Tech venture capital pouring into China
By James Borton

Zero2ipo's modern offices in Beijing, near Motorola Research's headquarters, is bustling these days. This nascent Chinese venture-capital market-research firm is a determined cheerleader for the latest high-growth ventures pioneered by techno-entrepreneurs in China, and drawing hardy, optimistic and realistic US investors.

US venture capitalists, many in Menlo Park, California, were severely wounded when the technology bubble burst a few years ago. But the improving US economy, surplus investment capital, Beijing's burgeoning growth and emergence of a Chinese venture-capital market are luring many Sandhill Road technology investors to the Middle Kingdom - their eyes wide open to opportunities and pitfalls.

China's rapid growth, at least in urban centers such as Beijing, Shanghai and Shenzhen, has pushed the Communist Party and its new leadership to accept the inevitable: that the country's racing economy must be bolstered by private equity investments. This is particularly important as the latest figures from the Commerce Ministry show that actual foreign investment rose 7.5 percent in March compared with a year earlier.

A home-grown venture-capital case in point: Zero2ipo. Established in 1999 by Gavin Ni, a Tsinghua University graduate, and several other Chinese graduates, the company now has 40 professionals with backgrounds in venture capital, investment banking and market research. "Our advisory venture service is the core business of Zero2ipo, including private placement, IPO [initial public offering], M&A [merger and acquisition], and venture-capital training and education," said Ni, an energetic thirtysomething consummate investment-capital salon organizer.

Ni first established, with support from fellow Beijing classmates, the Tsinghua Entrepreneurs Club (TEC) in 1998. In those pioneering years, TEC boasted a membership of more than 500, most of them zealous graduate students pursuing master of business administration (MBA) and PhD degrees.

Over the past few years, Ni has cultivated and expanded his business network composed of overseas investors and Chinese entrepreneurs. After all, he's an accomplished author and credited with publishing the first in-depth examination of Chinese venture capital and entrepreneurship. His company also hosts monthly investor and entrepreneur networking salons and an annual China Venture Capital conference.

China drew $1.57 billion in private equity in 2003
China attracted US$1.57 billion in private equity in 2003, compared with just $350 million the previous year, according to the Hong Kong-based Asian Venture Capital Journal.

Ni and other young Chinese entrepreneurs have many reasons to be bullish. New reforms and technologies are rocketing Chinese companies into the global markets. Witness a post-bubble brand of entrepreneurship, new venture capitalism and a revived Internet market, especially in those pioneer portals Netease, Sohu and Sina.com, all uniting, brightening and dotting the Middle Kingdom's information-technology (IT) landscape from Xi'an to Shenzhen.

In the past five years, China's home-grown venture funds such as New Margin Ventures and Chengwei Ventures, led by management teams trained in the United States, use their connections, or guanxi, to help Chinese startups navigate the country's tightly regulated economy. It was in the mid-1990s, long before the September 11, 2001, terrorist attacks in the US and the restrictive student-visa policies in that country, when many of China's brightest students went abroad to graduate school - and never returned.

Now it is a different picture, as many young highly educated Chinese return home, no doubt lured by the country's dynamic economic growth and the signs of greater freedom and opportunity in the private sector.

China still lacks a strong technology sector that can generate new enterprises, and so most domestic firms, which represent about one-third of the three-year-old Beijing-based China Venture Capital Association's membership of more than 80 funds, are turning to universities for prospective investments. Tsinghua Investment Management, a Sino-US fund, for example, includes China's prestigious Tsinghua University among its limited partners and has made 14 investments (about half were spinoffs of the university) since it was founded in 2000.

Chinese corporations start venture capital operations
As China's knowledge of the venture business increases, some major domestic corporations, especially high-tech firms, have established venture-capital operations. Companies such as Stone Group, Legend, Tsinghua Tongfang and Haier have created their own independent venture-capital firms or joint venture-capital firms to invest strategically in China's technology startups.

Few dispute that financial reforms in China are contributing to the new economy, and some analysts also attribute this economic dividend to the emergence of Chinese venture capital. Investment opportunities can be found in incubator companies now flowering in major universities such as Peking and Tsinghua, government-funded high-tech parks, and China's own ambitious equivalent of Silicon Valley - Zhongguancun Science Park.

"This venture business is both an experiment and an education for the Chinese, but remember, they are also quick studies," claimed Dan Schwartz, publisher and editor of leading trade magazine Asian Venture Capital Journal, which has offices in Hong Kong and New York.

After years of glacial bureaucratic steps, venture capital in China is now developing in a responsible manner, offering promising trends and increased transparency, according to Chinese and foreign experts. The National People's Congress has passed rules and recommendations to improve transparency, the scale of investments and, most important, exit strategies for the venture capitalists.

