulations. While an IPO exit is, in principle, pos-sible at any stock exchange in the world,the labor market frictions in a particularcountry can hardly be evaded. On theother side, many of the criteria are highlyinter-correlated. Black and Gilson (1998)call it a chicken and egg problem: it isimpossible to detect which factor causesthe other. One line of argumentation isthat modern, open and educated socie-ties develop a legislation that protectsinvestors and property rights, which favorthe output of innovation and the deve-lopment of a capital market. This leads toeconomic growth and to demand for VCand PE. However, the causality might bereverse: economic growth spurs innova-tion and the development of modern edu-cated societies. There is a third suggestion:The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 15 14. I. The Global VCPE Country Attractiveness Index Building the 2011 index Assessing six latent key driversHow we disaggregate the six key Finally, the individual weights for the An important principle of our index is to as- drivers six key drivers depend on the number sess the latent drivers of VC/PE attractiveness.According to the principal to assess latent of their level-2 constructs. For example, These are criteria that are not directly ob-key drivers with observable data, we di-1. Economic activity consists of three servable, but driven by others which cansaggregate each one into sub-categories.level-2 constructs, 2. Depth of the capi- be measured. For example, we assume inThese sub-categories are either indivi- tal market of seven, while 3. Taxation a rst step that the VC/PE attractiveness ofdual data series or constructs of seve- consists of only one. Overall, we use 22 le- a country is determined by the six key dri- ral determinants that we name level-2vel-2 constructs for our index, and hence, vers. However, as pointed out, the key driversconstructs. For example, as documented 1. Economic activity receives a weight of themselves are not measurable but need to in Table 1, we split the key driver 2. Depth 3/22, which is 0.136, while the weight of be estimated with sub-criteria. For example,of the capital market into seven sub-ca- 2. Depth of the capital market is 7/22, it would be ideal to express the quality of tegories: which is 0.318, and for 3. Taxation it is the deal-making environment in a country2.1. Size of the stock market 1/22 = 0.046, respectively. by the number of investment banks, M&A2.2. Stock market liquidity The advantage of this weighting scheme boutiques, law rms, accountants and2.3. IPO market activityis that the key drivers which include more consultants. But, unfortunately, such data2.4. M&A market activitylevel-2 constructs and hence, data series, does not exist on a global scale. Our only2.5. Debt and credit market gain more weight. That way, once again, alternative is to gather more general infor-2.6. Bank non-performing loans to total we diminish the effect of potential outliers mation on the level of debt provided by the gross loans in our data.3 banking sector, or estimates about the per- 2.7. Financial market sophisticationThe nal index structure results from ceived sophistication of the nancial systemsubstantial optimization efforts. We nd and the ease of access to loans. We assumeData series 2.2 and 2.6 are provided by that any statistically more advanced that these criteria affect the key driver,the Worldbank and data series 2.7 results techniques do not improve the index qua- depth of the capital market. Even if they are from a survey initiated by the World Eco- lity. The weighting scheme assigns appro- not perfect proxies, we claim that the better nomic Forum (WEF). However, the other priate emphasis according to the explana- these criteria are developed, the more deal-indicators are constructs themselves. For tory power of the individual key drivers. supporting institutions will exist to facilitateinstance, we assess 2.3. IPO market ac-We will return to this topic in a later sec- VC and PE activity. Hence, we assess a driver tivity by the issued volume and by the tion of this index. with observable data. This principle is main- number of issues. This approach has two tained at all individual levels for the index major advantages. First, individual dataSeparate VC and PE indices construction. An unobservable criterion series do not gain too much weight when To account for differences with respect to is assessed with several proxy parameters.they are grouped, and this limits the im- the two market segments, VC vs. PE, we In principle, we measure the attractiveness pact of outliers. Second, the overall results propose three related indices. The rst of a country by the six key drivers and use can be traced to more granulated levels one combines both segments (VCPE). The several proxies for their assessment. and hence, allow better interpretation andsecond one focuses on early stage VC and conrmation of the ndings. the third index on later stage PE. When calculating the individual VC and PE in- The six key drivers The weighting schemedices we discard data series that are less 1. Economic activityWe spent a great deal of time rening the important for either market segment. 2. Depth of the capital marketstatistical analyses and optimizing the 3. Taxation structure of the index. In this new opti- 4. Investor protection and corporatemized structure, we apply equal weights 3. Details about the possible statistical approachesgovernance for all data series, when we aggregateto determine weights for the data series are provided in 5. Human and social environment them to the level-2 constructs. We usethe academic paper Groh, Alexander, Liechtenstein, Heinrich and Lieser, Karsten (2010): "The European 6. Entrepreneurial culture and deal equal weights for the level-2 constructs to Venture Capital and Private Equity Country Attractivenessopportunitiesaggregate them on the next higher level Indices," Journal of Corporate Finance, Volume 16, Issue 2, April 2010, pp. 205 224. Related working papers are of the six key drivers. available at http://ssrn.com/author=330804.16The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 15. Table 1: Structure of the VCPE Index, the separate VC, and PE Indices, and the weighting schemesVCPEVCPE VCPE VCPEIndex Index IndexIndexIndex Index1Economic activity0.140.160.19 5Human and social environment 0.14 0.160.121.1Gross Domestic Product 0.330.330.33 5.1Education and human capital 0.330.331.1Size of the economy (GDP)0.330.33 0.335.1.1 Quality of the educational system0.500.501.2Medium-term real GDP growth0.330.33 0.335.1.2 Quality of scientic research institutions 0.500.501.3Unemployment 0.330.33 0.335.2Labor market rigidities 0.330.330.502Depth of the capital market0.320.210.44 5.2.1 Difculty of hiring index0.250.250.252.1Size of the stock market 0.140.250.14 5.2.2 Rigidity of hours index0.250.250.252.1.1 Market capitalization of listed companies 0.500.50 0.505.2.3 Difculty of ring index 0.250.250.252.1.2 Number of listed domestic companies 0.500.50 0.505.2.4 Firing costs 0.250.250.252.2Stock market liquidity (trading volume)0.140.250.14 5.3Bribery and corruption0.330.330.502.3IPO market activity0.140.250.14 5.3.1 Bribery and corruption Index 0.330.330.332.3.1 Market volume 0.500.50 0.505.3.2 