Risks and Expected Returns in the Venture Capital Process

Usually have management, business plan and market research.

 First-stage financing: financing for companies lacking capital to produce goods and launch them on the market.

 Expansion financing: The VC Fund finances businesses to expand production, expand market scope; or develop and upgrade a product and finance companies preparing for initial listing within the next 6 months to 1 year. At the same time, the Fund also helps businesses build a reasonable ownership structure. This stage has begun to bring financial benefits to all parties, including benefits in building high-tech capacity for the economy.

 Later stage : is the stage where businesses penetrate deeply into the market through accelerated business activities and creating new products. The stock market often plays the role of a bridge between businesses and the market during this stage .

Table 4: Expected Risks and Returns in the Venture Capital Process

Risk potential

Highest Lowest Technology Incubation Product Development LBO 7
	Stage
% ROI 8 expected	50% 40% 30% Highest Lowest
Profitability

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Source: Compiled from research by MSc. Dang Thi Thu Hoai, Central Institute for Economic Management and Research, 2003.

2.3.3 End of investment (also known as exit)

Venture capital operates in cycles, and each cycle usually ends with an exit, which is when venture capital managers liquidate their investments, recover capital and profits (if any) and distribute them to the participants. Exit is an important step, not only because it satisfies the interests of the participants but also because it will increase the efficiency of using the financial and non-financial contributions of venture capital managers due to the rotation of capital to support

7 LBO: Leverage buy out – Buy back with borrowed capital

8 ROI: Return on investment – Return on investment

for a new generation of startups. That is why this is a special feature of this capital channel.

Exits also have an impact on the relationship between a venture capital fund and its investors. Exits satisfy three problems in the venture capital manager-investor relationship. First , capital providers need a way to evaluate the skills of venture capital managers, so that they can decide which managers to provide new capital to. Second , capital providers need to evaluate the risk and return on venture capital investments relative to other investments, so that they can decide whether and how much to invest. Third , capital providers need to be able to withdraw capital from less successful managers. The exit of venture capital funds from specific portfolios creates a benchmark that allows capital providers to evaluate both the skills of different venture capital managers and the ability of venture capital to generate returns relative to other investments. At the same time, paying the exit proceeds to the capital providers would allow them to rotate funds from less successful venture capital managers to more successful ones.

Capital exit channels

- Initial public offering (IPO ): is when a company is listed on the stock market for the first time and sells shares to the public for the first time. Accordingly, the issued securities must be high-quality securities, the issuing company must be a company with future development prospects, and to be issued, the issuing company must satisfy many requirements of the securities market management agency. If a young company is successful and needs more equity capital to develop production and investment, this is a good thing to do.

This exit route, although costly, is the preferred route because it generally yields the highest valuation for the company while preserving the independence of management. The potential for an exit via an IPO allows the startup and the venture capital fund to enter into a

The implicit agreement automatically enforces control, whereas the venture fund agrees to return control to the successful startup, by exiting through an IPO with the assumption that the startup will retain control over a sufficiently large block of shares.

Through an IPO, the VC’s stake is reduced and the recipient company is no longer dependent on the VC’s stage-by-stage funding. The IPO reduces the startup’s liquidity constraints and the stock market reduces the need for close monitoring by the VC. Finally, the explicit contract between the VC and the recipient company ensures that significant control rights initially granted to the fund are lost after the IPO, regardless of whether the fund sells shares.

- Commercial sale : is a fairly common exit channel, especially in Europe where most countries have a financial market based mainly on banks. It is the sale (or merger) of a new company to a larger company. Compared to the exit channel of initial public offering (IPO), commercial sale is considered a faster and cheaper method. Large companies, especially those with complete products and stable income streams, are often more interested in buying profitable startups than building new businesses from scratch. In addition, business acquisitions are also due to the following main reasons: (1) Obtaining people, skills or intellectual property, especially in the high-tech sector; (2) Being able to combine the business areas of this enterprise to supplement and support other activities of the company; (3) Acquiring a competing business competitor to increase market share and gain large profits; (4) Customers always want to go upstream in the supply chain to ensure a stable supply and minimize costs; (5) Suppliers want to go downstream to control market share.

