Tag: Politicking

Russia and the WTO: The Private Equity Outlook

Posted on by Nikolai Karetnyi

Russia’s ascension into the World Trade Organization signaled an expected, but nonetheless major, opening of the Russian economy. Russian membership in the WTO will dramatically lower tariffs for both Russian exports and imports into Russia. These developments, coupled with Russia’s growing middle class, global engagement through the 2014 Winter Olympics and 2018 World Cup, and market reforms, seemingly transform Russia into a hotspot for private equity investment.[1] However, the actual picture is far from rosy. Despite ending its holdout as the last G20 nation not in the WTO, Russia will continue to challenge private equity investors through both structural and legal barriers.

Many forecast the effects of Russian membership to be similar to those of China’s. After joining in 2001, China’s exports rapidly grew and its economy adjusted to meet the rising global demand for cheap Chinese exports. But simply put, Russia is not China. Though Russia’s economy is also based on exports, these exports are often commodities rather than cheap products buoyed by low wage costs. Additionally, state ownership and interventionism remains the norm in the attractive commodity sectors, meaning that Russia will be slower to adapt new reforms to compensate for the opening of its markets. [2]

This is particularly significant for private equity companies aiming to invest in Russia. While barriers to foreign investment in the crown jewels of the Russian economy (oil and gas companies) are unlikely to be removed, more foreign investment could flow into Russia’s manufacturing sector. Between 2007 and 2011, the manufacturing sector accounted for 51% of investment projects and 92% of job creation. Other similar sectors, such as the industrial and food sectors, also attracted a high number of projects and significant foreign investors. With newfound access to European markets, these sectors should experience an influx of private equity investment in the near future. [3]

Despite Russia’s economic structural limitations, private equity investors remain confident in Russia’s future growth. [4] The main reason for this confidence is Russia’s growing domestic market. Due to rising wealth levels, about 25% of Russia’s population now calls itself middle class. [5] This is a stark contrast to the oligarch-driven wealth gap that typified Russian society in the 1990’s and early 2000’s. Russian companies, already experiencing a trade surplus, will look to capitalize on the growing middle class rather than exporting to new markets. However, the specter of European competition in Russia’s markets will necessitate expansion and an influx of both domestic and foreign private equity.

While economic forces have seemingly aligned to attract investors, Russia’s culture of bureaucratization and corruption continues to ward off private equity. Additionally, the politicization of Russia’s economy also creates a major barrier for American companies. Currently, the US and Russia do not have normal trade relations due to the Jackson-Vanik Amendment, thus the US is precluded from using WTO mechanism to challenge Russia’s higher tariffs on American goods. Strict government regulation of foreign investment and corruption at all administrative levels further complicates private equity investment in Russian companies. However, investors who have already successfully navigated these barriers remain confident in future growth. For new investors, the risks may be justified by the increasing rewards of Russian companies expanding inward to a robust domestic market.

[1] Positive Outlook for Russian Investment as it Joins WTO , Ernst & Young Emerging Markets Center (Sep. 7, 2012), http://emergingmarkets.ey.com/positive-outlook-for-russian-inward-investment-as-it-joins-wto/

[2] Matthew Philips, Don’t Get Too Excited About Russia’s WTO Deal, Bloomberg Businessweek (Aug. 22, 2012), http://www.businessweek.com/articles/2012-08-22/dont-get-too-excited-about-russias-wto-deal

[3] See note 1, supra.

[4] Lena Smirova, Russia Climbs Up Investment and Business Climate Rankings, The Moscow Times (October 25, 2012), http://indrus.in/articles/2012/10/25/russia_climbs_up_investment_and_business_climate_rankings_18629.html

[5] See note 1, supra.

JOBS Critics

Posted on by Luke Rachlin

As the JOBS Act awaited President Obama’s signature this week, critics, emboldened by accounting issues at the recently public Groupon, continued to take aim at provisions alleged to roll back crucial investor protections. Passed by strong majorities in both the House and Senate, the principle purpose of the JOBS Act is to promote capital raising among startups by easing their paths toward an IPO. Opponents of the Act, however, claim that its relaxed financial disclosure standards invite a reemergence of Enron-era accounting fraud.

