The Divestment of the VC in China

Venture capital business is widely regarded for regional economic development and also in capital market enlargements. Venture capitalists enable small firms to tap into technological resources and liquidate their investments. The most well-known way of exit is usually through IPOs. IPOs and mergers and acquisitions (trade sales) are the two primary exit mechanisms for liquidating portfolio companies. The most common strategy to exit or

“harvest” an investment is through an IPO. Venture capitalists generate the highest returns from firms going public.

There are three principal methods of exiting an investment: the first is through an IPO of shares to outside investors, the second is by selling the portfolio company directly to another company, the third is by selling the company back to the entrepreneur. IPOs are by far the most profitable and prestigious option for the VCs.

Venture capitalists take firms public when the equity valuations are at their highest, or turn to the alternative of private financing when valuations decline. More experienced venture capitalists seem to have better IPO timing. This may be due to their proficiency in recognizing when valuations peak. An alternative explanation might be that these seasoned venture capitalists simply have advantages over less experienced peers. They have important connections to investment banks, and less pressure to generate quick returns in order to attract investors for future funds, which affords them the time to wait until the market is optimal (Lerner, 1995).

Most VC backed firms prefer listing on new markets due to light listing requirements.

For example, the resurgence of the U. S. as a technology leader is intimately linked to the success of Silicon Valley (Koh et al., 2002). In U. S., the Silicon Valley model of VC has transformed the innovation process, particularly in the fast growing, high technology sectors where venture-backed firms had risen into prominence, such as Apple in the personal computer, Intel in the semi-conductor, Microsoft and Sun Microsystem in the software, Genetech in the biotechnology, and Amazon, eBay in the e-commerce sector (Rogers and Larsen, 1984).²⁵

5.1.1 The IPOs of Chinese Enterprises

In China, IPO is ranked second in terms of the VC’s post investment. According to ChinaVenture data, the majority of VC exits of 173 projects in 2009 in China were through trade sales (65.9%). This was followed by IPOs at 28.32%, normally the most lucrative exits including the U. S. Liquidation of investments was only 5.78% (Table 5-1).

Today, Chinese enterprises have become the majority firms of the global IPO activities.

From Table 5-3, we can see that the Chinese IPO scale remains active. In 2011, there were

25 Likewise, in Singapore, a number of well-known companies received VC financing at the early-stage of their development. Since the mid-1980s, VC has also contributed to the growth of the number of companies listed on the Stock Exchange in Singapore. These companies include Creative Technologies, Venture Manufacturing and Interwoven.

386 Chinese enterprises that completed their IPOs on the global capital market. The total funding size was RMB 409.7 billion, while VC backed IPO accounted for more than seventy percent of the amount, according to the statistics of ChinaVenture. In addition, the Chinese enterprises’ IPO has become the anchor source of the global stock markets. 808 companies listed overseas from 2002 to 2011, with 592 of them listed after 2006, according to Table 5-2.

Table 5-1: Divestment Routes of the Chinese VC by Project—2006~2009

Unit: %

Year Types of Exit

Trade Shares IPO Liquidation

2006 62.07 31.90 6.03

2007 53.85 42.31 3.85

2008 75.32 23.28 1.30

2009 65.90 28.32 5.78

Source: ChinaVenture (2009), Annual Statistics & Analysis of China’s VC Investments.

Table 5-2: Summary of Chinese Enterprises’ IPO—2006~2011

Unit: RMB billion

Year On Shore Off Shore

Num. of IPO Amount Num. of IPO Amount

2006 14 5.31 73 90.85

2007 66 126.33 81 314.88

2008 125 488.59 103 248.4

2009 76 87.16 54 57.88

2010 99 173.2 93 215.19

2011 347 485.12 143 238.34

Source: ChinaVenture (2009), Annual Statistics & Analysis of China’s VC Investments and Zero2IPO (2012), Yearbook 2012.

In the domestic market, the amount of IPOs in Shenzhen outperformed that in Shanghai due to its multi-tier market in Shenzhen, including the SME and ChiNext (we will discuss the multi-tier market further in Section 5.3). Among the offshore markets, New York and Hong Kong are the major funding routes of the Chinese enterprises.

Table 5-3: IPO of the Chinese Enterprises Backed by VC—2006~2011

Year

Projects Amount (RMB billion)

Num. of All

5.1.2 Performance of the Divestment of VC in China

The IPO returns of VC investments have been remarkable (as shown in Table 5-4), while the return in 2011 declined slightly from 8.04x in 2010 to 7.22x. According to Table 5-5, the onshore market enjoys higher return than that of the offshore. This is due to the limited investment options to the local investor, in our view.

Table 5-4: IPO Rate Return of the Chinese Enterprises Backed by VC/PE—2006~2011

Unit: %

2006 2007 2008 2009 2010 2011

Rate of Return 932 653 411 1140 804 722

Source: Same as Table 5-1.

In 2011, onshore IPO enjoyed an average return of 7.6x. On the other hand, IPO return in the U. S. market was higher than that of other markets. We strongly believe this is because the e-commerce sector (mostly in ZGC) enjoys benefits from the restricted policy, with the U.

S. being the main exit route, and therefore its return on investment was maintained at 10x, attracting one-tenth of the IPO fundraising.

From Table 5-6, we can see that the stock market welcomes the industries encouragedby the Chinese government, such as TMT, medical and health, new energy and energy saving.

The relevant IPOs enjoy significant return, meaning that the enterprises can more easily raise capital from the stock market for the future development and expansion.

Table 5-5: IPO Rate of Return of the Chinese Enterprises Backed by VC/PE in Exchanges—2010~2011 Unit: %

Exchange 2010 2011

Shenzhen-ChiNext 1,213 763

Shenzhen-SME 938 670

Shanghai 703 1,089

Average-on shore 1,040 760

Hong Kong-Main Board 164 140

Hong Kong-GEM - 322

NYSE 571 832

NASDAQ 281 670

Average offshore 350 566

Source: Same as Table 5-1.

Table 5-6: IPO Rate of Return of the Chinese Enterprises Backed by VC/PE in Industries—2010~2011 Unit: %

Industry 2010 2011

IT 1,462 539

Finance 1,422 471

Chemistry 1,233 1,025

Internet 1,156 990

Medical and Health 1,147 -

Telecommunication 780 529

Manufacturing 638 707

Energy and Mining 574 1,196

Housing material 567 -

Cultural and Media 560 126

Agricultural, Forestry, Fishery and Husbandry 431 518

Food and beverage 405 355

Automobile 3.62 3.68

Source: Same as Table 5-1.

IPO plays a crucial role for VC post investment in China. Even mergers and acquisitions stand on top as an exit route. Domestic listings are more lucrative and becoming the mainstream of IPOs. The industries encouraged or policy-protected by the government are more popular for investors, not only for the domestic but also foreign markets.