China’s Emerging Venture Capital Opportunities

Without question, China has quickly become the new economic growth frontier. Pursuing investment opportunities in China have become far easier as a result of recent changes in China’s law. Until just three years ago, China did not have an enabling law for the formation and availability of venture capital funds. Without such a law, substantial capital from China's private sector could not be effectively channeled into development of a high-tech sector for venture funding.

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.