Control of corruption0.330.330.332.3.2 Number of IPOs0.500.50 0.505.3.3 Extra payments/bribes0.330.330.332.4M&A market activity0.140.250.14 6Entrepreneurial culture and deal opportunities 0.22 0.260.062.4.1 Market volume 0.500.50 0.506.1Innovation0.200.202.4.2 Number of deals 0.500.50 0.506.1.1 General innovativeness index 0.500.502.5Debt and credit market 0.140.14 6.1.2 Capacity for innovation0.500.502.5.1 Domestic credit provided by banking sector0.25 0.256.2Scientic and technical journal articles0.200.202.5.2 Ease of access to loans 0.25 0.256.3Ease of starting and running a business 0.200.202.5.3 Credit information index0.25 0.256.3.1 Number of procedures to start of business0.200.202.5.4 Interest rate spread0.25 0.256.3.2 Time needed to start a business0.200.202.6Bank non-performing loans to total gross loans 0.140.14 6.3.3 Costs of business start-up procedures0.200.202.7Financial market sophistication0.140.14 6.3.4 Minimum capital requirements 0.200.203Taxation 0.050.05 6.3.5 Administrative requirements0.200.203.1Tax incentives and administrative burdens1.001.00 6.4Simplicity of closing a business0.200.203.1.1 Entrepreneurship incentive0.330.33 6.4.1 Time for closing a business0.330.333.1.2 Number of tax payments0.330.33 6.4.2 Costs for closing a business 0.330.333.1.3 Time spent on tax issues0.330.33 6.4.3 Recovery rate0.330.334Investor protection and corporate governance 0.140.160.19 6.5Corporate R&D 0.200.201.004.1Corporate governance 0.330.330.33 6.5.1 Company spending on R&D0.500.500.504.1.1 Disclosure index0.200.20 0.206.5.2 Utility patents0.500.500.504.1.2 Director liability index0.200.20 0.204.1.3 Shareholder suits index 0.200.20 0.204.1.4 Legal rights index0.200.20 0.204.1.5 Efcacy of corporate boards 0.200.20 0.204.2Security of property rights0.330.330.334.2.1 Legal enforcement of contracts0.330.33 0.334.2.2 Property rights 0.330.33 0.334.2.3 Intellectual property protection0.330.33 0.334.3Quality of legal enforcement 0.330.330.334.3.1 Judicial independence 0.200.20 0.204.3.2 Impartial courts0.200.20 0.204.3.3 Integrity of the legal system 0.200.20 0.204.3.4 Rule of law 0.200.20 0.204.3.5 Regulatory quality0.200.20 0.20 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual17 16. I. The Global VCPE Country Attractiveness IndexFor the VC index, we regard the level-2 We nd that several key drivers have VC and the combined VCPE index) because construct 2.5. Debt and credit market as a high importance for the state of a they are relevant on the level of the target having minor importance and hence, dis-countrys VC and PE market while othersrms. Similarly, we also discard the level-2 card it. We further delete 2.6. Bank non- are less important. Depth of the capital construct, measuring internet and com- performing loans to total gross loans,market has the highest explanatory power puter technology infrastructure, from our and 2.7. Financial market sophistication for cross-sectional VC and PE activity. This 2011 index. from the VC index. key driver is followed by entrepreneu-Furthermore, again due to a lack ofFor the PE index, we discard key driver rial culture and deal opportunities. Nextcorrelation, we discarded GDP per capi- 3. Taxation, because the criteria consi- comes economic activity, investor pro- ta from our list of data series. If we fo- dered are hardly relevant for the latertection and corporate governance on an cused on developed countries, individual stage segment. Similarly, we drop 5.1.equal level, followed by human and socialwealth would be an important indicator Education and human capital from theenvironment, then nally by taxation. This for VC and PE activity. However, including human and social environment key driverdecrease in importance is mirrored by theemerging economies, this data series is and only keep 6.5. Corporate R&D to as-weights we assign to the key drivers. The- contradictory as it has a strong negative sess the deal opportunities related to cor-refore, the chosen index structure assures correlation with economic growth. The porate proprietary research output.a weighting scheme that corresponds with fastest-growing VC and PE markets stillThe weights for the individual indexthe actual impact of the six key drivers.have low GDP per capita ratios, and hence, items in the separate VC and PE indicesWe did not follow this rigorous approach only one of the two drivers can be valid on are determined in the same way.in the 2009/10 edition of the index, where a broad cross-sectional scope.Table 1 presents the structures and we kept the weights of the six key driversFinally, we discard the ination rate the weights of the individual data series, balanced.from our list of data series because using as well as constructs for the combined Following the same rationale to im-real GDP growth we already control for VCPE, and the separate VC and PE indices.prove the quality of the 2011 index, weination. We provide more detailed information ondiscarded several data series we used inBeside the criteria that we need to ex- the data series in the appendix. There, we the 2009/10 index. Notably, we deleted clude for their missing explanatory power also explain the exact data aggregationsome data series describing the tax envi-with respect to VC and PE activity, we technique. ronment from the index. Surprisingly, we have discarded other data series with adetected no correlation between margi- predominantly lower quality in their latest Changes with respect to the priornal corporate tax rates, prot and capital update. A few of the ready-made indices index versiongains taxes, and VC/PE activity across our and survey results we included in 2009/10 The proposed data series, the index struc- sample countries. First, tax rules depend on edition no longer qualied for their in- ture and the applied weights result from the will of governments and are somehowclusion due to perplexing rankings and a comprehensive analyses on the drivers of arbitrary, hardly correlating with other so- doubtful index quality. VC and PE activity. Our goal is to provide cio-economic characteristics. Second, weAs a consequence, we present a much a framework for measuring a countrysinterpret this as the consequence of gene- leaner index, based on 54 data series attractiveness with respect to the VC andral partners efforts to create transparent(compared to 66 data series in our 2009/10 PE asset classes. Not much prior academicdeal and fund structures, so that national edition). The structure of the 2011 index research has elaborated on this issue to suchtax regimes do not affect the success of is more comprehensive and its statistical a broad scope. Usually, the country samplesVC/PE investments. The tax regimes are quality has increased. of other researchers are not as large as inprobably more important with respect to our index, and our data also tracks many the location of limited partners head- of the countries for a longer time period. quarters instead of the investee rms. For Therefore, we benet from a remarkable this reason, we only rely on the data series data collection allowing us to contribute to that evaluate entrepreneurial tax incen- academic research on the topic.tives and administrative burdens (for the18 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 