However, neither form is appropriate for private equity funds-a fund manager's rights and interests do not match his responsibilities, undertaken as a shareholder or investment advisor. Besides, a company-based fund is faced with stiff procedures for paying capital or quitting, which also doesn't match the characteristics of investment funds.

According to the new Partnership Enterprise Law, private equity funds are allowed to operate on the basis of a limited partnership. Under this framework, a fund management company, established as a common partner, is liable to unlimited responsibility and controls decision-making rights from management to investment, while also navigating some investments, capitalizing on an amount representing 1 percent of the total subscribed capital. Gains are comprised primarily from fund management fees and various dividends. The investor, taking the role of limited partner, is primarily obliged to finance but not manage the fund and answers to limited responsibility proportionate to investment quota.

The advantages of a limited partnership are that it maximizes the value of professional investment managers and provides a better agreement on their rights and responsibilities, among other things.

The new Partnership Enterprise Law also has explicit rules on taxes. The tax imposed on operating revenue and other income of the partnership enterprise shall, pursuant to state tax regulations, be borne by the constituents in the partnership separately. In fact, regardless of the tax conditions of different investors, the partnership mechanism offers to create a "penetrated financial" conduit, that is, profit or loss arising from fund investment is directly reflected in the financial statement of the investors, and tax treatment shall remain unchanged. This is the biggest benefit limited partnership brings to the fund in terms of tax issues.

To put it simply, the problem of fundraising is solved as a result of limited liabilities imposed on more individuals, based on the unlimited liabilities to be borne by an individual. In the eyes of investors, funds with a partnership structure are more flexible for them to enter or exit than funds with corporate and contractual structures, freeing them from onerous procedures when increasing or reducing their capital. Partners are able to share dividends according to terms and conditions as stipulated in the partnership agreement. This is conducive to flexible distribution of investment gains between the fund manager and investors.

Grouped investment

At present, preparations for ownership reform and IPOs are in full swing, offering big opportunities for private equity funds. Take the Zhongguancun Science Park as an example. A little over 200 of the total 18,000 enterprises that have registered in the park have completed their ownership transformation. The number of public companies is less than 100, leaving the remaining 90 percent incorporated as limited liability companies. This year, the China Beijing Equity Exchange, working in collaboration with Zhongguancun Administrative Committee, is pushing forward a drive to facilitate the ownership reform and listing process for companies located in the park. It is expected that at least 100 companies may complete the reform process for a conversion into joint stock companies this year. In three years, the number of companies having converted is expected to hit 1000.

Be it in the process of reform or IPO, financial support is essential, and this is where the opportunity lies for private equity funds. First of all, the bulk of hi-tech companies in the park have net assets of over 10 million yuan, clear business structures and established corporate governance. To complete a conversion into a joint stock company, a capital infusion is vital. However, companies don't want to lose control, either; in this case a grouped entry of private equity funds may be the way out. Presumably, a hi-tech company will sell 30 percent of its stock as equity, divided by three different funds, each representing 10 percent. The process changes the equity and governance structure and offers a warranty for security for the private equity funds. To this end, the China Beijing Equity Exchange is in the process of gathering together a group of private equity funds set up around the exchange for investment.

The period prior to public listing means a second round of investment opportunities for private equity funds, as another round of fundraising is needed during this period. All the non-public companies in the park will be held under the custody of the China Beijing Stock Register and Custody Center after completing shareholding reform. Private equity funds are accessible to information from this platform and are able to negotiate the second round of investment in return for greater return if these growth enterprises should ever plan to go public.

Bohai Sea Industrial Investment Fund, China's first sector fund, was launched on December 30, 2006, with a size of 20 billion yuan. The first 6.08 billion yuan was raised to provide financing to enterprises located in Tianjin, the area around the Bohai Bay and other regions of China. The equity investment targets of the Bohai Sea fund include: common stock, preferred stock, convertible preferred stock, and convertible bonds. Non-equity investment directions are government bonds, financial bonds and other fixed income bonds purchased in compliance with the relevant regulations.

Besides, the equity market also offers assistance in creating exit channels. Private equity funds usually choose to exit on domestic and overseas stock markets. They are also provided with free access to exit by conducting an equity transfer on the equity exchange platform, if the company receiving their investment remains unlisted.

(Xinhua Finance)