According to Wei Xiao, managing director for Beijing Venture Capital Co, there is still a shortage of qualified local professionals to support venture-capital investments. The changes in the industry have now ushered in foreign venture-capital companies eager for access to the Chinese market. And with China's national strategy of "revitalizing the country through science and education", many of these foreign investments are directed into training and education sectors to meet the rising demands in the new venture business.

China is still on a long march to create its own brand of an Intel-inspired culture, but each year in scores of science parks, there is an increasing level of innovation, widely regarded as the marrow of Silicon Valley's brilliant past and promising present. Across that wide blue Pacific Ocean, California still boasts its share of buccaneer capitalists, while China's surplus of state assistance is propped up with talented overseas Chinese spinning out their own variation of venture capitalism.

Beijing needs to back off, encourage private capital
Of course, the government remains the primary source of capital, pumping it into scores of incubators in state-owned high-tech parks. In the past few months, at several Beijing venture-business conferences, participants all agreed that the central government must reduce direct participation in venture capital and instead concentrate on formulating policies that support genuine enterprise development.

Venture funds are once again pouring into China from all over the globe. After the dot-com collapse, what is especially revealing are the number of Menlo Park-seasoned venture capitalists surging into Beijing's and Shanghai's technology parks.

While China is a global priority investment target in Asia, private equity investors have traditionally been concerned about reliable structures and legal protections for their investments, as well as realistic and achievable exit strategies. Those concerns are now receding as a significant number of successful transactions, both inbound investments and exits, have been completed.

The new leadership of the Chinese Communist Party has come to accept the inevitable: China's racing economic growth, especially in urban centers, requires fuel from private equity investments. In the current issue of Foreign Affairs, published by the New York-based Council on Foreign Relations, Elizabeth Economy claims in an article titled "Don't Break the Engagement" that private assets now exceed state assets by more than 1 trillion yuan, or $1.2 billion.

Although there remain some legal hurdles for successfully executed exit strategies, the atmosphere seems downright heady. Some legal experts still maintain a healthy skepticism.

"While the new regulations go a long way towards resolving many of the obstacles previously posed by Chinese law, the reality is that most foreign fund investors still prefer to make their investments through offshore holding vehicles, usually in the Cayman Islands, because this facilitates their exit transactions," said Howard Chao, the head of O'Melveny & Myers' Asia law practice.

Some rosy scenarios, and warnings
This investment strategy may be true for most US investors, but not International Data Group (IDG), the world's largest company specializing in high-tech services and publications. It first entered China's venture investment sector in 1989 and has made a total investment exceeding $200 million. Bolstering its investment, IDG Ventures has earned an internal rate of return (IRR) of about 65 percent on the 110 investments it has made in China since the early 1990s, according to its founder and chairman, Patrick McGovern.

IDD Ventures' stellar financial performance in China was underscored last year by its sale to Yahoo! of shares in the Chinese-language search-engine company 3721 Network Software Co Ltd in a cash deal valued at $120 million.

While there is no shortage of boosters for the development of the China Venture Capital Association (CVCA) with well over $1 billion in private equity funds, one recognized industry observer, Paul Waide, voices a cautious dissenting perspective.

"If you look at numbers from China's local firms that cover venture-capital investments, you will see wild claims like 90 percent of all venture investment comes from offshore, but the facts behind those numbers need to be considered. Semiconductor investments account for about a quarter of all private equity investments, and because some of the private equity funds also play in the venture space, the two often get lumped in the same basket," said Waide, editor of the online Pacific Epoch, based in Shanghai.

New rules help capital investors
Few dispute that as part of Beijing's long march to economic liberalization, the government has quietly approved investment rules that improve the lot of venture-capital investors.

"The 2003 venture-capital fund regulations are technically a great improvement over the original regulations," Matthew McGinn told Asia Times Online in an e-mail interview from Baker & McKenzie's Hong Kong office. "However, it will probably take a significant period of practical experience of smaller funds with Asian-based sponsors and investors who are themselves comfortable in China before any sponsor of large international funds is comfortable directly exposing itself, its offshore investors and its fund-management arrangements to the Chinese legal system."

The new laws allow foreign venture capitalists to set up wholly owned Chinese management companies and Chinese joint-venture limited partnerships, a giant step for foreign venture funds.

With IDG's venture success, along with New Margin Ventures, and Zero2ipo's trumpeting new entrepreneurial seminars and educational programs, the twilight world for entrepreneurs once trapped between rigid communist ideology and the new reforms seems to be moving toward dawn. As more and more techno-comrades move into new villas, flush with their successful ventures, their swelling ranks may channel more available capital to young innovators to wire a new Middle Kingdom. 

James Borton is working on a book The Electronic Silk Road: How Technology is Reshaping Education in China. He can be reached at asiareview@yahoo.com.

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