17. Africa (8):Algeria, Egypt, Kenya, Morocco, Namibia,The countries covered Nigeria, South Africa, TunisiaWe aim to cover as many countries as pos- sible. The selection of the sample countriesAsia (16): Armenia, China, Hong Kong, India, is purely driven by data availability. We are Indonesia, Japan, Kazakhstan, South Korea,able to increase our coverage from 66 in Kyrgyzstan, Malaysia, Philippines, Russia,the 2009/10 edition to 80 countries for Singapore, Taiwan, Thailand, Vietnam2011. Unfortunately, the African conti- nent is still under-represented with onlyAustralasia (2): Australia, New Zealandeight nations, but we hope to expand the number in future index editions whenEastern Europe (18): Albania, Bosnia-Herzegovina, Bulgaria,more data becomes available. We consider Croatia, Czech Republic, Estonia, Georgia,the following 80 nations and assign them Hungary, Latvia, Lithuania, Macedonia,to eight different geographic regions as Moldova, Poland, Romania, Slovakia, they are dened by the International Mo- Slovenia, Turkey, Ukraine netary Fund (IMF). The 14 new entrants are highlighted.Latin America (10):Argentina, Brazil, Chile, Columbia, Ecuador, Mexico, Paraguay, Peru, Uruguay, VenezuelaMiddle East (7): Bahrain, Israel, Jordan, Kuwait, Oman, Saudi Arabia, United Arab EmiratesNorth America (2): USA, CanadaWestern Europe (17): Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, United KingdomThe Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 19 18. I. The Global VCPE Country Attractiveness Index The VCPE country attractiveness ranking We gathered the individual data seriesExhibit 1 presents the ranking of The Glo- from Table 1 for our sample countries from bal VCPE Country Attractiveness Index 2011. 2000 onwards to most recent data retrie- The exhibit is open to debate. Some readers ved by the end of 2010. We calculated themight argue that particular countries are 2011 index scores and realized that the US ranked too high, others too low. However, we remains the most attractive for VC and PEnote that the index ranking is the result of allocations, retaining its ranking from thecommonly available, transparent, aggrega- 2009/10 index. However, the distance to itsted socio-economic data, which is relevant followers has decreased compared to last for investors in VC and PE assets. The results year. This can be mainly attributed to the can be traced to the level of the individual (economic) consequences of the nancialdata series, and hence, can be conrmed. crisis. We rescale the US score to 100,4 andPlease note, the underlying data is its two followers, the United Kingdom andmost the recent data available, but does Canada catch up to a level of 93.3%, com-not include future projections. Therefore, pared to 85.8% in 2010.we show the current attractiveness ran-king and leave it to investors and advi-sers to enrich the information we preparewith their own knowledge, experience andexpectations upon which to draw theirconclusions. 4. We explain the rescaling procedure in more details in the appendices.20The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 19. Exhibit 1: 2011 VCPE Country Attractiveness IndexVCPE Country Attractiveness Score 2011 0 10 20 30405060 708090 100United States (1.) 100.0United Kingdom (2.)93.3Canada (3.)93.3 Singapore (4.)92.4Switzerland (5.) 91.8 Japan (6.)90.9Australia (7.) 90.2Sweden (8.)85.0Netherlands (9.) 84.3Germany (10.)82.8 Finland (11.) 82.3Denmark (12.)81.8Norway (13.) 81.0France (14.) 79.6 Belgium (15.) 76.8Hong Kong (16.)76.5Korea, South (17.) 75.7 Malaysia (18.)72.5New Zealand (19.)72.5 China (20.) 72.3Israel (21.) 72.2 Austria (22.) 71.7 Spain (23.) 69.1 Ireland (24.) 67.7Saudi Arabia (25.) 67.5South Africa (26.) 66.9 Taiwan (27.)62.4United Arab Ermiates (28.) 61.6Chile (29.)61.5India (30.)61.4 Portugal (31.)60.4 Italy (32.) 59.6Luxembourg (33.) 59.3 Thailand (34.)59.3 Kuwait (35.)57.9 Poland (36.)57.4Czech Republic (37.) 55.0 Jordan (38.)53.2Turkey (39.) 52.8 Hungary (40.) 52.0Russian Federation (41.) 51.1 Mexico (42.)48.7 Brazil (43.)48.7 Greece (44.)47.9 Slovenia (45.)46.8 Oman (46.)45.6Colombia (47.) 45.3 Indonesia (48.) 45.2 Estonia (49.) 44.8Bahrain (50.)44.3 Bulgaria (51.)44.1 Croatia (52.) 43.4 Vietnam (53.) 42.2 Morocco (54.) 41.8 Egypt (55.) 41.8 Tunisia (56.) 41.5Lithuania (57.)41.3Philippines (58.)41.2 Peru (59.)41.1 Romania (60.) 41.0 Kazakhstan (61.)39.1 Slovakia (62.)39.1Kenya (63.)38.3 Nigeria (64.) 37.1 Uruguay (65.) 36.8 Argentina (66.) 36.4 Latvia (67.)29.4Ukraine (68.)27.8Georgia (69.)27.2 Namibia (70.) 26.4 Armenia (71.) 25.3 Moldova (72.) 22.0Macedonia (73.)19.3Ecuador (74.)17.9Albania (75.)17.8 Bosnia-Herzegovina (76.)17.3 Algeria (77.) 17.1Paraguay (78.) 15.7 Venezuela (79.) 15.2Kyrgyzstan (80.) 14.4 0 10 20 30405060 708090 100 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 21 20. I. The Global VCPE Country Attractiveness IndexExhibit 2: rankings according to the three different indicesVCPE Country Attractiveness Ranking80 7060 50403020 10 0United States United KingdomCanadaSingaporeSwitzerlandJapan Australia SwedenNetherlands GermanyFinland Denmark Norway FranceBelgium Hong Kong Korea, SouthMalaysia New ZealandChina IsraelAustriaSpainIreland Saudi Arabia South AfricaTaiwan United Arab Emirates Chile IndiaPortugalItaly LuxembourgThailandKuwait PolandCzech Republic Jordan TurkeyHungary Russian FederationMexicoBrazilGreeceSloveniaOman ColombiaIndonesiaEstonia BahrainBulgariaCroatiaVietnamMoroccoEgyptTunisia Lithuania PhilippinesPeruRomaniaKazakhstanSlovakiaKenyaNigeriaUruguayArgentinaLatvia Ukraine GeorgiaNamibiaArmeniaMoldova Macedonia EcuadorVCPE 2011 AlbaniaBosnia-HerzegovinaVC 2011Algeria PE 2011 ParaguayVenezuela Kyrgyzstan807060 504030 20 10 022The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 21. Rankings according to the separatecreasing its rank by several places. The ra-VC and PE indices tionale for these improvements is simple:Exhibit 2 combines the VCPE index withcompetitive disadvantages with respectthe rankings according to the separateto education and innovation are no lon-VC and PE indices. The triangles mark the ger considered, but the weight of the ca-VCPE index ranks. The diamonds designatepital market key driver has increased atthe VC index and the squares representthe same time. As these countries havethe PE index ranks. (meanwhile) relatively deep capital mar-The VC index country ranking does kets, their attractiveness for later stagenot change remarkably compared to the investment increases.combined VCPE index ranking. It remains In contrast, we nd that New Zealand,stable because we do not alter the indexIreland, Slovenia, the Baltics and Tu-structure to a great extent between the nisia lose several ranks focusing on PE2009/10 and 2011 editions. However, weattractiveness. This can be mainly attri-receive a much stronger ranking variation buted to two factors: a strong impact ofif we exclusively focus on the PE segment.the recent nancial crisis and, resultingFor the PE index, we discard taxation from discarding competitive advantagesas well as constructs and data series thatof these countries in the PE index, in par-are related to education, high-tech inno- ticular with respect to taxation.vation and starting or running businessesin early stages. This results