Since the early 1990s, Chinese government leaders have witnessed and admired the growth of the technology sector and the ensuing benefits to the United States’ economy.  They have attributed such growth, among other factors, to the presence of an active venture capital community in the US and other western countries. They have openly made known their desire to see the success of the western venture capital process replicated in China and have taken initiatives and adopted policies over the recent years to achieve this ambition. 

In the last decade or so, a number of US and other foreign venture capital firms made investments in Chinese start-ups through the use of off shore funding vehicles.

According to statistics compiled by the Asian Venture Capital Journal, the pool of venture capital dedicated to China, including both domestic and foreign funds, stood at $3.7 USD billion at the end of 2000.  This off shore entity system approach has been cumbersome, costly to deploy and, as a result, has only been applied to large, late stage venture investments. 

New legislative regulations recently passed in Shenzhen, one of the most progressive cities bordering Hong Kong, served to approve equity-based venture capital investments for startup companies.  Shortly after the Shenzhen regulation was passed, Beijing and Shanghai quickly followed suit with similar legislation. 

The document entitled 'Shenzhen tentative regulations governing venture capital - focusing on high and new technology' was approved in the Shenzhen Economic Special Zone and passed the governing body and was enacted into law.  It is also known as The Provisional Regulation on Investment Trust Fund of Shenzhen. The passing of this law created the much needed catalyst for venture capital funding and innovation. 

The passing of Shenzhen’s legislation represents a key facet of the gradual emergence of a new capitalist framework in China.

The opportunity for foreign venture capital firms to form joint venture operations with Chinese players under these new rules are especially enticing given China’s financial appetite and vast market opportunity. 

Such a joint venture arrangement allows each party to build on the other party's particular strength, with the Chinese party sourcing deals and the foreign party providing expertise in venture development and management. 

Another advantage of funds structured under the new Chinese law, as opposed to those structured in a jurisdiction such as the Cayman Islands, is that they are allowed to invest directly in local startups without the need to form a new entity, be it a joint venture or a wholly foreign-owned enterprise (WFOE). 

This flexibility is particularly helpful in early-stage investments where high transaction costs associated with forming a joint venture or WFOE often seem unjustified. 

China is the third largest country in the world, next to Canada and Russia; it has an area of 9.6 million square kilometers, or one-fifteenth of the world's land mass and a growing population of 1.3 billion people and a GDP of $980.6 billion USD. 

Much of China’s infrastructure is still being developed and the trend is to adopt leading technologies in an effort to provide the most advanced and productive services to this growing population. This represents a significant global economy and market size opportunity for a venture capital business. 

According to the Asian Private Equity Review, $10 billion in investment capital went into the region in 2006, a 74 percent compounded increase since 2000.  After Japan (which, as the world’s second largest economy, is typically considered a region unto itself), mainland China was the top destination for new investment.

Much of the current wave of Chinese entrepreneurial drive is attributable to US educated entrepreneurs flowing out of hot markets such as New York, Los Angeles, Silicon Valley and back into China. 

Tens of thousands of Chinese students learned advanced computer programming skills in the US during the 1990s with a large majority returning to China eager to apply their skills.  A number of entrepreneurs earned substantial amounts of money working on Wall Street or in the high-tech sector during the dot com boom and are well prepared to duplicate their successes in China. 

Given China’s economy the purchasing power of the US dollar converts to the Chinese yuan at about 10 times the purchasing power in China.  With this seed money, returning entrepreneurs can start whatever type of company they'd like, and China is welcoming them back. 

These Chinese entrepreneurs are not solely impassioned by money.  Patriotism is a key motivator.  The costs of living are considerably lower than in the west.  The Chinese deeply believe that China will lead the world in the 21st century.

This deep personal drive and ambition to assist China in that ascension is pulling these entrepreneurially driven businessmen back to China.  The investor community is fairly large and receptive to community oriented investments. 

Major corporations and the government have available funds, but lack of investment vehicles (seed investors, venture capital firms) needed to facilitate capital for high-tech startups were preventing this from occurring.  China never got onboard the venture capital funded dot-com days of the high-tech boom.  Historically, Chinese venture capitalists do not have a track record of funding companies based solely on ideas. 

Although China's financial markets have been in existent for more than ten years, Chinese startups and businesses are still highly dependent on bank loans as their main source of financing and capital. 

As the Chinese economy becomes more market-driven, the demand for a more efficient securities market to channel savings to investments increases.  An efficient financial market is a requirement for venture capital investing as it provides liquidity of the investment through public offerings of venture capital portfolio companies.  The public market liquidity allows the return of investor’s capital. 

The development of China's securities market is also important for the privatization of China's inefficient state-owned enterprises.  Furthermore, an efficient securities market will help reform China's pension and social security systems. 

