Kazunori Ozaki, Chairman and CEO of Ant Capital Partners (COURTESY OF ZERO2IPO)

The past year has been unforgettable for venture capital (VC) and private equity (PE) investors and managers in China, forcing many to tap every corner of their imaginations in order to adapt to the changes and challenges of the domestic capital market.

The government's efforts to guide and promote the establishment of the country's own equity investment industry have paid off. Inspired by the example of government-sponsored guidance funds, China's first generation of entrepreneurs began entrusting professional fund managers with wealth increments. As a result, renminbi funds, which are raised in China's local currency from institutional and corporate investors, have replaced dollar funds to be the market's major player this year.

For the first time since their introduction, the number of newly raised renminbi VC funds and their total worth accounted for 91.1 percent and 69.4 percent, respectively, of all new funds in the first 11 months of 2009. But overall, renminbi funds have yet to catch up with dollar funds in terms of the size of investments, according to the latest report by the Beijing-based Zero2IPO Research Center.

With the launch of China's growth enterprise board, the ChiNext, on October 31, VC and PE investors were given an effective investment exit channel to regain their investments from startup enterprises. While market observers questioned how long the first batch of 28 companies can continue to trade around more than 100 times their 2008 earnings, ecstatic qualified listing candidates queued up without delay to guarantee themselves a share on ChiNext.

Investors, fund managers, enterprises, and accounting and legal service agents gathered at the China Venture Capital and Private Equity Annual Forum in Shanghai December 9-10, discussing the prospects of renminbi funds, win-win solutions for both renminbi and dollar funds under the current policy framework, investment hotspots, as well as different investment strategies in various industries. The forum was organized by the VC and PE industry's integrated service provider Zero2IPO Group, parent of Zero2IPO Research Center.

New and inexperienced

Kathy Xu, Founder and Managing Partner of Capital Today Group (COURTESY OF ZERO2IPO)

Since 2006, local governments have established pilot guidance funds at provincial and municipal levels to woo cooperation with VC and PE funds and help shape the industry.

The government-sponsored funds are entrusted to professional fund managers and usually aim to support local small and medium-sized enterprises (SMEs) in specified industries. Thanks to these pilot efforts, an increasing number of renminbi VC or PE funds have been established to raise money from local institutional and corporate investors, and invest in companies with great potential.

Currently, renminbi funds enjoy overwhelming advantages over their foreign counterparts due to the unprecedented support of local governments, not to mention the determination of the Central Government in mobilizing private capital to serve the country's industrial restructuring and innovation.

As a result, dollar funds are losing their shine. Investors in dollar funds have to go through complicated procedures in order to exit their investments in joint ventures in China's capital markets.

"Comparatively, local funds are more convenient to invest with in China, and close communication with government is very important since an IPO as an exit channel remains a rare resource here," Roman Shaw, a founding partner of DT Capital Partners, told Beijing Review.

Despite these advantages, fund managers at the forum expressed concerns over the fact the market still lacks mature institutional investors and more professional managers.

"Except for the National Council for Social Security Funds, most equity investors have a superficial understanding of VC and PE in China," said Andrew Yan, Managing Partner of SAIF Partners. "Also, the industry has no more than 20 veteran fund managers who have a proven 10-year track record of ensuring investors expected returns."

Roman Shaw, Founding Partner of DT Capital Partners (COURTESY OF ZERO2IPO)

Despite the policy advantages local funds currently enjoy over dollar funds, in the long run the differences between the two are going to diminish, allowing the two to play "fair and square" and then integrate as one. This will be especially true when the free exchange of the renminbi with other currencies is realized under the pursuit of the renminbi's status as an international currency, said Bain Capital's Managing Director Huang Jinsheng.

"Managers of equity funds, which are regarded as 'smart, resourceful money,' still have to win investments with special services and resources. That's why a seasoned and competent team is preferable to handling these responsibilities," he said.

While discussing problems, fund managers who operate both local and dollar funds expected large institutional investors, such as the Social Security Fund and the China Development Bank, to set standards and rules, serving as an example for future local equity funds investors.

"What's important is the rules not the money because these government-sponsored funds, necessary as they are for the nascent industry in China, will eventually be withdrawn from the market, as was the case in Israel and other markets," said Yang Xucai, chairman of a startup guidance fund in Tianjin Municipality. "The market will be healthy and robust when rules are established to allow more funds to be involved in the industry."

Potential institutional investors, such as banks, insurance companies and large state-owned enterprises, are currently subject to a variety of restrictions on investments outside their core businesses. It will take some time for supervisors to loosen related restrictions, Shaw said.

Sustainable exit channel

The ChiNext has already proven its wealth-generating power and will become a major exit channel for equity funds in the future.

Daniel R. Quon, Managing Director of Asia for SVB Global (COURTESY OF ZERO2IPO)

During the forum, an opinion poll on the higher-than-expected performance of the ChiNext revealed that half of investors, fund managers and entrepreneurs believed an average 30 to 50 price-to-earning ratio

(P/E ratio) is appropriate for the growth board. Still, its more than 100 P/E ratio has made it the first choice for enterprises seeking a public listing in the coming years.

In the past 11 months, 58 Chinese enterprises with investments from equity funds have been successfully listed on domestic and overseas stock markets, and 20 have been listed on the ChiNext.

"The extraordinarily high P/E ratio is a result of the demand-supply imbalance, because only 28 stocks were offered while all the country's stock investors fixed their eyes on the growth board," Shaw said. "The China Securities Regulatory Commission was aware of the problem and that's why they are speeding up the approval procedures for more candidates to allow the indicator to reflect the real market value of listed companies."

Zheng Weihe, chairman of a Shenzhen-based VC company, attributed this fever to the inexperience of investors. He pointed out the fact that speculative investors dominated the market. About 90 percent of stock investors in China have less than 50,000 yuan ($7,321) in their brokerage accounts, Zheng said.

While considering the ChiNext as another exit channel in the future, many VC managers said the current market frenzy is unsustainable.

"Venture capital fund managers have to accompany companies they invest in for quite some time, because the cycle of an investment will usually last seven to 10 years," said Wu Xiaohui, Director of Intel Capital China. "It's a job for people with great patience and that's why we value the sustainability of the growth enterprise market more than the amount of returns it will yield us."

The wealth delusion in the ChiNext has already attracted some companies with overseas listing plans. They hope to have higher evaluations through making the company qualified for listing on the ChiNext to raise more money. But Wu contends a responsible fund manager should help such companies make rational decisions, reminding them of their major markets, the different procedures they have to go through to be listed in domestic and overseas stock markets, as well as the business models that different capital markets favor.

"Less transparent approval procedures in the domestic market generate more uncertainties," said Wu.

While the NASDAQ favors hi-tech and Internet companies, and the Hong Kong stock market favors commercial and retail businesses, the three domestic stock exchanges (Shanghai, Shenzhen and ChiNext) do not yet have a specific business niche, said Managing Director of Legend Capital Li Jiaqing.

In addition, the market positioning of the ChiNext still has some overlapping with the board for SMEs on the Shenzhen stock market, said Li.