in Hong Kong,China, South Africa, Taiwan, India, Bra-zil, Bahrain, the Philippines and Peru in-The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 23 22. I. The Global VCPE Country Attractiveness Index Comparisons of countries The general pattern: what rendersExhibit 3 reveals four important im-Focusing on the developed countries the US so attractive?plications. First, the United States (US)we nd many economically strong na- We broke down the index scores to the le-generally ranks ahead of other developed tions with vibrant entrepreneurial cultures vel of the six key driving forces, and theneconomies (e.g., Germany) with respect toand deal opportunities, with an excellent further down to the level-2 constructs inmost of the six key drivers of VC and PE human capital and social environment. order to enhance the discussion about theattractiveness, but especially to its capi-However, the nally decisive criteria for ranking. We found a typical pattern with tal market. Second, emerging countries the lower score compared with the US are respect to the attractiveness of countries (e.g., China) strongly attracts venture ca-the nancial markets, and investor pro- for VC and PE allocations. We demonstratepital and private equity investors by theirtection and corporate governance rules. this pattern by comparing the rst rankedeconomic growth. Third, many countries These ndings point to the discussion with the 10th and 20th ranked country, provide tax incentives that support en-about the competition of legal systems namely the US, Germany and China. Ex-trepreneurial activity. Fourth, emerging and the relation between law and nance, hibit 3 presents the key driver scores ofcountries score sometimes notably belowas all strong countries score highly for the Germany and China compared to the US the developed economies in terms of in-investor protection and corporate gover- (which scores 100 for each key driver by vestor protection and corporate gover- nance key driver. Strong investor protec- denition).nance, human and social environment, tion and corporate governance legislationand entrepreneurial culture and deal op- spurs the development of a national ca-portunities. This pattern becomes evidentpital market, which is required for the es-by further analyses which are presentedtablishment of VC and PE deal supportingin the appendix of this annual where institutions.we benchmark every individual countryagainst the US.Exhibit 3: six key driving forces comparison of theUnited States, Germany and China1. Economic Activity 150 125 6. Entrepreneurial1002. Depth of Capital Culture and Deal75Market Opportunities 50 25 05. Human andSocial Environment3. Taxation United States (1.)4. Investor Protection and Germany (10.)Corporate Governance China (20.)24 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 23. We brake-down our analysis on the le- ver scores between the US and Germanyby its liberal labor market, while per-vel-2 constructs and provide more details results from a higher appreciation of theceived bribery and corruption remains anthat support the detected general pattern.US corporate governance rules. On the investment obstacle in China. Finally, the Exhibit 4 points to the distance between other side, Germany leads with respect toexcellent score of the US for the entre-the scores of the US, Germany and China several other criteria, in particular with anpreneurial culture and deal opportunitieswith respect to the level-2 constructs that advanced protection of property rights, akey driver is mainly related to academicasses the capital market and corporatehigher quality of the legal system, a lowerresearch output and to the administrativegovernance. It also reveals the extraor-perception of bribery and corruption, andsimplicity and cost of starting, runningdinary state and growth of the Chineseregarding its general innovation capacity. and closing businesses.economy, and its well developed capital In addition, the exhibit shows that the VC/market. The difference of the investor pro- PE attractiveness of the human and socialtection and corporate governance key dri- environment in the US is mainly drivenExhibit 4: level-2 constructs comparison of the United States, Germany and ChinaVCPE Country Attractiveness Score 20110 20 4060 80100 120 140 160 180 200 1.1 Size of the Economy (GDP) 1.2 Medium-Term Real GDP Growth 1.3 Unemployment 2.1 Size of the Stock Market2.2 Stock Market Liquidity (Trading Volume)2.3 IPO Market Activity 2.4 M&A Market Activity2.6 Bank Non-Performing Loans to Total Gross Loans2.7 Financial Market Sophistication3.1 Tax Incentives and Administrative Burdens 4.1 Corporate Governance 4.2 Security of Property Rights4.3 Quality of Legal Enforcement5.1 Education and Human Capital 5.2 Labor Market Rigidities 5.3 Bribing and Corruption 6.1 Innovation6.2 Scientific and Technical Journal Articles6.3 Ease of Starting and Running a Business6.4 Simplicity of Closing a Business United States (1.) 6.5 Corporate R&D Germany (10.) China (20.)0 20 4060 80100 120 140 160 180 200 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 25 24. I. The Global VCPE Country Attractiveness Index Historic comparison improvements sively due to its tremendous economic vestment environment, economic growth of VCPE investment conditions andgrowth. Although this is a remarkable in- rates can be responsible for volatile ranks. nancial crisis impact crease of VC/PE attractiveness it should be At the other end of the exhibit, we In order to demonstrate shifts in VCPE interpreted with some caution as, despite nd those countries that lost ranking country attractiveness, we compare the its growth, Brazil is only ranked numberpositions in the global competition. The ranking for 2011 with 2007. It should be 43 in our index. For a further increase ofBaltics, Turkey, Ireland, Romania, and Slo- noted that some data series, e.g., the Ge- Brazils attractiveness, other key driversvakia conclude the list of countries that neral Innovation Index (GII) do not date need to be strengthened. This is equallydecreased their ranks. For Turkey, the de- back as far. However, we assume that valid for Indonesia. The country scores gradation results from a lack of economic this and similar indicators did not change particularly low with respect to investor growth and from a deterioration with res- substantially between 2007 and their protection and corporate governance (forpect to its human and social environment rst publication, and hence, keep them this key driver, Indonesia only ranks num-(relative to the other sample countries). constant.ber 75), and the gain of ranking positionsFor Ireland, the Baltics, Romania and Slo-The comparison presented in Exhi- is dominantly caused by its economicvakia, the downgrade is a direct conse- bit 5 shows the rank changes (positive togrowth. For Saudi Arabia, the rationale quence of the nancial/economic crisis. the right and negative to the left) of our is different. Not only economic growthLacking economic growth is superimposed sample countries between the 2007 andcontributes to its more favorable ranking,by frozen debt markets and low capital the 2011 index. It provides interesting in-Saudi Arabia substantially improved in allmarket activity. This result should alert