The VC Participants in China

Due to the political system, the VC source of Chinese is different from that of Japanese.

The main source in China is from the government, while the financial system finances the venture capital to be extremely limited. The experience in the United States suggests that, as an economic policy, allowing pension funds to invest in venture capital could be a great success. Therefore, in the source of funds, China should let individual fund and the commercial fund enter the venture capital market, break the sole funds source pattern.

Moreover, in the investment stage, the capital should invest into the seed and early stage of emerging and high tech enterprises. Today, there are four distinct types of VC firms in China,

 Foreign Firms;

 Government Firms (university firms included);

 Corporate Firms; and

9 However, today this pervasive government role in the economy is in one of the two institutional systems that potentially impact firms’ behavior. China’s transition has led not to a full-fledged market economy but to two divergent outcomes.

 Chinese-foreign Equity Joint-venture Firms.

Each of the different types of venture capital firms has experienced some successes and some difficulties, though foreign venture capital firms are most active. Each of the different types of venture capital firms has experienced some successes and some difficulties, though foreign venture capital firms are most active (Ahlstrom et al., 2007). The VC industry in China saw meteoric growth through the decade, first led by American and other foreign private equity firms, with domestic firms entering the scene in late 2006 and rapidly catching up. The American private equity firms are pioneers and industry leaders in the world. There players brought fresh and bold ideas into the fledging and tightly controlled capital markets in China (Zhang, 2011).

From Figure 3-1, we see the RMB funds become the main power of venture capital market in China. The raising and investment of RMB Funds increased rapidly, about 70%

newly raised funds in the total number were raised in RMB. Obviously, RMB began to dominate the absolute advantage in the number. although the foreign capital was still the main part in the volume, the foreign venture capital institutions have established RMB funds one after another with the gradual maturity of venture capital market. In terms of the structure of ownership, the local VC firms keep on growing and occupy around 40% of the investment amount (Figure 3-2). Both trends show that the Chinese venture capitalists are getting mature after 30 years development in China. The money inner China is not only sufficient for VC development, but also looks for investment opportunities outside.

It is mainly because that China government allows foreign private equity and venture capital firms to raise funds that are structured as limited partnerships (LP, it will be discussed in later content). It enables RMB funds to become the fund platform of choice for China's private equity market. These funds raise capital mainly from institutional investors such as government and corporate pension funds, insurance companies, and endowments, as well as

from high net worth private investors to play as the LP.¹⁰ Even Zhang (2012) argues that China still needs alternative mechanisms for simulating fund raising from the pension funds and the independent status of venture capitalists.

Furthermore, in July 2011, the China Securities Regulatory Commission (CSRC) issued the Regulatory Guidelines for Securities Firms’ Direct Investment Business (the Regulatory Guidelines), one of the highlights in the Regulatory Guidelines is that brokers’ direct investment subsidiaries are allowed to set up direct investment funds to raise capital by private placement, instead of only being allowed to participate in the direct investment business with their own funds. Since the issuance of the Regulatory Guidelines, brokers’

direct investment subsidiaries are not only expected to bring in LP to raise more funds, but also take a role as a general partner(GP) to gain ‘management fee + commission’ earnings.¹¹ The RMB fund therefore grows so tremendously in 2011.

 Foreign Firms

The most important and active venture capital firms in China were foreign venture capital firms in the past (the top active foreign firms please see the Table A-4 in Appendix).

The first international venture capital firms entered China in the early 1980s. The impetus for the development of the Chinese venture capital industry was government policy; in China the government still has a dominant role in the economy.

China moved toward allowing LP fund structure in the private equity market since 2009.

Today, even the new raised fund is mainly in RMB, the foreign LPs still control more than RMB 613 billion of capital, compare to the RMB 142 billion under local LPs, according to Zero2IPO Research.

10 The National Social Security Fund plays an crucial role on it, the accumulated investment in 2011 was RMB 19.5 billion, and expected to increase to 50.0 billion in 2013, according to the Fund disclosed.

11 KPMG, Mainland China Securities Survey 2011; on 11 September 2007, the CSRC gave brokers the green light to launch their direct investment business. So far, 31 brokers have been granted permission for direct investment, 25 of whom commenced business via their subsidiaries in 2010. They disclosed a total of 147 investment projects with a total value of RMB 6.5 billion.

Source: Zero2IPO (2012), Yearbook 2012.

Figure 3-1: Fund Raised in China by Currency—2004~2011

Source: ChinaVenture, “Annual Statistics & Analysis of China’s VC Investments”, 2012.

