According to Chen Youzhong, Managing Director and Partner of iD TechVentures Ltd., this year might witness the beginning of a major shift in the Chinese private equity fund market.
The sea change that Chen refers to is the shift of venture capital from investing in overseas IPOs of "small red chips," generally referring to companies registered outside the mainland but controlled by Chinese mainlanders, to direct renminbi investments in the A-share market and later exiting successfully.
Reformed domestic investment
In the United States, the NASDAQ and well-developed acquisition markets provide smooth channels for venture capital to exit. However, in China's two stock exchanges in Shanghai and Shenzhen, the qualification examination is very strict for small and medium-sized hi-tech companies, the favored playground of venture capitalists. This has contributed to the lopsidedness of foreign investment in the venture capital industry.
Overseas venture capital firms currently active in China include Warburg Pincus, The Carlyle Group, IDG, H&Q Asia Pacific, SOFTBANK Asia Infrastructure Fund, JPMorgan and Goldman Sachs Asia Fund. They have reaped a rich harvest through equity investments while at the same time domestic venture capital firms struggle to survive. This has seriously hindered the development of the Chinese venture capital industry.
With the release of the amended Partnership Enterprise Law, the environment for cultivating domestic private equity investment will gradually mature. By then, the current disadvantageous environment will have improved. There will be no legal barriers to domestic private equity firms raising domestic funds, investing in partnerships and completing acquisitions. Domestic venture capital firms will then have sound mechanisms for carrying out their investments, financing and exit strategies.
"The latest Partnership Enterprise Law makes renminbi investment possible and allows venture capital to reap higher returns with more investment opportunities," said Gu Jinghua, Vice President of iD TechVentures. According to him, the fact that venture capitalists can invest in domestic companies by establishing renminbi funds and later exit from the A-share market will bring them more profit.
However, this will no doubt accelerate the competition between domestic and overseas private equity firms. At present, these two types of private equity firms are cooperating more than they are competing because the Chinese market is large and the fact that they are registered in different countries and subject to different legal systems. After the new law comes into force, overseas private equity firms will be able to establish renminbi funds through joint venture or directly invest in Chinese companies, making the battle for market share between overseas and domestic private equity firms even fiercer.
Enterprises hope that renminbi funds appear soon because they will benefit a great deal from domestic venture capital investment and from being publicly listed on the mainland. IPOs on the NASDAQ or on the Hong Kong stock market are very costly while the costs for going public domestically and maintenance afterwards are much lower. The United States is still tolerant with regard to Chinese-concept companies, but in the future it will possibly raise the threshold gradually. Moreover, when aiming at raising funds and seeking a public listing on the mainland, entrepreneurs do not need to restructure their companies into a foreign company in order to please foreign venture capitalists and get listed on the U.S. markets.