in- sights and reveals a strong increase of VC other important key drivers.vestors as these countries were highly ap- and PE attractiveness for several countries, We continue with the interpretation preciated target countries for VC and PE and the impact of the nancial and econo-of Exhibit 5 and note that the increase investors in the past. However, the once mic crisis on others. It should be stressedof ranking positions of Vietnam is caused expected economic growth did not mate- that the index scores are calculated relativeby the initiation of capital market acti- rialize on a sufcient scope; respectively, to all other countries of the sample. That vity: stock market trading volume, M&Ait was not sustainable without improving means those countries that gained or lostand banking activity increased from verythe general socio-economic environment ranking positions did not necessarily im-low levels. This is also similar for Bahrain. as measured by the other key drivers. For prove/deteriorate their investment condi-Exhibit 5 further reveals that all thethis reason, a VC/PE bet on growth in a tions in absolute terms. They might just Middle East countries substantially im- particular country is risky as the country have outperformed/been outperformed by proved their rankings. In addition, the might fail to develop the appropriate in- others in the international competition to North African countries, Tunisia and Mo-vestment environment at the same pace. attract capital resources. rocco, experienced remarkable econo-We nd that Brazil, Saudi Arabia, and mic growth; this is equally valid for the Indonesia are the winners. For an inter- Western European countries, Portugal and pretation of this nding, we refer to theGermany. Taking Germany as an example, detailed country analyses in the appendixthe importance of the economic activity of this annual and note that Brazil gainskey driver should be noted. For countries these 14 ranking positions almost exclu- with a general very favorable VC/PE in-26 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 25. Exhibit 5: rank changes between 2007 and 2011 (-) Deterioration or (+) improvement of ranking position -15 -12 -9-6-3 0 3 6 91215 Brazil (43.) 14 Indonesia (48.)11Saudi Arabia (25.)11 Vietnam (53.)9Bahrain (50.) 8 Tunisia (56.)8 Morocco (54.)7 Portugal (31.) 7Germany (10.) 6Kenya (63.) 6 China (20.)5 Kuwait (35.) 5 Oman (46.) 5United Arab Emirates (28.)5Albania (75.) 4 Jordan (38.) 4 Peru (59.) 4 Belgium (15.)3 Croatia (52.)3France (14.)3 Hungary (40.)3 Malaysia (18.) 3New Zealand (19.) 3Colombia (47.)2Macedonia (73.) 2 Mexico (42.) 2 Nigeria (64.)2Paraguay (78.)2 Armenia (71.)1 Austria (22.)1 Bosnia-Herzegovina (76.) 1Canada (3.) 1Chile (29.) 1Denmark (12.) 1Netherlands (9.)1United Kingdom (2.) 1Australia (7.)0Ecuador (74.) 0 Italy (32.)0 Japan (6.) 0 Namibia (70.)0 Slovenia (45.) 0Sweden (8.) 0Switzerland (5.)0 Taiwan (27.) 0United States (1.)0 Uruguay (65.)0 Algeria (77.) -1 Bulgaria (51.)-1Georgia (69.)-1Hong Kong (16.)-1 Moldova (72.) -1Norway (13.) -1 Poland (36.)-1Ukraine (68.)-1 Finland (11.)-2Israel (21.)-2Kyrgyzstan (80.)-2 Singapore (4.) -2South Africa (26.)-2 Czech Republic (37.) -3 Egypt (55.)-3 Spain (23.)-3India (30.)-4Luxembourg (33.) -4Russian Federation (41.) -4 Greece (44.) -5Philippines (58.) -5 Argentina (66.)-6Korea, South (17.)-6 Thailand (34.) -6 Venezuela (79.)-6 Kazakhstan (61.)-7 Estonia (49.)-8Turkey (39.)-8 Ireland (24.) -10 Latvia (67.)-11Lithuania (57.)-11 Romania (60.) -13 Slovakia (62.)-14 -15 -12 -9-6-3 0 3 6 91215 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 27 26. I. The Global VCPE Country Attractiveness Index Emerging countries, and exceptional opportunities in BRIC? Among the emerging economies, inves- ving forces of VC and PE attractiveness Exhibit 7 presents the scores of the le- tors are paying particular attention toare often neglected. Exhibit 6 presentsvel-2 constructs for the BRIC economies. the development of the BRIC (Brazil, Rus-the six key drivers for the BRIC countries.It conrms Chinas exceptional position sian Federation, India and China) econo- As mentioned before, this pattern is veryregarding its economic size and growth mies. The expected economic growth and similar for most of the emerging markets.also compared to Brazil, the Russian Fede- catch-up potential resulting from the sizeThe exhibit reveals the skewnessration and India. of their population, the availability of among the key driving factors of VC and However, likewise it reveals some natural resources and transition to liberalPE attractiveness. All of the BRIC countries concerns about emerging market VC markets justies the exposure in BRIC. Asare characterized by a peak with respect and PE. Issues with respect to corpo- already noted, Brazil is the top performingto their economic activity. Nevertheless rate governance and the protection of country in terms of its gain of overallthe Russian Federation demonstrates only investors rights still remain investment ranking positions between the 2007 and 89% of the economic activity key driver of obstacles in BRIC. Further, perceived bri- 2011 index versions, and China leads the the US. Despite the deep capital markets bery and corruption levels are high, while ranking with respect to its exceptionalin China and India, and the heterogeneousinnovation and corporate R&D remains economic growth. The pace of the eco-characteristics with regard to taxation, all relatively low. We know from the BRIC nomic and capital market development,other key driver scores remain relativelyand other emerging markets that growth especially in China and India, is indeed low. This observation is conrmed by the and development is mainly concentrated astonishing. However, the other key dri- scores of the level-2 constructs.in particular hubs or certain regions, but not widespread. We also know that the benet of wealth creation is allocated to Exhibit 6: the six key drivers for BRIC rather small fractions of the population only. This presents not only a socio-eco- 1. Economic Activitynomic challenge for politicians in many 150 emerging countries, but is also reected 125 in their attractiveness for VC and PE. If 6. Entrepreneurial1002. Depth of Capital the countries cannot transfer the wealth Culture and Deal75 effects of growth to a broader part ofMarketOpportunities50 their population it is unlikely to improve 25 the other key driving forces for VC and 0 PE attractiveness. If the pace of econo- mic growth slows down, the countries will deteriorate their VCPE attractiveness ran- 5. Human andking. This happened to the Russian Federa-3. Taxation Social Environment tion, which lost four ranks as presented in Exhibit 5, due to lower economic growth. Brazil (43.)As previously argued, this is similar for4. Investor Protection and Russian Federation (41.)Corporate Governance India (30.) the other emerging countries (the Baltics, China (20.) Turkey, Romania, and Slovakia) ranked at the bottom in Exhibit 5.5 5. We note that Indias loss of four ranking positions is caused by a deterioration of perceived investor protection and lower scores in doing business indicators, but denitely not by economic growth.28 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 27. In summary, BRIC and other