The Seven Disciplines for Venturing in China

Before investing in China, venture capitalists and private equity investors need to take the time to understand the differences between Eastern and Western business practices.

Venture capital and private equity firms are transforming enterprises in China by exposing them to innovative practices and enabling them to tap into the global commercial and capital markets. In 2004, venture investing in China exceeded a record $1.2 billion, following a three-year downturn.1 Much of the early venture capital went to Chinese companies in sectors such as telecommunications, e-commerce and online gaming, but experienced investors recently have been diversifying into other areas including consumer business, manufacturing, pharmaceuticals and high-tech. On the surface, China’s institutional private equity and venture capital environment is similar to that of the United States and Europe. But there are important differences that investors interested in China need to understand.

To begin with, the Chinese venture capital and private equity market is young: The earliest China-focused funds were launched in the 1980s, and the concept of private capital in China is less than a generation old. In addition, investment firms based and registered in China face regulatory constraints on the organization of portfolio companies and their listing on foreign equity markets, posing serious challenges to raising capital. Listings on local stock markets require government permissions that are difficult to obtain; investor liquidity can be hampered by stringent lockup requirements. Even companies that manage to get their shares listed locally find that the Chinese stock market is not always attractive: The market has seen only modest upward movement in the last three years. This has made local sources of venture capital less appealing to entrepreneurs. Foreign-based venture funds are not always limited by the same factors and allow companies to exist on foreign equity markets. In fact, it is not unusual for venture-backed Chinese companies to move directly from first-round venture financing toward an initial public offering on the NASDAQ, Hong Kong or Singapore exchanges, something that is extremely rare in North America and Western Europe. These Chinese investments are generally in companies with good cash flows, thus positioning them to tap into foreign markets for growth capital and liquidity.

Nevertheless, venture capitalists and private equity investors operating in China face unique challenges. Elements that are taken for granted in entrepreneurial hotbeds such as Silicon Valley have yet to take hold in China. First, there is a lack of readily available information about opportunities, entrepreneurs and companies.

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References

1. China Venture Capital Annual Report 2004: Accounting for purchasing power parity, this figure is closer to $7 billion of investment in the United States, or approximately one-third the level of venture investment in the United States. www.zero2ipo.com.cn.

2. A. Kambil, P. Lee and V. Long, “Changing China: Will China’s Technology Standards Reshape Your Industry?” July 2004, www.deloitte.com/research.

Acknowledgments

The authors would like to thank Chang Sun, chairman of the China Venture Capital Association; Jasmine Lin, deputy secretary general of the CVCA; and other CVCA staff for their assistance with this study. We also thank the investors and other China experts who shared their experiences and insights with us. Finally, we thank our colleagues from China and other member firms of Deloitte Touche Tohmatsu, who helped us improve earlier versions of this study.