Recent news on internet startup Groupon has stoked much of that criticism. Last Friday, in response to an auditor’s determination of a “material weakness in internal controls over financial reporting,” the company revised fourth-quarter earnings down by $14.3 million.1 Had the Act been in place, Groupon’s revisions would not have been a product of adjusted reporting requirements; the relevant JOBS provisions apply only to companies with less than $1 billion in annual revenue and $700 million in market cap, while Groupon earned 1.6 billion in 2011.2 Nonetheless, critics contend that events at Groupon highlight the risks associated with easing financial disclosure requirements, generally. Had the Act been law before Groupon went public last year, some point out, its annual revenue of less than $1 billion would have made it eligible for relaxed reporting requirements and the company’s questionable accounting methods may not have drawn the attention that they are getting now.3

Among the specific provisions targeted by the Act’s opponents is that which allows emerging companies on the verge of an IPO to have “private conversations with the S.E.C. about planned disclosures,” not to be made public until 21 days prior to an offering.4 Andrew Ross Sorkin of NYTimes Dealbook wrote recently that the provision, which allows companies to avoid “embarrassing public gaffes,” may benefit those seeking to go public who would otherwise be discouraged by accounting scrutiny, but is “awful for the investors, who rely on the transparency of the process.”5 Had the Act applied to Groupon’s public offering, Sorkin explained, “it is unlikely the public would have found out in time about a series of questionable accounting gimmicks and metrics that the company had hoped to employ to bolster its numbers investors.”6

The same day that Sorkin’s comments were published, The Wall Street Journal’s Michael Rapoport weighed in on the 21-day provision, characterizing it as permitting companies to “iron out disagreements with regulators behind closed doors before they go public.”7 This practice, Rapoport agreed, “might have prevented investors from finding out about Groupon’s early accounting questions until after they had been resolved.”8

Others, however, are less concerned. Joel Trotter, a Latham & Watkins attorney on the task force responsible for devising ways to make it easier for companies to file publicly, was quoted by Rapoport claiming that “three weeks is an extremely long time in assessing information relevant to an investment decision.”9 AOL Founder Steve Case has similarly responded that, while the bill is “not perfect,” it will ultimately “strike the right balance” between encouraging IPOs and maintaining appropriate disclosure standards.10

Opinions are clearly divided and the debate surrounding a 21-day notice provision barely scratches the surface of that division. If the last major adjustment to financial disclosure standards (See SOX 2002) provides any indication, it does not appear that the debate will be ending anytime soon.

_________________________________________
1. http://dealbook.nytimes.com/2012/04/02/jobs-act-jeopardizes-safety-net-for-investors/
2. http://online.wsj.com/article/SB10001424052702304023504577317932455874856.html?mod=googlenews_wsj
3. Id.
4. http://dealbook.nytimes.com/2012/04/02/jobs-act-jeopardizes-safety-net-for-investors/
5. Id.
6. Id.
7. http://online.wsj.com/article/SB10001424052702304023504577317932455874856.html?mod=googlenews_wsj
8. Id.
9. Id.
10. http://dealbook.nytimes.com/2012/04/02/jobs-act-jeopardizes-safety-net-for-investors/

Interview with Angel Investor Esther Dyson

Posted on by Anna Walker

Last semester, Esther Dyson, an angel investor focused on health, biotechnology, and space flight innovation, was featured as a keynote discussion sponsored by the Telluride Association. After Ms. Dyson shared snapshots of her experiences, including her work as a journalist on Wall Street and her completion of cosmonaut training for a future space flight, I invited her to share some of her perspectives on investment with our readers. The following is an edited version of our conversation.

When did you start investing in startup companies?

To give you some background first, I started working as a fact-checker for Forbes. That provided tremendous training for all my work – perhaps the best training you could have – in asking the right questions, and being properly skeptical of the answers. I worked for Forbes for three years and then worked as an analyst on Wall Street for five years. Next, I worked for Rosen Research and bought the company, renamed to EDventure. I wrote its monthly newsletter about the computer industry, and ran its annual conference (PC Forum) from 1982 until 2006. That’s where I learned the most about computers and the internet.

Then, in the early ‘90s, I started spending a lot of time in Eastern Europe. An investor said to me, “Considering the amount of time you spend in Eastern Europe, why don’t you invest?” I had never thought of that; I was a journalist. But, when he offered me $1 million to invest, I closed down my Eastern European newsletter and started investing instead. I learned a lot from these early investments, including how much fun it could be. I started investing in United States startups as well.

You mentioned in our correspondence not having an MBA. Was it difficult breaking into the financial industry without this degree?

An MBA makes it easier to find a job, yes. But once you get the job, it all depends on how well you do it and whether you can learn.

When someone on Wall Street looked at your resume and asked, “Why no MBA?” what did you say?

I told them I worked as a fact-checker and reporter for Forbes for three years, and that I understood business from the players’ rather than from the professors’ side.

What other characteristics do you believe make you a good investor?

Curiosity and enthusiasm. I love what I do! I would love to make money with my work, and I am glad when I do – and of course I need money to keep investing. But for the most part, I don’t do anything I wouldn’t do for free. Fortunately most of it pays off anyway!

How important is it for investors to share ideology with the company receiving their investment?