emerging part of VC/PE business. Adding value andging and developed VC and PE markets asmarkets provide many investment oppor-exiting are at least of equal importance. exceptional growth opportunities come attunities and have strong needs to nanceIn fast-growth economies, the potential some cost. Finally, and this is particularlytheir expected economic growth. Howe- of general partners to add value (other important for emerging markets becausever, expected growth is often already than nancing) might be limited. In ad- of their recent boom, the public stockpriced and does not allow extra prots. dition, successfully exiting transactions markets provide investment alternativesIt is also more challenging in emerging becomes difcult, even if public capitalto capitalize on expected growth.countries to get access to transactions be- markets are well developed, when thecause of the immaturity of their deal sup-protection of investors is insufcient, andporting institutional environment. Hence, when bureaucracy and perceived briberydeal ow can be cumbersome and costly.and corruption lower the returns to inves-Furthermore, we should acknowledge that tors. Limited partners should well considerinvesting in corporations is only the minor advantages and disadvantages of emer-Exhibit 7: level-2 constructs for BRICVCPE Country Attractiveness Score 20110 2040 6080 100 120 140160180 200 1.1 Size of the Economy (GDP) 1.2 Medium-Term Real GDP Growth 1.3 Unemployment 2.1 Size of the Stock Market2.2 Stock Market Liquidity (Trading Volume)2.3 IPO Market Activity 2.4 M&A Market Activity2.6 Bank Non-Performing Loans to Total Gross Loans2.7 Financial Market Sophistication3.1 Tax Incentives and Administrative Burdens 4.1 Corporate Governance 4.2 Security of Property Rights4.3 Quality of Legal Enforcement5.1 Education and Human Capital 5.2 Labor Market Rigidities 5.3 Bribing and Corruption 6.1 Innovation6.2 Scientific and Technical Journal Articles6.3 Ease of Starting and Running a Business Brazil (43.)6.4 Simplicity of Closing a Business Russian Federation (41.) India (30.) 6.5 Corporate R&D China (20.)020 40 6080 100 120 140160180 200 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 29 28. I. The Global VCPE Country Attractiveness Index Tracking power of our index Our index ranks the attractiveness ofour index always provides the correct reason: some nancial centers serve as countries to receive VC/PE allocations answer to these questions. But, we sub- hubs and channel VC and PE abroad. from institutional investors based onmit that it is very helpful in this respect.Investors allocate their capital in these many socio-economic data series. The Therefore, we expect deviations between hubs because they rely on the efciency composite measure can deviate from our attractiveness measure and actual VCof the nancial community there. This is the actual risk capital market activityand PE activity in the particular countries exactly what we try to measure with our and these deviations might point to an to be at a minimum level. index. In fact, we focus on the demand inaccuracy of our measure. With respectTo analyze the tracking power offor VC and PE in a particular economy, to their allocations, investors are oftenour index, we compare the index scoresand likewise on the state of the profes- inuenced by herding behavior and fol- with the actual VC and PE activity in the sional nancial community that supports low trends to certain countries andvarious countries, using the data fromthe supply side and directs the funds regions. However, the countries mightThomson Financial. Our activity measure to the investee corporations. Therefore, not have sufciently developed VC/PEis the natural logarithm of an average of investments according to the location infrastructure to absorb the committedall VC and PE investments made by the of the general partners correspond best capital, leading to over-funding. The VC/general partners in a certain country overto the concept of our index. In addition, PE infrastructure is exactly what we aim the last three years. We use the naturalwe use investments and not raised to assess with our index: can we expectlogarithm to account for the large acti-funds because our index measures the sufcient deal opportunities resulting vity divergence (e.g., activity in the US vs. absorption capacity (either caused by from the entrepreneurial culture in aseveral emerging countries), and we use direct local demand or by channeling country, from its economic soundness, or an average over three years to smooth funds abroad) of the particular econo- from innovations? Are potential transac- uctuations. Especially for some emer-mies. Funds raised might deviate from tions efciently supported by the nan-ging countries, annual activity uctuates this capacity due to herding behavior of cial community? Are the public stock and strongly from peak levels to zero in sub- investors, caused by over-optimism or M&A markets liquid enough to facilitatesequent years. We chose the criterion lo-negligence. divestments? Are investors concerns le- cation of the general partners and not gally taken care of? We do not claim thatof the investments for the following30 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 29. Exhibit 8: tracking power of our index1,000,000 100,000 Three years average of VC and PE investments by general partners per country [USD mn]10,000 1,000 10010 1 010 20 30 40 50607080 90 100 110VCPE Country Attractiveness Scores 2011 The statistical measure for such a com-Nevertheless, we could still improve the nancing instead of VC transactions. Simi-parison is the Pearson correlation coef- tracking power of the index due to our op- larly, some investments in later stage com-cient. It ranges between 0 and 1, where 0 timization effort and the slight changes ofpany life cycles rather resemble expansionsignals no and 1 perfect tracking. Thethe index structure and weights in the 2011or development capital than traditionalcoefcient for our index is 0.8336, signa-version. If we compare the results of ourbuyout structures. Also for this reason ofling that the index performs well whenVC index with VC activity (only), the corre- varying denitions of VC/PE among thetracking a countrys investment activity. lation is 0.8242. The correlation of our PEglobe, we determine the combined GlobalHowever, it is calculated including onlyindex with actual PE activity is 0.8347. All VC and PE Country Attractiveness Indexthe 58 countries from our sample with these results can be considered excellentwhich provides a joint score for both assetnon-zero investment activity. We illus- from a methodological perspective andclasses.trate the high correlation in Exhibit 8.all correlations could be improved compa- Exhibit 8 reveals the tracking power ofred to the prior index version. However, itour index. We plot the countries invest- should be noted that there are inhomoge-ment activity on their index scores and neous denitions of VC and PE among thecan identify a strong link. We note that theglobe. Especially in emerging countries,prior 2009/10 index correlated with 0.8104some transactions might better be calledwhich was already a very satisfying result. infrastructure investments or projectThe Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 