The stock market is expected to receive new capital inflows from pension funds and the insurance industry.  Currently, pension funds are not allowed to invest in stocks.  This is likely to change given the current trend.  Insurance companies have received permission to invest increasing shares of their assets in stocks through investment funds.

Pension funds are also expected to enter the stock market through investment funds which will provide venture capital funds with capital to invest. 

Seed and angel stage investment capital within China is a rare find.  There are virtually no seed or early stage venture capital investors for these budding entrepreneurs.  Fully developed products, actual sales, and customers, all the things that didn't matter in the US during the dot com boom years, matter a lot in China.  But, once these operating criteria are established, a large pool of private equity expansion money exists, thus creating a well timed entry into this market. 

There are now several Venture Capital rivals operating in this emerging market, each deploying their own strategy and investment focus.  They include ChinaVest, AsiaTech, DragonTech, Beijing Venture Capital and numerous others focusing on electronics, semiconductor, real estate, telecommunications, medical devices, biosciences, but only a few in Software, and none focused exclusively on Software investments. 

Under like, similar conditions, about 50%-60% companies involved in venture investment in the US make no profits, whereas in China, 70% of the companies report excellent performance with return ratios hitting 35%, higher than the average level in other countries. 

One of the world's largest companies specializing in high-tech services, IDG, entered China's venture investment sector in 1990 and has made a total investment of nearly US$ 200 million.  China’s Ministry of Science and Technology recently signed a cooperation agreement with IDG.  Under this partnership, IDG will inject $1 billion USD in China's hi-tech economy to boost the development of China's high tech sector, per Alternative Assets. 

The Ministry of Science and Technology will provide some benefits to those invested companies by way of government projects.  China has been exploring the concept and practice of venture capital for more than a decade and it seems that the country is now convinced that venture capital is something to be promoted in order to stimulate the economy while generating personal wealth. 

The heightened level of innovation and technology start-ups requiring funding in China has increased dramatically over the last two to three years. 

Culturally, trust is more important than money in China.  It's been said that the key to doing business successfully in China depends on a person's "guanxi," a Chinese word for trust, coupled with connections.  Knowing the right people, or the right person to introduce you to the right people, is a key attribute of success.  The software only venture capitalist, armed with industry knowledge and his network of connections, makes for the ideal guanxi partner. 

The venture capital industry requires an ecosystem of follow-on capital resources, including late stage, expansion capital investors.  These are generally profiled as larger, general purpose, private equity investment funds who seek follow-on financing participation primarily from venture capital firms.  The existence of these larger investment funds diminish the venture capital risk by providing a readily available next funding stage market 

Coinciding with the introduction of Shenzhen’s venture capital law, China's fund management industry was also opened to foreign investment in 2002 via the World Trade Organization (WTO).  According to the US-China WTO agreement, foreign companies are now allowed to participate through joint-ventures.  Foreign companies are allowed to take a one third stake in joint-ventures which can be increased to 49% three years thereafter. 

As a result, many foreign investment firms have announced their intended participation in China's private equity fund industry.  This would generally be accomplished via relationships with venture capital firms, who “feed” startup investment opportunities to investment firms for follow-on expansion capital, thus creating a “Value Net” opportunity. 

Experienced Venture Capitalists tend to provide much needed structure, key management, strategic advice and operating experience to insure formidable growth company pool for investment banks.  US venture capital firms frequently work with larger investment banks for late stage, expansion capital funding.  The late stage companies have lower risk and higher probability as an initial public offering (IPO) candidate, as they are better poised for sustainable profitable operation much as Salesforce.com’s (NYSE:CRM) successful Asian entry. 

As US venture capital firms are becoming increasingly interested in China’s long term promise, the challenge of operating in the unfamiliar and often unpredictable Chinese environment remains daunting, especially for newcomers.  The visionary early stage venture capitalists may want to take the first mover advantage now, rather than waiting for longer term history and results.  After all, venture capital is all about risk taking and ceasing opportunities. 

The country’s highly skilled and motivated computer software work force is readily available in the key areas of Shanghai, Beijing and Shenzhen.  The overall employee payroll costs are attractive. There are dozens of innovative technology ideas emerging, along with highly driven, western oriented entrepreneurs. There are significant large investment funds already established in China with several others entering.  These larger funds add to the positive entry prospects and serve as Buyers.  The emergence of a stronger stock exchange market through recent legislative changes, i.e., allowing insurance and pension funds to invest in stocks is highly beneficial to venture investing. 

Venture capital deployed on the emerging China software market based in Shanghai, Beijing or Shenzhen will provide excellent opportunities to invest and develop startups into significant, high value companies, while providing exceptionally strong investor returns. 

The good news for all China investors is that there are now more than 123 million Internet users and they are well poised to surpass the US over the next two years.