Some domestic institutions or the individually wealthy intent on becoming limited partners (LPs) are keeping an eye on all this. According to incomplete statistics, currently 700 billion yuan of private equity has been invested in the Chinese stock market. The wealthy in China, who account for 10 percent of the total population, hold 60 percent of the total savings which amounts to 16 trillion yuan, indicating that wealthy Chinese can afford to get in on venture capital operations. It is therefore inevitable that domestic venture capitalists gradually win dominance in the domestic market.

Barriers to investment

"The Chinese stock market is so hot now," dozens of overseas private equity managers made such comments at the Private Equity Forum China 2007 held in Shanghai from January 31 to February 1. Overseas private equity firms frustrated by pursuing "small red chips" now have a new hope-they will help companies they've invested in get listed on the A-share market.

In fact, this idea is not new. Many overseas private equity firms are attempting to establish renminbi investment funds so as to exit conveniently from the A-share market.

"However, after the law comes into force, investors must take unlimited liability despite savings on taxes and will have slim chances of success," stated Xie Zhonggao, General Manager of the China Region for AsiaVest Partners. "In addition, problems will emerge during the enforcement of the law. Experienced as they are, domestic entrepreneurs and venture capitalists do not have experience in raising renminbi funds."

"It remains unpredictable for renminbi investment at this stage," concluded Xie.

For overseas private equity firms, it has been a problem transferring their profits converted into dollars overseas. The amended Partnership Enterprise Law stipulates a personal income tax rate of 20 percent, seemingly much lower than the enterprise income tax rate of 33 percent, but still a large number for overseas venture capitalists. Xie doubts whether it is acceptable to foreign LPs.

Fund managers generally do not put sufficient confidence in the venture capital market due to a series of considerations. Domestic venture capital partners are usually not professional and do not have a sound knowledge of venture capital investment and operational models. Besides, the poor state of the investment environment in China and a lack of trust in fund managers, as well as the unstable nature of venture capital investment in terms of profit and loss and the long investment period-all are restrictive factors preventing domestic LPs from entering the venture capital industry.

Nevertheless, Xie said the overall government policies are there to encourage and support the development of venture capital investment in China. The key issue at present is the government's attitude on some primary issues, including foreign exchange and the tax rate, according to him. Would the government restrain foreign venture capitalists from transferring profits converted in dollars overseas after they help the invested companies to secure a successful IPO on the domestic stock market? Should venture capitalists report the gross figure or the after-tax figure of their profits to shareholders?

Xie believes some venture capitalists will make moves after the two issues are fixed and at present there are few venture capitalists active.

Two models

"Sequoia Capital and Shenzhen Capital Group have met discreetly to discuss establishing a renminbi fund," disclosed Zhang Fan, founding managing partner of Sequoia Capital China. "The full circulation of the A-share market allows venture capitalists to exit with huge profits after getting their invested companies listed and this is attracting venture capitalists to actively invest via renminbi funds."

ID TechVenture is planning to establish a renminbi fund and will launch it by the end of this year. In addition, several top listed foreign venture capital funds are also considering establishing or operating renminbi funds. However, most of them are still pursuing a successful model due to the absence of any existing one.

For a long time, with foreign venture capital dominating the market, the venture capital industry chain consisted of LPs, the investors; general partners (GPs), the managers; and entrepreneurs, the investment recipients. Over 80 percent of the LPs are overseas investment institutions, banks and wealthy individuals. Although there are some foreign GPs, the majority of them are Chinese. Most entrepreneurs and projects are located in China. This model-raising funds (in dollars), exiting and going public overseas-has always been favored by venture capital funds and is also the favorite for large-scale enterprises being listed overseas.

Currently venture capitalists are interested in two models: One is that overseas LPs directly inject the funds raised overseas into renminbi funds and then invest in enterprises, and the other is "fund to fund"--overseas dollar funds partly invested in domestically established renminbi funds, and the rest taken care of by domestic LPs such as local governments, private businesses and publicly listed companies. In the second model, the Chinese partner of the overseas fund manages this renminbi fund and invests in domestic companies.

Up until the present, there are three joint venture foreign currency funds. Among them, the Sino-Swiss Partnership Fund and the China-Belgium Partnership Fund are direct equity investment funds and the Bohai Sea Industrial Investment Fund is the first contract-based industrial fund registered in China and also the first industrial investment fund raised in renminbi in China.

The Bohai Sea Industrial Investment Fund adopted the first model but hasn't yet completed the structuring. As to the second model, no one has yet attempted-this new venture capital investment is still in the exploratory phase.

(Xinhua Finance)