31 30. I. The Global VCPE Country Attractiveness Index Our index and historic VC/PE returns Concurrent to the nding that our indexPPMs. The gures are audited and inves-with the available data on VC/PE and on performs well when tracking VC and PEtors trust them. However, only success-our global scope. In addition, an IRR is a activity in countries, it is of particular ful general partners raise a subsequentcapital and time weighted return measure interest to analyze if it also corresponds fund and edit a PPM. Therefore, their usethat requires a reinvestment assumption with country performance. Unfortuna- is criticized by academic researchers, asand that has aggregation issues as descri- tely, performance gures are still one ofaverage performance gures from PPMs bed in Phalippou (2008). However, the IRR the best kept secrets in the VC and PE are upward biased. Nevertheless, there ispitfalls are the same for all transactions industry. The principle not to discloseno reason to believe that this upward bias and for all of our countries. Therefore, information on returns is equally validis different among particular countries. they do not affect our cross-sectional in developed and in emerging markets.This means benchmarking countries is country benchmarking approach. On top of that, the emerging VC and PE feasible because then countries are com-With these aggregate country perfor- markets are young with a general low pared relative to each other and the ab- mance measures, we can analyze to what activity (despite some exceptions) and solute terms are not important.extent our index not only tracks VC and hence, only a very few transactions fromLopez-de-Silanes, Phalippou and Gotts-PE market activity but also the average re- which achieved returns can be calcula- chalg (2010) put together from PPMs theturns. We can match the index scores of 49 ted. Therefore, an assessment of VC andmost comprehensive database on VC andcountries (thereof 24 emerging countries) PE performance is even more challengingPE returns at the investment level contai- with their aggregate performance data. for the developing countries than for thening the performance and characteristics We nd that the correlation between the developed. Commercial data suppliers of 7,453 investments, thereof 1,694 in index scores and a countrys average gross only provide very limited performanceemerging countries. The rst transaction internal rate of return is 0.56. This high gures. The only means to get reliable considered was closed in 1971 and the last correlation is expressed in Exhibit 9, which performance data on a sufcient scopeprior to 2006. We are grateful to Ludovicrepresents the average of the country re- for empirical analyses is via the exten- Phalippou for providing us with aggrega- turns and index scores when we group the sive effort to collect private placement ted country returns from this database.countries into deciles with respect to their memoranda (PPMs). A private placementThese returns are compiled as the mean index scores. memorandum is a document edited by a average of gross internal rates of return general partner that raises a VC/PE fund of all transactions in a particular country. and solicits capital commitments fromWe are aware that this is a rough estimate, institutional investors. It is a marketing disregarding different transaction closing document used for fundraising purpose. dates (fund vintage years), industries, deal General partners provide information structures and development cycles of the about their track records and the per- particular VC/PE markets. Unfortunately, formance of individual transactions in controlling for these effects is impossible32 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 31. Exhibit 9: historic performance and our index40%Average IRR of 49 sample countries grouped into deciles35%30%25%20%15%10%5%0%30 40 50607080 90 100Average index scores for 49 sample countries grouped into decilesExhibit 9 reveals that our index is not tions in any of them. We highlight thatonly a valid proxy for VC and PE activity,the internal rates of returns collected byit is also a good indicator for aggregate Lopez-de-Silanes, Phalippou and Gotts-country returns. The averages of historic chalg (2010) are calculated gross of anygross internal rates of return were actual- fees. We can assume that fees are higherly larger in countries that rank higher infor investors in markets with less compe-our index than in countries that rank low.tition among general partners. Therefore,Nevertheless, there are outliers, meaning we expect the less competitive emerginglow ranked countries with high returnsmarkets to be more costly for investors.and vice versa. Additionally, of course,This effect supports our result and shouldthere is a strong dispersion of returns increase the correlation if we consideredwithin the particular countries, driven bynet returns to investors.the existence of very successful transac-The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 33 32. I. The Global VCPE Country Attractiveness Index Summary and outlook We provide a composite measure thatWe nd a general pattern if we com- Emerging VC and PE provides interes- determines the attractiveness of 80pare the country characteristics. There is ating opportunities to investors. However, countries to receive capital allocations lot of dispersion with respect to the six key it is the discussed lack of balance of the from investors in the VC and PE assetdrivers. Some countries attract investors key driving forces that renders emerging class. The composite measure is based on with tax incentives. Many countries showVC/PE allocation decisions challenging. six main criteria: economic activity, depthstrong entrepreneurial culture and deal Exceptional growth opportunities come of the capital markets, taxation, investor opportunities. There is great dispersion in at the cost of disadvantageous conditions protection and corporate governance, the economic activity, especially with respectwith respect to investors protection, less human and social environment, and entre- to the emerging markets and in the humanliquid exit markets, innovation capacity preneurial culture and deal opportunities. and social environment. However, the twoand perceived bribery and corruption. The denition of these criteria is based onkey criteria, investor protection and cor-We invite you to observe and thorou- an extensive review of academic literature porate governance, and depth of capital ghly analyze our results. If you are an and on a survey we conducted among markets, make the difference. The com-investor, please enrich the provided in- institutional investors prior to our study.mon law countries dominate the others formation with your own expertise and The six criteria are not directly observable,regarding these criteria. We can conclude knowledge about the key driving forces so we use proxy variables to assess them that strong investor protection and cor-and market conditions in the particular for each country. As a result, we receiveporate governance rules lead to liquid andcountries to make your allocation deci- a country ranking, as well as provideefcient capital markets, and these evoke sions. If