This approach ensures the possibility of refinancing by a new investor at the end of a closed-end fund, while also ensuring independent valuation. In addition, it allows the management of the investee company to remain on board immediately.

even without the option of an IPO, and allows a company to refinance. However, this exit route can be detrimental to the company’s management, as they lose their independence when they are acquired or merged with a larger company.

- Share buyback : is a popular exit channel in VC and is very important for investors. At the same time, it also allows the capital receiving company to regain control after having to share and be governed by the venture fund. When conducting this form, the partner entrepreneur will buy back the venture fund's ownership in the business at a value higher than the valuation of the equity they are holding by borrowing capital from the fund itself (as well as from any other VCs participating). They will gradually repay the debt with the income from the acquired business and the debt payment will be completed at the closing stage.

II. THE ROLE OF SME IN THE NATIONAL ECONOMY

The scientific and technological revolution has created rapid and miraculous changes in the world. The time from research and development to application into production is very fast, and the product life cycle is also reduced. For businesses, research and development and technological innovation are vital to survival and development. As for countries that are masters and leaders in science and technology, it will directly affect the position of that country in the international arena. Therefore, countries around the world always want to create an open investment environment to attract more domestic and foreign capital in general to invest in industries in the national economy. And FDI capital in particular is for businesses (usually small and medium enterprises SMEs) to develop new technologies, highly creative but with high risk of failure. Thus, FDI has a direct impact on the following factors:

1. For businesses, FDI has two basic roles:

 Firstly, providing financial resources for businesses , especially high-tech businesses. For many different reasons, large corporations find it difficult to implement risky technological product innovation projects. Meanwhile, small and medium-sized enterprises are more successful in implementing these projects with financial support from investors, because the capital source

Venture capital does not require enterprises with projects to have collateral or credit as other traditional credit sources. In the 5 funding stages of the venture capital process (presented in the previous section), funding for the first 3 stages (seed/incubation stage, initial stage and start-up stage) plays a very important role because it affects the nurturing of creative ideas and solves the scarcity of other capital sources. In these 3 stages, the banking system is completely unable to provide capital for new technology ideas due to the high failure rate. Only when enterprises expand production and supply products to the market, then banks will provide capital at a relatively limited level to enterprises.

Table 5: Investment capital for businesses in stages 9

Stage

Research and Development (seed/incubation)

Testing (startup & early stage)

Expand production and accelerate

Main sources of capital

- State budget

- Funding from individual capitalists

- DTMH

- State budget

- DTMH

- Bank

- Capital market (stocks, bonds)

- DTMH

Source: Economic Research Journal, No. 305, October 2003, pp. 12-13. Venture capital has helped these enterprises innovate production and business, promoting the process of launching products to the market as well as listing on the stock market. In fact, most of the pioneering companies in creating and exploiting new generations of computers and software products, contributing to promoting the new technological revolution and the shift in industries such as Intel, Microsoft, Yahoo, Apple, and recently Google ... when starting up all received venture capital, Apple company in the early stages of its start-up received

400,000 USD of venture capital, Yahoo company received 4 million USD. In fact, in the US, not only the above mentioned businesses when establishing and developing depend on

9 This diagram is only correct in cases where a person/organization has a creative idea or new technology but does not have enough resources to develop their project.

Thanks to venture capital support, at least 50% of high-tech companies have received help through VC funding during their development.

Thus, the success of these enterprises not only brings profits to enterprises and capital providers but also contributes to economic development in general. The emergence of FDI activities has led to the emergence and completion of a series of other industries such as the stock market and high-tech fields. In terms of society, the emergence of FDI activities to invest in enterprises has contributed to solving the employment problem for many people in society.