Oh, very important. When you need to make a tough decision for the company, it is important to have your interests aligned. Startups should be selective when it comes to picking their investors because their investors end up having a big say in the company’s direction.

Do you use investment to promote or change public policy?

No. It’s hard to change public policy. In fact, I am very frustrated with Congress and both political parties. I use investment to do what I can to help companies, ideas, and people fulfill their potential. I do get involved in policy, but not usually through my investments. Unfortunately for most companies, the less they have to do with policy the better – at least until they grow quite large.

What role should public policy play in investment?

It depends on what the policy is. Generally, the best policy for free markets is antitrust enforcement. Competition and transparency are crucial for building companies and fostering success of the best players. Maintaining consumer choice is also important.

Most markets work well. If you introduce public policy in the market, such as subsidies for health care, you should make sure the policy has no adverse side-effects. Moreover, these policies should be clear, transparent, and have discrete objectives. For example, it’s usually better to subsidize people rather than specific products. You can help the poor or the ill without interfering with their ability to choose. Though I would support policies such as prohibiting the purchase of cigarette or soda pop with food stamps.

For me, areas in need of public spending are health incentives – not just health care – education, and our country’s infrastructure, such as roads and bridges and mass transit.

Thinking about your involvement as a board member for 23andme, what role should public policy play to protect privacy? For example, should public policy protect privacy over consumer health information?

The government should foster clarity and informed consent, and leave privacy choices to individuals. People should have access to their own data and retain control over whom to share it with. However, if individuals want subsidized health care, they have certain obligations to provide accurate data to be used in the context of that care – but mostly not in the context of an employer making job-related decisions.

The problem, however, is not privacy. The problem is how the data may be used and society’s overall economic and health-related policies. I would hate to see people with diabetes being charged an extra tax on junk food, for example.

Unfortunately, we are conflating economic issues, such as who should pay for health care and what they should pay for, with privacy issues, such as what health information individuals should be required to reveal and to whom these disclosures should be directed.

How should companies properly use the data they receive from consumers?

They should use it only in the way they have contracted with the user to use it.

Switching gears a little, and in closing, what are your most memorable accomplishments?

First of all, I like to say that I’m not done yet. I don’t sit around and think about everything I have done. I am proud of having trained as a cosmonaut and I am proud of being one of the first ten to publish my DNA with the human genome project. I am also proud of 23andme. But there are so many things I still need to learn and to do.

For more information about Esther Dyson please visit EDventure Holdings or check out her contributions on Project Syndicate.

Michigan & the Smart Money: What the State Needs Today to Build Tomorrow

Posted on by Joseph R. Morrison, Jr.

The smart money has not been flowing into Michigan in a long time. However, that money is starting to come back to Michigan again. This smart money—investments coming from well-informed and experienced financiers —is the key to a recovery for Michigan, and the state government needs to work hard to accelerate that trend. As Michigan shifts away from the auto-dependent economy that has forced the state into a multi-decade decline, the state government needs to focus its effort on attracting the smart money, and it needs to ramp that effort up now.

In order for the state to diversify away from the auto industry, Michigan should make a concerted effort to attract smart money with as much effort as it expends trying to attract tourists. Central to a recovery will be the smart money that helps grow new businesses. Venture capital companies can provide the money and expertise to help young companies get off the ground at a time when traditional funding routes are not open to start-up businesses. Michigan is ripe for continued growth if it focuses on showcasing what it has in spades: a strong university system that spins off opportunities and talent, an abundance of skilled labor, and low barriers to investment. Not only is there room for more money in Michigan but also the demonstrated venture capital returns are impressive enough that the state should be able to sell itself as an attractive investment locale if it makes the effort.3

Michigan’s CEO, Governor Rick Snyder, and its Board, Michigan’s legislature, need to coalesce around this reality; the path to recovery will come if Michigan focuses on attracting the smart money. Quick hits and fun headlines will not help, but venture capital firms like Detroit Venture Partners will. The venture capital investments can help build a solid foundation for a diverse economy, and they can leverage the work already done, such as Governor Granholm’s focus on attracting new industries by encouraging investment in battery and alternative fuel manufacturers. The blitz should ensure that local companies know where to seek the funds. Michigan should also showcase what the state offers to large venture firms around the country. This won’t be a sexy, short-term investment like film tax credits, but it will help create jobs, and it will build a strong foundation for growth and diversification.

Right after Governor Snyder gets home from his trip to Asia, where he will try to drum up trade deals, he needs to have his Chief of Staff put together a domestic itinerary. If Gov. Snyder puts in some hours promoting Michigan in Silicon Valley and New York City, those cities will be promoting Michigan in the not-too-distant future as the next great American turnaround story