Local private equity investors gained another advantage when the financial crisis dampened capital markets worldwide and delayed or cancelled many planned IPOs. Overseas venture investments are ebbing, as they can no longer be "quick-in, quick-out." As a further blow to investors' confidence, problems with some unsound investments began to surface when the IPOs dried up, posing a challenge to the trust between limited partners, investors in venture funds, general partners, or overseas fund managers.

ITAT Group Ltd. of Shenzhen, China's fast-growing apparel retail giant, for instance, planned an IPO to raise $1 billion in Hong Kong, but it was suspended last August because of allegations that the company doctored sales figures and engaged in other improper accounting methods.

But in local funds where investors understand what's going on here better than investors of overseas funds, limited partners have taken a much more prudent approach and have larger say in investments than their foreign rivals, which has provided "a guarantee to their capital security," Wu said.

Diversified exit channels

Discussions on when and how China should launch its own Nasdaq, a marketplace for hi-tech, high-growth and innovative companies to obtain financing and have flexible listing requirements, have been going on for almost a decade. The Nasdaq Stock Market, regarded as the cradle of the new economy and has served as Silicon Valley's "guts" in the United States, has helped to forge big names such as Microsoft Corp., Intel Corp., and Google Corp. Wanting to emulate Nasdaq's success, China has planned its own version of the market since 1998.

The discussions had not made a breakthrough until the Shenzhen Stock Exchange launched the SME board in May 2004. Although the SME board is not a true Nasdaq-like growth enterprise market, many venture capitalists have welcomed it, because it gave them the first ray of hope for an exit mechanism. China planned to reshape the SME board into a second board early last year, but the plan was suspended because of unforeseen events such as the Wenchuan earthquake on May 12 and the global financial crisis.

"The Shenzhen Stock Exchange is fully prepared to launch the second board and is now just waiting for the final go-ahead from top policymakers," said Chen Dongzheng, Director of the Shenzhen Stock Exchange, in an interview with China Daily.

"We need a real second board instead of just lowering the thresholds of the SME board now, because we have to help SME with financing difficulties amid the economic downturn, and more importantly, because it will enable China's venture investors to compete with their U.S. rivals on the same footing," Xiong said.

Roman Shaw, Managing Director of DT Capital Management Co. Ltd. of Shanghai, also stressed the importance of China having its own growth enterprise board as soon as possible.

"I don't think a sustainable venture investing industry in China can rely on the offshore business model of overseas venture funds, because dollar-oriented funds in China generally raise funds and exit investments at overseas markets, generating high returns to overseas investors," Shaw said. "China needs its own venture professionals and an exit mechanism to form an industry and eventually benefit the economy."

"The key solution to current exit concerns is having a multilayer exit mechanism in place, including the second board," said Fang Hanting, a venture capital observer at the Strategic Studies Department of the Ministry of Science and Technology. This should include sales between venture funds focusing on different stages of a project company, which accounts for 30 percent of all venture investment withdrawals in China, business founders' buybacks and investor exits through stock market IPOs, he said.