Second, support businesses in conducting business activities. Not only providing capital, VCs also support business administration such as recruiting professional management teams, planning production, sales, marketing ... In addition, they also provide legal advice such as intellectual property rights, patents, trademarks. VCs also support the issuance of shares of businesses, remove difficulties in applying for legal procedures for newly established businesses, as well as disputes when businesses encounter contracts ... All of these support activities are supported by VCs with the highest goal of helping businesses grow and develop quickly, and ultimately they will reap profits from the investment they have made.

2. For the financial market in general, and the stock market in particular

Securities trading is a form of capital business, so it is an important and inseparable part of the financial market. With the characteristic of withdrawing capital and making profits mainly through the stock market, securities trading has had a significant impact on the development of the financial market in general and the stock market in particular.

The IPO market is growing rapidly. One of the most important and popular exit methods of the IPO is to offer shares of the investee company to the public, which means transforming the company from a private joint stock company into a public company. This is a unique exit method of the IPO type, stemming from a characteristic of this type of fund that takes newly established or growing private joint stock companies as the main investment target. Even a private joint stock company being funded

The fact that the capital of the private equity fund is converted into a public company is also considered one of the factors proving the success of the private equity fund itself. However, the relationship between the private equity fund and the IPO market is not simply a one-way relationship, but on the contrary, they have a mutual influence. To convert a company from a private ownership form to a public company requires an active IPO market. Conversely, a developed IPO market is also one of the necessary conditions to create the premise for the private equity fund to promote its role.

In addition, the financial market also has a reciprocal relationship with other financial institutions such as banks, insurance, etc. Therefore , if the financial market operates well, it will also promote the development of these financial institutions and thereby the stability of the financial market in particular and the economy in general.

3. For the process of technological innovation

The relationship between FDI and technological innovation stems from the characteristics of FDI specializing in investing in projects with bold ideas, requiring large amounts of capital, and high technology is a field that meets these standards. There are many factors contributing to economic growth such as the quality of labor and capital, technological progress, the level of competition, economies of scale, resource reallocation, economic policy, etc. in which the technological factor plays an important role. Indeed, it contributes to increasing labor productivity of labor and capital factors, if investment in science and technology is effective, and therefore, inevitably leads to high economic growth. However, investment in technological innovation requires increased investment capital. In developing countries, the problem of lack of capital to develop science and technology to meet the needs of economic growth becomes a vicious cycle. To break that vicious circle, the state needs to have policies to attract investment capital for technological innovation in the most effective way. There are many different sources of capital to finance technological innovation. In which, venture capital is one of the key sources of funding to promote the development of science and technology, increasing the factor of energy.

TFP 10 and thus promote sustainable growth and development of the economy.

Attracting venture capital, especially from foreign sources and from the domestic private sector, will first of all reduce the pressure on investment capital for technological innovation activities. In addition, the skills and management experience of venture capitalists will lead to investment capital being used effectively for the process of developing and applying technology to economic activities. In addition, investing venture capital in the process of technological innovation will create opportunities for the development of new industries and new businesses, thereby contributing to economic restructuring, reducing unemployment, promoting sustainable economic growth and development.

In addition, venture capital also plays an important role in creating close links between organizations such as financial institutions, universities, technology-oriented enterprises, industrial corporations and forming a "complex network". The links in this network are closely linked together, supporting each other to develop together. The development in depth and breadth of this network contributes to promoting the development of science and technology, innovation of the education system, development of financial markets, development of small and medium enterprises in the field of technology development and application and thus contributes to promoting the economic growth of the country. Moreover, the effective operation of venture capital organizations and organizations in the network will limit the situation of information asymmetry, contributing to minimizing risks for investors and for the whole economy in the process of innovation.

For developing countries, where the financial market is not yet developed, small and medium private enterprises are not focused on and invested in, and scientific and technological resources are being wasted, it can be said that FDI is an important solution to develop these factors to achieve the best economic growth.

10 Total factor productivity (TFP) in Cobb-Douglass's product output formula: Y= AxK α xL 1-α where K, L are the input factors capital and labor.

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