Figure 3-2: Chinese Vs. Foreign VC investment—2006~2011

-5,000 10,000 15,000 20,000 25,000 30,000

2004 2005 2006 2007 2008 2009 2010 2011

US$ million

RMB Fund Foreign Currency Fund

7.0 8.0

20.0 25.0

37.7 41.1

0 10 20 30 40 50 60 70 80 90 100

2006 2007 2008 2009 2010 2011

%

Foreign Firms Local Firms JV

 Government Firms

Broadly speaking Chinese venture capital companies fall into three categories: They are set up by government agencies, such as the Shanghai and Shenzhen governments; by universities like Tsinghua, keen to trade on their technical expertise; and by large listed corporations like Haier and Legend (Haberich, 2011). In a series of new regulations and decisions, Chinese government at national, provincial and municipal levels sent strong encouraging on the country’s private equity industry, including the VC firms (for the top active local firms, please see the Table A-1 in Appendix).

In 1984, the National Research Center of Science and Technology for Development suggested that China establish a venture capital system to promote high technology (White et al., 2002). Local governments in China encouraged and sometimes sponsored venture funds to invest in state owned enterprises to bring them up to a world standard for productivity and quality. One early such company was China New Technology Venture Investment, founded in 1985. Some were established firms, and others were founded solely to invest in China firms, particularly established state owned enterprises.

Around 2000, with the internet boom, a number of venture firms tied to universities started to appear. Obviously these firms have the significant advantage of having access to and intimate knowledge of investment opportunities related to research carried out by their university, such as Tsinghua University and Peking University, arguably with the best reputation in technology.

In order to match Interim Measures on the Administration of Venture Capital Enterprises, Guiding Opinions on Regulating the Establishment and Operation of Venture apital Fund of Funds were promulgated by the State Council in October 18, 2008, which benefits the raising and investing of the Venture Capital Fund.

It causes a bunch of Guidance funds established coming up. The Shanghai government once attempted to use “seed” capital as start-up funds to promote innovation and transfer of scientific and technology achievements in the form of social funds participation in 1999. But the venture capital guidance funds hadn’t developed rapidly. After the promulgation of Interim Measures on the Administration of Venture Capital Enterprises, all the government began to establish guidance funds.

In 2008, with the promulgation of “the Guiding Opinions on Regulating the Establishment and Operation of Venture Capital Fund of Funds”, the establishment of venture capital guidance funds emerged prosperity. Such as Beijing City, Anhui Province, Jilin Province, Suzhou in Jiangsu Province, Shenzhen, and Zhongshan in Guangdong Province, Yunnan Province and so on prepared to establish guidance funds. The scale of guidance funds increased to US$ 1.29 billion in 2008 from the figure US$ 365.79 million in 2006, according to “China Venture Capital Annual Survey Report 2008” issued by China Venture Capital Research Institute (CVCRI).¹²

 Corporate Firms

As the Chinese government privatized more and more state assets by listing companies in Hong Kong or New York in the late 1990s and after 2000, some of those newly listed companies found themselves cash-rich beyond their needs. Some of this excess cash found its way into domestic venture companies. Accordingly, after the government published Proposal No. 1 in 1998 a large number of corporate venture firms were set up. They represent the majority of domestic venture capital funding and one in ten listed companies have its own venture arm (White et al., 2002). Meanwhile, as mentioned above, the local securities industry is allowed to invest directly and raise capital by private placement any kind of fund

12 CVCRI is one of the most influential hub and platform for China’s overseas investments and China’s venture capital industry development. CVCRI headquarter is located in Hong Kong, with operational headquarter in

including VC, buyout, industry and restructure etc. It also triggers more corporate firms to enter the VC market.

Table 3-1: Domestic Sources of Venture Capital by Distribution－2005~2008

Unit: %

Year Government Financial

Industries Enterprises Individuals Others Total

2005 31.9 14.8 46.4 3.0 3.8 100.0

2006 33.6 13.0 44.9 5.7 2.7 100.0

2007 24.1 7.9 53.5 10.5 4.0 100.0

2008 25.2 10.7 39.7 19.3 5.1 100.0

Source: CVCRI (2009), China Venture Capital Annual Survey Report 2008.

 Chinese-Foreign Equity Joint-venture Firms

The kind of structure is getting popular gradually. For the foreign partners the motivation for entering into such an arrangement tended to be access to local information and contacts. The Chinese side was looking for a stronger capital base and a faster move up the learning curve by associating with an experienced foreign team. Particularly, after the LP structure is applied, it becomes tendency.