you are a politician, please use our detailed analyses on the strengths and the required professional community toanalyses as demonstration how investors weaknesses of the particular nations and secure deal ow and exit opportunities forevaluate and benchmark your country. If information on the historic developmentVC and PE funds. This ultimately affectsyou are a researcher, and this is equally of the criteria. Our index performs well a countrys attractiveness for institutionalvalid for the whole constituency, please when tracking real VC and PE activity andinvestments in the VC and PE asset class. do not hesitate to criticize our approach historic aggregate country performance.However, this discussion reects theand ndings. We will continue to update However, it must not be interpreted as a capital supply side only. We should alsoour index annually. crystal ball for investment advisers. We take into account that, as revealed byAs the index evolves, we aim to cover highlight our intention to challenge the our analyses, many countries lack several more countries, assuming the right data is discussion about the determinants of vi- important characteristics. Without a suf- available. We will include new data series brant VC and PE markets and to propose cient entrepreneurial culture and deal (discard others), and further optimize the a valuable informational tool, but not anopportunities, with rigid labor markets,data selection and index structure. Hence, arbitrage instrument.bribery and corruption, there will be rst, we very much appreciate any critique andless demand for VC and PE and second, re- comment.turns to investors diminish.34 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 33. The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 35 34. II. How are fund size and fund performance related?36 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 35. The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 37 36. II. How are fund size and fund performance related? Giants at the gate: diseconomies of scale in private equity investment returns My co-authors, Florencio Lopez-de-Silanes and Oliver Gottschalg, and I have put together the largest and most up-to-date dataset on PE investment performance and characteristics. Our data comes from fund-raising private placement memorandums (PPMs) that we have collected over the past eight years from investors on every continent. After applying a number of lters, mainly to eliminate those investments that are too young to have a meaningful return, our nal sample contained 7,453 investments made in 81 countries by 254 PE rms between 1971 and 2005. This data allowed us to derive statistics for issues that are often debated in private equity and to document the main drivers of the cross-section of returns. Prompted by the large increases in the size of PE funds, we paid special attention to the impact of scale on returns and found evidence of the potential mechanisms that power this relationship. First, we provided new descriptive statis- six years, which account for nearly 18% of consistent driver of returns. Casual evi- tics and stylized facts on the distributionall PE investments, had a median IRR (PME) dence suggests that the scale of PE rms is of performance, duration and size of PEof only 8% (0.79). an important concern for investors. Lerner investments around the world. We found a Our statistics uncovered additio-et al. (2005) argue that the unprecedented dramatic dispersion in the rate of returns:nal stylized facts for investments acrossgrowth of the private equity industry investments in the 75th percentile havecountries. We documented substantial appears to have changed the industry in an internal rate of return (IRR) of 50%, underperformance of investments in emer- some permanent ways. First was the scale whereas those in the 10th percentile earnging markets, which may be of interest at which private equity groups operated. nothing. Most investments in our dataset given their recent spectacular growthThese concerns were particularly acute on are relatively long-lived, with the median surges. The data also allowed us to show,the buyout side, where multi-billion-dol- duration of the investments being nearly for the rst time, that most PE invest-lar funds have become the norm. Along four years. But evidence emerged from ourments around the world are small equi- similar lines, Swensen et al. (1999) repor- analysis that the long-lived investments ty-wise. The median equity investment is ted that many LBO rms appear to have are not the ones that deliver high returns.US$10 million only. The large deals trum-explicitly lowered their return hurdles [], In fact, we observed a strong negative as- peted in the press are, by far, the exception. pricing deals to yield returns in the mid- sociation between performance and dura-Second, we identied the drivers behindto-high teens. Indeed, the current scale tion. Quick ips (investments held less than the great variation in the performance ofof several PE rms contrasts sharply with two years), which account for 12% of all PEPE investments. Our investment-level datathat of PE rms 20 years ago. When com- investments, have median IRR (Public Mar-allowed us to document the performance paring the 16 professionals at KKR and the ket Equivalent [PME]) of 85% (1.94), whe-impact of several investment and PE rm470 at RJR Nabiscos headquarters, Jensen reas investments that were held more thancharacteristics. We found that the small (1989) suggested that PE rms were posi-investments outperformed the larger ones.tioned to generate superior performanceIn addition, and contrary to some of the partly because they were lean and focused Guest contribution by:arguments by fund managers, our resultsorganizations.show a close connection between publicToday, the industry is more concentra- Ludovic Phalippouand private equity: the average stock-mar- ted (Cornelius et al. 2007) and PE rms Associate Professor of Financeket return over the life of an investmentsometimes have hundreds of professionals University of Oxford Said Business Schoolhas a signicant impact on IRR.from a variety of backgrounds doing a ludovic.phalippou@gmail.comOur most important nding, however,large number of deals around the world.is that PE rm scale is a signicant and Blackstone, a prominent PE rm, des-38 The Global Venture Capital and Private Equity Country Attractiveness Index - 2011 annual 37. cribes itself as: A rm of 1,300 professio- This means that, if a rm turns out to beWe performed a series of tests whichnals in 15 ofces worldwide. But we aretoo big, it takes a few years for investorscorroborated the robustness of the nega-more than that, our portfolio companiesto adjust its size.tive scale effect. Diseconomies of scaleemploy nearly one million people around In view of these theoretical arguments, were present across subsamples; they sur-the world making us a major factor in eco- communication costs should be a key de-vived the use of alternative econometricnomies around the world. If our portfolioterminant of performance. Using the data methods and they were not the result ofholdings and transactions were combinedwe gathered for individual investments,a simple mechanical effect resulting frominto a single co